A New Theory of Sudden Hyperinflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


While everyone acknowledges that governments are printing and printing excess amounts of new money, more market observers are currently worried about deflation rather than inflation. There is a smaller group concerned about hyperinflation, but the theoretical underpinnings have been missing up to now that would justify how this could be possible. There is an explanation though and this indicates that hyperinflation can not only take place, but that is can happen suddenly.

There have been a number of impediments in how economists look at hyperinflation that have prevented original thought (and sometimes any thought at all) in this area.  Here are the necessary ideas:

1. Inflation is a currency losing its value (an idea most mainstream economist can't seem to grasp).
2. Severe deflation is a precursor to hyperinflation. They are not inconsistent events as is generally thought, but deflation sets the stage for hyperinflation.
3. Disinflation/deflation and inflation need not by symmetrical. For instance, if there is 30 years of disinflation, this doesn't have to be balanced by 30 years of inflation. The same amount of inflation could take place in only months or even weeks, let alone 30 years.
4. Inflation doesn't have to be a continuous phenomenon. The chart can have gaps in it with prices going up significantly overnight. Furthermore this can start from a low point where almost no inflation exists.

The origins of hyperinflation are with excess 'money' printing by a government. It is not possible to produce an ever-larger amount of currency and have each unit of that currency maintain its value. If it were, real money could be created out of thin air and everyone in the world could become infinitely rich overnight. This would also violate the basic laws of arithmetic. So excess money printing always devalues a currency and because of this less and less can bought with each unit of that currency.

This becomes a potentially dangerous problem when severe deflation takes place because of a shock to the financial system (the Credit Crisis for instance). To make up for the loss in value of assets (deflation), the government prints a huge amount of money. The printing causes devaluation of the currency and requires more printing to try to make up for the additional loss of value. A self-feeding money printing cycle then develops.

Even though huge money creation has occurred because of the Credit Crisis, we still haven't seen significant inflation yet. Indeed, the American government claims the U.S. inflation rate has fallen close to zero. How is this possible? The answer can be found in the banking system. The feds have pumped huge amounts of money into it (U.S. bank reserves have increased approximately 100 times or 10,000% since the Credit Crisis began) and banks have received this money at close to a zero percent interest rate.  Yet, if you look at commercial and consumer bank lending, you will see that they have been declining. So where did all this money go?  It was used to buy treasuries and this is what is allowing the federal government to fund its massive deficits. For all intensive purposes, this is a massive Ponzi scheme being run by the U.S. government.

Ponzi schemes though don't follow the same rules as normal businesses or economic statistics. They build to a crescendo over time and then suddenly collapse to zero instantly. The analogy for inflation will be the opposite however. Inflation will go to zero and then suddenly jump up to some very high level. In theory, zero interest rates should produce infinite inflation (hyperinflation), but nothing mandates that this has to be a gradual, long-term process. If you think about it, the Credit Crisis seems to have come out of nowhere. It didn't of course; there was a slow, long-term build up behind the scenes that just exploded suddenly. Inflation is likely to follow that same path of development. Global governments eventually got control of the Credit Crisis collapse by throwing trillions of dollars at the problem. That solution however won't work for dealing with inflation.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

The U.S. Imports Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


U.S. import price data for January indicates a rise of 1.4% from December and a 11.5% rise year over year. The price rise in January was the sixth one in a row. Higher energy prices were the major cause of both the monthly and yearly increases. The implications are inflationary.

Prices for imported oil were up 4.8% in January (the U.S. imports approximately two-thirds of its oil). Non-fuel imports were up 0.4%, led by a 1.5% price increase in industrial materials. Metals and chemicals were responsible for most of that rise. The price for foods, feeds, and beverages were up 1.3%. The report clearly indicated that commodities were responsible for almost all of the rise in U.S. import prices in January. Since all commodities are priced in U.S. dollars and the dollar rallied 0.7% during the month, the jump in import prices could have been worse - and will be if the dollar continues selling off as it did for most of 2009.

There was indeed a stark contrast between price changes for commodities and manufactured goods in January's report. Consumer goods were up only 0.2%, while capital goods and automotive vehicles decreased by 0.1%. Inflation has yet to filter into manufactured goods, which are at the end of the chain for price increases. Commodities are at the beginning. The report also indicated significant drops in air fare and air freight prices, both of which will reverse if oil prices stay high.

Over the last year there has been a dramatic change in the inflation picture based on import prices. Year over year price changes were negative and dropped each month from January to July 2009. Yearly prices decreased 12.5% in January and were down 19.1% in July. Since then, a major reversal from deflation to inflation has taken place. In November the yearly import price change became positive and was up 3.4%. It increased to 8.6% in December. In only six months from July 2009 to January 2010, the yearly change in U.S. import prices went from -19.1% to +11.5%. These are truly shocking figures.

In the last month, central banks have indicated they are starting to worry about inflation - China increased required bank reserves twice, the U.S. Fed halted five Credit Crisis liquidity programs and the Bank of England paused its quantitative easing (read money printing) program. All in all though these actions are merely very minor adjustments in monetary policies that are still highly expansionary. Inflation takes years to work its way through the financial system and by the time it is recognized, it is well-entrenched and it is too late to stop it without taking drastic action. Investors should consider the U.S. import price figures as a warning of things to come.

Disclosure: None

NEXT: Gold Down on IMF Sales, Then Up on Inflation

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

China Worries About Inflation, The EU Needs to Worry About Growth

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The Chinese just announced a second increase in reserve levels for their banks. The first increase took place less than a month ago. That announcement was the earliest of three major withdrawals of liquidity from global markets. The other two were the U.S. Fed closing down five of its Credit Crisis liquidity injection programs on February 1st and the Bank of England temporarily halting its quantitative easing (read money printing) program shortly thereafter. Stocks and commodities started selling down with the first Chinese announcement and continued selling off with the others. Global markets got hit again with the second announcement and adding to their worries was a poor GDP report coming out of the euro zone.

China has been leading the world out of the global recession. This hasn't occurred by magic. It has engaged in a huge amount of stimulus to reeve up its economy. While doing so it also froze the value of its currency, the yuan, and this has kept it tremendously under valued compared to a free market price (some estimates are that the yuan should be 40% higher, even a greater amount is possible). Economic stimulus and undervalued currencies are both in and of themselves inflationary. The combination of the two in large amounts can be explosive. So China is understandably trying to lower liquidity in its economy by reigning in bank lending. While these efforts are minimal so far, traders are anticipating more serious efforts down the road. Food inflation is a particular danger for the Chinese and too much of it can risk political destabilization. Food prices are already rising in many parts of the world and reached over 19% in next-door India at one point in December.

While the Chinese have probably engaged in the most significant stimulus measures globally for any sizable economy, the euro zone has not been as nearly aggressive. While the U.S. lowered its funds rate to zero, and the UK to 0.5%, the interest rates in the euro zone were only dropped to 1.0%. Less stimulus in the euro zone means less inflation in the future, but also means less economic recovery now. Fourth quarter GDP figures came in at 0.1%, indicating overall growth is flat. Leading economy Germany had a zero percent quarter over quarter growth rate. Much troubled Greece's economy sank 0.8% from the previous quarter. Italy was down 0.2%. For all of 2009, the size of the 16-nation euro zone economy fell 4%. Growth in the 27 member EU (a number of countries in the EU don't use the euro) was also only 0.1% last quarter. No matter how you look at it, Europe is economically weak.

In mainstream media reporting of Europe's predicament, one major news service stated, "the recovery in the third quarter now appears likely to have been due to temporary factors like government spending boosts, a build-up in inventory levels and car scrappage schemes that pay people to trade in old cars". The exact same factors have boosted GDP in the U.S., although that wasn't mentioned. The U.S. reported 1.4% quarterly GDP growth for the last quarter of 2009 and this was triumphed in news coverage. Investors can expect that number to be revised downward as was the case with the original third quarter figure. Greater stimulus in the U.S. has been one reason that American GDP numbers have been better than in Europe. Another reason is that the U.S. is willing to engage in more blatant manipulation of its economic statistics.It's a lot easy to 'fix' the economic numbers after all than it is to actually fix the economy.

A slow down in the Chinese economy will have a strong impact on the Western industrialized nations. Much of the improvement that has taken place since the depths of the Credit Crisis in the fall of 2008 has been because of increased demand from China.  The economies in the U.S., UK, Japan and Europe are still very weak. Based on recent actions, the powers that be in the US and UK seem oblvious to this. European leaders seem to be no sharper. Proposed austerity programs in the troubled euro zone economies - Greece, Ireland, Italy, Portugal and Spain will only cause further economic contraction. The fix for the Greece's debt problems - details are still forthcoming - is likely to be a win/lose situation.

Investors should expect that industrialized countries will be on inflation watch for a while longer. At some point even the incredibly oblivious U.S. Fed Chair Ben Bernanke will realize that there are still economic problems that have yet to be solved. More stimulus will follow. Stimulus is what has been behind the global market rallies that began in March 2009. Reduction of stimulus is what is behind the sell off that started in January. Investors should watch for signs that stimulus is returning. Until then, stock and commodity prices are likely to be pressured.

Disclosure: No positions.

NEXT: China is Selling Its U.S. Bond Holdings

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

The Fed Should be Careful What It Wishes For

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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Volatility is still the predominant feature of the U.S. stock market, with multi-hundred point moves being a daily occurrence on the Dow. For the moment, a Monday rally pattern seems to have replaced the Monday crash pattern that began in mid-September. The media reported yesterday's big move up in stocks as the market's approval of Fed chair Bernanke's endorsement of a new economic stimulus package. This of course makes no sense. The number of stimulus packages, special Fed lending facilities, special Fed asset purchasing programs, bailouts, bailout bills and government loans since the credit crisis began is now somewhere in the double digits - there have been so many, I've lost count. The need for more is just an admission of failure for all of the other initiatives, many of which were claimed to be just what was needed to turn things around. Apparently, the turning hasn't taken place yet.

The Fed announced even another new program this morning (for $540 billion this time). It will start buying commercial paper and dollar denominated CDs directly from money market funds. If you have been following this blog, you may have thought this was already being done. However, what was taking place is the Fed has been lending banks, a $123 billion so far, the money for this type of purchase. However, $341 billion has been withdrawn from money market funds by institutional investors since that program began. So the Fed has decided to eliminate the middleman (or more appropriately the middle-bank) and put an increased amount of funding behind this operation. This new program should not be confused with the one that begins on October 27th when the Fed will begin buying up to a trillion plus of commercial paper from an array of companies. The security of U.S. money market funds was supposed to have been assured about a month ago with the (legally questionable) establishment of a $50 billion dollar government insurance fund. It looks like things aren't exactly working as planned.

Today's country to announce the latest multi-billion dollar injection into its banking system is France. The French government will provide $14 billion in funding to the nations six largest banks. This appears to be part of their half a trillion bank rescue package announced several days ago. Between these two bailout announcements, French authorities were embarrassed once again with another bank trading scandal. Caisse d'Epargne announced an $800 million loss from derivative trading that allegedly took place because of rogue traders. It makes you wonder if there are there any controls on trading operations in French banks. Regardless, the biggest banks in France, just as in other advanced economies, will be assured of survival. Smaller and medium sized banks will be the ones taking the hit from the credit crisis.

The close to infinite liquidity being poured into the world's financial system is having the immediate desired effect of lowering interbank lending rates, which fell to their lowest level in a month yesterday. While the liquidity tsunami is good in the short-term, if successful it could lead to a very ugly long-term. Examination of a U.S. Adjusted Monetary Base chart shows a line going straight up (http://research.stlouisfed.org/fred2/series/BASE). This figure is currency in circulation, plus bank reserves and a massive increase in bank reserves is what is causing its vertical rise. Since banks are not lending at the moment, the inflationary effects will be muted from these additional reserves as long as the economy remains weak. A roaring economy where banks are lending out their reserves full stop would translate to an annual U.S. inflation rate somewhere around 2000% if the current rate of increase was maintained - and that would certainly make the stock market go up.

NEXT: Stock Market Enters the Bermuda Triangle

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.