Monday, June 22, 2009

The Simple Arithmetic of Hyperinflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The U.S. government inflation figures were out last week. According to official statistics, about as reliable as a pronouncement from Pinocchio, CPI fell 1.3% year over year. This was the biggest drop in 59 years. Core CPI was up 1.8% year over year, so no drop there. Core doesn't include energy and food prices, so the fall in oil prices from last year doesn't fully show up in it. The PPI figures had an even bigger annual drop. Mainstream news articles were filled with remarks about how great it is that the Federal Reserve has lowered interest rates to zero and flooded the economy with money to save us from deflation. I have no doubt that they will be very successful in this endeavor.

While there are still a lot of deflationists out there, I think even they could all agree that if a government has so much debt that its tax receipts could only cover interest payments on that debt, massive inflation would necessarily follow. This would happen because the government would need to constantly print a lot of new money to cover its regular expenses. Few outside sources would be willing to lend to that government. While this is an obvious worst case scenario, the inevitably of hyperinflation takes place somewhat before this situation is reached. Finding that exact inflection point depends on a lot of complicated mathematics involving a large number of factors and is subject to significant interpretation. For that reason, it is not possible to say that the U.S. has already reached it.

Examining the national budget figures for 2009, there is now $3.9 trillion in projected spending. Government receipts (mostly taxes) look like they will come in at $2.1 trillion. Only 53% of expenditures are covered. It is the decreasing coverage of government expenditures by tax receipts that led to the hyperinflation in Weimar Germany. The government had to print more and more money to keep itself running. Five years before their hyperinflation peaked, only 69% of the national budget was covered by taxes (yes, 16% more than is currently the case in the U.S.). Falling below 50% coverage seemed to have been the point of no return for the Weimar government.

What about interest payments on the national debt? In 2008, they were only $412 billion. This was during a time of multi-decade low interest rates that were close to zero for short term bills. Interest rates can't go any lower, but have a lot of room to go up. Everything else being equal, if we went back to the interest rates at the end of the 1970s, interest payments on the current debt would use up all tax receipts. Everything else will not be equal however. Every year the national debt is going to increase substantially and the interest rate needed to use up all tax receipts becomes lower and lower with time. Tax receipts need to rise enough to compensate for that. However, this would indicate a rapidly growing economy, that could easily raise interest rates more than enough to overwhelm the benefits of more taxes.

How can the U.S. government deal with this situation other than cutting the budget drastically (don't hold your breath for that one)? Since it is increasing the supply of government debt rapidly, it needs to increase demand even faster for its bonds. But foreign lenders are backing off. So the only solution is to print even more money, so it can buy even more of its own debt. Now that's going to help keep inflation under control!

NEXT: Stock Market Turns Ugly

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

1 comment:

hyperinflation said...

Thanks for giving such detailed information. According to me hyperinflation is in which entire currency of an economy is discarded or gets replaced.