An article by Edward Harrison originally posted at Credit Writedowns.
I am 100% sure that the U.S. will go into hyperinflation. Not tomorrow, but the problem with the government debt growing so much is that when the time will come and the Fed should increase interest rates, they’ll be very reluctant to do so and so inflation will start to accelerate.
-Marc Faber, Bloomberg, May 2009
During the world’s last inflationary period in the 1970s, the West witnessed social unrest of the most acute kind, bordering at times on anarchy. If stagflation can lead to anarchy, hyperinflation can lead to and has led to much worse. Hyperinflation is the economic apocalypse many doomsdayers pose as the logical end to the world’s experiment with fiat money.
In a letter to clients last June, Rob Parenteau of the Richebacher Letter wrote about Weimar, one of the worst episodes of hyperinflation:
"The Weimar Republic, born of a revolution in 1918, played host to a hyperinflationary breakdown of the German monetary system by 1923. Austria faced a similar episode of hyperinflation in 1921–2, and no doubt, the searing scars of these experiences deeply informed the thinking of Mises, Hayek, Haberler, Machlup and other leading contributors to the Austrian School in the 20th century.
"Hyperinflation episodes are characterized by rapidly accelerating inflation, a collapsing foreign exchange rate and, eventually, a widespread disorientation and disruption of productive activity. Keynes, writing in 1919, well before the terminal stages of the Weimar hyperinflation had been revealed, characterized the nature of the mayhem involved in such episodes as follows:
"As the inflation proceeds, and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery."
Is this what awaits the US or the UK? Marc Faber’s quote to open this post is symptomatic of the kind of rhetoric which says yes. I love Marc Faber. I consider his interviews first-class economic entertainment. You will continue to see him featured in my posts on a regular basis. And I certainly share some of his concerns about inflation, bailouts, moral hazard (and so forth and so on, as he would say).
But, is Marc Faber an ideologue pushing a rhetorical line of argument to the point of hyperbole or should we take his warnings very seriously?
Let’s attack this question using Zimbabwe and Weimar Germany as examples. These are the two most extreme cases of hyperinflation that economic historians have ever witnessed. They are instructive in regards to what causes hyperinflation and what does not.
Weimar Germany 1919-1923
After World War I, every nation which fought was broke because of the war’s cost. No country had enough gold assets to repay the billions of dollars they owed. And this was a multilateral problem. For example, Britain could not repay its debts to the US until the other Allies repaid their debts to Britain. The Americans were not sympathetic. The prevailing desire was recovering the over $25.5 billion the US had loaned to other nations during the war.
As a result of these debts, the war’s victors laid out draconian terms to punish the Germans in the Treaty of Versailles in 1919. War reparations were one third of Germany’s spending. Therefore, Germany’s budget deficit was half of GDP. (The situation in Iceland due to Icesave’s collapse comes to mind here). And to make things even worse, reparations were in a foreign currency.
It’s not as if the Germans could print off a bunch of Reichmarks to make good on their reparations. When the Germans defaulted on their obligations, the Belgians and the French moved in and occupied the Ruhr region, Germany’s industrial heartland. The result was widespread strikes and idled productive capacity. Afterwards, demand for goods in Germany far outstripped the productive supply.
So, with a huge portion of tax revenue going to pay reparations in foreign currency, the German government turned to the printing presses to make good on its domestic obligations. The surge in money supply and the lack of productive resources led to hyperinflation and collapse.
The key to Weimar’s hyperinflation was two-fold.
- The German government had a large foreign currency debt obligation.
- The German economy lost huge amounts of productive capacity causing prices to soar as demand outstripped supply.
While the facts in Zimbabwe are different, the underlying causes for hyperinflation were the same: foreign currency obligations and a loss of productive capacity.
Zimbabwe had established Independence from Britain in 1980. Yet, by the late 1990s 70% of productive arable land was still held by the small minority 1% of white farmers in the country. After years of talk about redistribution, in 2000, the President Robert Mugabe began to redistribute this land.
The redistribution process was a disaster, both legally and economically. Many whites fled as violence escalated. The result was an enormous decline in Zimbabwe’s agricultural production. With agricultural production having plummeted, Zimbabwe was forced to pay to import food in hard currency.
Meanwhile, the government turned to the printing presses to fulfil its domestic obligations. as in Germany, the foreign currency obligations, the loss of productive capacity and the money printing was a toxic brew which ended in hyperinflation.
Hyperinflation in the UK or USA?
So, that’s a brief outline of what happened in the two most notorious cases of hyperinflation. Notice that in each case you had an enormous foreign currency obligation and a massive loss in productive capacity. The U.S. has not suffered this kind of loss. In fact, productive capacity swamps demand for goods in the U.S. And, as the embedded presentation on hyperinflation from Marshall Auerback shows, the fiscal deficits in the U.S. are a far cry from the 50% of Weimar.
Marshall talks about this using an MMT framework. But, his three most compelling slides on pages 4 to 6 don’t depend on MMT. They simply demonstrate that without pricing power or a large fiscal deficit and large foreign currency demands, talk of hyperinflation is misguided. Crucially, Marshall writes:
Inflation is ultimately about competing distributive claims over real resources. The main limitation then, or rather the determinant of the limits of a “sustainable” fiscal policy, especially with respect to hyperinflationary risks, have to do with real resource constraints, not “running out of money” or absence of government financing, for countries possessing sovereign currencies.
The inability to tax and dependency on foreign currency are central to hyperinflation or national solvency. Moreover, in Zimbabwe and Weimar, it was the trashing of productive supply that created inflation (think supply versus demand).
So, that’s the economics. What about the ideology? Well, the MMT’ers say that the Austrians ideologues and the gold fetishists have a deflationary bias when inflation doesn’t change the real productive capacity of a nation. Clearly, the hyperinflation talk is a gimmick with which to discourage deficit spending. You should see this debate as about a specific policy prescription driven by ideology. The other side of this ideological divide was taken up by Dean Baker in the Guardian’s “Cliches won’t fix the financial crisis“
Nevertheless, inflation does alter business decision-making via accounting’s tie to nominal numbers and the money illusion. Moreover, inflation reduces relative wealth by transferring income from those who receive the money first like banks versus those who receive their money later, your typical widow living on fixed income bonds and annuities. Finally, inflation encourages the accumulation of debt by benefitting borrowers over savers. I see inflation as a problem to be avoided.
Ideologically then, I see inflation as the increase in the money supply.
Economics. an increase in the VOLUME of money, which eventually leads to a persistent, substantial rise in the general level of prices and results in the loss of value of currency.
-What is Inflation?, Credit Writedowns, June 2008
And where inflating the money supply does not eventually lead to consumer price increases, it does lead to asset price increases which foster a stronger boom-bust tendency.
So, people like me look at large government deficits in a fiat currency system as an invitation to print money and inflate the money supply. If you take this way of thinking to a logical extreme, you end up with what Marc Faber is talking about: hyper-inflation.
But, this is ideology – not economics. The claims of hyperinflation awaiting the US or the UK seem hyperbole at best, misinformation and deception at worst. Hyper-inflation has very specific pre-conditions in foreign currency obligations and a loss of tax revenue and productive resources. ‘Printing money’ alone doesn’t get you there. So, it simply isn’t credible to claim that Hyperinflation in the US or the UK is in the offing now or anytime in the immediate future.
As for Anarchy in the UK, that’s another matter.
Cue the Music.