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James Turk’s
article Hyperinflation Looms dated April 20, 2010, is based on
Quantity Theory of Money (QTM). It draws an analogy between Weimar Germany of
1923 and the United States of 2010. Both precepts are invalid. As far as the
QTM is concerned, it suffices to point to the very fact, admitted by Turk,
that it is possible to have a shortage of money simultaneously with the
overworking of the printing presses. Hyperinflation is not the same as the
ultimate inflation of the money supply. It is the ultimate depreciation of
the currency unit. The two concepts are far from being the same, QTM
notwithstanding.
The reason why QTM fails is that money is not one-dimensional. It is in fact
two-dimensional. Quantity is one, and the velocity of circulation is the
other dimension. Central banks control the former, and the market firmly
controls the latter. As long as fair weather lasts, velocity may be ignored.
But as soon as the weather grows foul, velocity returns with a vengeance. If
it increases, we talk about inflation. If it decreases, we talk about
deflation. In the extreme case the increase in velocity may start feeding
upon itself and velocity could grow beyond any limit. People buy anything
they can lay their hands on because they expect prices to rise further. This
is hyperinflation, wiping out the value of the currency unit. It is an
irreversible process: once fiat currency loses its value, it is lost for
good. The pendulum has stopped swinging. If there is a bounce, it is the
dead-cat bounce.
But it is also possible
that, at the other end of the spectrum, the shrinkage in the velocity of
circulation refuses to stop and starts feeding upon itself. People postone
buying indefinitely because they expect prices to fall further. This is
hyperdeflation. It manifests itself in the ever rising value of the currency
unit. It is important to remark that it can happen while some prices are
still rising. Other than gold, food and energy are two important
exceptions. People have to eat, and they want to keep themselves warm and
mobile, no matter what. Paradoxically, this may reinforce deflation. Because
of rising food and energy prices people will have that much less to spend on
other goods, accelerating price declines in other sectors. This defeats the
arguments of Turk and others who try to refute the case for deflation by
pointing to high or rising cost of food and energy.
The point in
either pathology of money is that the government is helpless. Once the point
of no return is reached, there is nothing governments can do to convince
people that the process will end — short of opening the Mint to gold
and/or silver. As far as people are concerned, the feedback from their
experience tells them to expect more of the same.
I am not trying to adjudicate between the two schools of thought, one
asserting that hyperinflation and the other asserting that hyperdeflation of
the dollar is inevitable and imminent. I am merely trying to point out
certain facts about deflation that most people are unaware of, or tend to
ignore.
Let me state first that it is not impossible for the dollar to go into
hyperinflation during the next 12-month period. For example, consider the
case of a shooting war between the U.S. and Iran in the Persian Gulf. After
an initial euphoria the American military could start suffering setbacks on
the ground, in the sea and in the air, simply because of the longer lines of
communication from the home base, and also because of the disadvantage of the
aggressor in face of patriotic zeal on the part of the defenders (c.f.
Vietnam). In this scenario hyperinflation of the dollar could be a possible
outcome. But short of war threatening to destroy supplies and producing
facilities the word ’hyperinflation’ rings hollow in the ear.
Post-World-War I Germany versus
Post-Cold-War U.S.
To draw a parallel, as
Turk does, between Weimar Germany and present-day U.S. is, to say the least,
grotesquely unrealistic. In 1923 the once mighty German army was defeated and
disarmed, the navy was scuttled, the territory of the country was badly
truncated by the peace treaty of Versailles, the Rhineland was under military
occupation while the rest of the country was still under a partial blockade.
No speculator would touch the falling Reichsmark, except to short it.
By contrast, the United States in 2010 has an army, navy and air force that
can be put on high alert in a matter of minutes. Its military bases pockmark
the face of the globe. The over-riding fact is that the whole world is still
anxious to sell its wares on the American market, and is happy to lend back
to it the proceeds of the sale in order to finance future U.S. purchases.
Furthermore, it is a fact that the bond market trading U.S. Treasury debt is
still the largest and most liquid in the world. Significantly, it still has
room to go up ― thus offering speculators juicy profits at a time when
the bloom is off the stock and the real estate markets. How can you compare
the circumstances of a beggar with those of the emperor — prodigal and
bankrupt as though the latter may be?
All the signs around us point to deflation. The money supply is being pumped
up on an unprecedented scale, but all it does is pushing on a string. You
cannot make a case, as Turk is trying to do, out of the fact that the price
of crude oil doubled as compared to its recent low. Another fact, more
startling, is that the price of crude oil has declined 45 percent as compared
to its all-time high. We must see the general decline in world prices, even
though in some cases they may be disguised as a loss of pricing power of the
producers. True, list prices have not declined, but nobody trades them. They
are for window-dressing only.
Obviously, you need a theory to explain what is happening other than the QTM.
I have offered such a theory. I have called it the Black Hole of Zero
Interest. When the Federal Reserve (the Fed) is pushing the rate of interest
down to zero (insofar as it needs pushing), wholesale destruction of capital
is taking place unobtrusively but none the less effectively. Deflation is the
measure of wealth in the process of self-destruction — wealth gone for
good. The Fed is pouring oil on the fire as it is trying to push long-term
rates down after it has succeeded in pushing short term rates to zero. It
merely makes more wealth self-destruct, and it makes the pull of the Black
Hole irresistible.
But why is it that the inordinate money creation by the Fed is having no
lasting effect on prices? It is because the Fed can create all the money it
wants, but it cannot command it to flow uphill. The new money flows downhill
where the fun is: to the bond market. Bond speculators are having a field
day. Their bets are on the house: if they lose, the losses will be picked up
by the public purse. But why does the Fed under-write the losses of the bond
speculators? What we see is a gigantic Ponzi scheme. The Treasury issues the
bonds by the trillions, and promises huge risk-free profits to the bond
speculators in order to induce them to buy. Most speculators believe that the
Treasury is not bluffing and they buy. Some may believe that the Fed is
falsecarding doubts and they sell. But every time they do they only see
foregone profits. What we have here is a rare symbiotic relation between the
government and the speculators.
When he was forced out of business by the courts, and his customers lost
everything they invested, Charles Ponzi declared that he would have paid them
to the last cent as contracted if they had let him. There is no reason to
doubt his sincerity. Now, 90 years later, Charles Ponzi’s dream has
come true. The US government is duplicating Ponzi’s scheme in the bond
market. The only difference is that the stake is much higher: it is the
national, nay, the world economy! And, most importantly, this time there is
absolutely no danger that the courts will stop the racket. The world begs to
be fooled.
Antal E. Fekete
DISCLAIMER
AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY. THE
AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING THAT
IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL ANY
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BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS
COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS TO BE
TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED
AT ANY TIME FOR ANY REASON.
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© 2002-2008 by Antal E. Fekete
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