Episodes of Hyperinflation from Diocletian to Bernanke - How It Might Unfold Today

Both hyperinflation and protracted deflation are extraordinary economic events. And it is telling that they are much more common in the 20th century and after than in all preceding recorded history. Ah, the joys of modernity.

While prices can certainly increase based on fluctuations in supply and demand, by my definition 'a general price inflation is an increase in the money supply without a corresponding increase in real output causing an increase in general price levels.'

War and other natural disasters and dislocations can cause temporary bouts of severe inflation and deflation, but endogenous episodes of hyperinflation or deflation are almost always the result of policy error in a genuinely sovereign currency, that is, not contingent on an external entity. Although that policy error can be precipitated as a response to some external stimulus, very often unfunded war debts for example.

War is a spectacularly unproductive expenditure, and a nation that engages in continual wars is almost always brought to eventual economic ruin, if for nothing else than overreach.

Hyperinflation is generally considered to be an increase of over 50% in price levels based on a monetary phenomenon. This increase is caused by decisions on the part of the central bank to increase the money supply at a high rate leading to a loss in its value.

Although it is a low probability event I have said that a hyperinflation, since it is a policy decision, is certainly possible in the US dollar. I have spent quite a bit of time trying to assess the probabilities, and in order to do that, one must understand the actual mechanism by which it would occur. I had been unable to find that described elsewhere, except in the most general of terms and the piling on of anecdotal evidence.

Based on my own thinking, the most likely cause of it would be an inappropriate response to a threat to the banks because of an event in the derivatives market which is a major credit bubble, intricately interlocking almost all financial institutions.  Critical Mass: The Mispricing of Derivatives Risk and How the Financial World Ends.

I think there is sufficient room for doubt that the Fed, the President and the Congress would 'do the right thing' for the public rather than their crony capitalists when it comes down to it. They are caught in a credibility trap, and are unable to police or reform the system without indicting themselves.

I have even entertained the thought that a few of the Banks have used their own precarious positions as leverage, a sort of soft extortion, or mutually assured destruction, to fundamentally do as they please. I am not alone in this. Mr. Max Keiser calls them 'financial terrorists,' and in his highly expressive way he may be right.    That was certainly evident in the passage of the TARP.

I would be prepared to say that most of the very powerful businessmen and politicians I have met, with a few notable exceptions, are not very nice people, and as they would themselves proudly attest, not ordinarily human. They tend to the emotional and spiritual depth of salamanders, or gekkos to borrow a meme. Hard to say where they might fit on Maslow's hierarchy. On par with toasters?

It is funny how often a society confuses the accumulation of wealth and power with wisdom and virtue, when history shows it to be most often quite the opposite.

I have often wondered at their propensity to collect beautiful things. Did J P Morgan really enjoy his wonderful collection of manuscripts? Did William Randolph Hearst rise to ecstasy with his art collection? I am sure that I understand Mr. Dennis Kozlowski's enjoyment of his $15,000 umbrella stand. I do have children you know.

Here is a list of some of the more famous episodes of hyperinflation throughout history.

Episodes of Hyperinflation - San Jose State University

Here is my own list of of Serious Inflations Since WW II.

For the specific feel of a hyperinflation, there are few better books than When Money Dies: The Nightmare of the Weimar Collapse by Adam Fergusson. This is a link to an online copy of the book.

Some Common Fallacies About Inflation and Deflation is also worth reading if for nothing else than to find out 'what works' best in such circumstances as a hyperinflation.

And lastly there are my own recollections of a country on the cusp of a hyperinflationary episode, Moscow Memories of 1997.

If there is such a hyperinflationary episode in the US, it will almost certainly be a massive theft of wealth, under cover of some false flag episode or similar story, blaming it on China or Iran, or some natural disaster, for example.

The Fed and the monied interests are unlikely to voluntarily accept responsibility for the disaster, for the same reasons that they are unwilling to engage in genuine reform. The way that the theft of customer funds at MF Global was handled may give you some idea of how it might unfold, except on a much larger scale. You would be fortunate to tithe only ten percent to the monetary powers, the dark rulers of this world, and spiritual wickedness in high places. Their only response is 'more.'

John Williams on the Retail Sales Number - A Brief Interlude on Hyperinflation and Deflation

Although I am still firmly in the stagflation camp, I do allow at least for the possibility of a protracted deflation or a bout of serious inflation, or even a hyperinflation.

Just because something is possible does not make it probable, much less inevitable. I exhausted the subject of deflation, at least to my satisfaction, some years ago. Please do not recommend I read anything more about it. Those who believe it is coming will believe it no matter what, as Gary Shilling has done, with an exquisitely unrequited love, for many, many years.

Deflation is the outcome of a policy choice, nothing more, in an independent fiat currency regime.  So as you can see I am not intolerant of the Modern Monetary Theorists when they repeat what Lord Keynes, and even Friedman and Schwartz, have said for so many years.  It is the 'deficits don't ever matter' meme, wrapped in sophistry, that is cloying. The overlay of state fascism on monetarism is repugnant, and it has been attempted, and failed, several times in the last century.  And it will fail again if it is tried again, as do all Ponzi schemes that fail to conquer the majority of the world.

On the other hand, I am still struggling with the mechanism that John Williams believes makes hyperinflation in the dollar so likely.  I made a study of the forty or so serious inflations since WW II a couple of years ago, and think I understand it.

The difference here is that none of these hyperinflations involved the world's reserve currency, or a country not set upon by the compulsion or after effect of a highly destructive war, or some other exogenous force, or  even a fatal political collapse as in the case of the former Soviet Union. 

I am going to read the paper referenced below again to try and understand why John thinks a hyperinflation fits the case so well here. I still believe it is not probable. But if the American political structure collapses, then it is a different story. But I cannot think how likely that may be, at least for now. It is not that I cannot imagine it; a major policy error in response to a derivatives collapse that threatens the TBTF Banks is one such scenario. A concerted financial attack on King Dollar by a coalition of large economic powers is another. It is just that none of these seems particularly likely at this time.

From John Williams at Shadowstats:

Opening Comments and Executive Summary.

Inflation increasingly is the issue. Looking at February data, where the headline retail sales number put in its strongest monthly showing in six months, headline consumer inflation likely showed its strongest monthly gain in at least 11 months. Higher prices accounted for much of the February sales gain. Whatever gain was left over for the series—net of inflation—was accounted for by unseasonably mild winter weather in much of the country, in the context of ongoing concurrent seasonal factor distortions and normal monthly reporting volatility.

Along with labor data, trade balance, industrial production and housing construction, real (inflation-adjusted) retail sales—as a measure of the physical demand for consumer goods and services—is one of the key monthly economic releases. Accordingly, today’s Commentary is relatively brief, just outlining the nominal (not-adjusted-for-inflation) retail sales detail. A more comprehensive discussion on the latest inflation and economic information will follow in Friday’s (March 16th) Commentary, which will cover February inflation (CPI and PPI) and key economic (industrial production and real retail sales) reporting.

Hyperinflation Watch.

Irrespective of any intervening economic, inflation and financial-market developments, the broad economic, inflation and hyperinflation outlooks discussed in Hyperinflation 2012 of January 25th are not changed...

Critical Mass: The Mispricing of Derivatives Risk And How the Financial World Ends

Jim Sinclair does a good job of explaining the difference between the notional and real value of derivatives, and how that real value comes to bear on the financial system in the event of a default. You can read this here for a review of the basic concept if you do not understand it.

Within my own view of money, uncollateralized financial instruments like derivatives are credits, or potential money. When an event triggers them so that they become real, with a significant presence on the balance sheet and the income statement, then they become money.

In the financial world we see the extraordinary growth of derivatives in notional value, to almost unbelievable proportions. This mass of derivatives facilitates the withdrawal of money from the real economy in the form of wealth transferal, such as bonuses and commissions for example. But they do not become actual money themselves until some trigger event. To perhaps stretch our analogy to the physical world, it could be described as the withdrawal of the ocean, as money is siphoned from the real economy by the financial world, in advance of the arrival of a tsunami as derivatives start hitting the balance sheets and are transformed into 'real money.'

This could be the cause of a hyperinflationary policy error which I have been alluding to for the past several years.  The policy error is not in the simple setting interest rates, but the Fed's failure to regulate the banking system and manage its risks.   In this the Fed, particularly under Greenspan, was an abysmal failure, and improvement has not been forthcoming.

The explosion of the realization of derivatives would create enormous fortunes and unpayable debts. Depending on how the monetary authorities deal with it, the potential for a Weimer experience is there. Nationalizing the banks and canceling the transactions is one way out. Attempting to sustain these mythical financial structures will take the existing currency system down. That is the limit of the Fed's power.

Most theories and models are tested at the extremes of their limits, and I suggest that the coming financial crisis will wash many of the current economic and monetary models away, scouring the detritus of years of conflicting interests and fanciful adornments down to their foundations.   But the responsible parties will all sit back and say, "We did not know."    But of course they did.  They just did not care, as long as it paid them handsomely.

Taking this discussion of derivatives an important step further, the most significant elements of concern in derivatives are the same as they are in all financial schemes: unsustainable leverage and the mispricing of risk.

In derivatives the unsustainable leverage arises from the fact that the impact or risk magnitude of the derivatives, which are often uncollateralized, are artificially reduced by the assumed effects of 'netting.' And the risk is mispriced, not only in the terms of the agreement itself, but in the failure to properly account for counterparty risk as the instrument plays out in a larger risk portfolio. There is individual contract risk, and then there is the cascading risk of a highly compacted financial system.

We see situations today in which a single bank may have a hundred or more trillion dollars of notional value in derivatives on their books, against much less than a trillion in assets.

But the risk in such a large position is allowed because the banks can show that they have supposedly 'netted out' the risk by making other derivative arrangements that offset their own risk, in the manner of a hedge. As the amounts of derivative netting grows larger and more intertwining, the secondary effects of counterparty risk become tightly compressed.

What if a counterparty fails? Then all its own agreements fail, many of which may be hedges that also fail, and a cascading failure of these financial instruments in a tightly compressed and overleveraged system becomes catastrophic.

In 2002 Warren Buffett famously referred to derivatives as 'financial weapons of mass destruction.' But beyond that headline, few in the media took the time to actually communicate what Buffett was really saying, and the risks that the unregulated derivatives markets posed to the banking system.

The collapse of Lehman Brothers threatened to trigger a financial meltdown. A panicked leadership of the country was able to stop it, but at the cost of many trillions of dollars, and a distortion in the real economy that still goes largely unmeasured. And this was by intent, because the leaders feared a loss of confidence in the system. And so while the meltdown was averted, a credibility trap was created that is the epitome of moral hazard.

The influence and knowledge, call it soft blackmail of mutually assured destruction if you will, that the 'Too Big To Fail' banks obtained in this coverup of the depths of the fraud and mispricing of risk in the financial system has given them enormous power over the political process. It would have been more effective to have nationalized the banks and cut the risk out at the source, but the new president Obama was badly advised to say the least, by advisors he himself appointed, who were in fact long time insiders in the creation of the risk situation itself.

The global financial system is like a nuclear bomb. At its center are at most ten banks whose financial posture is overleveraged and interdependent not only amongst themselves but also with their national economies. It is not a question of 'if' they fail, but 'when,' and what is done about it.

The bailouts become geometrically larger given the size and interwoven complexity of the bets. The only feasible solution is to nationalize the banks, keep the real parts of the economy whole, and restart the system in a more sustainable manner. This is essentially what Franklin Roosevelt did in 1933, and to a more limited extent what J.P. Morgan did with the NY banks in 1907. In both instances they dictated terms and made the banks sign to preserve the system.

In the case of the 2008-9 crisis, Bush-Obama failed to dictate terms, and essentially allowed the banks to do whatever they wished to keep going without reforming the system, taking huge sums of money and paying off their bets while maintaining their bonuses and most of their positions. And this was a monumental political failure indeed, and history will probably not be kind.

When the next crisis occurs, there are still a variety of responses. The monied interests will wish to promote another bailout, with harsh terms being dictated to the public, rather than to the banks. This is what is happening in Greece. The terms will be so draconian and unsustainable that state fascism is the most likely longer term outcome. Germany is struggling with that decision today, in light of  bad results in their last two experiences along those lines. 

I am not hopeful that the leaders of the political world will have the resolve to do what it takes to bring the banks back under control, given the power that big money has obtained over our worldly leaders.


Following are edited excerpts from the Berkshire Hathaway annual report for 2002.

I view derivatives as time bombs, both for the parties that deal in them and the economic system.

Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. For example, if you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction, with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration, running sometimes to 20 or more years, and their value is often tied to several variables.

Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter-parties to them.

But before a contract is settled, the counter-parties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands. Reported earnings on derivatives are often wildly overstated. That’s because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.

The errors usually reflect the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid, in whole or part, on “earnings” calculated by mark-to-market accounting. But often there is no real market, and “mark-to-model” is utilized. This substitution can bring on large-scale mischief.

As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counter-parties to use fanciful assumptions. The two parties to the contract might well use differing models allowing both to show substantial profits for many years.

In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.

Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counter-parties. Imagine then that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company.

The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown.

Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counter-parties tend to build up over time. A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. However under certain circumstances, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z.

In banking, the recognition of a “linkage” problem was one of the reasons for the formation of the Federal Reserve System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously-strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. (Such as in the case of AIG for example - Jesse) In these industries, firms that are fundamentally solid can become troubled simply because of the travails of other firms further down the chain.

Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade, and eliminate bumps for individual participants.  (This is the Greenspan argument for example, but he and others went further in fighting any sort of regulation in this area. - Jesse)

On a micro level, what they say is often true. I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others.

On top of that, these dealers are owed huge amounts by non-dealer counter-parties. Some of these counter-parties, are linked in ways that could cause them to run into a problem because of a single event, such as the implosion of the telecom industry. Linkage, when it suddenly surfaces, can trigger serious systemic problems.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so  far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.

As an endnote, it appears that the money in derivatives was too good for even Mr. Warren Buffett to pass up. Berkshire Profit Falls 30% On Insurance, Derivatives.

Netting

Here is a fairly simple financial industry explanation of 'netting.'

"Rather than execute a disastrously complicated web of transactions, swap dealers, and ordinary banks, use clearing houses to do exactly what we just did above, but on a gigantic scale. Obviously, this is done by an algorithm, and not by hand. Banks, and swap dealers, prefer to strip down the number of transactions so that they only part with their cash when absolutely necessary. There are all kinds of things that can go wrong while your money spins around the globe, and banks and swap dealers would prefer, quite reasonably, to minimize those risks.  (Presumably by assuming them away, as in the case of Black-Scholes. Except the assumptions made in netting as compared to the risk handwave in Black-Scholes seem like planet killer class ordnance compared to conventional bunker busters. - Jesse)

An Engine Of Misunderstanding

As you can see from the transactions above, the total amount of outstanding debts is completely meaningless. That complex web of relationships between A, B, and C, reduced to 1 transaction worth $1. Yet, the media would have certainly reported a cataclysmic 2 + 3 + 4 + 5 + 2 + 6 = $22 in total debts.  (But borrowing from Sinclair's description, if a major counterparty in this daisy chain fails, the notional netting can become 'cataclysmic,' and enormous losses can be realized, especially if there are linkages to the commercial credit and banking systems. And this is where 'mark-to-myth' and bailouts come in. - Jesse)

Charles Davi, Netting Demystified

Here is a visual representation of what a Lehman size failure would look like in today's financial markets.

Gold Daily and Silver Weekly Charts - Emperor Agonistes

Gold and silver surged higher today on the expanding troubles in the Middle East, and the faltering US dollar reserve currency. Buying from Asia remains very strong, particularly in China.

I flattened out my positions and am sitting in cash, waiting for another opportunity to enter a trade. As always, I do not touch my long term positions. That was a big move down in the stock indices and a big move up in the metals. No need to tempt fate when both sides of a pair trade work for you.

"Actually as I said what we are experiencing is an ongoing debasement of the dollar and I don’t mean to bang on the same drum, but this is the reality and it is critical for readers to understand this important fundamental. This is why all risk assets are rising in price. The increase in the S&P 500 in this case is a precursor to a potential hyper-inflationary event. This befalls a country which runs such high expenditure to deficit ratios. All things equal, this will end badly.”

Ben Davies, Hinde Capital

As you know I still believe that stagflation is the most likely outcome for the US, as the result of the policy failure created by a credibility trap that prevents the government from making the necessary reforms to its political and financial systems. Hyperinflation and Deflation are both possibilities, but remain outliers for now.

I could definitely see some improbably lunatic outcomes in the States, given the hubris of wealthy purveyors of propaganda and their shills who are leading their sleep-walking electorates to ruin. The US now has the worst unemployment of the ten major developed countries, depending on which deceptive government statistics you might favor.

If there was a double dip and a major depression there is some sizable minority segment of the US public that would either deny it was happening on ideological grounds, or simply fail to notice it was happening until they either starved to death or were overwhelmed by hordes of crazed zombies, as long as the electricity remained on and the mainstream media was continuing to dish out mindless pap for a diversion and corporatist propaganda for the news.

There is a commonplace saying that most conspiracy theories cannot be true and 'fall apart' because of the many people who would have to be involved,  and who cannot be all that clever and also keep things secret. I think that is wrong. Many conspiracy theories fall apart under skeptical and rational examination and factual inquiry. But some do not. The Madoff Ponzi scheme was certainly a conspiracy. What is not known is its breadth, how many insiders there there, and what happened to all the money.

Conspiracies are possible because too many people can be persuaded to become self-delusional idiots and true believers who allow themselves to be badly used by a very few clever men, who themselves are quite capable of making plans and keeping secrets with an impressively ruthless determination. 

And excepting for the inner circle which often quickly flees the scene or remains completely unknown, after a major conspiracy reaches a bad end and is exposed, the majority of those involved will deny that it ever happened, and that they even did the things that they undeniably did.  Or at least, that they never intended any harm, or ever meant to commit  outrageous acts against decency and common sense. And they will be outraged if you dare to hold them to account for their crimes.  And when they are finally forced to see the enormity of their actions for the first time, they are dumbfounded and seek to either skulk away, shrug it off, or remain in obstinate denial, seeking to punish someone, anyone, excepting themselves.

This is the backstory of the US financial crisis, and the credibility trap in which its government and intellectual elite are caught today. 

Weekend Reading - When Money Dies: The Nightmare of the Weimar Collapse - Adam Fergusson

When Money Dies

CFR: China Poised to Shock the Oil Market And Its Possible Consequences for Hyperinflation

I found this paper published by the Council on Foreign Relations to be a plausible argument in favor of the exhaustion of cheap oil, also known as Peak Oil. This growth in Chinese oil consumption into the 'knee of the curve' given its growing per capital income could very well cause an oil shock as the title of the paper suggests. As you may recall it was an oil shock that triggered the stagflation of the 1970's, a black swan event if there ever was one.

The weakness in its logic is assuming that things which happen in one country will necessarily happen in others, based on relatively simple vectors like per capita income. Examples of possible differences are the national infrastructure in roads, deployment of population relative to travel needs and the availability and pricing of public relative to private transportation. Since these are often significantly affected by policy decisions it is sometimes difficult to forecast them accurately.

Notice that China is under running the trends of the comparison countries at current levels. Why would we assume they would start tracking more closely to model once a certain threshold is surpassed? And then there are the growth assumptions for China, which could be optimistic. Extending aggressive trends is sometimes a dangerous forecasting method. It would also have been interesting to see where India fits on this chart.

Most of these factors modulate the timing of the outcome, but not necessarily the outcome itself. So the trend to cheap oil exhaustion remains persuasive; but as we all know, anything can happen, and sometimes it does.

As competition for oil increases it could have interesting effects on currency valuations, inter currency rates, and international relationships.

It was a bit of a coincidence that I had just reread How Hyperinflation Will Happen by Gonzalo Lira. It is a compelling read.

He had asked me to provide some feedback and any possible weakness in his argument, which I did in a comment at his site and in a few email responses.

Here is my edited comment from his site:

Although the scenario of a 'run on Treasuries' is possible as a path to hyperinflation, I do not think it is probable unless there is a significant 'trigger event' to precipitate it. The magnitude of the 'trigger event' required could lessen with time if the US financial situation continues to deteriorate.

Why do I say this? Because the TBTF banks have no incentive to join in the selling if the Fed stands to defend a price in the market. For JPM and Citi it is likely to be suicide to do so. Even the mighty Goldman is unlikely to buck the system, as it were. The NY Fed not only knows where the bodies are buried, it has helped to bury quite a few of them itself.

It took a 'Soros' for example to call the Bank of England out in their support for the pound in that famous incident. I see no such party of sufficient size and inclination now to take on the US Treasury and NY Fed in the debt markets.

I do think a trigger event or incident is possible. I believe it would involve an exogenous party of size, for example China, and an announcement regarding Treasury reserves.

I also think the Treasury run could be triggered by a precipitous decline in the value of the dollar. Note this implies the Treasury run would start on the shortest end of the curve, Fed notes of zero duration. Then the longer end would follow.

Very nice description of such an event, and chilling to say the least. But I think we are some distance from this without a substantial 'trigger event.'

And then I picked up this CFR essay which describes something which might fit the criterion of a 'trigger event.' After all, it was the oil embargo which precipitated the stagflation of 1970's. An oil shock could shake an already weakened US dollar as the trade deficit opened into a yawning chasm.

But I do remain convinced that hyperinflation is unlikely simply because the TBTF banks 'have the Fed's back' which is why they were allowed to continue to remain in business, with substantial subsidies, and grow even larger. All it takes to create a money machine is the Federal Reserve of New York and one or two captive Primary Dealer banks. The dodgy backroom deals are probably more abundant than we realize or suspect even now. And I do not even wish to thing of the loathsome creatures that would enjoy taking advantage of a crisis of this magnitude to further promote their oligarchy and a New World Order.

As a reminder, black swan events like market crashes and runs on banks tend to be on the edges of probability. But they can happen, and are more likely to happen at certain times. Therefore it is potentially fatal to assume that things will always remain the same, and that the big trend changes will never occur.

Council on Foreign Relations
China Will Force the World Off Oil
By Paul Swartz
August 23, 2010

As a country’s per capita income increases, its per capita oil consumption increases. Consumption growth tends to be modest up until $15,000 income per head, but then accelerates rapidly. China is quickly approaching this point. South Korea, which consumes 3% of world oil output, is too small to disrupt oil markets.

China is too big not to disrupt them. Were China’s per capita oil consumption to be brought up to South Korea’s, its share of global consumption would increase from today’s 10% to over 70%. In order to cap China’s share at 22%, which is the U.S. share today, global oil output would have to increase by a massive 13% per annum over ten years – well beyond the 1% growth averaged since 1975.

This rate of growth is inconceivable, even if vastly more expensive sources of supply, such as the Canadian oil sands, were developed at breakneck speed. If China’s recent economic growth pace continues, it will surpass South Korea’s current per capita GDP shortly after 2020 – meaning that the world may be forced onto alternative energy sources much sooner than it realizes.

ShadowStats: CPI-Alt Running 4.3%, Gold $2,382, Silver $139

Something Weimar this way comes?

There is almost no doubt in my mind that we will see these prices of $2382 for gold and $139 for silver. I am just not sure exactly how we will get there, and when. But we should expect the unexpected, or at least that which is not expected by the many.

The gold / silver ratio between those prices is 17, which is close to the historically important ratio of about 16. The legal ratio of gold to silver set in France in 1803 was 15.5, and this was emulated in England and later in the US.

Obviously I am thinking of a possible return to a bi-metallic 'weak standard' through the inclusion of both gold and silver in the basket of currencies that will be replacing the US dollar as a unit of value in international trade. There are also several movements in the developing world to adopt silver for domestic use as a store of value and at least partial backing for their currency when the more prominent fiat currencies begin to hyperventilate. I think these movements will gain some traction as the currency wars intensify.

The current ratio is about 67. I cannot help but feel that silver is going to be simply amazing when its time comes, in part due to the decades of price suppression by US banking institutions.

According to the latest report from Shadowstats:

Alternative Consumer Inflation Measures

"Adjusted to pre-Clinton (1990) methodology, annual CPI inflation was roughly 4.3% in June 2010, versus 5.4% in May, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, was about 8.4% (8.37% for those using the extra digit) in June, versus 9.2% in May.

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS. Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept. Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS.

Gold and Silver Highs

Adjusted for CPI-U/SGS Inflation. Despite another recent all-time high in the price of gold in the current cycle, gold and silver prices have yet to approach their historic high prices, adjusted for inflation. Even with the June 28th historic high gold price of $1,261.00 per troy ounce, the earlier all-time high of $850.00 (London afternoon fix, per Kitco.com) of January 21, 1980 has not been breached in terms of inflation-adjusted dollars. Based on inflation through June 2010, the 1980 gold price peak would be $2,382 per troy ounce, based on not-seasonally-adjusted-CPI-U-adjusted dollars, and would be $7,689 per troy ounce in terms of SGS-Alternate-CPI-adjusted dollars.

In like manner, the all-time high price for silver in January 1980 of $49.45 per troy ounce (London afternoon fix, per silverinstitute.org) has not been hit since, including in terms of inflation-adjusted dollars. Based on inflation through June 2010, the 1980 silver price peak would be $139 per troy ounce, based on not-seasonally-adjusted-CPI-U-adjusted dollars, and would be $447 per troy ounce in terms of SGS-Alternate-CPI-adjusted dollars.

As shown on page 22 in the Hyperinflation report, over the decades, the price of gold has more than compensated for the loss of the purchasing power of the U.S. dollar as reflected by CPI-U inflation, while it has effectively fully compensated for the loss of purchasing power of the U.S. dollar based on the SGS-Alternate CPI."

Curtain of Tragedy Will Be Raised Soon Enough, But Perhaps Not Next in Japan

"Ninety-five percent of Japan's debt is domestically owned. Fickle foreigners have almost no sway. Indeed, Japan's problem is still an excess of savings ." (at abormally low rates of return that serve to subsidize government mismanagement and malinvestment.)

An interesting piece from the Japan Times below, raising the issue of a hyperinflationary collapse of their economy and the yen. As you know, I forecast in 2005 that a new school of economic thought is likely to rise out of the financial crisis which the world is in today. The crisis is certainly not over, despite the government propaganda and economic window dressing that is being applied. Quite likely we have only seen the end of the first Act in what is going to be a three part drama lasting about nine more years.

In particular, the understanding of money and monetary theory is still in its infancy, having been sidetracked by the ideologues in the service of corporatism and big government. In fairness, economics is difficult because there are an enormous amount of variables, and the time lags are highly significant and varied. The fact that economics is a social science with a profound impact on public policy decisions does not help advance academic research. It does seem that the field has a surfeit of economists for hire who often seem to produce studies in order to support pre-ordained conclusions and biases. The average person can only mouth the opinions given to them by television and these studies as 'proofs' of the opinions they hold so dear. Their judgement is easily led in this, since it has no depth.

Economics is a subject rarely taught in the general curriculum. A person reads a few articles by supposedly learned men, and thinks themselves in a position to pronounce broad judgements for or against anything. Those who would appear informed enjoy repeating slogans and cartoons of thought to support their biases, which they themselves do not really understand, but draw emotional comfort from them. The irony is that they are so often arguing nonsense, and against their own best interests. Such is the power of propaganda to hold up caricatures and denounce them, and energize the public to enslave themselves.

Most discussions which I read get the Japanese economic experience all wrong. There is a complete misunderstanding of the roots of their deflation, the bubble as it was occurring, their long deflation and national stagnation, the single party political system and oligarchic economic structure, and the tremendous psychological impact which defeat had on the Japanese national psyche at the end of World War II.

As I have pointed out before, deflation and inflation are part of a policy decision in a purely fiat regime. The bias is to expansion as it is in all Ponzi schemes. People constantly create artificial rules regarding the inability to expand the money supply at will. Their minds cannot accept that something which they value so highly is created out of thin air by the monied interests.

The assumptions one makes when engaging in economic analysis are all important. Data is often sketchy and selective. People take naive examples and extrapolate them into real-life scenarios, crushing their complexity. This is due to the weakness of their model.

I think the field will progress more quickly once some new insights are made, and a new model, or skeleton if you will, is struck that allows the mathematicians to begin to flesh it out again.

For now, at least in my opinion, most economic thought is impoverished since the revolutionary insights of Keynes and so many others in response to the world depression of the 1930's. The jargon that currently passes for knowledge is a sign of decadence. I find all of the schools to offer little more than caricatures of what is a highly complex and richly interactive system.

My personal opinion is that Japan will not collapse until its export mercantilism collapses, or the average age of the overly homogeneous population strangles its ability to maintain a high savings rate and a ready market for government debt at artificially low prices.

I expect the UK and a portion of the european region to founder first, and then perhaps China, which appears to be an enormous bubble, an accident waiting to happen. Its collapse may be a precipitant to collapses in the developed world. The US dollar will have its day to devalue into a reissuance, but perhaps not until Europe and the UK are sorted out first. But the dollar is a doomed currency, the vanity of vanities. All fiat currencies are doomed; they are invariably the victims of human willfulness.

The adulation which the media and financiers had showered on Mussolini and Hitler and their economic recoveries in the 1930's was widespread, as it was for Japan Inc. in the 1980's, and for China today. The crowd always gets it wrong, but it is surprising how often the monied interests and the professionals get it wrong as well, and remain stubborn in their misjudgement until they are overwhelmed by its consequences. Or perhaps that is their intention. Who can say, who can truly 'think like a criminal.' You are a prisoner of reason, balance, and natural restraint. These are creatures of their own appetites, with a hole in their being which one can barely appreciate.

The Bankers will make the world an offer which they think it will not be able to refuse. One currency, and then one government. People being irrational are not likely to take that deal, once again.

There are those who say that they very sure what is coming, what will happen, what the future will bring. For the most part they are speaking out of fear and false pride. The only certainty is that if they really knew what is going to happen, they would cast themselves down from high places in despair.

Grab something solid and hang on to it, and to the faith that sustains you. Do not be distressed if it feels as though the world has lost its reason, and is made blind, and all is deception and trial, for this is part of the process which has begun. If a war comes, then the world will lose its ability to reason in its temporary madness. We are in for a rough ride, and revelations of what is life and what is nothingness, what is true and what is false.

“When pride comes, then comes disgrace. But with disgrace comes humility, and with humility comes wisdom. The humility of the righteous will guide them, but the sly illusions of the proud will destroy them." Prov 11

People will ask, and I can only say that I do not know if this is the end time, as no one can know this. What does it matter, since surely we are all heading towards the last things and a judgement, at our own pace. But it may certainly feel like it is something more general, more momentous, at some point before our blasphemous generation puts itself back into balance with God and nature again, and the crisis has past.

As the song says, "You ain't seen nothing yet."

How to Live Before You Die by Steve Jobs

Japan Times
Government Debt Crisis: Bubble prophet fears new disaster
By REIJI YOSHIDA
March 19, 2010

Economist Noguchi warns soaring public debt may bankrupt Japan, bring back hyperinflation

Prominent economist Yukio Noguchi is one of the few who correctly predicted the collapse of Japan's bubble economy in 1987, warning the preceding euphoria was based on a major distortion in land prices.

Now the doomsday prophet is making another terrifying prediction: Japan is likely to be devastated by a snowballing public debt that will bankrupt its government and trigger catastrophic hyperinflation.

"There is little hope," Noguchi said in an interview with The Japan Times at Waseda University's Graduate School of Finance in Tokyo. "Japan's fiscal conditions are so bad, it can no longer be fixed without causing inflation. I'm very pessimistic."

Noguchi is not the only one deeply fretting the debt.

They may still be a minority, but an increasing number of economists and market players are voicing deep concerns about Japan's fiscal sustainability and fear catastrophe may strike in the near future.

Compared with Greece, Japan's gross government debt is far worse, at 181 percent of gross domestic product — the highest among the developed countries. Greece's debt-to-GDP ratio is 115 percent.

Japan's present debt-to-GDP ratio is only comparable with what it was at the end of World War II. At that time, the only way the government could reduce the debt was through hyperinflation, which wiped out much of the people's wealth with skyrocketing prices.

"I can't tell exactly what will happen (this time), but what actually happened after the war was that the price level surged 60 times in just over four years," Noguchi said.

"If the same thing happens again, a ¥10 million bank account will have the same net value of just ¥100,000 today. It's actually possible," he warned.

The alarmists even include Ikuo Hirata, chief editorial writer of the Nikkei business daily.

Hirata predicts the huge debt will eventually force the Bank of Japan to purchase Japanese government bonds on a massive scale, eroding market confidence and pushing up long-term interest rates.

A rise in long-term interest rates of even a few percentage points would sharply increase debt-servicing costs on the bonds and critically damage the government's already precarious finances.

"The curtain of the tragedy will be raised next year," Hirata warned in a Nikkei article on Dec. 21.

Pessimists like Noguchi and Hirata are still in the minority — at least for now. The yield on 10-year JGBs, their barometer, hasn't indicated any trouble yet.

"Talk of a massive JGB bubble — let alone default — is far-fetched," the Financial Times said in its Feb. 8 editorial titled "Japan's debt woes are overstated."

The editorial pointed out that, for a long time, JGB yields have been effectively fixed at the ultralow level of around 1.3 percent — compared with the 3.6 percent yield on 10-year U.S. Treasury bonds and the 4 percent for its counterpart in Britain as of Thursday.

"Ninety-five percent of Japan's debt is domestically owned. Fickle foreigners have almost no sway. Indeed, Japan's problem is still an excess of savings," the FT said.

"For some time yet, the government will not find it hard to secure buyers for JGBs. Japan's debt problem will be worked out in the family."

But most experts, including those at the International Monetary Fund, agreed that Japan's midterm future is shaky, and that the government could face difficulty financing its public debt in around 10 years.

In a July report, the IMF warned that Japan may find it "difficult" to finance its debt domestically toward 2020 because household savings are expected to keep falling in line with its rapidly graying population and declining birthrate.

Households maintained an average savings rate of more than 10 percent in the 1990s, much higher than in other developed countries. But as the aging workforce started tapping their assets to support retirement life, the savings rate — which supports Japan's fiscal deficit — fell to 2.2 percent in fiscal 2007, according to IMF figures.

Households directly and indirectly account for the financing of at least 50 percent of all outstanding JGBs, mainly through accounts and other assets at banks, Japan Post Bank and pension funds, the IMF said.

The IMF simulation indicates gross public debt could exceed household financial assets as early as 2019, which would likely force the government to seek more JGB buyers abroad, probably with a higher interest rate, since foreign investors in general demand a higher return on bonds than the ultralow 1.3 percent offered by Japan.

"The results indicate that domestic financing will likely become more difficult toward 2020, while other sources of fundings are available, including from overseas," the report said.

Masaya Sakuragawa, professor of finance at Keio University in Tokyo, recently conducted a simulation on the sustainability of the nation's public debt. His conclusion is that the only way to save Japan from bankruptcy is to drastically raise the politically unpopular consumption tax to at least 15 percent — a level he describes as "a rather optimistic scenario."

"If the debts keep increasing at the current pace, there is a possibility that (Japan) will face big trouble in around 10 years," Sakuragawa said.

The simulation examined two scenarios. The first hikes theconsumption tax to 10 percent by raising it a point a year from fiscal 2014 to 2018. The second hikes it to 15 percent, raising it over a longer period, from fiscal 2014 to 2023.

Under the 10 percent tax scenario, the debt expands forever, making sovereign bankruptcy inevitable. But the 15 percent scenario starts bringing the debt to heel in 2025.

Sakuragawa admitted the simulations weren't that realistic because they are based on some optimistic assumptions: that the social security budget won't drastically expand, interest rates will remain low, and the economy will keep growing at an annual pace of 1.5 percent.

The professor argued that a more drastic increase in tax revenues will be needed to save Japan from going insolvent, a crisis he says would wipe out much of the value of JGBs and trigger a domestic financial panic.

"The possibility is high that panic like a run on banks would break out. People would try to withdraw their money, but banks would go insolvent because they wouldn't have enough assets anymore," Sakuragawa said.

According to Sakuragawa, a dramatic rise in the consumption tax is the only viable option. Economists agree that, compared with other taxes, the sales tax would have the least impact on potential economic growth because the burden would be thinly spread to all taxpayers, he said.

Tax hikes, especially in the sales levy, are always a political taboo. When the former ruling Liberal Democratic Party introduced and then later hiked the consumption tax, it took a drubbing at election time. Even the LDP's Junichiro Koizumi — the most popular prime minister in recent memory — pledged not to touch the sales tax for fear of triggering a voter backlash.

"Koizumi should have raised the consumption tax. He had such high popularity, but he still did not want to raise the tax," said a former senior government official who was one of his closest aides.

"Japan's finances are in a stalemate. There will be no way out," he said.

Prime Minister Yukio Hatoyama, head of the ruling Democratic Partyof Japan, has pledged not to raise the consumption tax for at least four years, although key politicians in both the ruling and opposition camps have started discussing the urgency of fiscal reconstruction.

Deputy Prime Minister and Finance Minister Naoto Kan surprised the public last month by floating the idea of starting discussions as early as this month on a sales tax hike.

Kan has pledged to adopt a midterm fiscal policy framework by June and reach a conclusion on "fundamental tax reforms" by the end of March 2012. Market players are keen to see what strategy the government maps out for fiscal reconstruction.

Kan, however, told the Upper House Budget Committee on March 4 that he will stick with an expansionary budget to prop up the economy for at least "one or a few more years." He also said it is still too early in the global slump to start talking of an "exit strategy" to mop up liquidity.

"If we shift to an exit strategy too early, the results will be much worse," Kan told NHK on March 8, signaling that an immediate switch to fiscal austerity could throw cold water on the economy and reducetax revenues even further.

Keio University's Sakuragawa and many other fiscal experts remain skeptical about the government's financial future. He said the public and politicians will avoid taking bold action on government finances until a shock hits the JGB market and starts pushing up long-term interest rates.

"So the scenario that I hope will happen is that Japan will face a minor crisis first, and the people will finally realize that a government bankruptcy will have a catastrophic impact on them," he said.

"Basically, Japanese people are good (at grasping situations). So they will eventually be willing to accept a rise in the tax," Sakuragawa said.

Treasury to Resume the Monetization of the Fed's Programs to Support the Wall Street Banks

"It is impossible to introduce into society a greater change and a greater evil than this: the conversion of the law into an instrument of plunder." Frederic Bastiat

This Treasury Supplemental Financing Program is designed to provide public funds for the Fed's efforts to purchase and then liquidate toxic assets and derivatives from the financial sector, effectively absorbing their losses and monetizing them.

The Treasury creates new notes and sells them on the open market. The money obtained in these sales is deposited at an account at the Federal Reserve. The Federal Reserve uses this money to purchase toxic assets from the banks at its own discretion and pricing, subject to little oversight and market discipline.

Senator Chris Dodd said "the Fed could become an 'effective Resolution Trust Corporation,' purchasing and ultimately disposing of depreciated assets.

It looks very much like a stealth bailout. It is even more of a scandal because of the Fed's resistance to any disclosures on the principles and specifics by which they are allocating taxpayer money.

Where this gets even more interesting is that the Fed in turn is buying Treasury debt after issuance through its primary dealers, debt that was issued by the Treasury to provide funds to the Fed.

Even more than a stealth bailout, this is starting to smell like 'a money machine.' Money machines are what Bernanke euphemistically called 'a printing press.' What is odious about this particular printing press is that the output is being given directly to a few big banks by a private organization which they own.

I believe that it is still illegal, by the letter of the statutes, for the Fed to directly purchase Treasury paper. But in this case, the Fed is buying Treasury paper with money supplied by the Treasury. Since the paper is passing through the marketplace, and the Primary Dealers are taking their commissions, it may be in conformance with the letter of the law. But it looks like it violates the spirit of the law.

And given that in many cases the Primary Dealers are the principal beneficiaries of the subsidy programs, selling their toxic debt to the Fed at non-market prices, this starts to appear like a right proper daisy chain of self-dealing and fraud.

As you can see from the background information below, this is a 'temporary' program from 2008 that the Treasury keeps promising to 'wind down.'

This is not a resolution trust by any measure. One only has to compare what happened with the Savings and Loan Resolution Trust, with the orderly liquidation of assets, losses assumed by the individual banks and their management, and investigations and prosecutions for fraud.

And the bankers involved in the Savings and Loan bubble and collapse were not still in business and giving themselves record bonuses within twelve months of their collapse, and engaging in the same frauds and speculation that led to the crisis.

Wall Street bonuses jumped 17 percent last year
SteveEder and Jonathan Stempel
Tue Feb 23, 2010 2:39pm EST

NEW YORK (Reuters) - Bonuses on Wall Street rose 17 percent last year to $20.3 billion even as the industry faced a public backlash over pay practices.

The rise in payouts, reported by New York State's comptroller, came at a time when Wall Street was recovering from the financial crisis of 2008, which forced a taxpayer rescue of the industry that, in turn, stoked widespread anger across
the United States.

Comptroller Thomas DiNapoli said on Tuesday profit for all of Wall Street could top $55 billion for 2009, nearly triple the previous record year. Last year, the U.S. economy began to stabilize and lenders raced to repay federal bailout money they had come to view as a stigma."

Further, the Savings and Loan bankers were not flooding the Congress with lobbying money to hinder reform of the banking system, and to shift the focus of Congressional discussion to the reduction of legitimate programs like Social Security to finance the public subsidies being given to the very banks responsible for the financial crisis in the first place.

As a possibly related aside, today's US Treasury 2 year auction was unusual. Indirect Bidders had 100% of their bids filled as noted by ZeroHedge.

MarketWatch
Treasury to expand Supplementary Financing program
By Greg Robb
Feb. 23, 2010, 12:01 p.m. EST

WASHINGTON (MarketWatch) -- The Treasury Department announced Tuesday that it is expanding its Supplementary Financing Program to help the Federal Reserve manage its enormous balance sheet. In a statement, Treasury said it will boost the SFA to $200 billion from its current level of $5 billion. The fund had been up to $200 billion but was scaled back when Congress delayed passage of an increase in the debt limit.

Now that an expansion of the debt limit has been signed into law, the department is able to resume the program. Starting on Wednesday, Treasury will conduct the first of eight weekly $25 billion 56-day SFP bills to restore the program. The department said it will then roll the bills over. "We are committed to work with the Fed to ensure they have the flexibility to manage their balance sheet," a Treasury official said.

September 17, 2008
HP-1144
Treasury Announces Supplementary Financing Program

Washington- The Federal Reserve has announced a series of lending and liquidity initiatives during the past several quarters intended to address heightened liquidity pressures in the financial market, including enhancing its liquidity facilities this week. To manage the balance sheet impact of these efforts, the Federal Reserve has taken a number of actions, including redeeming and selling securities from the System Open Market Account portfolio.

The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives.

Calculated Risk
Treasury to Unwind Supplementary Financing Program
11/17/2008

One of the credit indicators I was tracking was the activity in the Treasury's Supplementary Financing Program (SFP). This was the Treasury program to raise cash for the Fed's liquidity initiatives.

Once the Fed started paying interest on reserves, the supplemental financing program wasn't needed any more to sterilize the expansion of the Fed's balance sheet. The Treasury announced today that the program will be unwound...

As it should be obvious, these guys cannot give up the needle on their own.

What is a "Nominal" Stock Market Chart Versus a "Deflated" View?

Lots of interesting questions in the email bag over the weekend.

A reader asks 'What exactly is a nominal or artificial stock market rally as you use the terms?'

Nominal is used to mean "being such in name only; so-called; putative." This is an example of a nominal, or artificial stock market rally that someone had posted over at Alphaville earlier this year. (Hat tip to Rasputin of WSB for reminding me of where I had seen these charts.)

The Zimbabwe Industrial Index



I would have preferred a logarithmic chart for this extreme view of a hyperinflation in action, because the final moonshot tends to crush the detail of the prior action by skewing the scale so high. Still on the surface that looks pretty good right? Enough to get Jimmy C. to pound some teak on the table on Mad Money?

Another way to show the detail is to deflate the nominal chart.

The 'deflated' view is when you take the index and show what its value would be in terms of some other value, in this case the US dollar.

The Zimbabwe Industrial Index Deflated by the US$



Here is an example of the SP 500 viewed from two perspectives.



"Oh this is all very well and good Jesse, but when I go to the grocery store or to the gas station or the convenience store to buy my instant Lotto tickets I pay in dollars and not gold or euros."

Yes, but when your suppliers go to buy their goods that are imported, they pay in dollars that are depreciating. You know that some prices are moving higher despite slack demand overall. This is what we call 'selective inflation.' This is how it starts.

The trick of course is to get off Bernanke's monetary hamster wheel. If you are not in the US, reducing exposure to the dollar is more straightforward. If you are a Yank, then generally you would look to add exposure to contra dollar hedges to lessen your currency risk. You might also wish to begin to secure some essentials for your future.

Having said all this, as you may recall we are dubious on the hyperinflationary and severe deflationary scenarios for the US. It seems that a severe 'stagflation' is most likely based on current policies. Obama and crew are inflating the currency, but it is selectively being applied to the FIRE and Health sectors, resulting in a very slack stimulus to overall employment and the median wage.

The worst of both worlds: Inflation and Unemployment.

This is the policy mistake made by Japan in trying to reflate a status quo that was broken beyond all sustainable repair. But what can you expect when you reappoint the same team of Timmy and Larry to key economic positions, the crew that started the mess in the 1990's under Robert Rubin?

Continuity of error you can believe in, it appears.

Some Common Fallacies About Inflation and Deflation: the Weimar Nightmare in Review

There are several fallacies making the rounds of the economic community, often put forward by pundits on the infomercials for corporate America, and also on the internet among well-meaning but badly informed bloggers.

The first of these monetary fallacies is that 'the output gap will prevent inflation.' The second is that a lack of net bank lending or other 'debt destruction' will require a deflationary outcome. Let's deal with the output gap theory first.

Output gap is the economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.

The theory is that when GDP underperforms its potential, with unemployment remaining high, there can be no inflation because demand is weak and median wages will be presumably stagnant. This idea comes from neoliberal monetarist economics, and a misunderstanding of the inflationary experience of the 1970s.

The thought is that sustained inflation is due to a 'wage-price' spiral. Higher wages amongst workers cause prices to rise, prompting workers to demand higher wages, thereby fueling inflation. If workers do not have the ability to demand higher wages there can be no inflation.

While this is in part true, it tends to confuse cause and effect.

The cause of a monetary inflation, which is a broadly based inflation across most products and services relatively independent of demand, is often based in a monetary expansion of the currency resulting in a debasement and devaluation.

A monetary expansion is relatively difficult to achieve under an external standard since it must be overt and often deliberative. A gradual inflation is an almost natural outcome under a fiat currency regime because policy-makers can almost never resist the temptation of cheap growth and the personal enrichment that comes with it.

There can be short term non-monetary inflation-deflation cycles that tend to be more product specific in a market that is not under government price controls. But this is not the same as a broad monetary inflation or deflation.

The key difference is the value of the dollar which has little or nothing to do with a business cycle or product demand/supply induced inflation/deflation.

In the modern era the Federal Reserve can increase the money supply independent of demand by the monetization of debt, with the only restrictions on their ability to increase supply being the value of the dollar and the acceptability of US sovereign debt. This requires the acquiescence of the Treasury and the cooperation of at least one major money center bank.

People tend to invent 'rules' about how the money supply is able to increase, and confuse financial wagers and credit with money. This is in part because the average mind rebels at the reality behind modern currency and the ease at which it can be created. Further, people often invent facts to support theories that they embrace in an a priori manner.

In a pure fiat currency regime, the swings between inflation and deflation are almost always the result of policy decisions, with the occasional exogenous shock. A government decides to inflate or strengthen their money supply relative to productivity as a policy decision regarding spending, central bank credit expansions, banking requirements and regulations, among other things.

As a prime example of a rapid inflation despite a severe economic slump, what one might call uber-stagflation, is the Weimar experience.

Since pictures are worth 1000 words, let me be brief by showing you a few important charts.

The basic ingredients of the Weimar experience are...

A high level of official debt issuance relative to economic growth

High unemployment with a slumping real GDP



Wage Stagnation



I should stop here and note that although the statistics at hand involve union workers, in fact unemployment was widespread in the Weimar economy. The saving grace of being in the union was that one was more often able to retain their jobs and some level of nominal wage increases.

Anyone who has read the history of the times knows that unemployment, underemployment and slack demand was rampant, and that hoarding was commonplace as people refused to trade real goods for a rapidly devaluing currency.

Rapidly Rising Prices Despite Slack Demand and High Unemployment



So much for the wage price spiral and the output gap.

A Booming Stock Market, at Least in Nominal Terms



Booming Price of Precious Metals as a Safe Haven Even While Basic Material Prices Slumped

Notice the plunge in the price of copper as the economy collapsed and gold and silver soared.

If one can obtain a copy, as it is out of print, one of the best descriptions of the German inflation experience is When Money Dies: the Nightmare of the Weimar Collapse by Adam Fergusson. There is a copy of the book available online for free here.

From my own readings in this area, the people who tended to survive the Weimar stagflation the best were those who:
1. Owned independent supplies of essentials including food and shelter and were reasonably self-sufficient.
2. Had savings in foreign currencies that were backed by gold such as the US dollar and the Swiss Franc
3. Possessed precious metals
4. Belonged to a trade union and/or had essential skills or government position which guaranteed a wage
5. Were invested in foreign equity markets, and even in the domestic German stock market for a time

People will argue now that the Fed understands that inflation is caused by perceptions, and that by managing those perceptions inflation can be avoided because even those prices are rising and the currency is being devalued, if they ignore it the inflation cannot reach harmful levels.

This is what I call the "psychosis school" of behavioral economics.

Granted, perception is important, and managing perception may delay outcomes for a period of time. But unless the underlying cause of the problem is remedied during what is at best is an extended interlude, the resulting break in perception will ignite a firestorm of cognitive dissonance, loss of confidence, and social unrest.

In summary, in a purely fiat currency regime a sustained monetary inflation or deflation is an outcome of policy decisions regarding fiscal policy, monetary policy, and economic balance and output.

As long as the government is able to generate debt, deflation is a highly unlikely outcome. And when the government reaches the practical limits of debt creation, the underpinnings of the currency give way and the economy tends to collapse in a stagflationary slump.

There are no predetermined outcomes in a fiat monetary regime. Deflation, stagflation and hyperinflation are not 'normal' but are certainly possible if the central authority is permitted to abuse the real economy and the money supply for protracted periods of time.

What about Japan? Japan is the perfect example of a policy decision made by a fiat currency regime in what was decidedly NOT a free market, but under the de facto control of a highly entrenched bureaucracy, a single political party, and large corporate giants in pursuit of an industrial policy that favored exports and domestic deflation.

The difference between the Japan of the 1980s and the US of today could not be more stark. Choosing a deflationary policy and high interest rates as a debtor nation is economic and political suicide. It would be interesting to see what happens if the US elites try to take that path.

We will know if there is a true monetary deflation in the US because the value of the dollar will start increasing dramatically with regard to other hard assets, other currencies, goods and services, and precious metals and commodities. Prices will decline especially for imports as the dollar gains in purchasing power.

Remember that a true monetary inflation and deflation would only show up over time. Even in the Great Depression in the US, as demand slumped and prices fell, the stage was set for a significant devaluation of the US dollar and a rise in consumer prices well in advance of the eventual recovery of the economy that caused the Fed to tighten prematurely. As I recall the actual contraction in money supply lasted two years. This again highlights was an amazing piece of bad policy that Japan represents in its 'lost decade.'

People embrace beliefs for many motivations. So often I find they are not 'rational' and based on a scientific study of the facts, even on the most cursory level. Fear and greed and prejudice are often motivations that are surprisingly resilient, even in the face of overwhelming evidence against them. Leadership understands this well.

There are often appeals to private judgement. I do not care what you say, this is what I believe, what I think, what I feel. This is appropriate in the supra-natural realm, but in the natural realm there may be private judgement but the facts are public, and the outcomes are well beyond the complete control of the most fully-managed perceptual campaigns, at least so far in human experience.

"The lie can be maintained only for such time as the State can shield the people from the political, economic and or military consequences of the lie. It thus becomes vitally important for the State to use all of its powers to repress dissent, for the truth is the mortal enemy of the lie, and thus by extension, the truth is the greatest enemy of the State." Joseph Goebbels, of the perception modification school of economic thought

What is truth? It is difficult to estimate but not completely out of reach.

Our own view is that a serious stagflation with further devaluation of the US dollar as it is replaced as the world's reserve currency is very likely, after a period of slackening demand and high unemployment. A military conflict is also a probable outcome as countries often go to war when they fail at peace.

Weimar was not an anomaly although the level of inflation was indeed legendary. Argentina, post Soviet Russia, and most recently Zimbabwe are all similar examples. Serious Instances of Monetary Inflation Since World War II

There are many, many variables in play here, and policy decisions yet to be made. It is highly discouraging to see Obama's Administration fail so miserably to do the right things, but there is always room for hope, less so today than six months ago however.

Argue and shout grave oaths and wave our hands though we might, we are in God's hands now.

Let's see what happens.

A very special thanks to our friend Bart at Now and Futures who makes these charts, among other things, available on his highly informative web site for public review. If you are not familiar with his work you might do well to view it. We do not always agree, but he demands attention because of the rigor which he applies to his work for which we are grateful, always.

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.