Hyperinflation

A successful entrepeneur's take on the European sitaution...

By 1789, a lot of French people were starving. Their economy had long since deteriorated into a weak, pitiful shell. Decades of unsustainable spending had left the French treasury depleted. The currency was being rapidly debased. Food was scarce, and expensive. Perhaps most famously, though, the French monarchy was dangerously out of touch with reality, historically enshrined with the quip, “Let them eat cake.” Along the way, the government tried an experiment: issuing a form of paper money. It didn’t matter to the French politicians that every previous experiment with paper money in history had been an absolute disaster. The Bourbon monarchy paid the price for it, eventually losing their heads in a 1793 execution. History shows there are always consequences to entrusting a paper money supply to a tiny handful of men. The French experiment is but one example. Our modern fiat experiment will be another.

In many Western industrialized nations, debt has overwhelmed or is about to overwhelm the economy's debt-servicing capacity. In the run-up to a debt crisis, bad debt tends to move to the next higher level and may ultimately accumulate in the central bank's balance sheet, provided the economy has its own currency. Many observers assume that, once bad debt is purchased by the central bank, the debt crisis is solved for good; that central banks have unlimited wealth at their disposal, or can print unlimited wealth into existence.

However, central banks can only create liquidity, not wealth. If printing money were equivalent to creating wealth, then mankind would not have to get up early on Monday morning. Only a solvent central bank can halt hyperinflation. The longer governments run large deficits, the longer central banks continue to monetize them, and the longer their balance sheets grow, the higher the potential for enormous losses and thus hyperinflation.

Necessary preconditions for hyperinflation are a quasi-bankrupt government whose debt is monetized by a central bank with insufficient assets. One way or another, owning physical gold is the safest and most effective way of insuring against hyperinflation.

Think Americans are the only people in the world toiling under a gargantuan debtload, which at last check was a massive $55.3 trillion, or about $175K per person? Think again. Meet Sherry Sheng, a 29-year-old Shanghai policewoman, who bought herself a 4,000 yuan ($642) black fur jacket, splurging for the last time before she starts paying off the mortgage on her first home.

Sherry is what is known as a Chinese "housing slave."

In April of 2010, Zero Hedge first brought up the topic of the Fed's DV01, or the implicit duration risk borne by the Fed's burgeoning balance sheet which at last check will approach 25% of US GDP by the end of 2013 (tangentially, back in 2010 the Fed's DV01 was $1 billion - it is nearly $3 billion now and rising fast). Recently, we have noticed that the mainstream media has, with its usual 2 year delay, picked up on just this topic of the implicit and explicit risk borne by Bernanke's grand (and final) monetary experiment. And slowly but surely they are coming to the inevitable conclusion (which our readers knew two years ago), that the Fed has no way out? Why? Ray Stone of Stone McCarthy explains so simply, a Nobel prize winning economist can get it.

Warren Buffett’s aphorism: "price is what you pay; value is what you get" has been rightly celebrated. But to be a true value investor, it helps to have values. Courtesy of near-zero interest rates and global competitive currency debauchery, it is increasingly difficult to assess the value of anything, as denominated in units of anything else. The business of investing rationally becomes problematic when market participants are pursuing maximum nominal returns without a second thought as to the real (inflation-adjusted) value of those returns. In a global deleveraging that is likely to persist for some years, the heavily indebted countries will desperately need to attract foreign capital to help service their heavy debt loads. And in order to do so, they will likely devalue their currencies. There is an increasingly disorderly currency war going on out there, and the advantage of gold is clear – they can’t print it, they can’t default on it, and there will always be demand for it. Simply put, in the global currency wars, owning gold is like abandoning the battlefield altogether.

"The financial problems of the Postal Service are getting bigger every year," is how US Postmaster General Donahoe tried to convinced Congress not to block the bill the end Saturday delivery of mail. Raising the specter of mutually assured destructive bailouts in the future, the CEO rattle lawmakers (and other stakeholders) as NBC News reports, Representative Darrell Issa noting "It's very clear that ultimately, either the rate payer or the taxpayer will have to pay the $20 billion in debt of the Postal Service." Indeed Mr. Issa - so by our reckoning the plan to tax emails was a non-starter and so we compare the 73.5 billion pieces of mail handled by the USPS and the $20bn budgetary gap, it would appear the answer is simple - the current 46c stamp will have to rise in value by 27c or 60% in order to meet the shortfall. The problem of course is the legal limit on increasing stamp prices is bounded by what the BLS' official annual inflation report is, and which as the Fed is happy to reminds us, is at best 2% per year. Luckily, every problem, in this case too little inflation, has a solution: in this case hyperinflation.

As the chart below shows, in some 200 years of history, when expressed as a ratio of total sovereign debt to tax revenues, the empirical data as compiled by Reinhart and Rogoff ranges from 2x to 16x. This is shown by the blue bars in the chart below.  So where are we in this cycle as the debt clock counts down? As the red bars show, we are in a very uncomfortable place, with Japan now at the highest such ratio in history, well above the highest recorded which always ended up in default, while the US, whose such ratio is over 600%, is above the long-term average of about 520% public debt/revenue. The problem is that every current and subsequent attempt to reflate merely pushes both of these higher, until one day the marginal growth creation of every dollar in new debt becomes negative. How much higher can consolidated global debt go before global GDP is not only no longer growing, but every incremental dollar in debt has a negative impact on GDP, as was the case for the US in the fourth quarter? Keep an eye on global economic growth: if and when the world enters outright recession: the most feared outcome by all central bankers who realize they are out of weapons and their only recourse is much more of the same, that may be cue to quietly leave town.

JPY could fall a lot further because weak JPY has been the most effective tool to create equity market wealth and spur Japanese demand. Moreover, Citi's Steven Englander notes, Japanese policymakers do not have many other options. If JPY is ticket for the Nikkei to regains ground lost versus other equity markets, USDJPY would have to go into three digits. By implication JPY would have to weaken a lot more. The loss of market share in part reflects long-term structural issues but Japanese governments (like others) are more mindful of incurring the anger of domestic political constituencies by making tough structural reforms than of G20 counterparts by weakening the exchange rate. From a political perspective, the Nikkei-JPY relationship is too much a good thing for Japanese policymakers to give up - but divergences are abundant at the short- and long-end of the JGB curve - and too much of a good thing in this case is a disaster.

Asset inflation often produces something called "wealth illusion," the belief that pricier asset holdings necessarily make one permanently richer. Illusions are dangerous. Eventually, painful reality intervenes. The "wealth illusion" of asset inflation is seductive, which is why central banks in charge of a fiat currency and subject to no external disciplines so often drift in that direction. Politicians smile in satisfaction and powerful Washington lobbies cry for more.  But an economy built on an illusion is hardly a sound structure. We may be doomed to learn that lesson once again before long.

The insanity that has gripped policymakers all over the world really is a sight to see. There was a time when central bankers were extremely careful not to do anything that might endanger the currency's value too much – in other words, they were intent on boiling the frog slowly. And why wouldn't they? After all, the amount by which the citizenry is plucked via depreciation of the currency every year is compounding, so that the men behind the curtain extract more than enough over time. The latest example for the growing chutzpa of these snake-oil sellers is provided by Lord Adair Turner in the UK (as it faces its triple-dip recession) - who sees the current policy is evidently failing, so he naturally concludes that there should not only be more of it, but it should become more brazen by veering off into the 'Weimaresque'.

While Japan's recent attempt to massively reflate and break out of its "liquidity trap" - an artificial construct to explain what happens when an artificial model, created by a flawed and artificial economic theory explodes in a singularity of Econ PhD idiocy leaving billions of impoverished people in its wake, is nothing new, there are those who are rather skeptical this latest attempt to achieve what Japan has not been able to do in over 30 years will work. And while one can come up with complicated, expansive, verbose theories based on Keynesian DSGE models and other such gibberish, why this time will be different for Japan, there is a very quick and simple argument why it won't.

The most vocal justification provided for the disappointing Q4 GDP print by the mainstream was an increase in US government "austerity" resulting in a decline in the government contribution to the economic bottom line in the last quarter (or first fiscal quarter of 2013). Ironically, both total spending and total debt issuance in the past quarter increased, which means that far from being austere, the US actually spent more, not less, i.e., the opposite of austerity. And while it is true that Defense spending declined by a tiny amount in the past quarter compared to the year ago, it was more than offset by a surge in Medicare and Medicaid, as well as Social Security, or, as they are better known, welfare. And, as the CBO yesterday showed, these two components of US spending, which together account for half of all US spending and which couldn't be funded by all US revenues even if the government spent $0.00 for all other programs, which will soar in the coming years as US society ages, as more workers retire, and as more are reliant on Uncle Sam for the payment of every bill. So the next time someone say that the US has a defense spending problem and nothing else, show them this chart.

How does the saying go: it is better to keep your mouth shut and be thought a clueless Keynesian muppet than to open it and remove all doubt? Sure enough, if there was any confusion as to the level of economic comprehension (or lack thereof) of Japan's chosen savior du jour, one who is hell bent on destroying its currency and sending energy costs into the stratosphere (but don't worry - as Rajoy would say, inflation is plunging, except for the things that are soaring) the following two snippets should clear up the situation once and for all.

Gold climbed $5.70 or 0.34% in New York yesterday and closed at $1,673.50/oz. Silver inched up to $31.86 in Asia, then it fell back to $31.38, and then rose to a high of $31.91, but eased off in afternoon trade and finished with a loss of 0.35%.

Gold rose to a new record nominal high on the TOCOM at 0.156 million yen per ounce. The resignation of Bank of Japan Governor, Shirakawa on March 19 is pressuring the yen as is increased tensions in the Pacific between China and Japan -  Japan accused China of targeting a Japanese naval vessel and helicopter.