Bill Totten's Weblog

Saturday, May 23, 2009

Get ready for Obama's coming hyperinflation

San Francisco Examiner editorial (April 29 2009)

Santayana's maxim - those who refuse to learn from history are doomed to repeat it - has grown threadbare from heavy use. But it unavoidably comes to mind this week, as President Barack Obama and his fellow Democrats on Capitol Hill blithely put the final touches on the chief executive's proposed 2010 federal budget.

With an unprecedented deficit that's approaching $2 trillion, this budget proposal is a surefire prescription for hyperinflation. So every senator and representative who votes for this monster $3.6 trillion budget will be endorsing a spending spree that could very well turn America into the next Weimar Republic. For those too young to remember, that was the period in Germany in the years between the two world wars when people needed wheelbarrows full of money to buy a loaf of bread.

In a 1993 interview, Harvard University law professor Friedrich Kessler offered a chilling portrait of the Weimar Republic: "It was horrible. Horrible! Like lightning it struck. No one was prepared. The shelves in the grocery store were empty. You could buy nothing with your paper money."

Thanks to the expanding profligacy on Capitol Hill, a version of such economic hell will likely happen here, according to two prominent economists. Johns Hopkins University professor Steve Hanke notes that the Federal Reserve's balance sheet "has more than doubled in size since August. Unless the Fed shrinks its balance sheet", he warns, "... inflation will roar back with a vengeance".

The printing presses have been running nonstop since Congress approved the Troubled Asset Relief Program and the $787 billion bailout of insolvent firms that went wobbly after abusing "easy credit". Yet with interest rates now close to zero, Hanke points out that the Fed is merely "prescribing more of the same".

In their groundbreaking Monetary History of the United States (1971), Anna Schwartz and the late Nobel Prize winner Milton Friedman found that then (as now) a huge influx of foreign capital accompanied the early stages of Weimar hyperinflation. Schwartz, who today believes the "systemic risk" cited as justification to recapitalize failed financial institutions was just an excuse to save bankers' hides, agrees that massive inflation is "unavoidable".

There have been other, more recent, bouts of hyperinflation. After years of deficits, the former Yugoslavia tried to print its way out of a similar predicament, then imposed price controls to counter the inevitable fifteen to 25 percent annual inflation rate. Economic collapse quickly followed the worst hyperinflation in history. On November 12 1993, one million dinars could be traded for one German deutsche mark; by January 4 1994, the exchange rate was six trillion to one.

With Obama's reckless 2010 budget - which was passed without a single Republican vote - Democrats are playing with inflationary fire.

Bill Totten


  • I doubt that we are facing an imminent hyper-inflation. It may happen in due time because of the large amounts of money pumped into the
    system, but not in the next two-three years as far as I can see. I may be wrong, of course, but I seriously doubt that we are facing an
    imminent hyper-inflation. What I am more worried about is deflation, which seems to be what is happening at the moment. The US unemployment is about to exceed 10% by optimistic forecasts, so what we are facing is income destruction of the potential "consumers", which inevitably will result in continued demand destruction. When demand disappears, how the heck can the prices go up"? Further, this demand destruction is not just a US phenomenon: demand is being destructed across the globe.


    By Anonymous Sabri Oncu, at 8:41 AM, May 24, 2009  

  • The conventional terms - inflation, deflation, are no longer adequate for describing the overall effect of Fed-released excess liquidity. This is because the new money went to reflate a burst debt-driven asset price bubble. But the new money is not going to consumers in the form of wages to restore demand, but instead going only to debt-infested distressed institutions to allow them to deleverage. Thus deflation in the equity market (falling share prices) will slow down, while aggregate wages will continue to fall to further drastically reduce demand. Falling demand will deflate commodity prices, but not enough to restore demand because wages are falling faster. When financial institutions deleverage with free Fed money, the creditors receive the money while the Fed assumes the liability. Deleverage reduces cost while increases cash flow to allow zombie institutions to return to profitability with unearned profit. Thus we have profit inflation with price deflation in a shrinking economy. What we will have is not Weimar Republic type hyperinflation, but zombie financial institutions turning nominally profitable in a collapsing economy. The danger is that this unearned nominal profit is mistaken as a sign of recovery. Normally, hyperinflation favors debtors by destroying the value of liabilities owed to creditors. Deleveraging with Fed money cancels debt a full face value with money that has not been earned by anyone. That kind of money is toxic in that the more valuable it is ( with increasing purchasing power to buy more), the more it degrades wealth because no wealth has been put into the money to be stored, thus negating the fundamental prerequisite of money as a storer of value. This is not demand destruction, but money destruction as a restorer of value while it produces a negative effect on demand.

    Thinking about the value of any real asset (gold, oil etc) in dollar terms is misleading. One should think about the value of the dollar in asset (gold) terms, because asset (gold) is wealth. The Fed can create money but it cannot create wealth.

    Excerpt from my article: Central Banking Practices Monetarism at the Expense of the Economy

    Central bankers are savvy enough to know that while they can create money, they cannot create wealth. To bind money to wealth, central bankers must fight inflation as if it were a financial plague. But the first law of growth economics states that to create wealth through growth, some inflation must be tolerated. The solution then is to make the working poor pay for the pain of inflation by giving the rich a bigger share of the monetized wealth created via inflation, so that the loss of purchasing power from inflation is mostly borne by the low-wage working poor, and not by the owners of capital, the monetary value of which is protected from inflation.

    Inflation is deemed benign as long as wages rise at a slower pace than asset prices. The monetarist iron law of wages worked in the industrial age, with the resultant excess capacity absorbed by conspicuous consumption of the moneyed class, although it eventually heralded in the age of revolutions. But the iron law of wages no longer works in the post-industrial age in which growth can only come from demand management because overcapacity has grown beyond the ability of conspicuous consumption of a few to absorb in an economic democracy.

    That has been the basic problem of the global economy for the past three decades. Low wages have landed the world in its current sorry state of overcapacity masked by unsustainable demand created by a debt bubble that finally imploded in July 2007. The whole world is now producing goods and services made by low-wage workers who cannot afford to buy what they make except by taking on debt on which they eventually will default.

    Henry C.K. Liu

    By Anonymous Henry C.K. Liu, at 8:44 AM, May 24, 2009  

  • Henry makes good points. I've been drafting an article along similar lines:

    Why debt-leveraged asset-price inflation ends in debt deflation

    The present crash is more than just a bubble bursting. The financial system was structured to fail. The bubble was a way to postpone the debt crash by a policy of inflating asset prices to provide collateral against which debtors could borrow to pay their bankers. This is the essence of Ponzi schemes (now called Madoff schemes): borrowing the interest to pay lenders or investors. Retirees were to be paid out of stock-market gains. Savers too. The "magic of compound interest" could be reality only as long as the economy also "magically" produced a surplus large enough to cover the exponentially growing volume of debt ­ not only bank debt but pension debt, Social Security debt, retirement funding.

    This is not a monetary problem as such. It is a debt problem. It appears as a fiscal problem to the extent that taxes on the financial sector and wealthy creditors are cut, stifling the real economy from producing the surplus that is needed to pay them.

    Take the past year's jump of nearly $10 trillion in U.S. federal debt, for example. This giveaway is unparalleled since the government gave away vast landholdings to the railroad barons in the 1860s. Yet some orthodox financial observers have expressed surprise that this particular form of "debt financing" is not inflationary. Many consumer prices are drifting down, and wages and many asset prices are plunging, especially for real estate. Instead of the government "spending money into circulation" by hiring employees and buying goods and services, it simply handed over Treasury bonds to the banks (the largest political campaign contributors). The expense of paying interest on this debt is to be borne by the "real" economy of employment and production ­ that is, by "taxpayers," in contrast to the Finance, Insurance and Real Estate (FIRE) sector receiving public handouts and which has obtained tax exemption for most of its revenue. This state of affairs has led stock prices to soar, at least temporarily since March 2009, headed by bank stocks benefiting from the government bailout.

    Academic theory has little to say about this state of affairs. The monetary system is a topic that attracts cranks, especially philosophically oriented individuals who speculate abstractly about how to devise a "unit of account" or standard of measurement to provide "stable purchasing power" ­ and therefore presumably, monetary stability and economic fairness. Most such theorizing aims at making money "neutral," to facilitate the "wheels of commerce" while "preserving purchasing power." A fatal over-simplifying assumption is that prices tend to rise and fall together at the same rate ­ asset prices for real estate, stocks and bonds, and commodity prices for fuel and food, manufactures and other consumer goods. In practice, the focus is on the consumer price index and wages. Yet the dynamics that determining prices for property and financial assets are altogether different from the forces determining consumer prices and wages.

    (Continued in next comment)

    By Anonymous Michael Hudson, at 9:03 AM, May 24, 2009  

  • (Continued from previous comment)

    The most important starting point should be recognition that money is debt. The financial system is a credit system, which is to say, a debt system. Money is whatever unit debts are denominated in. The State Theory of Money holds that governments give value to money by accepting it in payment for tax debts and fees. In Bronze Age Mesopotamia silver played this role, but with a fixed price schedule with barley and other means of payment for public-sector transactions and account keeping. The main source of economic instability stemmed from the fact that this "hard" commodity money was plugged into the system of debts to private- and public-sector creditors. Most debts in early times were owed to the public sector, as taxes or user fees. In antiquity, the public sector was the major creditor as provider of public services for user fees and as levying tribute and taxes (most "taxes" originated as tribute). Only in modern times has the public sector become a debtor to private creditors. And in today's twist, the national Treasury is bailing out these creditors ­ a creditor to the creditor class, albeit as a pure giveaway.

    The most important characteristic of debts is that they generally accrue interest. Private creditors receiving this interest ­"savers" ­normally recycle it by finding yet new borrowers in an exponentially growing dynamic. So the monetary system tends to expand the volume of savings and debts. This means that debtors as a whole tend to owe creditors more and more money. This leads to increasing economic polarization between creditors and debtors. When carrying charges on the economy's rising volume of debts can't be paid, a financial crash ensues. Creditors foreclose on the property of debtors. It does not matter whether the debts in question are measured in gold or paper or some abstract, artificially administered "market basket."

    By Anonymous Michael Hudson, at 9:04 AM, May 24, 2009  

  • Henry:

    > > This is not demand destruction, but money destruction as a restorer of value while it produces a negative effect on demand.

    The end result of which is demand destruction, is it not? By the way, what Henry described is known as debt overhang: the creditors get most the newly injected money and the rest gets almost nothing: businesses continue to bankrupt, lay-offs and hence unemployment increase, incomes decrease, demand for consumption goods go down and hence consumption goods prices decrease, more businesses go bankrupt and the cycle continues until we hit a bottom.

    What is being mistaken as recovery is what Henry said: "The danger is that this unearned nominal profit is mistaken as a sign of recovery," where the unearned nominal profit he mentioned is the money that goes to the creditors. This whole thing is about bailing out the creditors. To bail out the economy, you need to give that money to those who would spend them, that is, to the people, not to the creditors. And until something starts to increase the incomes of the people, the fears of inflation are unwarranted.


    By Anonymous Sabri Oncu, at 9:09 AM, May 24, 2009  

  • From Sabri Oncu:

    By the way, something I suggested elsewhere a while ago was this:
    rather than buying the toxic assets, which came to be known very
    recently as "legacy" (to better manage the public psychology, I guess)
    assets of the banks, the government should buy the debts of the banks
    in the debt market at fire-sale prices and write them to zero. This is
    another alternative to what is being done to improve the balance
    sheets of the banks: remove the debt, rather than replace the toxic
    assets with cash, which in the end goes to the creditors of the banks.
    If you do what I suggest, then the banks may be willing to restructure
    the debts of the households, which happen to be the assets of the
    banks. If they are not then as the government you can force them to
    restructure these debts, as you are the main creditor of the banks
    under this scenario.

    One problem with this is that many of the creditors of the banks are
    the pension and mutual funds. And this is one of the main reasons why
    the US government does not want the prices of the financial assets,
    mostly the prices of the stocks to deflate, I guess. Most of the crazy
    Americans have their retirement investments in stocks (about 60-70

    Can there be a way to slow the stock-price deflation while at the same
    time increasing the incomes of the Americans to get out of this mess?

    I doubt it!

    This is why I think things will get even messier!

    But I don't think the dollar will collapse any time soon, since the
    rest of the world is not doing that great either.

    What currency will replace the dollar any time soon?


    By Blogger Bill Totten, at 10:01 AM, May 25, 2009  

  • From Henry C K Liu

    Yes. Make wage increases deductible from corporate income tax and made layoffs taxable.

    Henry C.K. Liu

    By Blogger Bill Totten, at 10:01 AM, May 25, 2009  

  • From Sabri Oncu

    Very good idea Henry: there is nothing wrong with rewards and punishments!

    It is all about what gets the rewards and what gets the punishments!


    By Blogger Bill Totten, at 10:12 AM, May 25, 2009  

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