A firestorm of criticism has been kicked off recently and squarely aimed at Rick Ackerman. He posted the following missive the other day on his blog that has been met with extreme disdain from Gonzalo Lira of the hyper-inflationist camp and with scholarly criticism from FOFOA. I am posting all three for the a complete overview of Rick’s fallacious reasoning regarding hyper-inflation.
In short, a hyper-inflation is brought on by a collapse in economic activity, not too much. When confidence in an economic system and its currency is lost, assets held in paper go to zero. But, tangible things retain value. Tangible things can and will be exchanged for very short term paper as well as other tangible things to facilitate trade transactions during an economic collapse. Governments response is always to provide liquidity to transact business. Therefore the demand for cash money must come first before supply will be present. Something Ackerman missed in a huge way.
Read on, First Ackerman himself:
Big Gap in Logic Weakens Hyperinflation Argument
[Yesterday’s commentary touched off quite a debate, and so I am running it for a second day to encourage further discussion. However, I am supplementing the essay with a link to one of my favorite bloggers, Charles Hugh Smith, who offers his own, compelling reasons for asserting that hyperinflation is simply not in the cards. Basically, he argues that it would not suit the interests of the rich and powerful, who after all are heavily invested in financial assets that would plummet in value. I have argued the same point, albeit from a different angle, by asking the inflationists to explain why the supposed Masters of the Universe would permit hyperinflation when it would effectively allow Joe Sixpack to pay off his mortgage and all other debts held by the rich and powerful with confetti. Smith’s paper is entitled The Mechanics of Hyperinflation: Bankers vs. Politicos, and it can be accessed by clicking here. He provides a further link to an Austrian analysis that explains why Weimar’s money blowout was quite different from anything that might occur in the U.S. The crux of it is that Germany’s money supply was controlled by the political class rather than by such rich and powerful behind-the-scenes players as created and still control the Federal Reserve. I would ask that anyone who joins in the discussion from this point forward be familiar with Smith’s argument, if not necessarily with the Austrian treatise. Please note that if your additional comments are not published it is because I have raised the bar to eliminate repetition. RA]
I awakened Sunday morning on three hours of sleep, lucid of mind and filled with dread from an essay linked below that I’d read before going to sleep. Amidst the desiccated hell of Colorado’s, and the entire Southwest’s, pine-forest die-off and a disturbingly winterless winter, even my wife still doesn’t get it. She seems to think that because peak real estate valuations have held up so far in our Rock Creek neighborhood, that they will continue to hold or even rise. It’s difficult to say why prices have stayed aloft here in Superior, Colorado, which lies just south of Boulder, about 20 minute from downtown Denver. Most likely, a combination of factors is involved. For one, in comparison to Boulder real estate, where downtown condos with a view of the Flatirons are listing — though not selling — for as much as $3 million, you can buy twice as much house in Rock Creek for half the money. Second, the supply of homes in the development is very tight, since only a few new dwellings were built here in recent years. Third, the schools nearby are rated among the best in Colorado. And fourth, there is the planned Conoco-Phillips campus for research into alternative sources of energy. The company has yet to break ground, but once this project is completed the facility will be a beehive for an estimated 7000 scientists, engineers, consultants and other white-collar workers.
Even so, I don’t believe for a minute that Rock Creek will somehow avoid the deflationary juggernaut that has already crushed real estate valuations across the U.S. by more than 30 percent. I predicted here years ago that home prices would eventually fall by at least 70 percent before deflation ran its course, and I am sticking with that forecast. It implies that even after the wholesale price destruction that has occurred over the last three years, the worst is yet to come.
And yet, for the moment, it is understandable that the hyperinflation argument has been enjoying (if you’ll pardon that word) a bold resurgence – one that has caused even me, a hard-core deflationist who has been writing on the topic since the mid-1990s, to second-guess myself. After all, fuel and grocery prices are rising steeply, and Federal debt — $14.270 trillion and counting – has entered a vertical parabola. While this appears to buttress the hyperinflationists’ arguments, and although Peter Schiff’s scenario – hyperinflation triggered by all-out monetization of T-Bonds – remains plausible in theory, it became quite clear to me, lying awake Sunday morning before dawn, why deflation will prevail – will in all likelihood smother an incipient hyperinflation before it even gets off the launching pad.
Total Collapse in Mere Hours
Let me explain. To begin with, we cannot have a Weimar-style hyperinflation for reasons that will be obvious to anyone who has read Adam Fergusson’s classic on the 1921-23 Weimar hyperinflation, When Money Dies. As Fergusson makes clear, this panic fed off a cash economy, not credit; and it required close collusion between the government and trade unions. In contrast, the U.S. economy is cashless and the unions are widely reviled. That said, let me cut to the chase: Hyperinflation occurs when people, fearing their money is about to become worthless, panic out of currency and into physical goods. This is highly unlikely to happen in the U.S. for several reasons, to wit: 1) Whereas Germany’s hyperinflation took several years to ramp up, today’s financial markets are primed for a catastrophic collapse that could conceivably run its course in a week, if not mere hours; 2) under the circumstances, there would be no shifting of financial assets into hard goods simply because any financial assets one holds at the time of the collapse would become worthless before one could sell them; and, 3) at that point, there would be insufficient currency available to drive a hyperinflation, since mattress money is likely to be scarce and because branch banks keep only about $25,000-$50,000 in cash on hand. All of which implies we will go straight to deflation without the emancipating, hyperinflationary interlude that some mortgage debtors might be hoping for.
Until now, I have been reluctant to air the simplistic argument, used by economists when they are at their most condescending, that inflation implies nothing more than an increase in the money supply. Although that’s a truism that we would not argue with, it holds little value for anyone attempting to predict how a drastic increase or decrease in the money supply might play out symptomatically. While the textbook theory of it could account for the gas-and-groceries inflation that QE1 and QE2 have produced so far, it fails to explain logically how we would go from grocery-store inflation to systemic and pervasive hyperinflation. To repeat: Hyperinflation would require the shifting of cash money into physical goods and assets. But other than mattress money and the relatively paltry sums of cash on hand at branch banks, there would be precious little cash to shift. And if the panicked money is assumed to come out of Treasurys and other paper assets, it begs the question of how much the paper assets will fetch on the day when there are no buyers other than the Federal Reserve.
My argument is simple, and I will not yield ground to any hyperinflationist who fails to explain, if the system collapses, where the money will come from to bid tangible assets skyward. Nor will I even print comments from the flat-earthers who see the financial system somehow muddling along, avoiding a collapse indefinitely. In any event, I would urge you to click here for Jim Quinn’s powerfully persuasive essay if you want to know why a financial collapse is not just likely, but inevitable.
Now here is FOFOA’s response:
Big Gap in Understanding Weakens Deflationist Argument
Last night Rick Ackerman published a piece called Big Gap in Logic Weakens Hyperinflation Argument:
“My argument is simple, and I will not yield ground to any hyperinflationist who fails to explain, if the system collapses, where the money will come from to bid tangible assets skyward.”
Several of Rick’s readers directed him to one of my posts to which he replied:
“Well, I tried. The thoughtful but logic-challenged article you’ve linked, as well as every “pro-inflation” comment in this forum, has contrived to ignore the main point of my essay — namely, that all of that printing press money would have to find its way into the economic system to become hyperinflationary. Please tell me how this would occur. And while you’re at it, explain how hyperinflation would occur if the financial system were to collapse this very evening. Please don’t try to argue that this is impossible.”
Logic-challenged as I may be, it appears that Mr. Ackerman has thrown down the gauntlet here on a very specific question. It is a question that was clearly addressed in my most recent hyperinflation posts, but I will try again to clarify it here. Rick asks:
“Where will the money come from to bid tangible assets skyward?”
I will try to answer this question with the simplest possible answer (Occam’s preference). I will avoid complicating elements like internal versus external dollars and international controls and flows. I’ll just stick to fundamentals, as well addressing his additional challenge:
“And while you’re at it, explain how hyperinflation would occur if the financial system were to collapse this very evening.”
First, the question. “Where will the money come from?” is a question of supply. Yet the answer to hyperinflation lies on the demand side of the equation. This is Rick Ackerman’s big gap in understanding. Let me explain.
The value of money, like everything else in life, derives from supply and demand. There are two distinct entities that each control one side of the equation, kind of like a tug-of-war. The printer controls supply and the marketplace controls demand. A tug-of-war is actually an apt analogy. When demand for a currency spikes its price, the printer just eases his grip on the rope, releases more rope and the whole demand side just falls on its butt.
We saw this with the yen after the earthquake and with the dollar a little over a year ago. With a fiat currency, this is the way it works. No matter how hard demand pulls, if the printer doesn’t want the price of the currency to spike all he has to do is release more rope. It’s his ace in the hole. He can always send the marketplace to its butt. The printer is firmly in control of the supply side.
But in the same way that the marketplace has no control over the supply side, the printer is powerless on the demand side. ANOTHER alluded to this years ago when he wrote:
Know this, “the printers of paper do never tell the owner that the money has less value, that judgment is reserved for the person you offer that currency to”!
So it is the receiver of currency—not the giver—that determines its value. That’s the power of demand. And what do you think happens to the printer when the demand side drops the rope? If he was pulling he falls on his butt. If he was releasing, he’s now pushing on a limp string. And this is part of what confounds deflationists. They can only imagine hyperinflation happening while demand is pulling and the printer is releasing. They imagine “inflation-on-steroids,” but that’s not how hyper works.
The measure of any money’s store of value is a continuum of time. It is directly linked to demand and velocity. Even the worst money (say, Zimbabwe dollars during the hyperinflation) works as a very temporary store of value. Perhaps you read stories about workers in Zimbabwe getting paid twice a day and then running out to spend it before coming back to finish the shift. This is an example of the briefest time period in which currency stores value.
The point is, this is the way collapsing money demand plays out in reality. It plays out as the collapsing of the store of value time continuum scale. And as the time in which a currency stores value becomes shorter and shorter, the currency circulates faster and faster.
So a falling demand = a rising velocity. Likewise, a rising demand = a falling velocity and a longer store of value. And that’s how money demand works. Now let’s look at how the two sides of the supply and demand equation (tug-of-war) can affect the value of a currency.
During stable times money is always in demand, more or less, which gives the supply side (the printer) control over the value of a fiat currency. He can loosen or tighten at will, because the demand side is always, to some extent, pulling on the rope. So during stable and predictable times, it is fair to say that the value of money is primarily a factor of quantity, or supply. Demand for money (or its velocity) is relatively stable during these times delivering (almost) full control of value to the printer—the supply controller.
But during unstable times something changes. The demand side of the equations suddenly takes value-control away from the printer. This is where we are today, and where we have been since 2008.
When the economy is struggling, unemployment high, home prices falling, people are afraid to spend their money. This drives up the demand for money, slows the velocity of money, raises the value of money and lowers the prices of things and assets. Likewise, when the financial markets are crashing, the demand for cash skyrockets while plunging assets bid frantically for dollars. Both of these demand-driven events act just like a large deflation in the money supply as they drive up the value of money and lower the prices of other things.
When this happens, the money printer tries to counter demand by increasing supply. But today, clearly, demand is in the driver’s seat, not supply. That’s because in 2008 we moved from the stable and predictable into the unstable and uncertain.
Now I want you to think about this for a moment. Because everything I’ve been describing so far sounds like deflation. And I have hardly mentioned prices, or the difference between credit money and physical cash, or the difference between luxury items and necessities, or any of the other myriad things that confuse and complicate the issue. And that’s because I’m trying to focus your attention on this one concept. That the printer is no longer in control of the value of currency through the supply side. Instead, the marketplace is now controlling it from the demand side. And so far that has meant mild deflation.
You see, monetary supply and demand can act as exact substitutes for each other. A 50% rise in demand has the same effect as the 50% decline in supply. Or said another way, it takes a 100% increase in supply to counteract a 100% rise in demand. And that’s exactly what we see happening today. A spiking demand for currency because of instability in some markets and the economy, as well as earthquakes and unrest in the Middle East, jacks up the price on the currency exchange and drops the price of other assets which is instantly met with quantitative printing (supply increases) to ease the pain, raise the price of assets, and recklessly counter that which is actually in the driver’s seat today, demand.
Once again, during stable times, supply gently drives demand. During unstable times, demand drives (forces the hand of the printer who controls only the) supply. Did you figure it out yet? During stable times greed allows the printer of the currency to drive its value through supply controls. During unstable (or uncertain) times fear takes the wheel, leaving the printer at its mercy in the back seat.
So what are you afraid of? And what is everyone else afraid of? Could other people’s fears ever affect (or change) yours? What are you more afraid of, running out of dollars or dollars becoming worthless? This is the problem with fear; it can turn on a dime without ANY notice.
Here is part of a comment I wrote on March 15th, following the initial response of the markets to the Japanese earthquake:
Fear is the main emotional motivator in any currency collapse, just like it is in financial market meltdowns. And as we saw even just last night, the herd can stop on a dime and reverse course 180 degrees overnight, from greed to fear, based on a single news item.
The initiating spark of hyperinflation (currency collapse) is the loss of confidence in a currency. This drives the fear of loss of purchasing power which drives people to quickly exchange currency for any economic good they can get their hands on. This drives the prices of economic goods up and empties store shelves, which causes more panic and fear in a vicious feedback loop.
The printing of wheelbarrows full of cash is the government’s response to price hyperinflation (currency collapse), not its cause. This uncontrollable (knee-jerk) government response happens in some cases, but not all. Let me repeat: The massive printing that first comes to mind when anyone mentions hyperinflation is not the cause, it is an effect, in the common understanding of hyperinflation which is the collapse of a currency.
Deflationists like to view the economy as a machine. They think “this money here must reach this quantity and then flow there and only then that will happen.” But the economy isn’t a machine. Machines don’t have emotions like greed and fear, but the economy does.
I can’t say what will trigger the shift from fear of running out of dollars to fear of dollars becoming worthless. It could be anything. It could very likely be Rick Ackerman’s inevitable “catastrophic collapse that could conceivably run its course in a week, if not mere hours”! All I can say for certain is that it will happen fast and unexpectedly at some point. And when it does, the demand side will release its grip on the currency “tug-of-war rope” and run over to the “real stuff rope” and start tugging on that one.
Rick writes (in a comment): “And while you’re at it, explain how hyperinflation would occur if the financial system were to collapse this very evening.”
Okay Rick. If the financial system collapsed tonight and wiped out everyone’s assets, their 401Ks and IRAs, their pension and trust funds, the US dollar would spike on the currency exchange like never before. I could imagine it rising well above 100 on the USDX, maybe even to 150, as all that financial sludge frantically unwinds. As you say, many will simply be wiped out as much lower valuations are imputed onto their 401Ks. They will never see it coming; never get the chance to withdraw that retirement money and use it to bid up real goods. So what? Do you really believe this will cause the dollar’s purchasing power to rise?
What do you think will be the Fed’s response? I’ll tell you. It will make sure that the supply of dollars matches the demand. It will do another emergency $500 billion swap with foreign CBs to calm the foreign exchange market. It will expand its balance sheet once again to make sure there is plenty of liquidity here at home. And it will start buying whatever crap the primary dealers bring to its window. It will flood the markets with fresh Fed liabilities (obligations to print more cash) in a futile attempt to quell demand as the dollar goes to 100, 110, 120… up, up and away.
But no matter what quantity of financial assets are wiped out, the cash in the system will remain. And the obligations for more cash printing will remain. And that’s all the cash it will take to spark the most amazing hyperinflation the world has ever seen, as the fear turns from ‘running out of dollars’ to ‘running out of food’ in the wake of a devastating financial collapse.
In parts two and three of my September hyperinflation posts I explained how the US government MUST respond to a currency collapse by printing more currency in order to keep its stooges doing its bidding. I explained the mechanism by which the hyperinflation will become a physical cash hyperinflation, not an electronic credit money hyperinflation because bank credit money will devalue faster than the cash. And I explained the mechanism by which million dollar Federal Reserve Notes will find their way into the hands of hungry, impoverished and unemployed people on food stamps. Hint: It’s not through credit expansion or rising wages! LOL
Here’s the thing. Hyperinflation is a currency event only. The price of three eggs may well rise to $100 billion as seen in this photo:
But those same eggs will still only cost one apple. This is an important enough concept that you should spend some time thinking about it. There will be shortages. Supply lines will be disrupted. And the relative value of stuff will change. But it won’t change anywhere near the extent to which currency values will change. And if there’s one thing the US has after 30 years of deficit spending, it’s lots of real stuff! Tonnes of it!
I remember when my neighbor had his house foreclosed. He still had four cars, lots of very nice furniture and a quad-runner in the garage. Two of the cars were subsequently repossessed and when I saw him a few months later he was driving a much older car. But the point is, he was not only broke, he was in a negative net-worth hole of several hundred thousand dollars yet he still had all this stuff!
I have another friend who is equally broke yet he has all of the latest gadgets. He has the best digital camera, a nice iPhone, three computers, at least two iPads (he has to get the new one whenever it comes out) and much much more. There is lots of “stuff” here in the States. Lots and lots of it! And much of that stuff will become a secondary currency of sorts when the hunger sets in. That’s how an impoverished, unemployed American will get his hand on the new US$1 billion note. He’ll sell his iPad to a government stooge for a billion so he can buy a loaf of bread!
Think about it. That’s all I ask.
And once again, here are the links to my three “logic-challenged” hyperinflation posts. They are recommended reading by economics professor Dr. Krassimir Petrov. Professor Petrov also recommends one of my older hyperinflation posts from two years ago, a recommendation that I second.
Hopefully I answered Rick’s question with a little dose of fresh understanding.
Rick: “Where will the money come from?”
FOFOA: “It’s already here. You need only understand how hyperinflation actually unfolds to see it.”
(If you can’t see the video, click here.)
Posted by FOFOA at 11:29 PM
And finally, here is what Gonzalo Lira has to say:
“Nothing personal, buddy, you’re just dinner.”
Ackerman’s piece said, in effect, that dollar