HYPERINFLATION SPECIAL REPORT
Issue Number 41
April 8, 2008
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Inflationary Recession Is in Place
Banking Solvency Crisis Has Opened First Phase of Monetary Inflation
Hyperinflationary Depression Remains Likely As Early As 2010
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Overview
The U.S. economy is in an intensifying inflationary recession that eventually will evolve into a hyperinflationary great depression. Hyperinflation could be experienced as early as 2010, if not before, and likely no more than a decade down the road. The U.S. government and Federal Reserve already have committed the system to this course through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, and gross mismanagement.
The U.S. has no way of avoiding a financial Armageddon. Bankrupt sovereign states most commonly use the currency printing press as a solution to not having enough money to cover their obligations. The alternative would be for the U.S. to renege on its existing debt and obligations, a solution for modern sovereign states rarely seen outside of governments overthrown in revolution, and a solution with no happier ending than simply printing the needed money. With the creation of massive amounts of new fiat (not backed by gold) dollars will come the eventual complete collapse of the value of the U.S. dollar and related dollar-denominated paper assets.
What lies ahead will be extremely difficult and unhappy times for many. Ralph T. Foster, in his “Fiat Paper Money” (see recommended further reading at the end of this issue), closes his book’s preface with a particularly poignant quote from a 1993 interview of Friedrich Kessler, a law professor at Harvard and University of California Berkeley, who experienced the Weimar Republic hyperinflation:
“It was horrible. Horrible! Like lightning it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money.”
This Special Report updates and expands upon the three-part Hyperinflation Series that began with the December 2006 SGS Newsletter, exploring: (1) the causes and background of the evolving hyperinflation and great depression; (2) why circumstances will differ from the deflationary Great Depression of the 1930s; (3) implications for politics and the financial markets; (4) considerations for individuals and businesses.
The broad outlook has not changed during the last year. More generally, though, developments in the economy and the financial markets have been in line with projections and have tended to confirm the unfolding disaster. Specifically, the current inflationary recession has gained much broader recognition, while the still-unfolding banking solvency crisis has confirmed the Fed’s and the U.S. government’s willingness to spend whatever money they have to create in order to keep the financial system from imploding. While the dollar has taken a heavy hit — down roughly 20% against key currencies from last year — selling of the U.S. currency still has been far short of the outright dollar dumping that eventually will lead to flight to safety outside of the U.S. dollar. That event is important to the shorter-term timing of the pending hyperinflation.
Regular readers may recognize text from last year’s Series, as well as material from various SGS newsletters, but such is the nature of revisions to prior material. Points that may be repeated from earlier newsletters are done so in sequence to help build the arguments explaining the unfolding crisis. Great thanks are extended to the numerous subscribers who offered ideas, questions and materials that have been incorporated in this report.
Defining the Components of a Hyperinflationary Great Depression
Deflation, Inflation and Hyperinflation. Inflation generally is defined in terms of a rise in general prices due to an increase in the amount of money in circulation. The inflation/deflation issues defined and discussed here are as applied to goods and services, not to the pricing of financial assets.
In terms of hyperinflation, there have been a variety of definitions used over time. The circumstance envisioned ahead is not one of double- or triple- digit annual inflation, but more along the lines of seven- to 10-digit inflation seen in other circumstances during the last century. Under such circumstances, the currency in question becomes worthless, as seen in Germany (Weimar Republic) in the early 1920s, in Hungary after World War II and in the dismembered Yugoslavia of the early 1990s.
The historical culprit generally has been the use of fiat currencies — currencies with no asset backing such as gold — and the resulting massive printing of currency that the issuing authority needed to support its system, when it did not have the ability, otherwise, to raise enough money for its perceived needs, through taxes or other means.
Foster (see recommended further reading at the end of this issue) details the history of fiat paper currencies from 11th century Szechwan, China, to date, and their consistent collapses, time-after-time, due to what appears to be the inevitable, irresistible urge of issuing authorities to print too much of a good thing. The United States is no exception, already having obligated itself to liabilities well beyond its ability ever to pay off.
Here are the definitions:
Deflation. A decrease in the prices of goods and services, usually tied to a contraction of money in circulation.
Inflation. An increase in the prices of goods and services, usually tied to an increase of money in circulation.
Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless. A fairly crude definition of hyperinflation is a circumstance, where, due to extremely rapid price increases, the largest pre-hyperinflation bank note ($100 bill in the United States) becomes worth more as functional toilet paper/tissue than as currency.
As discussed in the section Historical U.S. Inflation: Why Hyperinflation Instead of Deflation, the domestic economy has been through periods of both major inflation and deflation, usually tied to wars and their aftermaths. Such, however, preceded the U.S. going off the gold standard in 1933. The era of the modern fiat dollar generally has been one of persistent and slowly debilitating inflation.
Recession, Depression and Great Depression. A couple of decades back, I tried to tie down the definitional differences between a recession, depression and a great depression with the Bureau of Economic Analysis (BEA), the National Bureau of Economic Research (NBER) and a number of private economists. I found that there was no consensus on the matter, so I set some definitions that the various parties (neither formally nor officially) thought were within reason.
If you look at the plot of the level of economic activity during a downturn, you will see something that looks like a bowl, with activity recessing on the downside and recovering on the upside. The term used to describe this bowl-shaped circumstance before World War II was “depression,” while the downside portion of the cycle was called “recession.” Before World War II, all downturns simply were referred to as depressions. In the wake of the Great Depression of the 1930s, however, a euphemism was sought for future economic contractions so as to avoid evoking memories of that earlier, financially painful time.
Accordingly, a post-World War II downturn was called “recession.” Officially, the worst post-World War II recession was from November 1973 through March 1975, with a peak-to-trough contraction of 5%. Such followed the Vietnam War, Nixon’s floating of the U.S. dollar and the Oil Embargo. The double-dip recession in the early-1980s may have seen a combined contraction of roughly 6%. I contend that the current double-dip recession that began in late-2000 already is rivaling the 1980s double-dip as to depth. (See the Reporting/Market Focus of the October 2006 SGS for further detail.) Please note that the definition for “great depression” below has been revised to a contraction in excess of 25% (from 20% stated in the March 16, 2008 newsletter), in order to be consistent with the usage in last year’s Series.
Here are the definitions:
Recession:Two or more consecutive quarters of contracting real (inflation-adjusted) GDP, where the downturn is not triggered by an exogenous factor such as a truckers’ strike. The NBER, which is the official arbiter of when the United States economy is in recession, attempts to refine its timing calls, on a monthly basis, through the use of economic series such as payroll employment and industrial production, and it no longer relies on the two quarters of contracting GDP rule.
Depression:A recession, where the peak-to-trough contraction in real growth exceeds 10%.
Great Depression:A depression, where the peak-to-trough contraction in real growth exceeds 25%.
On the basis of the preceding, there has been the one Great Depression, in the 1930s. Most of the economic contractions before that would be classified as depressions. All business downturns since World War II — as officially reported — have been recessions. Using the somewhat broader “great depression” definition of a contraction in excess of 20% (instead of 25%), the depression of 1837 to 1843 would be considered “great,” as technically would be the war-time production shut-down in 1945.
The current economic contraction is about halfway towards being classified as a “depression,” based on my definitions and GDP accounting. As the Great War became World War I with the advent of World War II, so too may the Great Depression become Great Depression I, as the current crisis reaches its full, terrible potential. As with the two world wars, what may become known as Great Depression II had its roots in Great Depression I.
Current Environment
Before examining how the current circumstance can evolve from an inflationary recession to a hyperinflationary depression and then great depression, it is worth defining the nature of the current economic and inflation conditions in the United States, and likely near-term developments.
Based on the regular material discussed in the SGS Newsletter, the U.S. economy is in an inflationary recession as will be reported in official statistics. Real (inflation-adjusted) fourth-quarter 2007 GDP, in July’s benchmark revision, and/or first-quarter 2008 GDP should be in contraction, with most underlying economic series showing distressed levels of activity consistent with a recession. Annual CPI inflation is at 4.0% and headed higher. Oil prices remain over $100 per barrel, weakness in the dollar is just beginning to impact the CPI, and the inflationary effects of soaring broad money growth should start to surface around mid-year. Official CPI could be running in double-digits by year-end 2008.
Net of gimmicked methodologies that have reduced CPI inflation reporting and inflated GDP reporting, the U.S. economy has been in a recession since late-2006, entering the second down-leg of a multiple-dip economic contraction, where the first downleg was the recession of 2001 that really began back in late-1999. Annual CPI inflation currently is running around 11.6%, again, facing further upside pressures.
The current outlook does not exclude further bounces and dips in economic activity. As was seen during the Great Depression, in severe contractions the economy can hit bottom and then bounce briefly until it falls again, finding a new bottom. As discussed in the Depression/Great Depression section, the current economic downturn reflects a structural shift, which increasingly has constrained consumer activity during the last several decades, and which cannot be turned quickly. The current downturn, by my numbers, already is halfway to qualifying as a depression. The evolving depression quickly will move to great depression status, when the hyperinflation hits, as such will be extremely disruptive to the conduct of normal commerce.
The efforts by the federal government and the Federal Reserve to prevent a systemic collapse as a result of the banking solvency crisis has started to spike broad money growth, as measured by the SGS-Ongoing M3 measure, which currently shows a record annual growth rate of 17.3%. While the Fed has not been formally creating new money — yet — by adding to reserves, it has had the effect of creating new money by re-liquefying otherwise illiquid banks, by lending liquid assets versus illiquid assets. As a result, a number of banks have been able to resume more normal functioning, lending money and creating new money supply. As the systemic bailout proceeds, formal money creation will follow and already may be starting to show up in official accounting.
In response to the rapidly deteriorating fundamentals underlying the value of the U.S. dollar, selling of the greenback has been intense, but contained, with brief periods of stability as seen at the moment. In the near future, dollar selling should build towards an extreme, with heavy foreign investment in the dollar fleeing the U.S. currency for safety elsewhere. With the domestic financial markets and U.S. Treasuries so heavily dependent on foreign capital for liquidity, the Federal Reserve — now touted as the formal financial market stabilizer — will be forced increasingly to monetize federal debt. That process will build over time, given the federal government’s effective bankruptcy, as discussed in the section U.S. Government Cannot Cover Existing Obligations. Therein lies the ultimate basis for the pending hyperinflation.
Again, the current circumstance will evolve into a hyperinflationary depression, then great depression. Although such is not likely much before 2010, or after 2018, that financial end game for the current markets will tend to come sooner rather than later and will break with surprising speed when it hits. As discussed later, this likely will not be a deflationary environment as seen during the Great Depression.
What lies ahead for the current year will be severe enough and financially painful enough to affect the outcome of the 2008 presidential election. Historically, the concerns of the electorate have been dominated by pocketbook issues. Prior to gimmicked methodologies making the reporting of disposable personal income largely meaningless, that measure was an excellent predictor of presidential elections.
In every presidential race since 1908, in which consistent, real (inflation-adjusted) annual disposable income growth was above 3.3%, the incumbent party holding the White House won every time. When income growth was below 3.3%, the incumbent party lost every time. Again, with redefinitions to the national income accounts in the last two decades, a consistent measure of disposable income as reported by the government has disappeared. Yet, even with official reporting, the current annual growth in real disposable income is at 2.2%, well below the traditional 3.3% limit.
Accordingly, odds are quite high that the numbers for 2008 will favor an incumbent party loss, i.e. a victory for the Democrats. Where I always endeavor to keep my political persuasions separate from my analyses, for purposes of full disclosure, my background is as a conservative Republican with a libertarian bent.
What follows or coincides politically with a hyperinflationary depression offers a wide variety of possibilities, but the political status quo likely would not continue. Times would be financially painful enough to encourage the development of a third party that could move the Republicans or Democrats to third-party status in the 2010 mid-term or 2012 presidential elections.
Historical U.S. Inflation: Why Hyperinflation Instead of Deflation
Fire and Ice
Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.
– Robert Frost
As to the fate of the developing U.S. great depression, it will encompass the fire of a hyperinflation, instead of the ice of deflation seen in the major U.S. depressions prior to World War II. What promises hyperinflation this time is the lack monetary discipline formerly imposed on the system by the gold standard, and a Federal Reserve dedicated to preventing a collapse in the money supply and the implosion of the still, extremely over-leveraged domestic financial system.
The accompanying two graphs measure the level of consumer prices since 1665 in the American Colonies and later the United States. The first graph shows what appears to be a fairly stable level of prices up to the founding of the Federal Reserve in 1913 (began activity in 1914) and Franklin Roosevelt’s abandoning of the gold standard in 1933. Then, inflation takes off in a manner not seen in the prior 250 years, and at an exponential rate when viewed using the SGS-Alternate Measure of Consumer Prices in the last several decades. The price levels shown prior to 1913 were constructed by Robert Sahr of Oregon State University. Price levels since 1913 either are Bureau of Labor Statistics (BLS) or SGS based, as indicated.
The magnitude of the increase in price levels in the last 50 years or so, however, visually masks in the first graph the inflation volatility of the earlier years. That volatility becomes evident in the second graph, with inflation history shown only through 1960.
What is shown in the second graph is that up through the Great Depression, regular periods of inflation — usually seen around wars — have been offset by periods of deflation. Particular inflation spikes can be seen at the time of the American Revolution, the War of 1812, the Civil War, World War I and World War II.
The inflation peaks and the ensuing post-war depressions and deflationary periods tied to the War of 1812, the Civil War and World War I show close to 60-year cycles, which is part of the reason some economists and analysts have been expecting a deflationary depression in the current period. There is some reason behind 30- and 60-year financial and business cycles, as the average difference in generations in the U.S. is 30 years, going back to the 1600s. Accordingly, it seems to take two generations to forget and repeat the mistakes of one’s grandparents. Similar reasoning accounts for other cycles that tend to run in multiples of 30 years.
Aside from minor average annual price level declines in 1944 and 1955, the United States has not seen a deflationary period in consumer prices since before World War II. The reason for this is the same as to why there has not been a formal depression since before World War II: the abandonment of the gold standard and recognition by the Federal Reserve of the impact of monetary policy — free of gold-standard system restraints — on the economy.
The gold standard was a system that automatically imposed and (more…)
