Inflationists vs. Deflationists: Economics as Bread and Circuses

In a purely fiat currency regime, a sustained inflation or deflation is a policy decision.

Since few systems in this world are pure, one has to account for exogenous factors and endogenous lags.

But it remains, deflation or inflation are the result of policy decisions in a fiat regime. If one does not understand that, then there is a fundamental misunderstanding of how things work in a modern monetary system which operates free from a hard external standard.

It is not an idle point, by the way, to understand that in a fiat regime there is a significantly greater latitude in policy decision than otherwise.

That is why central banks wish to maintain a fiat regime, and not to be encumbered by an external standard such as gold.

Once one realizes that it is a policy decision, one realizes that this 'inflation versus deflation" is not about some deterministic outcome based on market forces, but rather on a policy decision, what the governance thinks "should" be done.

Granted the Fed does not have perfect latitude. There are the restraints of law and the Congress, and the necessary cooperation of the Treasury and the banking system.

However, the most legitimate, the least endogenous limitation in a fiat system is the value of the bond and the dollar to external market actors. This is the tradeoff that the Fed and Treasury must make in weighing the outcome of their actions.

All this backslapping and scoring of points between the inflation and deflation 'camps' is particularly obtuse because this monetary chess match is most heatedly being argued about by people who think they are watching a game of ping pong.

Yes we will likely see a deflationary episode in the short term, certainly in prices as the aggregate demand contracts, as the Fed fights the credit collapse. We briefly saw deflation at the trough in 2002, depending on how one chooses to define deflation.

But, make no mistake, the Fed can print money and monetize Treasury debt until the cows come home. Bernanke was not lying when he put his cards on the table in his famous helicopter speech some years ago. He wasn't just trying to fool us as some would hypothesize.

They will monetize debt and 'print money' covertly and quietly because they do not wish to trash the Bond and Dollar, since this is the fuel of their machine.

Economic cargo cultists frequently resort to imaginary restrictions on the Fed, such as they can't do this or they can't do that. Growth in money supply must come from the lending of the private banking system. The Fed "only controls the monetary base" and "doesn't set interest rates."

That is all bollocks. It is playing with words, parsing the truth, Clintonesque.

First, there are some gray areas in the statutes that prohibit the Fed from DIRECTLY buying debt from the Treasury without subjecting it to the discipline of the marketplace, ie. taking through a public auction first. The law is soft on this point, but one might contend it is not necessary to change it if the Fed has one or two banks that are policy captives. We believe they do.

Second, growth in the money supply has to come from the lending of banks, the creation of new debt, only when you have run out of 'old debt' and prior obligations to spending.

Does ANYONE who has been following the fiscal discussions in the US believe that we will run out of debt in our lifetimes? The lending of the banks, the creation of new debt, is a measure of economic vitality in some dimensions yes. But growth by debt creation is NOT the only way for an economic system to function, and it may indeed may not be the best. But regardless, it is not necessary while there is debt that can be monetized, and certainly we have a surfeit of that.

The only limitation on the Fed and Treasury are the Congress and the acceptance of the dollar and the Bond in a fiat regime. Period.

Unless there is some greater conspiratorial policy reason, any net debtor that chooses deflation rather than inflation of the means of the repayment of their debt should have their head examined.

There are those who believe that the US "creditor class" will seek to encourage liquidationism and deflation to protect their private fortunes, created during the bubble period.

This is not actually a bad theory, except that the real creditor class lives in China, Japan, and Saudi Arabia. Since two of them are virtual client states of the US and the third is bound to its industrial policy the status quo seems to have some momentum, despite the best attempts of Zimbabwe Ben and His Merry Banksters to denigrate our currency and their customers' sovereign wealth.

One might suspect that the domestically wealthy (note the distinction between that and 'creditor class') would like to channel the bulk of the inflationary effort into their own pockets and benefits for the bulk of the effort before it stops short of hyperinflation, and then cut off the spending.

Hey, we're already doing that! Isn't it nice to see how things work?

People forget that in many ways this is a replay of the Great Depression, wherein a Republican minority in the Congress, and ultimately the Republican appointees on the Supreme Court, fought the New Deal tooth and nail, to the point of class warfare and a suspected plan to take the country into fascism in sympathy with the industrialists of Germany and Italy.

It was interesting to see the "Chicago School" A Dark Age of Economics making arguments against fiscal stimulus that would be worthy of freshmen economics students. One can make the case that these mighty brains are so highly specialized that they have forgotten the basics. An alternative reason might be a willingness to declare that 2+2=5 if it suits your ideological bias and those who must be obeyed. It was just a tiny bit satisfying to see Krugman and DeLong administer and intellectual beating to these luminaries.

So, as you may have noticed, Jesse is cranky today, and not merely because he was rousted from a warm bed to clear a snow-covered driveway. It is also because this country is in a dangerous, potentially fatal, situation and is suffering from an absolutely incredible, ongoing lack of adult supervision and serious discussion about the basic issues. Deception and spin is no longer an exception, but standard operating procedure.

Right now we are still in a 'credit crunch' which is a predictable (and we did predict it last year and even earlier than that) result of a collapsing bubble. In the very short term it was a liquidity problem, as the system seized, but as that was addressed the true problem is exposed as a solvency, not a liquidity, problem. And that problem exists because those that should take the hit for the writeoffs to resolve their insolvency want desperately to pass it on to someone else, eg. the public. There is still an enormous amount of accounting legerdemain (or would that be "ledgerdemain?")

There is not a shortage of liquidity; there is a scarcity of trustworthy market information in terms of value and risk that is causing a seizure in credit growth from fear. Why take 5% from someone who may already be bankrupt when you can accept a relatively no-risk 2% from the Fed? As the waters reced in this recession one would think the nakedness would be more apparent, except that the Treasury and Fed have been supplying portable cabanas to their favorite emperors, to spare their tender sensitivies and enormous bonuses.

We allow that a deflation can occur. If the Fed raised short term rates to 20% tomorrow and started draining, and raised reserve requirements to 50%, we would see a true monetary deflation in short order. But with regards to the here and now, as opposed to some alternate hypothetical universe, currently The Fed Is Monetizing Debt and Inflating the Money Supply.

We would like to see an intelligent examination of the series of policy errors that created the one decent example of a contemporaneous deflation in a fiat regime, that of modern Japan. Because it would then help people to get beyond it, and consider the other twenty or more examples of countries facing serious inflation or even hyperinflation since World War II. But let's just suffice to say that the problems in Japan were somewhat particular to their situation and it was a genuine policy choice which they made.

We might also make the same errors, or even repeat the errors of the Fed in the 1930 of withdrawing liquidity too precipitously because of a misplaced fear of inflation. But with a Democratic administration and a more knowledgable, almost complacent Fed in place this does not seem probable to us at all.

The country is still drunk on easy money and hubris and preoccupied with bread-and-circuses debate between political and financial strategists masquerading as policy experts, while insiders loot the country.

All this noise serves to do is to distract the nation from a identifying the causes of the current crisis and instituting meaningful reforms to keep us from throwing a quick fix at our latest disaster and setting up another cycle of bubble, boom and bust again.

There can be no sustained recovery in the economy until there is financial reform, and a revival of the individual consumer through an increase in the median wage. Right now consumers are attempting to repair their balance sheets by defaulting on debt. This is not productive in the longer term. And it is a bit of an ironic exercise as well, since the debt is being tacked right back on to the taxpayers through the public balance sheet in the government bailouts.

Why is every solution being addressed to and through the unreformed corporate sector? Is it because the best way to deal with a scandal which you caused is to put your own people in charge of investigating it, and setting the agenda for the discussion of potential reactions to maintain the status quo? Anyone who has been in a large corporation should be well familiar with such an obvious tactic. This is likely a reflection of our distorted economic and public policy infrastructure.

A proper examination of relative value and risk cannot be expected yet until we sober up. Let's hope that happens soon, and not as the result of critically damaging economic and social pain.

Is Money Supply a Relative Absolute?

There has been discussion over the weekend regarding an intriguing blog entry from friend Cassandra Inflation v. Deflation with regard to the Fed's monetization of debt. The principle assertion seems to be that if the Fed is merely replacing existing credit dollar for dollar as it is written off, then the result is not inflationary.

If the original wholesale money market borrowing and lending was not inflationary, then why should its substitute be inflationary? Indeed, the real question is whether the expansion of the Fed's balance sheet is keeping pace with the contraction of money market credit more generally. If not, then the consequence may be deflationary.

Implicit in this of course are two conditions. The first, that the level of wholesale borrowing and lending had not been and would have continued not to be inflationary, and secondly, that the expansion of the Fed's balance sheet is equivalent dollar for dollar with the debt it is said to be replacing.

These distinctions will be lost on most, but they are quite important, and we urge to reader not to gloss over them in preparing a rebuttal to support their bias du jour.

Let's consider an hypothesis someone put to us some time ago. They claimed that the appropriate rate of growth for any money supply is zero, which they considered 'neutral.'

To this we put the question, "If one holds the money supply static for a long period of time in a country whose population is growing at 10% per annum, and GDP is growing at 10% as well, is this a neutral money supply growth rate?

The answer of course is no. Money supply that remains static in a growth situation, whether one measures it in a ratio to economic growth or per capita, is obviously on a deflationary trend because supply is not growing at a rate equivalent to the increase in demand.

Seems obvious in this perspective right? We are not saying it is good or bad, appropriate or not. It is what it is, a growth in money supply that is lagging the growth in demand for money.

Conversely, if money supply is kept static in a country where the population is decreasing, and economic growth contracting, is it neutral? No it is inflationary, since the growth rate of money supply (zero) is greater than the growth rate of the demand for money, which is in decline presumably.

Now, one can imagine all sorts of possible scenarios as exceptions because there are lags in all economic cause and effect. To complicate matters there is no instantaneously correct rate of money supply growth without a context since reality is inherently in a state of flux.

However, though, it is clear that a static money supply is not necessarily neutral compared to the state of the growth of the money supply in a different economic context.

Secondly, we will postulate something we are not quite ready to prove yet, and that is that credit is not the same as money supply. We offer a piece instead that was blogged some time ago in which the various components of money supply are discussed.

Money Supply: a Primer

Its something to consider, and has received too little attention in our opinion.

If you have one thousand dollars in cash, in your pocket, is it completely equivalent to one thousand dollars worth of honey which you have at home in your pantry, in terms of its affect on inflation or deflation?

Forgiving the pun, the honey is decidedly less liquid than the cash.

What if you have one thousand dollars in cash, and another thousand is owed to you by an acquaintance in a distant city who promised to pay it back on demand the last time you spoke to them a year ago. Are those equivalent dollars?

Does it matter who is holding the money? What if the bulk of the money being added to to the economy is being given to gamblers in Las Vegas, rather than lets say farmers in Pennsylvania. Is there a difference in that money's effect on inflation or deflation? Yes there are few differences in the very long run, but sometimes the run becomes so long that it is irrelevant to the policy questions at hand.

This essay does not seek to provide answer to these questions at this time, since this is basis for a new perspective in economics. And unfortunately the discussion is premature. It is rather like a room full of well seasoned drunks, after a week long binge, gathering to attend a lecture on sober thought. We have so utterly lost the conception and relationship of value and risk that we must sober up a bit before we can even think about it once again.

Rather, the purpose of this essay is to cast doubt on the certainty that what we call money is always and everywhere equivalent in force and power and influence as an economic actor no matter where and how it is held.

Having said all that, it is obvious that the Money Supply as measured by the means at our disposal is growing at a rate more significant than economic growth, and that difference is now even greater as the economy slows and contracts. As an engineer and an operational business unit manager we always tend to fall back on what can be measured, what is real and knowable, when theory fails and the bosses are lost in flights of fancy.

The Fed is Monetizing Debt and Inflating the Money Supply

As water is added to the ecosphere, it flows and pools in many places. Money as water in the econosphere is evaporating through debt retirement, but perhaps not through debt destruction, or at least not in the same way. Someone must lose if a debt is written off right? What if that loss is booked at the Fed, and they realize that loss by simply 'making it go away' at least as far as the real economy is concerned? Is there a contraction in the money supply anywhere?

There are all questions worth considering, and we will have much more data as the results of Mr. Bernanke's experiments produce additional data.

But one thing is certain in our minds, and that is certainty in this situation is an illusion. We do not think that even the Fed knows exactly what they are doing. Rather, they are feeling their way through uncharted waters, projecting perhaps a confidence, but this is primarily for effect, not as a genuine state of mind.

And based on first principles, deflation, while possible, is never a certainty in a fiat regime where there is a central monetary authority that holds the power to monetize debt. The only boundary on their power is the acceptability, or value, of the money they produce, and that is also known as inflation.

Obviously the Fed may do a poor job or an outstanding job of managing the nation's money supply and economy. We will not really know until after the fact given the lags in these sorts of machinations.

But what is different, what is dangerous, is that the Fed has grasped the reins of a highly complex system, that is now more global than at any time before, and is trying to pull it in a certain direction, without immediate feedback on what it is that is happening. The last five or six times in which the Fed has done this something 'unexpected' has occurred.

Another factor most do not consider which is of some importance is the potential for systemic reform in the economy that is the context for the actions of the money supply. Without serious financial reform we most likely will take spin on the wheel of boom and bust again, with a greater disparity of wealth and a greater loss of democratic freedoms.

Either state is possible, make no mistake, but the probability is highest that the loss of control will be an inflation, with the key metric being 'how bad' and 'how difficult to subdue once it is unleashed.' Why? Because inflation is the default condition of a fiat currency that becomes uncontrolled. Deflation requires a sustained effort for whatever reasons, generally policy error or a conflict in desired outcomes.

A softer, much more judgemental reason, is that those who are now telling us that inflation is not an issue are the very ones who have been acutely wrong, for whatever reason, since this crisis began, if not years before that. They speak their book, and shamelessly. But that is no determinant, merely a confirmation of sorts.

What concerns us most is that the Fed is quite confident, in their own words, that they know how to deal with inflation after Volcker. That reminds us too much of hubris, and the classical myth of Phaëton who confidently took the reins of the chariot of the Sun from the golden Apollo, and very nearly burned down the world in the process.

The Fed's Game Plan: What Ben Bernanke Is Thinking

Bernanke's game plan is becoming more apparent. Based on a reading of his papers and his public statements, here is a distilled view of what we think is his game plan.

1. Grow the money supply quickly and abundantly

2. Stabilize the Banking System to avoid destructive banking failures

3. Do not withdraw the monetary stimulus prematurely to fight inflation.

4. Manage 'confidence' aggressively to dampen the expectation of inflation later, and a panic liquidation now.

Each of these legs of his policy is a reaction to lessons he believes the Fed learned from the Great Depression.

As you consider the specific things he is doing, it is likely that they will fit very nicely into this framework.

He is obviously fighting the 'last war,' the last great battle that the Fed is known to have waged, and lost. For it did lose, as there was no lasting recovery until the world suffered through the Second World War.

Whether he will be successful or not remains to be seen. It is important to bear in mind that the Fed is absolutely confident that they know how to stop inflation once it gets started, even if it becomes rather serious.

The over-arching theme is that this is an emergency, and so long term niceties like moral hazard and systemic reform will be left for later: the ends justify the means.

William Poole says that this is a dangerous approach, because longer term consequences like inflation appear with a one to two year lag after a significant monetary stimulus such as we have just seen.

The timing of the Fed's dampening of inflation will be critical, and perhaps constrained by the real economy. How can the Fed tighten sufficiently if the real economy remains sluggish?

Bernanke is determined to err on the side of too much stimulus, given the trauma of the Fed's experience in the Great Depression. Coupled with the Fed's confidence in their ability to stop any monetary inflation, this raises a higher level of probability in the most likely outcome of the Fed's latest and greatest monetary experiment.

We cannot help but wonder what he thinks the Fed will be doing this time that will be different than 2003-2007 when they reflated the financial system after a market crash the last time without meaningful reforms, resulting in the stock market and housing bubbles.

Whatever happens, it will certainly provide the raw material for economic papers yet unwritten.

Serious Instances of Inflation Since World War II

Presented here is a summary of the major instances of inflation post World War II.

Although each country had its particular set of conditions and triggers for their painful experience of monetary inflation, the most common thread seems to be unpayable debts due to war or civil and societal dislocation.

Particularly strong labor union movements or protectionist policies against offshoring and imports do not appear to be common factors.

An expanded list with additional countries including the pre WWII era can be found at Wikipedia.

Inflation is the common condition of a fiat monetary system. Less probable outcomes are hyperinflation and deflation, with a serious inflation and disinflation nearer the norm.

Hyperinflation is normally associated with some outlier event in the political sphere and/or a series of policy errors by the monetary authority. Hyperinflation is more common when associated with an external monetary standard, but this is not a prerequisite.

Although not uncommon for a short term (less than one year) after unusual and intense monetary expansion, normally referred to as deleveraging or disinflation, a true deflation is a relatively rare phenomenon, especially in fiat currency regimes, usually attributable to a protracted series of policy errors or intentional actions to contract the money supply by a nation's monetary authority. The most familiar instances of a significant deflation are the Great Depression, particularly in the United States, and Japan during the 1990's.


Angola

Angola went through its worst inflation from 1991 to 1995.

In early 1991, the highest denomination was 50,000 kwanzas. By 1994, it was 500,000 kwanzas. In the 1995 currency reform, 1 kwanza reajustado was exchanged for 1,000 kwanzas. The highest denomination in 1995 was 5,000,000 kwanzas reajustados. In the 1999 currency reform, 1 new kwanza was exchanged for 1,000,000 kwanzas reajustados. The overall impact of hyperinflation: 1 new kwanza = 1,000,000,000 pre 1991 kwanzas.

Argentina

Argentina went through steady inflation from 1975 to 1991.

At the beginning of 1975, the highest denomination was 1,000 pesos. In late 1976, the highest denomination was 5,000 pesos. In early 1979, the highest denomination was 10,000 pesos. By the end of 1981, the highest denomination was 1,000,000 pesos. In the 1983 currency reform, 1 Peso argentino was exchanged for 10,000 pesos. In the 1985 currency reform, 1 austral was exchanged for 1,000 pesos argentinos. In the 1992 currency reform, 1 new peso was exchanged for 10,000 australes. The overall impact of hyperinflation: 1 (1992) peso = 100,000,000,000 pre-1983 pesos.

Belarus

Belarus went through steady inflation from 1994 to 2002.

In 1993, the highest denomination was 5,000 rublei. By 1999, it was 5,000,000 rublei. In the 2000 currency reform, the ruble was replaced by the new ruble at an exchange rate of 1 new ruble = 1,000 old rublei. The highest denomination in 2008 was 100,000 rublei, equal to 100,000,000 pre-2000 rublei.

Bolivia

Bolivia went through its worst inflation between 1984 and 1986.

Before 1984, the highest denomination was 1,000 pesos bolivianos. By 1985, the highest denomination was 10 Million pesos bolivianos. In 1985, a Bolivian note for 1 million pesos was worth 55 cents in US dollars, one-thousandth of its exchange value of $5,000 less than three years previously. In the 1987 currency reform, the Peso Boliviano was replaced by the Boliviano at a rate of 1,000,000 : 1.

Bosnia-Herzegovina

Bosnia-Hezegovina went through its worst inflation in 1993.

In 1992, the highest denomination was 1,000 dinara. By 1993, the highest denomination was 100,000,000 dinara. In the Republika Srpska, the highest denomination was 10,000 dinara in 1992 and 10,000,000,000 dinara in 1993. 50,000,000,000 dinara notes were also printed in 1993 but never issued.

Brazil

From 1986 to 1994, the base currency unit was shifted three times to adjust for inflation in the final years of the Brazilian military dictatorship era. A 1967 cruzeiro was, in 1994, worth less than one trillionth of a US cent, after adjusting for multiple devaluations and note changes. A new currency called real was adopted in 1994, and hyperinflation was eventually brought under control. The real was also the currency in use until 1942; 1 (current) real is the equivalent of 2,750,000,000,000,000,000 of those old reals

Chile

Beginning in 1971, during the presidency of Salvador Allende, Chilean inflation began to rise and reached peaks of 1,200% in 1973. As a result of the hyperinflation, food became scarce and overpriced. A 1973 coup d'état deposed Allende and installed a military government led by Augusto Pinochet. Pinochet's free-market economic policy ended the inflation and except for an economic depression in 1981 the economy has recovered. Overall impact of the inflation: 1 current Chilean Peso = 1,000 Escudos.

China

The Republic of China went through the worst inflation 1948-49.

In 1947, the highest denomination was 50,000 yuan. By mid-1948, the highest denomination was 180,000,000 yuan. The 1948 currency reform replaced the yuan by the gold yuan at an exchange rate of 1 gold yuan = 3,000,000 yuan. In less than 1 year, the highest denomination was 10,000,000 gold yuan. In the final days of the civil war, the Silver Yuan was briefly introduced at the rate of 500,000,000 Gold Yuan. Meanwhile the highest denomination issued by a regional bank was 6,000,000,000 yuan (issued by XinJiang Provincial Bank in 1949). After the renminbi was instituted by the new communist government, hyperinflation ceased with a revaluation of 1:10,000 old Renminbi in 1955.

Georgia

Georgia went through its worst inflation in 1994.

In 1993, the highest denomination was 100,000 coupons [kuponi]. By 1994, the highest denomination was 1,000,000 coupons. In the 1995 currency reform, a new currency lari was introduced with 1 lari exchanged for 1,000,000 coupons.

Israel

Inflation accelerated in the 1970s, rising steadily from 13% in 1971 to 111% in 1979. From 133% in 1980, it leaped to 191% in 1983 and then to 445% in 1984, threatening to become a four-digit figure within a year or two. In 1985 Israel froze all prices by law. That same year, inflation more than halved, to 185%. Within a few months, the authorities began to lift the price freeze on some items; in other cases it took almost a year. By 1986, inflation was down to 19%.

Madagascar

The Malagasy franc had a turbulent time in 2004, losing nearly half its value and sparking rampant inflation.

On 1 January 2005 the Malagasy ariary replaced the previous currency at a rate of one ariary for five Malagsy francs. In May 2005 there were riots over rising inflation, although falling prices have since calmed the situation.

Nicaragua

Nicaragua went through the worst inflation from 1987 to 1990.

From 1943 to April 1971, one US dollar equalled 7 córdobas. From April 1971 to early 1978, one US dollar was worth 10 córdobas. In early 1986, the highest denomination was 10,000 córdobas. By 1987, it was 1,000,000 córdobas. In the 1988 currency reform, 1 new córdoba was exchanged for 10,000 old córdobas. The highest denomination in 1990 was 100,000,000 new córdobas. In the 1991 currency reform, 1 new córdoba was exchanged for 5,000,000 old córdobas. The overall impact of hyperinflation: 1 (1991) córdoba = 50,000,000,000 pre-1988 córdobas.

Peru

Peru went through its worst inflation from 1988 to 1990.

In the 1985 currency reform, 1 inti was exchanged for 1,000 soles. In 1986, the highest denomination was 1,000 intis. But in September 1988, monthly inflation went to 132%. In August 1990, monthly inflation was 397%. The highest denomination was 10,000,000 intis by 1991. In the 1991 currency reform, 1 nuevo sol was exchanged for 1,000,000 intis. The overall impact of hyperinflation: 1 nuevo sol = 1,000,000,000 (old) soles.

Poland

Poland went through its worst inflation between 1990 and 1993.

The highest denomination in 1989 was 200,000 zlotych. It was 1,000,000 zlotych in 1991 and 2,000,000 zlotych in 1992. In the 1994 currency reform, 1 new zloty was exchanged for 10,000 old zlotych.

Romania

Romania is still working through steady inflation.

The highest denomination in 1998 was 100,000 lei. By 2000 it was 500,000 lei. In early 2005 it was 1,000,000 lei. In July 2005 the leu was replaced by the new leu at 10,000 old lei = 1 new leu. Inflation in 2005 was 9%. In 2006 the highest denomination is 500 lei (= 5,000,000 old lei).

Russia

In 1992, the first year of post-Soviet economic reform, inflation was 2,520%, the major cause being the decontrol of most prices in January. In 1993 the annual rate was 840%, and in 1994, 224%. The ruble devalued from about 40 r/$ in 1991 to about 30,000 r/$ in 1999.

Turkey

Throughout the 1990s Turkey dealt with severe inflation rates that finally crippled the economy into a recession in 2001. The highest denomination in 1995 was 1,000,000 lira. By 2005 it was 50,000,000 lira. Recently Turkey has achieved single digit inflation for the first time in decades, and in the 2005 currency reform, introduced the New Turkish Lira; 1 was exchanged for 1,000,000 old lira.

Ukraine

Ukraine went through its worst inflation between 1993 and 1995.

In 1992, the Ukrainian karbovanets was introduced, which was exchanged with the defunct Soviet ruble at a rate of 1 UAK = 1 SUR. Before 1993, the highest denomination was 1,000 karbovantsiv. By 1995, it was 1,000,000 karbovantsiv. In 1996, during the transition to the Hryvnya and the subsequent phase out of the karbovanets, the exchange rate was 100,000 UAK = 1 UAH. This translates to a hyperinflation rate of approximately 1,400% per month. And to this day Ukraine holds the world record for most inflation in one calendar year, which was set in 1993.

Yugoslavia

Yugoslavia went through a period of hyperinflation and subsequent currency reforms from 1989 to 1994.

The highest denomination in 1988 was 50,000 dinars. By 1989 it was 2,000,000 dinars. In the 1990 currency reform, 1 new dinar was exchanged for 10,000 old dinars. In the 1992 currency reform, 1 new dinar was exchanged for 10 old dinars. The highest denomination in 1992 was 50,000 dinars. By 1993, it was 10,000,000,000 dinars. In the 1993 currency reform, 1 new dinar was exchanged for 1,000,000 old dinars. But before the year was over, the highest denomination was 500,000,000,000 dinars. In the 1994 currency reform, 1 new dinar was exchanged for 1,000,000,000 old dinars. In another currency reform a month later, 1 novi dinar was exchanged for 13 million dinars (1 novi dinar = 1 German mark at the time of exchange). The overall impact of hyperinflation: 1 novi dinar = 1027 pre 1990 dinars. Yugoslavia's rate of inflation hit 5 × 1015 percent cumalative inflation over the time period 1 October 1993 and 24 January 1994.

Zaire (now the Democratic Republic of the Congo)

Zaire went through a period of inflation between 1989 and 1996.

In 1988, the highest denomination was 5,000 zaires. By 1992, it was 5,000,000 zaires. In the 1993 currency reform, 1 nouveau zaire was exchanged for 3,000,000 old zaires. The highest denomination in 1996 was 1,000,000 nouveaux zaires. In 1997, Zaire was renamed the Congo Democratic Republic and changed its currency to francs. 1 franc was exchanged for 100,000 nouveaux zaires. The overall impact of hyperinflation: 1 franc = 3 × 1011 pre 1989 zaires.

Zimbabwe

At Independence in 1980, the Zimbabwe dollar was worth about USD 1.25. Since then, rampant inflation and the collapse of the economy have severely devalued the currency, causing many organisations to favour using the US dollar or South African rand instead.

Must Have Titles for the Deflation Section of Your Financial Library

Deflation by A. Gary Shilling (Paperback - 2002)

Deflation: How to Survive and Thrive in the Coming Wave of Deflation by A. Gary Shilling (Paperback - 1999)

Deflation: Why It's Coming, Whether It's Good or Bad, and How It Will Affect Your Investments, Business, and Personal Affairs by A. Gary Shilling, 1998

After the Crash : Recession or Depression : Business and Investment Stategies for a Deflationary World by A. Gary Shilling (Paperback - Mar 1988)

The World Has Definitely Changed by A. Gary Shilling ( Hardcover - 1986)

Is Inflation Ending: Are You Ready? A Sober Look At the Prospects for a Decline in Inflation by A. Gary Shilling and Kiril Sokoloff (Hardcover - Mar 1983)
20 Used & new from $0.01

US Monetary Deflation

There isn't any monetary deflation visible in the data, at least so far.

This is despite the drop in the Consumer Price Index which appears to be driven by quickly weakening aggregate demand, as reflected in the National GDP numbers, in conjunction with a powerful short squeeze in the eurodollar which we have documented earlier that had a dampening effect on key import prices, in particular oil.

Whether a true monetary deflation develops later is another matter. We are still early in this economic downsizing of the financial sector and a massive credit bubble created by lax banking regulation and an over-accommodative Federal Reserve.

Granted there is credit creation outside of the banking system that was and still is significant, particularly with regard to feeding asset bubbles. But the role of the banks has been underplayed in this. The banks, in conjunction with the Fed, were key enablers of this series of credit and asset bubbles we have seen. Fannie and Freddie were bagmen, to borrow an analogy, but the banks were the capos with Greenspan as consigliere.

The growth of credit (indebtedness) is not money supply. It is potential money that feeds into inflationary expectations, most obviously in asset prices and consumption based on debt taken on against inflated assets. Whether my house if valued at $690,000 or $500,000 means little unless one is a speculator, or financing their daily consumption through HELOCs rather than productive growth in the median wage.

Along the same line of thought, the liquidity being added by the Treasury and the Fed to the banking system, reflected in the spike in the Adjusted Monetary base, is not feeding a monetary inflation yet either, but rather a parabolic bubble in Treasuries, and perhaps the Dollar although this is not yet demonstrable given the many degrees of freedom in the calculation.

There is an even more sophisticated linkage, with the expected lags, which we will be exploring in future charts and discussions. But if one considers the percentage growth in money supply and credit shown below against the growth in GDP which is now negative the hand of the Fed and Treasury in the economy is pronounced.

As a warning however, there are lags, and we still will expect a contraction in money supply to show up next year, probably coindicent with a trough in financial asset prices as occurred in 2002.

Consumer Price Inflation Chart from the Propagandaministerium

From the New York Times

Looks like we are experiencing a really serious deflation.

Print faster Ben. Bail out those banks. Do whatever it takes. Save us!




This is from ShadowStats.com

Here is the Consumer Price Index calculated using the sames rules that were in place in 1990 before Daddy Bush, Slick Willy and Junior worked their changes on it.

We like the drop in gasoline prices. We'll like the deflation even more if and when it shows up in healthcare, food costs, tuition, electricity, insurance, appliances, and automobiles.

Until then, be happy and keep eating your government recommended Dog Chow.





We beieve we are seeing significant price declines in key commodities like oil and some building materials. Price and narrow money deflation is a natural phenomenon in periods of swift asset declines, as we had seen in 2002 before the Fed started their reflation which led to the housing and equity bubbles.

But to hold this out as an 'apples to apples' comparison back to 1920, which many will do because it either supports their econo-religious theories, or promotes an atmosphere favorable to the government interventions, is reprehensible.

Bernanke Unleashes the Power of the Monetary Force

The Fed will lead us out of deflation, but how many years will we spend in the wilderness?

Federal Reserve Open Market Committee
Release Date: December 16, 2008
For immediate release

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent. (That's it, we're effectively at ZERO - Jesse)

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.

Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. (TASLF for homes and businesses. Will that be a two-page form like TARP? Can I fill it out online? - Jesse)

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. (Did Ben threaten them with martial law? Or just scare the hell out of them? - Jesse)

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

Nailing our Thesis on Inflation and Deflation to the Door

Apparently some people who divide the world into Inflationistas and Deflationistas took exception to the blog from yesterday which showed most of the usual money measures and noted that we are not seeing any real contraction yet, merely a slowing in growth in some measures.

We should add that we prefer to address inflation and deflation from a money supply perspective, fully acknowledging that there is a dimension called 'aggregate demand.' There is a qualitative difference between a general deflation caused by slack demand versus one caused by a contracting money supply, and vice versa for a general inflation.

It was particularly amusing to see the Adjusted Monetary Base attacked as a standard of the Inflationistas. It was included in our set of charts only because some of those promoting the deflation argument pointed to it as a sign of hoarding, and therefore having a negating affect on the other money supply figures. So we took a look at it both short term and long term. It is in the bounds of normality.

It is the hallmark of a dogmatic or fundamentalist mindset when the same data is used to both attack and defend the same proposition from completely opposite directions.

In a purely fiat regime, a monetary inflation or deflation is a policy decision. That decision may involve restrictions and limitations on the creation of money, a set of artificial boundaries, but that is the extent of it. It is a matter of resourcefulness and will.

You can't make the banks lend. Like hell I couldn't. They would lend or dry up if you used the right policy tools, and they know it. Its all of a choice. Its intent. Lending involves risk, and if you can make decent returns without risk and the policy wonks give you that choice you will take it.

Without a binding external standard the size of the money supply is bound only by the acceptability of one's currency by those with real goods to exchange for it.

Now, just because deflation in the money supply has not yet shown up does not mean it won't. Fiat decisions cut in both directions. As we stated, we know how to cause a deflation with some reliability.

Additionally the alternatives are not between deflation and hyperinflation. The opposite of hyperinflation is a hyper-deflation in which there is an undersized money money, most of it being held by a small oligarchy and is used to control the broader public.

There is a wide middle ground between these two alternatives that is much more probable.

To complicate things there are a number of exogenous events that may significantly impact the dollar in particular. Right now the US dollar is the world's reserve currency and many international trade arrangements, notably oil, are predominantly priced in dollars. This creates an artificial support and demand for the dollar. If this were to disappear, the demand for dollars would likely subside, placing a downward pressure on the optimal money supply levels. But keep in mind that exogenous events can cut both ways, for and against.

By definition exogenous means not able to predict reliably from the model. But this is one of those things we are watching and closely. Will there be a new formal Bretton Woods II? Will the key world players continue accept the Fed as its global currency administrator? One can speculate the possible outcomes and their implications, but not with certainty until something happens.

Having said all that, it would be less than straightforward not to note that inflation is the natural and most probable outcome for a fiat currency unconstrained by an external standard.

What tosses so many is the example of Japan and their persistent deflation following a real estate bubble. The cause of this is a series of continuing policy decisions. Discouragement of consumption, encouragement of exports, a static and aging population that is racially homogeneous and discouraging of immigration. A strong emphasis on savings at low rates. It has been and will continue to be a policy decision determined by one of the most powerful and entrenched bureaucracies in the developed world with a strong commitment to industrial policy and central planning.

We do not wish to be a deflationist or an inflationist: we want to be on the right side of the market as it unfolds. There are people we respect on both sides of the discussion from a theoretical perspective including the more extreme hyperinflation. Roubini and John Williams are at polar extremes for example. What does one do? Look at the data, the arguments and sort them out objectively. Even the great Roubini puts his pants on one leg at a time.

So, we'll try our best to stay out of the religious debates, long on rhetoric and short on thought. Its hard to be an agnostic amongst fundamentalists but its where the scientific method leads us for now.

Some comments from earlier this year on hyperinflation: Hyperinflationary Depression in the US in 2010 - John Williams

Is the Money Supply Contracting?

The bottom line is that although growth is slowing in MZM which is our preferred broad liquidity indicator, there is no indication that money supply growth is cntracting (e.g.negative).

Theories abound. We like to look at the data.

There are various interpretations and we look into almost all of them.

But we like to keep an eye on the data, and skip arguments that are long on rhetorical flourishes and short of hard analysis.

A monetary deflation is possible. A price deflation in response to slack aggregate demand is not only possible it is happening. We are in a recession. Demand is decreasing. And money supply growth should be decreasing in sympathy with that.

We could even tell you how to cause a monetary deflation, and are confident we could do it. Raising short term interest rates to 20 percent would probably do the trick pretty handily. Right now they are a negative number, however.

There are also theories that the banks are hoarding cash and the money supply figures are no longer valid. The money is flowing to Europe and not into the US economy.

Well, we can look into this, but it does not seem to be borne out by anything we have looked at in more than one dimension yet. We have an open mind.

But we're short on economic creationism and long on hard data and analysis in our book.