The Road to Zimbabwe Revisited

“Lenin was right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” [Keynes, 1919]

Inflation expectations appear to be on the rise, and there is increasing speculation from analysts about hyperinflation if the U.S. continues to pursue its current monetary policies to revive the economy. One such article appeared today, which I found thought provoking and deserving of a response: “The Road to Zimbabwe” by Robert Huebscher in the June 23 issue of AdvisorPerspectives.

There is no question that we are going down a path of greatly reduced purchasing power of the dollar. John Williams at Shadowstats provides a great service with more meaningful and factual data that can provide better insight into economic and market trends. However, the economics of inflation are far more complex than the relatively simple view he provides. I would also disagree that the facts he points to imply that we will see such rampant inflation in the next 12 months or less. There could be other facts that do, and we might well experience something extreme, but I don’t follow the conclusion from what’s presented here.

The point is, as Keynes says, that inflation is very complex and truly not one man in a million will be able to properly diagnose and/or predict the effect with any degree of certainty. Points that need to be considered:

• The government’s unfunded liabilities are astronomical, but that’s amortized over the next 75 years or so. How does that factor in to the next 12 months specifically? If we print only the money we need next year, what causes inflation to accelerate faster than it has in, say, the last year or so?
• I would argue all historical currency collapses that necessarily result in hyperinflation have been accompanied by speculative shorting of the currency in a targeted coordinated attack by well financed investors with access to large pools of capital relative to the targeted currency. The printing of currency by a sovereign government generally cannot result in what we would call hyperinflation in and of itself. Where is this speculative attack against a currency with the global volume of the US dollar going to come from? I don’t think it’s possible to leverage enough pools of capital to short the dollar with enough vigor to drive it down into hyperinflation the way Zimbabwe did, or the smaller Asian currencies were in the late 90’s, or Latin America currencies were in a number of examples, or Soros famously did with the British pound. There is no doubt that as reality sets in on the dollar, foreign dollar holders will divest themselves of bonds and dollars, reducing their long positions, but is this enough to hyperinflate the dollar in a way that US consumers experience the result? I don’t think it’s possible, even if we can divine the intentions of notoriously secretive sovereign wealth funds.
• As the dollar weakens, all other nations will inflate as well. They cannot afford to see their exports to the US collapse any more than we can tolerate a collapse of the dollar. So the question has to be asked, what does the dollar collapse relative to? Hyperinflation implies it collapses against the price of bread, gasoline, everything, if not other currencies as well. If it doesn’t collapse relative to other currencies, what does that look like? Will it collapse against all commodities and precious metals? Probably. Will it collapse relative to real estate? Maybe. Who knows? Inflation shows up in various asset classes at wildly different rates. What if gold skyrocketed in value to $5000/oz.? Could the US govt. exchange gold to sop up enough of the money supply to mitigate inflation. It might be able to if it wanted. The velocity of gold is much lower than currency. Devaluing the dollar against gold has been theorized as a mitigating mechanism to shore up the economy, as FDR did in the thirties. Again this is a complex scenario that is not out of the realm of possibility and which impact would be hard to predict.
• Inflation calculations necessarily must include the velocity of money. The higher the velocity, the faster and the greater the inflation. What if the money supply increases dramatically, but the velocity of money continues to decline? What if the vast majority of consumers continue to see their wealth decline and either hoard cash, or the increased money supply can’t find its way into the right hands to create demand in prices across the board? If the vast majority of consumers don’t see increasing dollars in their hands, either through increased unemployment, or declining real wages, it’s hard to say what the results will be. All it takes will be a single asset class to sop up the extra dollars (like gold above), the way foreigners have been sopping them up for the last decade or more in the form of US bonds for the apparent affects of inflation to be mitigated even with accelerated govt. spending. Could we have another asset bubble like Internet stocks that sops up excess cash so it does not flow into consumer prices or prices of imported goods? This is more likely if the increased money supply stays in the hands of only a relatively small number of parties with a low velocity of money. Will Ben drop it from a helicopter or will banks sit on it to bolster balance sheets? Who can predict?
• Which brings me to another point. The vast majority of the money supply comes not from govt. printing excess cash but from bank loans and free flowing credit. This is probably still in the process of contracting, although eventually inflation may overwhelm this effect. Since a dollar on deposit can eventually (maybe years later?) contribute to a 10x increase in the money supply, how are we going to increase the rate of bank loans from what we’ve already seen? Loans are getting tighter, Americans are trying to save more, businesses are taking on less risk. All factors that will continue to mitigate inflation in the near to mid-term.

I would be inclined to agree more with Marc Faber’s view of hyperinflation here on CNBC (below and at: http://www.cnbc.com/id/31450173). It’s probably coming, but it won’t come as fast as the dollar bears predict. It’s a much more complex situation with enormous contrary forces in place than any one person can accurately predict.

Comments

[fathers day gifts]

The recession hits Zimbabwe badly and the government of Zimbabwe publishing a new currency everyday.

[Helen]

To my mind it is a great article.
http://www.pdfqueen.com