Hyperventilation on Hyperinflation?

I’ve taken a much needed break from economics and I’m ready to ease back into the research groove. I’m still focused on currency exchange and things related to the monetary policy so I thought I would bring up one of the current global concerns. Will the incredible amount of expansionary Monetary Policy combined with recent stimulus on the Fiscal side lead to a new era of inflation? This actually has been a point of contention for a few months in the econ and finance blogs, but I really haven’t followed it all that closely because the economy has been in such a free fall and I don’t believe we’ve hit a bottom yet. Under those circumstances, a little inflation actually has benefits for an economy. It can send signal to the production market that the demand for goods is higher than the supply which can gin up production and provide some upward momentum to a recovery. Inflation in this sense is just a mild signal to the economy that eventually sends it towards its Full Employment Equilibrium. Some economists are looking way beyond that and believe that the groundwork set in current policy will go on for way too long. This could result in inflation or even hyperinflation.

Hyperinflation is a different animal and is thought to be entirely the result of the overprinting of money by the central authorities. They physically print way too much money and the value of the money declines. There are many historical examples of this; most notably the Wiemar Republic (pre-NAZI Germany). The best Inflation-1923current example is Zimbabwe.

There’s some pretty wild anecdotes about post World War 1 Germany. Families would have to meet their breadwinners at the factory at noon with wheelbarrows ready to catch the morning’s pay so they could rush and buy the daily dinner before prices could change and they couldn’t afford even a loaf of bread. There are also pictures of people (see the one on the left) burning money in stoves to keep warm in the winter since that was cheaper than using the money to buy fuel for the stove. Hyperinflation is inflation that reaches the triple digits annually. Zimbabwe had to stop calculating its inflation rate once it hit triple digits daily! These are both extremes, but there are examples in Latin America and other African nations that show how disrupted an economy can become when money is poured into an economy that is not producing anything to buy. I had a student from Argentina tell me that his parents tell the story of when they had to ensure they had established a price on dinner before they ate or the price would change during the meal.  I’ve also heard similar stories from students from Uganda who returned there over breaks.

Bloomberg.com reports that there are some people suggesting that inflation in the U.S. will not only go up, but will basically go up at levels that we’ve never experienced before in this country.

The U.S. economy will enter “hyperinflation” approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Marc Faber said.

Prices may increase at rates “close to” Zimbabwe’s gains, Faber said in an interview with Bloomberg Television in Hong Kong. Zimbabwe’s inflation rate reached 231 million percent in July, the last annual rate published by the statistics office.

“I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

This is not a widely held view, however, you’re beginning to hear more and more folks wondering if and when Bernanke will begin to apply breaks to his current policy of Quantitative Easing.  As of right now (7/27/09 and 3:30 pm CDST) gold is sitting neutral at 953. That would indicate a market that isn’t too worried about the prospect of hyperinflation yet and it does appear that most of the short term rates the Fed watches and targets will continue to hover near zero.

Edward Harrison of Credit Writedowns had the same thought earlier.

Just last week, I made similar comments in my post, “More thoughts on the fake recovery.”

In my view, the Federal Reserve has effectively demonstrated it is willing to risk hyperinflation in order to beat back the deflationary forces.

But I was using hyperbole.  Faber, however, is dead serious.  It is the secret desire of the Fed to want inflation that has U.S. government bond yields going berserk.  But, most people are not expecting hyperinflation in the United States ever.

I have a difficult time believing that Bernanke or any one around our age that entered banking specialties during the Volcker years would ever want a repeat of that recession it took in the 1980s to wring out the persistent double digit inflation occurring at that time.  The dollar is way too dominant in the currency markets as a safe haven to even risk a return of inflation rates to the high single digits.  However, I have seen things occur recently that were beyond my imagination even last year so I’m not prepared to rule anything out.  Only to say that I find it highly improbable that the Federal Open Market Committee (FOMC) will monetize the debt the way it did in the 1960s and 1970s.

I will add one thing that plays on my mind when I calculate those probabilities.  That is the potential for President Obama to find a more pliable Federal Reserve Chair. While the appointments to the FOMC have extremely long terms or are Fed Presidents, the Chair serves a shorter term.  We do have historical precedent for appointing Fed Chairs that behave more politically.  Ronald Reagan, during his first term, tried to remove Chairman Volcker because the recession was seriously hurting his chances of a second term.  Wall Street and the banking industry, at that time, were not close to the POTUS and made it clear they wanted Volcker to stay.  Reagan complied and had the luck of the Irish in timing as the recession turned the corner in time for him to claim “morning again in America”.   I’m not quite so sure we’d see this play out similarly with the current Administration.So, right now I’ll commit to saying I find it unlikely we see hyperinflation but those probabilities could change with a few twists and turns in the beltway.

One of the biggest indicators for me will be the level of unemployment come the next election cycle.  If inflation cycles begin, you can historically find them starting about six months before a possibly uncomfortable unemployment rate.  This  is especially true of Democratic administrations since they’ve been much more likely to be concerned about unemployment rates because of the make up of their constituencies.  However, only time will tell given this administration’s close relationship with the financial industry and other business interests.

While most of these hyperinflation articles have shown up in typical business sites, I was surprised to find this recent blog post by Sheldon Filger on HP.

Massive quantitative easing by the Fed is pouring trillions of U.S. dollars into the money supply, essentially conjured out of thin air. This is being done without transparency, the rationale being that frozen credit markets require a vast expansion of the money supply in an attempt to get the arteries of commerce flowing again. Similarly, the U.S. government is spending vast amounts of money it does not have, with the Treasury Department selling unprecedented levels of government debt in a frantic effort to fund the wildly expanding U.S. deficit. These two forces, quantitative easing and multi-trillion dollar deficits, are the core ingredients of an explosive fiscal cocktail that I believe will ultimately lead to hyperinflation.

This is a really interesting read.  He obviously has set high odds that the FED will become obliging and this is his rationale.

What is most frightening about the policy moves being enacted by the Fed and Treasury is that their actions may not be a reckless gamble after all. They may have come to the conclusion that only hyperinflation will enable the United Sates to avoid national insolvency. In effect, they may be pursuing the exact opposite course undertaken by Paul Volcker in the early 1980’s. If that is their prescription for the dire economic crisis confronting the U.S., then one must conclude that Ben Bernanke, Timothy Geithner and Larry Summers have learned nothing from history. Once the spigot of hyperinflation is tuned on, it becomes a cascading torrent that is almost impossible to switch off, and which in its wake inflicts inconceivable levels of economic, political and social devastation. Before it is too late, President Obama should put the brakes on his economic team’s dangerous gamble with the haunting specter of hyperinflation. If he fails to act in time, a hellish prospect may be his economic and political legacy.hand-da-vinci

Oh well, on the one hand … and then on the other hand …

2 Comments on “Hyperventilation on Hyperinflation?”

  1. lorac says:

    Hi Dakinikat – sorry, this is OT, but I know you were working on a PUMA mission statement, and I just got something in the mail from Will Bowers, so I wanted to show it to you, in case you were interested:

    Will Bower sent a message to the members of PUMA / Just Say NO DEAL.

    Subject: PUMA 2.0: One Year Old, Moving Forward

    Come join the New York Area PUMAs on May 31st, and help us formulate an action
    plan to move PUMA forward on its one-year anniversary!

    On the agenda: Breakout sessions, guest speakers and panel discussions on the
    following four PUMA Principles:

    1) Electoral Reform: Making Every Vote Count
    2) The Fourth Estate: Reforming The Media
    3) Social Justice: Equal Rights for Women and the LGBT community
    4) Reviving Democracy: The Separation of Powers and The Constitution