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Inflation and Monetary Regimes
“Inflation presupposes the existence of money, which evolved as
an unplanned social institution by a number of inventions and
innovations during a period of perhaps 2500 years . . . It follows that
inflation cannot be older than money. But if seems that especially
rulers soon detected the potential to increase their revenues by
tampering with its value . . . The damage and suffering caused by
inflation during the course of history are enormous. Still, the worst
excesses of inflation occurred only in the 20th century.
This development was a consequence of the further technical development
of money from coins to paper money and book money together with changes
in the monetary regime or constitution ruling supply and control of
money.”
-
Peter Bernholz, “Monetary Regimes and Inflation”
Peter Bernholz is the Professor Emeritus
of Economics in the Center for Economics and Business at the University
of Basle, Switzerland. His 2003 book, Monetary
Regimes and Inflation, serves as a comprehensive guide to
historical inflationary episodes and the influence of both political
administrations and monetary regimes in fostering them. Professor
Bernstein analyses the 29 known hyperinflations dating back to the Roman
currency debasement in the fourth century and concludes that deficits
in excess of 40% of expenditures, significantly raise the risk of
hyperinflation. While most of the world is focused on the current
fiscal difficulties across the Eurozone today, we would note that our
own government has recently entered into the Bernholz Warning Track
with a 42% ratio of deficit to expenditures at our last count.
Importantly, we do not interpret this as a sign of an immediate
inflation on the horizon, as our own work points to heightened levels
of deflation in the intermediate term, primarily due to the
impact of ongoing private sector deleveraging on the money multiplier.
We’d also encourage investors not to lose sight of the collapse in M3,
which has no precedent since the Great Depression, despite the fact that
Mr. Bernanke no longer pays attention to the series, deeming it too
erratic to be of much use.
But, we digress. Irrespective of our
own views, it is critical for investors to understand what is coming
down the pipe and position portfolios accordingly. Wayne Gretzky once
explained, “I skate to where the puck is going to be, not where it has
been.” In this light, we’d suggest that as household balance sheets
are repaired over time, the effects of unprecedented monetary stimulus,
debt monetization and currency debasement will almost certainly be felt
through a striking return of inflation later in the decade. So in an
effort to determine “where the puck is going to be,” we’ll be spending
some time in coming weeks reviewing Bernholz’s Monetary
Regimes and Inflation. Let’s begin with some history to
better understand the conditions in place today:
The price levels in the US, UK, France
and Switzerland do not exhibit a trend until 1914. Professor Bernholz
reckons that the change from a non-inflationary to an inflationary
environment can be explained by the change of monetary regime post
1914. Under Metallic Standards, like the gold, silver or
copper standards, the amount of money in the system is regulated by the
supply of gold, silver or copper. Since the quantity of these metals is
limited, structural inflation can only occur if new deposits are
discovered and inflation is still limited by the additional supply
brought into circulation. But after World War I, several countries
moved toward a Weakened Metallic Standard, weakening further
with the advent or Bretton Woods after World War II. Discretionary
Paper Money Standards have no natural limit for the expansion of
the money supply. The issue then, as described by German Professor of
Economics, Adolph Wagner in 1868, is that “Men would first have to be
capable of unlimited self-discipline to resist any temptation to
increase money arbitrarily, even if their very existence, or that of the
state, were at stake.” If nothing else, recent history promises that
today’s “men” do not have this discipline. When faced with the decision
to let the economy naturally (painfully) adjust or print, the printing
press is man’s best shot at re-election. It is no, coincidence then,
that all hyperinflations in history (with one exception) have occurred
after 1914, under Discretionary Paper Money Standards.
Professor Bernholz concludes that the
tendency of currencies towards inflation depends on the monetary
regime. Paper money standards with “independent” central banks (we
struggle to think of any) are less inflation-biased than those with
dependent central banks. On a side note, we find it curious that the US
stock market has not experienced a material loss in the third year of
an election cycle since 1929. Yet, we are to believe that the US
Federal Reserve is “independent.” Coincidentally, stimulus at the right
time tends to stimulate the economy, reduce unemployment, and improve
re-election chances. But inflation follows with a lag after the
election, and measures taken to reduce inflation have negative follow-on
effects on economic activity and employment. Consequently, inflation
pressures must be contained in time to allow for a new stimulation of
the economy before the next election! A vicious cycle indeed. A cycle
responsible for the inflationary bias of democratic governments,
according to Bernholz. More recently, David Einhorn expressed similar
views at the recent Ira W. Sohn Investment Research Conference:
“Politicians value staying in office
more than they value the long-term health of the country. Spending money
in the short-term buys votes. It’s not good politics to take on the
obvious long-term insolvency of popular programs that transfer wealth
from the young to the old. The elderly reliably show up on Election Day.
Children have no voice at the polls. The AARP is an extremely powerful
interest group. There is no similar organization lobbying on behalf of
ten year olds.”
Importantly, the positive impact of an
expansionary monetary policy is short-lived. But Bernholz correctly
suggests that voter’s “rational ignorance” will judge the performance of
government on these former policies where results are targeted to
particular segments of the population and costs are spread widely so as
not to be felt. The convenience of such a strategy is that expenditures
can be increased without burdening anybody. Sure, we will have to pay
back the mounting debt, but that is a problem for the next generation,
the next administration, and after the next elections.
It is obvious from the above commentary
that the temptation for inflationary deficit financing are highest
during periods of slow, or no, economic growth. We suggest anyone
questioning this argument, keep a close eye on Europe, and the ECB’s
recent change of heart on the subject of debt monetization. Critically, Bernholz concludes that a
hyperinflation has never occurred throughout history, which was not
driven by a huge budget deficit of the state.
With this in mind, we’ll conclude our
initial look at Monetary
Regimes and Inflation with a quick peek
at the state of fiscal balance sheets, as recently published by the
Economist:
»
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As suggested earlier, the EURUSD daily chart is giving bullish signals.
http://stockmarket618.wordpress.com
http://www.zerohedge.com/forum/latest-market-outlook-1
Actually this is a good point which may settle a heated argument in another article #412808. With two major wars going on, why isn't the US experiencing major inflationary pressure, today?
(please don't say it's coming)
Is BBI still a buy?
Just wondering.
BBI is asking for a bankruptcy loan!
Maybe is BBI goes down to 0.001 you can take some risk in buy for 500$.
If it ever returns out of BT, you'll make some money, but you really risk to lose it all.
Uh . . 1929 was not the 3rd year of an election cycle. I'm presuming the author is refering to presidential election cycles. Hoover was elected in Nov. 1928 and took office in 1929. It was the first year of an election cycle.
I'm not sure about the stock market performance in 1991, but the economy as a whole was pretty weak, so that would run counter to the guy's point but it's more the exception that proves the rule than a thesis buster.
I always thought that with the advent of computers and then the Internet, the velocity of transactions and the ability to create even more interest bearing derivatives is the cause of the downfall of the existing fraudulent system.
Suddenly, one could leverage their fractional reserves a billion models come Sunday and all at once. Well my friends, they unwittingly unleashed the Cracken of the exponential function and kicked it into asymptotic high gear.
good point!
Chris thanks for saying "irrespective" instead of "irregardless!"
Man, that one is like the proverbial fingernails on the chalkboard. Eeeeck.
My most recent pet peeve is the mispronunciation of "ebullient". It has 4 syllables with the emphasis on the 2nd. Not 3 syllables with emphasis on the first. Gawd!
I apologize for the rhetorical flourishes, it's a matter of conversational conversion.
Can you please be a little more "pacific". Apart from "anyways" and "acrost" (as in acrost the way), the one that really kills me is "...in my nectar of the woods"
Poor english skills is giving this site a negative "astigmatism".
Shit, after hearing things like "it's a mute point", "for all intensive purposes", and "pouring over the data", the butchering of "ebullient" would be a step up.
I'm E bull ent about my sosal security.
Hot damn!
For YEARS I thought I was the only one who noticed how MOST people, even politicians, say "Sosal Security". Even when I point it out to people, and the pronunciation is repeated, they almost never seem to hear it.
And what is up in the last couple of years with people who can NOT say "-ul"? I don't know how many people I have heard lately saying the "GOOLF" of Mexico! Where the fuck did THAT start?
And if I read one more person state "he could care less" when they really mean "he could NOT care less", I am going to figuratively cut their heart out!
Oh, and one more thing, for all you clueless West Coasters, "Don" and "Dawn" are NOT pronounced the same! Learn how to say the sound "Ah" already, for Christ's sake! I recently met a woman from California who described her husband as "stalky", and I thought maybe she was married to Larry Kudlow and was describing his many green shoots! (Of course, she meant "stocky" --- again, NOT pronounced the same way!)
Also for the Left Coasters, I need to point out:
"Email" is pronounced "Ee-may-ul", NOT "Ee-mell"
"Feel" is pronounced "FEE-uhl", not "Fill"
"Oil" is pronounced "OY-uhl", not "Ole"
This is all just another sign of the degeneration of our contemporary educational standards and culture.
nukular
You mean it's not "...Don's early light"? All these miserable, uneducated years.
I brought up Dubya's pronunciation of "nukular" at a small party a couple of years ago and nobody, to a person, had any notion that either pronunciation was wrong or right. I had to pronounce them both and point out the difference. One of them was a Texas Teacher of the Year!
You've got to be kidding about them not having noticed Bush's "nukular" before! I and others I know were making fun of that from the very beginning of his reign! Well, that and just about everything else about him.
Now, Fred, yore mama has tole you to stay out o' other peoples bidness.
Get back to that book larnin', yore gonna need it.
RockyRacoon
Umm
" Yo mama done tol ya not be messin wid udder folks bidness."
I skip the book learnin part cause no one reads or recommends books other that whitey and Twilight.
What 'definition' of inflation is used in this article?
This link comes to mind:
http://www.entertonement.com/clips/wtqvtsttwb--I-love-goldMike-Myers-Austin-Powers-in-Goldmember-Goldmember-
And the deflation we've seen over the past 30 years, and the most recent hyperdeflationary episode, hasn't been/isn't very harmful?
We've had inflation until recently.
Deflation is the (painful) cure to prior excesses of malinvestment.
“Inflation presupposes the existence of money,..."
Economists are truly a unique breed.
anarkst
Reminds me of those researchers who discovered that medicated elderly are more likely to cause auto accidents.
...and all that gov't money spent on the research that shows that rich people are happier than us poor bastards. I coulda told 'em that for a buck fifty.
But do you have a PhD ?
I coulda had that for two fifty. ($250,000 that is...)
5 grand actually, from a diploma mill
http://killcarb.org/tranphd.jpg
Dr Hulk
I read this book earlier this year. I highly recommend it to anyone interested in the topic.
Interesting that this came up; my copy arrived from Amazon today.
I just finished reading "New Monetarism" by Roche and Mckee, highly recommended. For most ZH readers there won't be any surprising conclusions, but it has some helpful insights nonetheless.
Thx, I'll take your word for it.
Order shipped
It's an illuminating tackling of the subject. It never occurred to me that hyperinflation is primarily a twentieth century phenomena. Lots of historical references, charts and even equations. Bernholz shows a pattern that runs through history of how Gresham's Law is followed by (what he labels as) Their's Law (good money chasing out the bad). Though not a lengthy effort, I'd hardly call it light reading. He ends every chapter with a list of conclusions one can draw through the data and facts offered in each respective chapter.
It fits that hyperinflation is a recent phenomenon. It's just a byproduct of recent financial 'innovations' (AKA advanced Ponzi economics)...
The MSM focuses on debt and current deficit to GDP. But as you point out, it is current deficit to current revenue that must be considered. If a govt doesn't tax much of GDP, it doesn't have access to revenue other than by borrowing. In May, the Feds brought in about half as much revenue as they spent.
I'm not clear as to the rationale for expecting much time delay in any high inflation, or at least high interest rate, situation.
The only way to truly prepare for major discontinuities is to be early.
The reason not ot expect inflation in prices is that as the government inflates the currency the private sector causing deflation by reigning in spending and battening down the hatches. The velocity of money is crashing while the govt pumps in cash. eventually the velocity of money is going to ramp back up and at that point helicopter Ben seems to think that the Fed has the programs in place to sop up all those trillions of dollars that have been created.
I think he's just spouting bullshit and he has no expectations of being able to gobble up all that money. I think he part of the plan along with our socialist government representative who are trying to remake the country. To do so you have to first wipe the slate clean and no better way to do that than to wipe out the currency and make everyone poor.
If the people lose faith in the money, velocity won't matter. It will still hyperinflate.
We could have an extended big inflation first, and then hyperinflation. Or if the people lose faith in debt and the dollar, we could skip an extended period of inflation and go to hyperinflation.