What causes hyperinflations? The answer is: Quasi-fiscal deficits! Why have we not seen hyperinflation yet? Because we have not had quasi-fiscal deficits!
Please, click here to read this article in pdf format: December 18 2012
As anticipated in my previous letter, today I want to discuss the topic of high or hyperinflation: What triggers it? Is there a common feature in hyperinflations that would allow us to see one when it’s coming? If so, can we make an educated guess as to when to expect it? The analysis will be inductive (breaking with the Austrian method) and in the process, I will seek to help Peter Schiff find an easy answer to give the media whenever he’s questioned about hyperinflation. If my thesis is correct, three additional conclusions should hold: a) High inflation and high nominal interest rates are not incompatible but go together: There cannot be hyperinflation without high nominal interest rates, b) The folks at the Gold Anti-Trust Action Committee will eventually be out of a job, and c) Jim Rogers will have been proved wrong on his recommendation to buy farmland.
(Before we deal with these questions, a quick note related to my last letter: A friend pointed me to this article in Zerohedge.com, where the problem on liquidity being diverted back to shareholders in the form of share buybacks and dividends was exposed, before I would bring it up, on my letter of March 4th. )
A forensic analysis on dead currencies
When I think of hyperinflation, I think of dead currencies. They are the best evidence. There is a common pattern to be found in every one of them and no, I am not talking of six-to-eight-figure denomination bills or shortages of goods. These are just symptoms. Behind the death of every currency in modern times, there has been a quasi-fiscal deficit causing it. Thus, briefly, when someone asks: What causes hyperinflations? The answer is: Quasi-fiscal deficits! Why have we not seen hyperinflation yet? Because we have not had quasi-fiscal deficits!
What is a quasi-fiscal deficit?
A quasi-fiscal deficit is the deficit of a central bank. From Germany to Argentina to Zimbabwe, the hyper or high inflationary processes have always been fueled by such deficits. Monetized fiscal deficits produce inflation. Quasi-fiscal deficits (by definition, they are monetized) produce hyperinflation. Remember that capital losses due to the mark down of assets do not affect central banks: They simply don’t need to mark to market. They mark to model.
The only losses that can meaningfully affect central banks stem from flows (i.e. deficits), like net interest losses. These losses result from paying a higher interest on their (i.e. central banks’) liabilities than what they receive from their assets. These losses leave central banks no alternative but to monetize them, in a deadly feedback loop. They are like black holes: Once trapped into them, there is no way out, because (fiscal) spending cuts are no longer relevant, unless they produce a surplus material enough to offset the quasi-fiscal deficits. And that, by definition, is impossible.
This raises questions like: Why would a central bank need to pay interest on its liabilities? Why would the monetization of the losses necessarily lead to a spiralling process?
Why would a central bank need to pay interest on its liabilities?
This is a key point to understand inflation. According to mainstream economists, inflation is a process that pops once the potential output gap of a currency zone is eliminated. Inflation is the consequence of reaching full employment of resources, they say, and place the situation within the context of “hydraulics”. In the figure below, I illustrate this context, showing two glasses: One is not full, and therefore, there should not be inflationary pressures.
Please, do not laugh at the figure. It also contains a citation from a speech given by Fed’s Governor Jeremy C. Stein a few months ago, that uses this same metaphor to illustrate how the Fed thinks about their policies. If it wasn’t so sad, it would be comic. And it is sad because there is absolutely no historical evidence of a nation sustainably living under inflation that would have reached full employment. In fact, it is quite the opposite: Inflation breeds unemployment, which breeds shortages and further inflation. This is why this whole situation is so sad. Millions of lives have been and will continue to be ruined because of this error.
The truth is however that inflation and financial repression are inseparable. They are different faces of the same coin, and as inflation develops, financial repression morphs into plain confiscation. As at December 2012, we have only had increasing financial repression, mostly in the form of price manipulation. Some of this manipulation is open, as with interest rates, and some of it is covered, as with gold, the consumer price index or the unemployment rate. But as the US fiscal deficits grows, the manipulation will be increasingly open and the fear of confiscation will be very tangible. Yes, the manipulation will be so open that even the GATA (Gold Anti-Trust Action Committee) will completely lose its raison d’être. It will be worthless to expose what will be public.
With regards to the fear of confiscation, there is a good example in the drop in deposits from the banks in the periphery of the Euro zone. Any rational investor could see that his bank was being coerced into purchasing the worthless debt of its sovereign and that the likelihood of being caught in a bank run was exponentially rising. Policy makers in the Euro zone chose not to confiscate. It was too early to do so, in the presence of other alternatives. But deposits dropped nevertheless, and to restore them, the European Central Bank will have to pay higher interest rates on its sterilized purchases, when it finally engages in Open Monetary Transactions (i.e. purchase of sovereign debt with maturity under three years). I explained this in September: Since the backstop of the ECB removes jump-to-default risk from the front end (i.e. 1 to 3 years, in sovereign debt), selling the sovereign debt to the central bank for cash will be a losing proposition for banks. The Euro zone banks will demand that the purchases be sterilized, to receive central bank debt in exchange and at an acceptable interest rate. This rate will have to be higher than it currently is. This is why, in my opinion, we are seeing a stronger Euro and weaker Treasuries.
Why would a government want to maintain a certain level of deposits?
Governments need bank deposits to fund the bonds they force their banks to buy. The regulations, the pressure on the bankers, the open threats are all part of the same means to coerce bankers to fund their debts with your savings. Is this what was behind the failed moves in 2012 to destroy the US money market funds?
Essentially, hyperinflation is the ultimate and most expensive bailout of a broken banking system, which every holder of the currency is forced to pay for in a losing proposition, for it inevitably ends in its final destruction. Hyperinflation is the vomit of economic systems: Just like any other vomit, it’s a very good thing, because we can all finally feel better. We have puked the rotten stuff out of the system.
Why would depositors not want to renew deposits?
Whenever the weight of deficits passes a certain milestone, people begin to flee en masse from the system. They not only take their savings from the system, but they generate income outside it too. This has happened since times immemorial. Below is a picture of buried coins, found in Hertfordshire. They are presumed to have been hoarded in 4th century during the final years of Roman rule.
Then and now, the tax pressure ended breaking capital markets and trade. In the early stages, everyone seeks to stop investing and collect by any means whatever capital that can be recovered. Nobody should be surprised if, with these low interest rates, the wave of share buybacks and dividend payments increases. The shrinkage of the system exacerbates the fall in tax revenue and the intervention of central banks, leading to the self fulfilling outcome of quasi-fiscal deficits. Production falls and the shortage of goods, together with the increase in the circulation of money, triggers high inflation. Price controls follow. If this is correct, Jim Rogers is wrong and you should not buy farmland. Farming will not be profitable. The increase in food prices would not be a signal to encourage farming, but the reflection of the fact that farming is not profitable because it is easy to tax. Hence, the food shortages. The same applies to real estate in general, as the rule of the mob spreads and the rights of debtors and tenants are favoured over those of creditors and landlords. Hyperinflation therefore is not just a run from a currency, but from the economic system entirely. Thousands of years of Diaspora are screaming to us in the face that the advantage of gold as an easy-to-transport and store asset is not to be underestimated.
Why have we not seen a quasi-fiscal deficit yet and how close are we to see one?
I think that at this point one can easily see how high nominal interest rates (to attract deposits) and hyperinflation go together. The loss of confidence in the system pushes nominal rates higher, which causes even more pain to produce, unleashing shortages of goods and higher prices. Von Mises, for instance, remembered that in the case of the German hyperinflation, “…With a (my note: nominal) 900 per cent interest rate in September 1923 the Reichsbank was practically giving money away…” (Chapter 7, in “Money, Method, and the Market Process”).
Frankly, I do not have a definitive answer to the question of why we have not seen a quasi-fiscal deficit yet. But I can intuit that we are still far from seeing one. There are many factors at play. The existence of coercive pension plans (i.e. monies coercively taken from salaries to fund collective distributions) could be playing an important role. These funds are “other peoples’ monies” to their managers and they will not risk their careers to protect them from governments that force them to assign a zero risk weight to US Treasury holdings. It is conceivable that as funds are burdened with losses, the contributors wake up to them and decide that at a certain point, one is better off working outside the system than in it, to avoid this hidden tax. Just like Romans left the city, millions of workers in the developed world may decide to become self-employed and leave the system. This is a typical characteristic of under-developed economies.
So far, the Federal Reserve does not even need to sterilize what it prints. The European Central Bank did have to sterilize but the market does not demand an interest rate on its liabilities, higher than that of the sovereign debt it purchases. Not yet…Perhaps because the market somehow still believes that institutional structure of the European Monetary Union is fixable. Further downgrades in the risk rating of core Europe, the concurrent rise in the yields ofGermany’s sovereign debt and corporate defaults in USD denominated bonds will eventually wipe this belief. For now, the European Central Bank has been successful in not even having to pay interest on deposits.
If I have to think of a main and most likely trigger of quasi-fiscal deficits, I have to name the future bailout of the next wave in corporate defaults, particularly from the Euro zone.
Martin Sibileau
December 18th, 2012 at 1:38 PM
Coming out in the open and admitting manipulation of Gold will initially discourage some but actually reassure others into buying precious metals. The constant question for the people accumulating Gold is ~are we in a bubble yet~, if the manipulation would openly admitted, like it has been in previous cases, the burying and hoarding would actually increase.
One question. The end of FDIC has been mentioned by PIMCO as a catalyst for lower yields on the short end of the curve. Should it actually push more hoarding behavior as a result?
December 20th, 2012 at 7:08 AM
[...] by admin on December 20, 2012 var addthis_product = 'wpp-264'; var addthis_config = {"data_track_clickback":true,"data_track_addressbar":false};if (typeof(addthis_share) == "undefined"){ addthis_share = [];}Submitted by Martin Sibileau of A View From The Trenches blog, [...]
December 20th, 2012 at 10:05 AM
Excellent article. Thank you. Typo in the last sub heading, affecting readability.
Suggest:
“Why haven’t we seen a quasi-fiscal deficit yet and how close are we to seeing one?”
January 7th, 2013 at 12:50 PM
QUESTION 1.
What if the threat from Draghi is just a threat to force a bid on periphery bonds or at least scare the shorts on the periphery bonds while the plan is actually to never buy those bonds and never enter into the dynamics of having to issue central bank debt with high levels of interest payments? What is your view on that?
CAN A PIERCING OF BOND BUBBLE IN ITSELF PRECIPITATE REAL TROUBLES FOR WESTERN GOV EVEN WITHOUT QUASI FISCAL DEFICIT?
If the put is not used, it must be credible at all time nonetheless, and hence the recent convergence of interest rates. It seems to me that if money printing has been generating gains for bond holders in nominal prices resulting in flattening the curve and being deflationary because those sitting on the bonds feel good about their gains in sitting idle, the reverse would actually invert the dynamics.
The loss would be an incentive to drop, sell the bonds and spend them in the circulation instead of being idle as monied capital, but not an instrument of circulation (deflationary).
But when the curve starts to steepen, do we actually start to see a self-fulling dynamic that reverses in the other direction, that is monied capital (bonds) are sold and spent into the circulation? First they might just chase other financial assets like equities, but rising long bond nominal rates always hurt PEs (commodities are only sensitive to real rates). This steeper curve might shock bonds from being hoarded and force them to be spent in a spiral loop in the real economy, that might be viewed as ~good~.
The Fed might call that virtuous, but it would shorten the average time length of monetary instrument (Henry Thorton explains that masterfully) and the multiplier would move up as a result.
WOULD THE MARGIN INCREASE IN TAX REVENUES OFFSET THE MARGINAL INCREASE IN INTERESTS?
In other words, we have steepening on long bond curve because of convergence in Europe, without necessarily the need for Central bank to execute the threat which would lead to quasi-fiscal deficit. This steeper curve kick-starts a dishoarding of financial assets into the circulation and a shortening of the time length of circulation instrument (higher multiplier). The inflation expectations build-up and more bonds are sold and spent, nominal GDP rises. The Fed is way behind the curve in fighting this because that is in the interest of the Gov to ~inflate~ away.
THE FED LIKELY TO BE WAY BEHIND THE CURVE BECAUSE REAL RATES AT THE CURRENT LEVELS OF DEBT WOULD CRUSH THE ECONOMY.
Problem comes when shorting bonds and buying commodities becomes fashionable… How can the Fed can come up with a Volcker moment and very high real rates when the debt to GDP is still very high? I am not even considering the risk of funding for government, the rising interest rates might create this problem of perception and the nominal increase in circulation might generate higher nominal tax revenues, but not enough to compensate to higher nominal cost of funding. revenues.
So what I am exploring is inversion of behavior created by a piercing of bond bubble. In other words, a loss on bonds which incentives people to spend them instead of chasing more ~ bond gains~ (which is actually creating deflation) and those losses force them to be converted into circulation which makes nominal GDP and inflation expectation to rise which further create losses on bonds in a feedback loop.
WOULD TAX REVENUES INCREASE FASTER THAN COST OF INTEREST?
Now the tax revenues better increase faster than the incremental cost of debt due to rising yields, or the Fed might have to print money to repress the yield. But if this move happens while inflation expectations have risen and at a moment where the nonimal GDP is rising nicely (real GDP sucks though), then it would be perceived to be very inflationary.
BOTTOM LINE QUESTION
If Treasuries market is perceived to be in a bear market, can the resulting increase in inflation expectation and nominal increase in GDP create marginal tax revenues in excess of marginal cost of debts? If Fed buys bonds into a recovery it might actually trigger a sell-off in bonds because it would be perceived as printing into the recovery. Did the FED just do that in December 2011?
If incremental tax revenues are lower than interest costs, then is it game over anyway for over-indebted govs like the US even without having the ECB enter into the death spiral of actually executing its Open Market Transaction?
I KNOW A LOT OF QUESTIONS, JUST TRYING TO CONFRONT MY LINE OF THOUGHT HERE…
January 7th, 2013 at 3:11 PM
Erratum **
Did the Fed just do that on December 12th 2012? Instead of December 2011….
January 9th, 2013 at 12:33 AM
Hi, here are my thoughts on your questions:
1) What if the threat from Draghi is just a threat to force a bid on periphery bonds?
Eventually, as the periphery deepens its crisis, the central bank will have to intervene. Yes, today is a threat, but I have no doubt that if the moment arrives, the central bank will buy the bonds.
2) CAN A PIERCING OF BOND BUBBLE IN ITSELF PRECIPITATE REAL TROUBLES FOR WESTERN GOV EVEN WITHOUT QUASI FISCAL DEFICIT?
It would only be the case if the central banks withdrew their support. That is highly unlikely. Hence, quasi-fiscal deficits would follow.
3) WOULD THE MARGIN INCREASE IN TAX REVENUES OFFSET THE MARGINAL INCREASE IN INTERESTS?
Higher taxes bring lower production, activity, which reduces tax revenues. As citizens take their capital out of the taxing jurisdiction, interest rates increase, widening the fiscal deficit in a circular way.
4) THE FED LIKELY TO BE WAY BEHIND THE CURVE BECAUSE REAL RATES AT THE CURRENT LEVELS OF DEBT WOULD CRUSH THE ECONOMY.
The Fed is helpless. They can only buy whatever the market doesn’t. This portion grows over time.
5) WOULD TAX REVENUES INCREASE FASTER THAN COST OF INTEREST?
Pls. see answer #3
Thanks for writing.
Cheers,
M.
January 9th, 2013 at 12:36 AM
In December/12, the Fed explicitly adopted what is called a “passive money” strategy. In other words, the supply of money becomes endogenous, determined in this case by the labour market. But it is not true. They will manipulate the labour stats to justify monetizing sovereign debt or simply switch the strategy. In my view, the rise in rates is mainly driven by the policy of the European Central bank. I wrote about this in September.
January 15th, 2013 at 6:43 PM
Hi Martin,
Very interesting article and I have re-read it many times and also been thinking about Fed exit strategies. If the Fed would need to start selling assets to reduce excess reserves and/or if it starts getting into a quasi-deficit situation could it increase reserve requirements to compensate for an increase in the the money multiplier and/or velocity. i.e. forcing banks to keep excess reserves with the Fed without paying them interest?
Thanks for your articles and very much looking forward to the reply.
January 15th, 2013 at 11:48 PM
JR,
Thanks for the question. I believe you are mixing concepts here. At least within the thesis proposed by my post: The assumption is that the central bank falls into a quasi-deficit situation because it needs to achieve a target amount of deposits. And it needs those deposits to fund the government’s deficit. Therefore, by definition, THERE CANNOT BE EXCESS RESERVES. On the other hand, there is no need to manipulate the credit multiplier/ reserve requirements, because under high inflation, there is no credit. Banks do not lend to the private sector under high inflation (I am talking about a level of 15% to 50%, before the hyperinflation is triggered). All the funds provided by deposits is channeled to fund the government. Higher reserve requirements would only increase interest rates unnecessarily.
Regards,
Martin.
January 16th, 2013 at 5:53 AM
I assume the CB falls into a quasi deficit if the yield it gets on its UST purchases is lower than what it pays on the ‘excess reserves’ (which I get aren’t excess as such as they cover the asset side purchases of the Fed’s balance sheet) on the liability side. My thinking is that since the Fed has now extended its duration due to TWIST etc if can suffer significant market losses IF/WHEN it needs to sell assets to ‘scratch’ these excess reserves to contain inflation (per John Hussman ’16 cents’ article for example). It could also pay enough interest on the excess reserves to stop banks lending them out (as Jim Grant calls it ‘bribing the banks’) but that’s how they get into a deficit situation. So my thinking was since the reserve requirements/margins have since the 1920′s/30′s gone from 50 to lets say 10% give or take could regulation be enforced to go the other way and force banks through regulation to keep deposits at the Fed without the Fed paying the interest on them and hence kicking the can a bit further down the proverbial road i.e. avoiding a quasi-deficit? I guess it would effectively mean M2 gets replaced by M0/M1 and the later being used to fund the government via the Fed?
January 17th, 2013 at 11:23 PM
JR,
The scenario I have in mind is not one where the central bank has control. Typically, at this stage, inflation is printing in the two digits and we are long past the time where a central bank is worried to contain inflation. The worry is simply how the government can pay its bills, given that it has no access to the bond market. In this case, unlike what you have in mind, the central bank does not want to sell assets to scratch liabilities. On the contrary, it wants to keep those liabilities, because they sustain deposits at the banks and the deposits are needed to fund the government. Furthermore, if the deposits are withdrawn and become circulating currency, not only is the borrowing capability of the government affected, but inflation spikes exponentially, as the currency is dumped to buy either foreign exchange or gold and inflation expectations are increased.
Remember: The deposits at the bank are not supplying the private sector with credit. In a two-digit inflation scenario, credit has evaporated long ago and left a wave of bankruptcies, defaults. All the deposits go 1000% to finance government deficits. As at January 17 2013, this is not the case yet.
M.
January 20th, 2013 at 8:39 PM
Martin,
If (when) the ECB implements the OMT, why would bondholders only exchange bonds for higher yielding ECB debt? Couldn’t the ECB simply pay the par value or a premium over the market price to the bondholders, instead of selling them its own debt? It would still be an attractive proposition for bondholders, as they would be getting more than they could in the market and they can even replace those same sovereign bonds with higher yielding ones (and trade those to the ECB, if sovereign borrowing rates rise too high). Presumably, this would still require some monetization, but not lead to quasi-fiscal deficits perpetually. Assuming yields stabilize and come back down, couldn’t this strategy work each and every time there was a crisis, barring a massive panic? Or at least work for a very long period of time, much longer than most predict?
January 20th, 2013 at 10:49 PM
Thanks for your question, Flo. Please, note that if the ECB does not sell the banks its own debt, there is no sterilization. And Mario Draghi clearly said there would be sterilization. But, if there was no sterilization and the supply of money grew, there would be no need to pay par on the sovereign bonds…
January 21st, 2013 at 12:57 AM
I remember Draghi said the purchases would be sterilized, but I thought that was more of an attempt to decrease yields as much as possible without actually purchasing bonds (the hope is that the OMT is never implemented). I think that an actual crisis would force the ECB to take any action, even if it means reneging on previous statements, to keep the Eurozone intact, unless countries start leaving the Eurozone willingly. Don’t you think so?
When you say there’d be no need to pay par on the sovereign bonds in the case where the money supply was increased – do you mean that the ECB would just fund government debt directly, via non marketable loans? Wouldn’t the ECB opt instead to buy new issues at auction or from current bondholders in order to affect yields? Or would the lower need to issue bonds after direct loan packages have the same effect? Sorry for the many questions – I’m just trying to make sense of this. Thanks for entertaining my previous questions.
January 21st, 2013 at 11:43 AM
Flo,
Sterilization and capping sovereign debt yields are two different and independent things. The ECB can or cannot sterilize its purchases. In this case, it said it would sterilize. You are making your own assumptions with regards to what the ECB was actually hoping to do. I do not agree with them but just wanted to clarify.
When I say that there would be no need to pay par on bonds, I am saying that if the objective is to simply expand the supply of money without sterilizing, paying par does not add anything to the picture. Therefore, I would not assume purchases at par.
At this point, speculating on whether the ECB would participate in the primary or secondary markets is an intellectual exercise of dubious utility, because the ECB explicitly told us it would work in the secondary market.
Cheers,
M.
April 8th, 2013 at 10:11 AM
Quasi-Fiscal deficits are not what causes hyperinflations.
I suggest you do a bit of research into exchange rates.
April 8th, 2013 at 10:57 AM
I am always willing to learn. Can you please be more specific? What do you have in mind? Thank you.
April 8th, 2013 at 12:08 PM
What I don’t get from your article is why the US Fed would ever need to pay interest on its liabilities. It simply issues currency, and the only implicit interest would be if we experienced outright deflation, which the Fed can easily prevent. So it seems unlikely that the US Fed would ever find itself in such a situation.
Also, the Fed has a mandate of price stability and full employment. So far, it has done a reasonable job of managing to those, the late 70′s excepted. While I do believe that the Fed’s policy has allowed the US govt to avoid making necessary hard choices, I think it’s perhaps a bit paranoid to assume that this will go on forever. The bad economic consequences for the USA of runaway inflation are just too high for the Fed to permit it.
Interesting article. Thanks.
Kim G
Boston, MA
April 8th, 2013 at 12:28 PM
Sorry, my apologies I do not mean to be blunt.
I am not willing to give away too much information on a public forum but since you are an Argentine, you could start with this paper:
http://www.jstor.org/discover/10.2307/2077742?uid=3739920&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=21101871404993
The relationship between Seigniorage and Inflation is one of the keys to a hyperinflation.
But as is the case in all hyperinflations they always without a doubt begin with an exchange rate devaluation.
In other words Milton Friedmans assertion that inflation is always and everywhere a monetary phenomenon is simply specious at best.
Hyperinflations are an exchange rate phenomenon, not a money supply phenomenon.
April 8th, 2013 at 12:46 PM
Kim G., Governments finance themselves in 3 ways. Tax, Borrowing or Seigniorage.
As long as inflation expectations remain low and money demand remains high, seigniorage revenue finance ala QE1 and QE2 works as long as the relationship between steady state inflation rate and seigniorage revenue (seignuiorage is the differenct between the value of money and the cost to product it – in other words, the economic cost of producing a currency within a given economy or country, and in our modern banking system the cost is ZERO as it takes a key stroke of a zero to add to seigniorage, if the seigniorage is positive, then the government will make an economic profit; a negative seigniorage will result in an economic loss.)
If inflation begins to rise, and possibly a modest rise will be sufficient to change the steady state dynamic in our case, the rate of inflation tax increases, but the base on which the tax is levied decreases since the real monetary base is reduced as individuals reduce their demand for money.
Seigniorage revenue rises and then falls as inflation rises. There is an inflation rate that produces a maximum amount of seigniorage with a stable rate of inflation. ABove that steady state inflation rate, is it possible to collect more seigniorage than the maximum amount before seigniorage begins to fall due to the inflation rate but onlt if the inflation rate is constantly increasing (this is the essence of hyperinflation) but this is due to the fact that a certain high reate of inflation consumers will not accept more new currency and real seigniorage revenue will shrink toward zero. At the same time this occurs, interest rates are rising with inflation, reducing government acces to borrowing; the rate of government debt growth shrinks. If at this point the eocnomy is not growing strongly in real terms and real tax revenue does not increase enough to offset a decline in borrowing and seigniorage revenue, expenditures MUST be cut or a hyperinflation process may commence.
This is how countries get themselves in serious trouble. This explains the BOJ’s apparent inflation phobia. A country in a weak fiscal position that depends on seigniorage revenue to fill its funding gap cannot afford to start the inflation ball rolling.
A surge of inflation caused by currency depreciation is the common trigger.
With that said a hyperinflation in the US is near impossible with a less than 1% chance it could occur.
I could go through the concepts of a hyperinflation and why it couldn’t happen here but ultimately the most important thing to know is that there is a reason the Fed and US gov own the most gold in the world.
In case there is a late 1970′s style cost-push inflation we can always back our currency by gold and end the inflation immediately.
With that said I do expect 20% inflation in the US for 5 years straight.
April 8th, 2013 at 12:48 PM
FYI, it seems you deleted my previous post with the link to the inflation article.
April 8th, 2013 at 1:30 PM
Sorry, one of your comments was automatically filtered as spam. I think I restored it. If I didn’t would you pls. accept my apologies and resend? Thank you. I will respond as soon as I can. Cheers, M.
April 8th, 2013 at 2:11 PM
@Guest,
Sorry, I could not download the paper you referred me to. But here’s a question to you….Should we be expecting a devaluation in Argentina, from the official $5,15 rate? Or do you think that the market price of $8.40 already shows a devaluation? If the market price is $8.40, how can a devaluation of the $5,15 rate be relevant at all?
If I am correct, you believe that by shaping fx dynamics expectations, one can manage an inflationary process…
April 8th, 2013 at 2:37 PM
@Kim G,
If the Treasury market collapsed, the Fed would have to issue its own liabilities, in exchange for US govt ones, to sustain the money market, commodity markets and balance sheet of banks. The market would demand a rate on its liabilities.
On another note, I don’t agree with your view on the success of the Fed, but that’s another story. However, if the Fed is monetizing the US govt deficit, you have to ask yourself who will keep purchasing if, as you say, we cannot assume that this will go on forever.
Cheers,
M.
April 8th, 2013 at 2:47 PM
@Guest,
Thanks for the comment. I, of course, disagree with your view, but am very familiar with it. I still remember that exam I gave on Cagan’s model, with regards to optimal inflation target. I chose zero as the optimal and the professor almost had a heart attack!
I promise you I will devote a letter to the subject. It’s too complex to write about in the comments section.
Cheers,
M.
April 8th, 2013 at 2:51 PM
Yes, it was the one on the Argentina article that was deleted.
The current situation in Argentina is vastly different than the 1991 or 2001 hyperinflation episodes. As 2001 showed the hyperinflation was set off by a devaluation of the Peso vs the dollar.
Today Argentina has enough US dollar export earnings to cover their fiscal expenditures thus the reason they do not need to tap international bond markets to finance the government. They also have not been able to since the 2002 default.
IMO I don’t see them experiencing another hyperinflation ala 2001 or even the much worse hyperinflation in 1991.
Any country can have long standing high inflation 20 to 30% per year which normally helps the economy/citizens as long as there is low private debt and the government is not too corrupt as is the case in South Korea. SK experiences 15% + inflation every year but functions perfectly normal with high standards of living.
Anyway there is a reason Argentina bought 55 tons of gold in 2004 and it is to stop any runaway inflation spiral that could turn into hyperinflation.
April 8th, 2013 at 3:02 PM
Although Cagan is cited in numerous papers he would not agree with my view.
The problem is most people try to put themselves in some sort of economic camp, as it seems you are an Austrian while others are monetarist or Keynesian.
The truth is none of them are right but you can use certain parts of their theories to understand how the economy is structured, how inflation works, how the modern credit creation process works etc.
April 8th, 2013 at 3:13 PM
@Guest,
Sorry, but I think you got it all mixed up. To begin with, there was no hyperinflation in 2001. The devaluation did not trigger any inflation. Government spending reactivated inflation, after at least two years of recession.
Today Argentina doesn’t have enough exports to cover anything. The reason they don’t tap govt markets is that they simply can’t. They are in default. Hence, they seized pension funds, nationalized companies like YPF, etc. And now, they simply print what they need.
I don’t see how a 20-30% annual inflation can help anyone.
April 8th, 2013 at 3:52 PM
Sorry it should be 1990 Hyperinflation in Argentina not 1991.(It started in 1989)
Okay so instead of “hyperinflation” I will use the term currency crisis and inflation episode because as I will demonstrate below the CB was able to stop a hyperinflationary event.
Argentina has had two major currency crisis and inflation episodes since 1989.
1) In the 2001-2003 currency crisis: peso/dollar exchange rate declines from 1:1 to 3.8:1 from 2002 to 2003 (bond market begins to price in the exchange rate crisis a year earlier after detecting faults in the currency peg)
2) this caused import prices to surge.
3) The Central Bank reacted by increasing the money supply in order to circulate goods and services at the new higher price level as inflation rsies to a 40% annual rate.
4) The central bank does not continue to icnrease the money supply, so demand does not rise and feed back into prices.
5( exchange rate stabilizes and inflation falls.
They did the opposite in the 1989 – 1990 inflation episode and currency crisis which culminated in an annual inflation rate of 120% plus an exchange inflation rate peak at 20,026%.
Both episodes were set off by an exchange rate crisis.
And yes, Argentina does earn enough dollars from exports (soy beans etc) to operate outside the structure of the International Monetary System. They are only in default of the 10% or so of holdouts like Elliott that wanted par on the sovereign bonds they bought at distressed prices.
If they wanted to issue Argentine sovereign debt they could because there would be plenty of international investor demand in this low interest rate environment.
US dollars are important to every country because they must earn enough foreign exchange (mostly in dollars) to buy the necessities that a country needs like oil which is priced only in dollars.
Our economy cannot handle high inflation rates because of the private and public debt burden in the system. We were able to tolerate high inflation in the late 1970′s because of the low overall debt of both private and public.
This is no longer the case but the Fed Reserve has no choice but to raise the inflation rate high enough to inflate the debt away.
I think when they do achieve this scenario they will lose control of the bond market as they did in 1979 to 1982 when the US was months away from blowing up the US bond market (as Volcker has said).
April 8th, 2013 at 4:21 PM
@Guest,
Sorry, I don’t know where you get all these facts wrong, but I am always open to ideas/comments, regardless….so your comment stays. However, pls., accept my apologies if I don’t answer this time.
April 8th, 2013 at 4:41 PM
Please tell me where my facts are wrong?
April 8th, 2013 at 5:06 PM
Unfortunately it seems you believe that governments are manipulating the gold price.
This is simply not true. They do control and price fix the bond market but not the gold price.
The gold price is linked to oil and there is a temporary over supply in the US due to overleverated shale plays that will deplete rapidly in short time then the oil price will begin to rise with oil.
Gold price manipulation is a myth for gold bugs. To give an example why would governments confiscate gold when they can do this?
Cyprus merely underlines the ludicrous fear of goldbugs that governments might again confiscate gold as in 1933, first by locating it, then by circumventing efforts to move it, then by sending officers to collect it.
Why bother chasing down the < 1% who own gold when 10% of all savings can be quaffed from all bank accounts electronically in an instant with no resistance except after the fact?