HYPERINFLATION SPECIAL REPORT (UPDATE 2010) Part I

by Walter J. (John) Williams

Commentary Number 263

December 2, 2009

Economy and Financial System Face Eventual Great Collapse

Government and Fed Actions Have Narrowed Timing for Hyperinflationary Great Depression to Next Five Years

High Risk of Ultimate Dollar Crisis Unfolding in Year Ahead

(Editor’s Note: I’ve split this report into three parts. This was given less than one month before the 2010 New Year and the possible breaking of the hyperinflation crisis in 2010. Some have transpired, some loom on the horizon.)

Overview

A Great Collapse. The U.S. economic and systemic solvency crises of the last two years are just precursors to a Great Collapse: a hyperinflationary great depression. Such will reflect a complete collapse in the purchasing power of the U.S. dollar, a collapse in the normal stream of U.S. commercial and economic activity, a collapse in the U.S. financial system as we know it, and a likely realignment of the U.S. political environment. The current U.S. financial markets, financial system and economy remain highly unstable and vulnerable to unexpected shocks. The Federal Reserve is dedicated to preventing deflation, to debasing the U.S. dollar. The results of those efforts are being seen in tentative selling pressures against the U.S. currency and in the rallying price of gold.

Crises Brewed by Federal Government and Federal Reserve Malfeasance. The crises have been generated out of and are centered on the United States financial system, triggered by the collapse of debt excesses actively encouraged by the Greenspan Federal Reserve. Recognizing that the U.S. economy was sagging under the weight of structural changes created by government trade, regulatory and social policies — policies that limited real consumer income growth — Mr. Greenspan played along with the political and banking systems. He made policy decisions to steal economic activity from the future, fueling economic growth of the last decade largely through debt expansion.

The Greenspan Fed pushed for ever-greater systemic leverage, including the happy acceptance of new financial products, which included instruments of mis-packaged lending risks, designed for consumption by global entities that openly did not understand the nature of the risks being taken. Complicit in this broad malfeasance was the U.S. government, including both major political parties in successive Administrations and Congresses.

As with consumers, the federal government could not make ends meet while appeasing that portion of the electorate that could be kept docile by ever-expanding government programs and increasing government spending. The solution was ever-expanding federal debt and deficits.

Purportedly, it was Arthur Burns, Fed Chairman under Richard Nixon, who first offered the advice that helped to guide Alan Greenspan and a number of Administrations. The gist of the wisdom imparted was that if you ran into problems, you could ignore the budget deficit and the dollar. Ignoring them did not matter, because doing so would not cost you any votes.

Back in 2005, I raised the issue of a then-inevitable U.S. hyperinflation with an advisor to both the Bush Administration and Fed Chairman Greenspan. I was told simply that “It’s too far into the future to worry about.”

Indeed, pushing the big problems into the future appears to have been the working strategy for both the Fed and recent Administrations. Yet, the U.S. dollar and the budget deficit do matter, and the future is at hand. The day of ultimate financial reckoning has arrived, and it is playing out.

Saving the System at Any Cost. The Federal Reserve and the U.S. Treasury moved early in the current solvency crisis to prevent a collapse of the banking system, at any cost. It was the collapse of the banking system and loss of depositor assets in the early-1930s that intensified the Great Depression and its attendant deflation. A somewhat parallel risk was envisioned in 2008 as the system passed over the brink. The decision was made to avoid a deflationary great depression.

Effective financial impairments and at least partial nationalizations or orchestrated bailouts/takeovers resulted for institutions such as Bear Stearns, Citigroup, Washington Mutual, AIG, General Motors, Chrysler, Fannie Mae and Freddie Mac, along with a number of further troubled financial institutions. The Fed moved to provide whatever systemic liquidity would be needed, while the federal government moved to finance corporate bailouts and to introduce significant stimulus spending.

Curiously, though, the Fed and the Treasury let Lehman Brothers fail outright, which triggered a foreseeable run on the system and markedly intensified the systemic solvency crisis in September 2008. Whether someone was trying to play political games, with the public and Congress increasingly raising questions of moral hazard issues, or whether the U.S. financial wizards missed what would happen or simply moved to bring the crisis to a head, remains to be seen.

In the midst of the crises, the Obama Administration has introduced major new government programs, ranging from carbon tax plans to a national health care and insurance program. Irrespective of any stated goals of not increasing the federal deficit further, these programs will have severely negative impact on the federal deficit, either from massive net expenses, or from losses in tax revenues in a weaker economy. The various initiatives generally will act as major depressants on business activity. The U.S. Treasury has delayed publishing the U.S. Government’s 2009 GAAP-based financial statements for two months, until February 2010. With my estimate of a GAAP-based 2009 annual deficit of roughly $9 trillion, there may some method in pushing off unhappy accounting until after the health-care package is resolved.

While the system will be saved at any cost, and the government will spend whatever it can spend until the financial markets rebel, the ultimate cost here will be in inflation and the increasing debasement of the purchasing power of the U.S. Dollar.

Hyperinflation Nears. Before the systemic solvency crisis began to unfold in 2007, the U.S. government already had condemned the U.S. dollar to a hyperinflationary grave by taking on debt and obligations that never could be covered through raising taxes and/or by severely slashing government spending that had become politically untouchable. The U.S. economy also already had entered a severe structural downturn, which helped to trigger the systemic solvency crisis.

The intensifying economic and solvency crises, and the responses to both by the U.S. government and the Federal Reserve in the last two years, have exacerbated the government’s solvency issues and moved forward my timing estimation for the hyperinflation to the next five years, from the 2010 to 2018 timing range estimated in the prior report. 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, gross mismanagement, and a deliberate and ongoing effort to debase the U.S. currency. Accordingly, risks are particularly high of the hyperinflation crisis breaking within the next year.

Numerous foreign governments have offered unusually blunt criticism of U.S. fiscal and Federal Reserve policies in the last year. Both private and official demand for U.S. Treasuries increasingly is unenthusiastic. Looming with uncertain timing is a panicked dollar dumping and dumping of dollar-denominated paper assets. Such is the most likely event to trigger the onset of hyperinflation in the year ahead.

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 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 dollars (not backed by gold or silver) will come the eventual destruction of the value of the U.S. dollar and related dollar-denominated paper assets.

What lies ahead will be extremely difficult, painful and unhappy times for many in the United States. The functioning and adaptation of the U.S. economy and financial markets to a hyperinflation likely would be particularly disruptive. Trouble could range from turmoil in the food distribution chain to electronic cash and credit systems unable to handle rapidly changing circumstances. The situation quickly would devolve from a deepening depression, to an intensifying hyperinflationary great depression.

While the economic difficulties would have global impact, the initial hyperinflation should be largely a U.S. problem, albeit with major implications for the global currency system. For those living in the United States, long-range strategies should look to assure safety and survival, which from a financial standpoint means preserving wealth and assets. Also directly impacted, of course, are those holding or dependent upon U.S. dollars or dollar-denominated assets, and those living in “dollarized” countries.

The balance of this special report is broken into the following sections:

* Defining the Components of a Hyperinflationary Great Depression
* Two Examples of Hyperinflation
* Current Economic and Inflation Conditions in the United States
* Historical U.S. Inflation: Why Hyperinflation Instead of Deflation
* U.S. Government Cannot Cover Existing Obligations
* Hyperinflationary Great Depression
* Closing Comments

Defining the Components of a Hyperinflationary Great Depression

Deflation, Inflation and Hyperinflation. Inflation broadly 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, in the dismembered Yugoslavia of the early 1990s and most recently, in Zimbabwe where the pace of hyperinflation may have been the most extreme ever seen.

The historical culprit generally has been the use of fiat currencies — currencies with no hard-asset backing such as gold — and the resulting massive printing of currency that the issuing authority needed to support its spending, when it did not have the ability, otherwise, to raise enough money for its perceived needs, through taxes or other means.

Ralph T. Foster (hereinafter cited as Foster) in Fiat Paper Money, The History and Evolution of Our Currency details the history of fiat paper currencies from 11th century Szechwan, China, to date, and the consistent collapse of those currencies, 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. Formal deflation is measured in terms of year-to-year change.

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 on “Historical U.S. Inflation,” 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 domestic gold standard in 1933 and abandoning international convertibility in 1971. 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, where popular usage of the term “depression” had taken on the meaning of a severe recession, 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,” and the upside was called “recovery.” 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 has surpassed the 1980s double-dip as to depth. 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 a the somewhat narrower “great depression” definition of a contraction in excess of 20% (instead of 25%), the depression of 1837 to 1843 would be considered “great,” as would be the war-time production shut-down in 1945, at least technically.

Two Examples of Hyperinflation

Weimar Republic. Ralph Foster closes his book’s preface with a particularly poignant quote from a 1993 interview of Friedrich Kessler, a law professor whose university affiliations included, among others, Harvard and University of California Berkeley. From firsthand experience, Kessler described 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.”

The hyperinflation in Germany’s Weimar Republic is along the lines of what likely will unfold in the United States. The following two graphs plot the same numbers, but on different scales. The data are the monthly averages of the number of paper German marks that equaled one dollar (gold-backed) in 1922 and 1923, with that number acting as something of a surrogate for the pace of inflation.

The first plot is a simple arithmetic plot, but the earlier detail is masked by the extreme numbers of the last several months, suggestive of an extraordinarily rapid and large rise in the pace of inflation. The second plot is on a logarithmic scale, where each successive power of ten represents the next tick mark on the vertical scale.

While the hyperinflation did hit rapidly, annual inflation in January 1922 already was more than 200%, up from as low as 6% in April 1921. The existing currency was abandoned at the end of 1923.

Milton Friedman and Anna Jacobson Schwartz noted in their classic A Monetary History of the United States that the early stages of the Weimar Republic hyperinflation was accompanied by a huge influx of foreign capital, much as had happened during the U.S. Civil War. The speculative influx of capital into the U.S. at the time of the Civil War inflation helped to stabilize the system, as the foreign capital influx into the U.S. in recent years has helped to provide relative stability and strength to the equity and credit markets. Following the Civil War, however, the underlying U.S. economy had significant untapped potential and was able to generate strong, real economic activity that covered the war’s spending excesses.

Post-World War I Germany was a different matter, where the country was financially and economically depleted as a penalty for losing the war. Here, after initial benefit, the influx of foreign capital helped to destabilize the system. “As the mark depreciated, foreigners at first were persuaded that it would subsequently appreciate and so bought a large volume of mark assets …” Such boosted the foreign exchange value of the German mark and the value of German assets. “As the German inflation went on, expectations were reversed, the inflow of capital was replaced by an outflow, and the mark depreciated more rapidly … (Friedman p. 76).”

Indeed, in the wake of its defeat in the Great War, Germany was forced to make debilitating reparations to the victors — particularly France — as well as to face loss of territory. From Foster (Chapter 11):

“By late 1922, the German government could no longer afford to make reparations payments. Indignant, the French invaded the Ruhr Valley to take over the production of iron and coal (commodities used for reparations). In response, the German government encouraged its workers to go on strike. An additional issue of paper money was authorized to sustain the economy during the crisis. Sensing trouble, foreign investors abruptly withdrew their investments.

“During the first few months of 1923, prices climbed astronomically higher, with no end in sight… The nation was effectively shut down by currency collapse. Mailing a letter in late 1923 cost 21,500,000,000 marks.”

The worthless German mark became useful as wall paper and toilet paper, as well as for stoking fires.

The Weimar circumstance, and its heavy reliance on foreign investment, was closer to the current U.S. situation than it was to the U.S. Civil War experience. In certain aspects, the current U.S. situation is even worse than the Weimar situation. It certainly is worse than the Civil war circumstance.

Unlike the untapped economic potential of the United States 145 years ago, today’s U.S. economy is languishing in the structural problems of the loss of its manufacturing base and a shift of domestic wealth offshore; it is mired in an economic contraction that is immune to traditional economic stimuli. As the U.S. government has attempted in recent decades to assuage electorate discontent with ever more expensive social programs; as the Federal Reserve has moved to encourage debt expansion as a remedy for lack of real, inflation-adjusted, income growth; the eventual bankruptcy of the U.S. dollar was locked in. The problem here was taken on and created willingly by U.S. government officials — embraced by both major political parties — not imposed by a victorious and vengeful enemy of war.

In the early 1920s, foreign investors in Germany were not propping up the world’s reserve currency in an effort to prevent a global financial collapse, and they did not know in advance that they were doomed to take a large hit on their German investments. In today’s environment, both central banks and major private investors know that the U.S. dollar will be a losing proposition. They either expect and/or hope that they can get out of the dollar in time to avoid losses, or, in the case of the central banks, that they can forestall the ultimate global economic crisis. Such expectations and hopes have dimmed markedly in the last two years, as the untenable U.S. fiscal condition has gained more public and global recognition.

Zimbabwe. Hyperinflation in Zimbabwe, the former Rhodesia, was a quadrillion times worse than it was in Weimar Germany. Zimbabwe went through a number of years of high inflation, with an accelerating hyperinflation from 2006 to 2009, when the currency was abandoned. Through three devaluations, excess zeros repeatedly were lopped off notes as high as 100 trillion Zimbabwe dollars.

The cumulative devaluation of the Zimbabwe dollar was such that a stack of 100,000,000,000,000,000,000,000,000 (26 zeros) two dollar bills (if they were printed) in the peak hyperinflation would have be needed to equal in value what a single original Zimbabwe two-dollar bill of 1978 had been worth. Such a pile of bills literally would be light years high, stretching from the Earth to the Andromeda Galaxy.

In early-2009, the governor of the Zimbabwe Reserve Bank indicated he felt his actions in printing money were vindicated by the recent actions of the U.S. Federal Reserve. If the U.S. went through a hyperinflation like that of Zimbabwe’s, total U.S. federal debt and obligations (roughly $75 trillion with unfunded liabilities) could be paid off for much less than a current penny.

This image of a sign in a restroom facility at a South African border station with Zimbabwe speaks for itself.

What helped to enable the evolution of the Zimbabwe monetary excesses over the years, while still having something of a functioning economy, was the back-up of a well functioning black market in U.S. dollars. The United States has no such backup system, however, with implications for a more rapid and disruptive hyperinflation than seen in Zimbabwe, when it hits. This will be discussed later.

Part II will be published tomorrow.

I extend by deep thanks to the various readers who have raised questions and provided ideas and material. As always, please feel free to offer your comments or raise your questions by e-mail to johnwilliams@shadowstats.com.

Copyright 2010 Shadowstats.com

3 Responses to HYPERINFLATION SPECIAL REPORT (UPDATE 2010) Part I

  1. casuist says:

    Hey, if only we could print good governance, or a sound fiscal policy or something.

  2. […] HYPERINFLATION SPECIAL REPORT HYPERINFLATION SPECIAL REPORT (UPDATE 2010) Part I […]

  3. รับทำ seo says:

    good molly DumpDC , i review your blog , this a nice blog and useful. Good for me. useful Texas Independence and Inflation content. i going to plan to read and comment your site.

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