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Inflation is a natural consequence of loose government
monetary policy. If those policies get too loose, hyperinflation can occur.
As gold investors, we'd like to know if the precious metals would keep pace
in this extreme scenario.
Hyperinflation is an extremely rapid period of inflation, but
when does inflation (which can be manageable) cross the line and become
out-of-control hyperinflation? Philip Cagan, one of the very first researchers
of this phenomenon, defines hyperinflation as "an inflation rate of 50%
or more in a single month," something largely inconceivable to the
average investor.
While there can be multiple reasons for inflation,
hyperinflation historically has one root cause: excessive money supply. Debts
and deficits reach unsustainable levels, and politicians resort to diluting
the currency to cover their expenses. A tipping point is reached, and
investors lose confidence in the currency.
"Confidence" is the key word here. Fiat money holds
its purchasing power largely on the belief that it is stable and will
preserve that power over time. Once this trust is broken, a flight from the
currency ensues. In such scenarios, citizens spend the money as quickly as
possible, typically buying tangible items in a desperate attempt to get rid
of currency units before they lose value. This process increases the velocity
of money, setting off a vicious cycle that destroys purchasing power faster
and faster.
The most famous case of hyperinflation is the one that
occurred in Germany during the Weimar Republic, from January 1919 until
November 1923. According to Investopedia, "the average price level
increased by a factor of 20 billion, doubling every 28 hours."
One would expect gold to fare well during such an extreme
circumstance, and it did - in German marks, quite dramatically. In January 1919,
one ounce of gold traded for 170 marks; by November 1923, that same ounce was worth 87 trillion marks.
Take a look.
(Click on image to
enlarge)
Inflation was at first benign, then began to grow rapidly, and
quickly became a monster. What's important to us as investors is that the
price of gold grew faster than the rate of monetary inflation. The data here
reveal that over this five-year period, the
gold price increased 1.8 times more than the inflation rate.
The implication of this is sobering: while hyperinflation wiped
out most people's savings, turning wealthy citizens into poor ones literally
overnight, those who had assets denominated in gold experienced no loss in purchasing power.
In fact, their ability to purchase goods and services grew beyond the runaway
prices they saw all around them.
One can't help but wonder how the people
whose wealth evaporated in Germany during this time felt. In effect, they
were robbed by the government - they were on the losing end of a massive
transfer of wealth. Of course, there are two sides to the story, as those who
held significant amounts of gold and silver were the recipients.
Could the US experience a wealth transfer
like the one that wracked the Weimar Republic? While the federal government
and most so-called economic "experts" dismiss the notion, the economic data suggest that it's already started.
We can't help but speculate about whether most citizens
dismissed the idea of inflation during the calm period in 1920-'21. Did
respected economists scoff at the idea that Germany could suffer
hyperinflation, just before it struck? Did some politicians proclaim that "a
little inflation would be good?"
Those who today argue that our obscene debt levels, runaway
deficit spending, and money-printing schemes are sound strategies and believe
they won't lead to out-of-control inflation might want to rethink those
beliefs. We've seen this movie before: it doesn't have a happy ending.
The historical record is clear on what happens when countries
embark on fiscal and monetary paths today's leading economies are embracing.
If gold's recent price performance is anything like the calm before Germany's
hyperinflationary storm, this is a time to be accumulating more gold.
Keep in mind that hyperinflation is not a rare event. Since
Weimar Germany, there have been 29 additional hyperinflations around the
world, including those in Austria, Argentina, Greece, Mexico, Brazil, Taiwan,
and Zimbabwe, to name a few. On average, that's one every three years or so.
While hyperinflation devastates those who experience it, there
is a healing aspect to it. Since the responsibility for this type of disaster
lies solely at the feet of government, there may be some Darwinian justice to
the way hyperinflation purges the perverse fiscal and monetary imbalances
from an economy. After the Weimar Republic hyperinflation, the second half of
the 1920s was a strong period for Germany, with low inflation and steady
growth.
It's no secret that many currencies around the world,
including the US dollar, are choosing the path of inflation. If we were to
slip into hyperinflation, there will be disastrous consequences for those
unprepared. Given that the US dollar is the world's reserve currency, the
problems would spread to practically every country on earth. Hyperinflation
will shake people's confidence not only in the US dollar, but in the paper
currency system as a whole.
What will actually come to pass, we don't know. What we do
know is that the measures to cure hyperinflation include tying the currency
to a hard asset or even replacing it with one. When creditability in fiat
money dissipates, gold may be the only viable option left standing.
Again, the investment implication is obvious: continue to
accumulate gold.
How much is enough? Well, how many ounces do you own in
relation to your total assets? Anything less than 5% will not offer you a
sufficient level of protection in a high inflationary environment.
Another way to look at it is this: how many ounces do you need
to cover your monthly expenses? In Weimar Germany, inflation rose
uncomfortably for two years - and then pinched harder, spiraling into a
destructive hyperinflation for another two. Consider what it would take to
maintain your standard of living for a couple years instead of just a couple
months.
And don't listen to any government's ongoing pronouncements of
confidence in the current system, along with the mainstream media's noisy and
frequently inaccurate portrayals of the gold market. (For example, these two
headlines appeared on the
same day: Gold
Edges Lower as Worries over Europe Simmer; and Gold Settles Higher on Spanish Bailout
Plans.) In a world awash in ignorance about real money, if not
deliberate obfuscation, you have to study the relevant history, draw your own
conclusions, and stick with them.
This example shows how gold can perform during hyperinflation.
If that worst case scenario comes to pass, will the example your family's
finances sets be a positive or a negative one?
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