Chronic Deficit Spending: What is Hyperinflation and Can it Happen Here?

DJH: This is the third installment of my four part series Chronic Deficit Spending; The End of Life as We Know It? In the first part, we answered the question “How Big is It?” and demonstrated how Obama’s deficit spending and taxes would cost as many as 50 million private sector jobs over the next 10 years.

Then we looked at “Who Get’s Hurt?” and saw that while most government and union workers are well protected from the ravages of deficit spending induced inflation, private sector workers, in particular, retiring Baby Boomers stand to get financially decimated if the Obama budget comes to pass.

Popular Photo of German bringing a wheelbarrow of marcs to buy a loaf of bread

Today, I want to talk about an even more serious threat called Hyperinflation, which may sound like really bad inflation, but it’s actually much worst! We’ve never suffered from hyperinflation in the US and quite frankly, I’m just starting to study it myself, so there’s a lot of external sources in this piece.

How is Hyperinflation different than Regular Inflation?

Inflation broadly is defined in terms of a rise in general prices due to an increase in the amount of money in circulation. The inflation/deflation issues defined and discussed here are as applied to goods and services, not to the pricing of financial assets.

In terms of hyperinflation, there have been a variety of definitions used over time. The circumstance envisioned ahead is not one of double- or triple- digit annual inflation, but more along the lines of seven- to 10-digit inflation seen in other circumstances during the last century. Under such circumstances, the currency in question becomes worthless, as seen in Germany (Weimar Republic) in the early 1920s, in Hungary after World War II, in the dismembered Yugoslavia of the early 1990s and most recently, in Zimbabwe where the pace of hyperinflation may have been the most extreme ever seen.

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

Ralph T. Foster in Fiat Paper Money, The History and Evolution of Our Currency details the history of fiat paper currencies from 11th century Szechwan, China, to date, and the consistent collapse of those currencies, time-after-time, due to what appears to be the inevitable, irresistible urge of issuing authorities to print too much of a good thing. The United States is no exception, already having obligated itself to liabilities well beyond its ability ever to pay off (Source: Hyperinflation – 2010).

Recent Hyperinflation Events

• 1922 Germany 5,000%
• 1985 Bolivia >10,000%
• 1989 Argentina 3,100%
• 1990 Peru 7,500%
• 1993 Brazil 2,100%
• 1993 Ukraine 5,000%”

(Source: Professor Lebow, Drexel University)

Who gets hurt the most?

One effect with serious consequences is the reallocation of wealth. Hyperinflations transfer wealth from the general public, which holds money, to the government, which issues money. Hyperinflations also cause borrowers to gain at the expense of lenders when loan contracts are signed prior to the worst inflation. Businesses that hold stores of raw materials and commodities gain at the expense of the general public. In Germany, renters gained at the expense of property owners because rent ceilings did not keep pace with the general level of prices (Source: Economic Library – Hyperinflation).

More from The German story

Although hyperinflation is usually associated with third world countries, the truth is, one of the most extreme cases in history occurred in industrial Germany in 1922. At that point in history, Germany was one of the top industrial powers in the world.

The German hyperinflation illustrates the redistribution that hyperinflation causes in a dramatic way. It eliminated the value of all life insurance policies and all savings left in banks. When life insurance policies were paid in 1923, the value of the check was usually worth much less than the stamp used to post the letter.

The hyperinflation eliminated all debts that existed prior to 1921. For example, the value of German mortgages in 1913 measured in U.S. dollars was about $10 billion; in late 1923 these mortgages were worth only one U.S. penny.

By 1924 the inflation had radically redistributed the wealth of Germany. The segment of society that was hit the hardest seems to have been the middle class. The poor had little wealth to lose while the rich were often able to get their wealth into forms not adversely affected by inflation. Wealth held in foreign bank accounts, gold and precious metals, and land maintained value.

If redistribution were the only effect of inflation, one could argue that it is not a serious problem. Since for every loser there is a winner, society as a whole may break even (if this redistribution is not seen as being too “unfair”). However, inflation also makes ordinary decisions more difficult to make, and it causes people to change their behavior. The changes in behavior, which cause social losses, are again dramatically illustrated in a hyperinflation.

Costantino Bresciani-Turroni argues that the hyperinflation destroyed the wealth of the stable classes in Germany and made it easier for the National Socialists (Nazis) to gain power (Source: The German Nightmare)

Could it happen here?

In many ways, we are behaving much like Germany in the 1920’s. We are printing money at unprecedented rates and even more frightening, our President has put forward a ten-year budget that requires another $10 trillion expansion in the money supply.

In his piece US Crosses the Bernholz Line — Hyperinflation Early Warning Signal, economic historian Peter Bernholz has identified that inflation starts to take on hyperinflationary characteristics some time after the deficits of a country as a share of government expenditure rise above a third and stay there for several years.

According to Bernholz, the great hyperinflations of France, Germany, Poland, Brazil, and Bolivia all occurred after deficits reached that magic percentage or higher (In Bolivia, it reached 91%). The United States crossed over the Bernholz line last year.

Japan is even deeper into the warning despite concerns of many that it has a deflation problem. Ambrose Evans-Pritchard writes:

2010 will prove to be the year that Japan flips from deflation to something very different: the beginnings of debt monetization by a terrified central bank that will ultimately spin out of control, perhaps crossing into hyperinflation by the middle of the decade…

Japan has been [above the Bernholz line]…almost continuously for the last eight years….Japan’s Bernholz index will rise above 50pc this year for the first time, meaning that it will have to borrow more from the bond markets than raises in tax revenue.

Clearly, crossing the Bernholz Line does not mean that hyperinflation is immediately around the corner. It’s an early warning signal. What it does indicate is that a government is having trouble raising money outside of borrowing it. This results in tremendous supplies of new debt that the markets must absorb, pushing interest rates higher, and thus putting enormous pressure on a central bank to monetize the debt.

The specifics of how long after passing the Bernholz Line a hyperinflation kicks in varies greatly. But like a doctor, who detects in a patient the first signs of Alzheimer’s, the prognosis is not good (Source: The US Crossed the Bernholz Hyperinflation Line)

Is Hyperinflation Obama’s Secret Plan?

Okay, I think we can all agree that hyperinflation is a really bad thing. I also think we can agree that Obama is either on a path to bring about a hyperinflation event in the US, or at the very least, playing with fire.

But think about this, everyone I talk to agrees that Obama must know that the US cannot sustain these massive deficits, but what if Obama is not worried about hyperinflation for one very frightening reason. Hyperinflation wipes out all debt! That would include the $14 trillion that Obama and the dems have recently approved. What if Obama is actually counting on hyperinflation to complete the annihilation of the private sector in America?

I’m not a conspiracy theorist, just saying…

Dave

Postscript

Last week the EEU bailed out the nation of Greece, which was on the verge of bankruptcy due to the kind of reckless deficit spending that Obama has been pursuing in the US. Click here to read the story:

Collapse of the euro is ‘inevitable’: Bailing out the Greek economy futile, says FRENCH banking chief

Coming Next — Chronic Deficit Spending: What would Dave do?