Hyperinflation v Deflation

There’s has been a lot of talk about which way out of the debt mess Western economies will take. People often confuse “hyperinflation” with “inflation” — but the two are quite different phenomena with different root causes. Hyperinflation and deflation are both caused – at core – by insolvency – too much debt, not enough in assets to cover the debt, and no possible way of growing into the debt. And what both hyperinflation and deflation share is that both are non-self-correcting. Both create a vicious circle where the monetary system completely separates itself from the monetary needs of the rest of the economy — and either debases itself into irrelevance or crushes the real economy.

Figuring out whether Western economies have in fact reached that point of no return (regardless of whether we realize it yet or not) is one of the most critical tasks every investor must now undertake. Because if we have reached that point, then figuring out which of those options will be the way out is the most critical portfolio allocation task. And if we haven’t reached that point or won’t reach that point; then a portfolio should be allocated completely differently.

I don’t really know whether we have reached that point. I do know that unless the US and Europe take massive action within the next five years or so, that we will definitely reach that tipping point by then. And I don’t see much “massive change” on the horizon. So for practical investment purposes, I think the answer to “Have we (US/Europe) reached a tipping point where the only way out of insolvency is hyperinflation or deflation?” is a “pending/conditional yes”.

Given that – how will the US get out of it?

The decision that countries make to “get out” of the mess depends ENTIRELY on who has the power and on who is the threat (by that I mean a literal hang-them-from the-trees threat) to that power — creditors or debtors.

In early 1920’s Germany, the threat to the Weimar Republic was not the Versailles Treaty creditors (France/Germany/Britain) – but the mass of Germans – left and right – who did not believe in democracy and who believed the debt was illegitimate and that the Weimar Republic was itself illegitimate if it tried to pay that debt off. So Weimar hyperinflated and destroyed its money (attempting to counter the first threat by making others beneficiaries of hyperinflation); then crushed the German economy in the various on-off cycles of “reparations debt renegotiations” to foreigners — and ultimately destroyed itself and the German economy and fell apart to a force that reneged on the foreign debt — and ultimately fought WW2.

The hyperinflationary experiences of South America and Zimbabwe also share similarities:
1. a government that chooses hyperinflation in order to benefit some debtors within society
2. because the government is itself threatened by internal civil war or revolution if it (government or, technically, whoever owns the monopoly over money) fails to alter the forces of support/opposition via hyperinflation
3. and creditors are foreign or otherwise viewed as “outside” the society that matters to those in power and furthermore are viewed as weak/illegitimate/ unwilling to go to war/ etc
4. and that the debt itself can be perceived/marketed/positioned as “illegitimate”.

What really surprises me about these conditions is how unlike they really are to the US today. Yes, much of the current debt is held by foreigners but there is virtually no sense among Americans that the debt itself is illegitimate. And zero sense that the future liabilities which will become debt within the next decade or two are illegitimate.

Further, the vast majority (close to 100%) of the current/future expenditures of the government are simply recycled subsidies to domestic creditors. Interest payments are an obvious example. But “defense spending” is mostly the means of delivering a subsidy to those large multinationals/banks who view the role of government as nothing more than providing them with an advantage against smaller domestic competitors and/or larger foreign competitors. SS/Medicare are simply income subsidies (based on age) given to the domestic demographic with the highest net worth in order to induce them to stop working. And there ain’t much else in the government budget.

In other words, in Western society – with the nature of today’s debt loads – there is no disconnect between government creditor and government debtor. The recipients of government expenditures have a huge vested interest in deflation. They benefit immensely from deflation both because their net worth has more purchasing power over time – and because the income subsidies they receive have more purchasing power. If foreigners sell the government debt they own; it will be gobbled up by domestic creditors with only a minor change in interest rates demanded.

Those who would benefit from hyperinflation (those with no assets who only have their time/labor (which expires if not used and thus can’t accumulate in surplus) to offer) — or repudiation of the debt and all payments on it entirely (the young for whom the debt is entirely illegitimate – a payment to the past not the future which they did not even experience or approve) are irrelevant in today’s society.

I have changed my mind on this over time. Used to think that hyperinflation was the inevitable way out. But until such time as a serious revolutionary type threat emerges – which will be intergenerational in nature; then I just don’t see much possibility of hyperinflation being chosen as the way out. And I don’t see that type of threat on the horizon either.

This is not to say that the upcoming period will be a deflation where the creditors want a currency that is as stable as gold. That ended a long time ago — and in large part is buried precisely because government has discovered different ways to reward long-term creditors (ie via direct income payments to them or on their behalf after a certain point in their life).

But the basic trend in US and European society is likely to be deflationary. We are going to turn Japanese. any “inflation” will mainly be for the purposes of disguising the underlying deflation – rather than for the purposes of repudiating the underlying debt. We are going to mortgage the future for the present/past. Because we can. And that will persist until such time as those who care more about the future than about the present/past are willing to repudiate the present/past — by violence most likely.


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