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Deflation As A Precursor Of A Weimar-like Inflation
Most people consider deflation the biggest enemy of the gold price, as gold is generally seen as an excellent hedge against inflation. Whilst this is generally correct, it doesn’t mean that a (short) period of deflation is a prelude of a crashing gold price.
As the very low inflation rate (and as there’s even official deflation in Italy and Belgium at this point in time), the European Central Bank is taking additional measures to pump several hundreds of billions of euros into the financial system which should theoretically boost the consumption pattern of the Eurozone citizens. It’s no secret the ECB wants the inflation rate to be ‘close to but not exceeding’ 2%, which is deemed to be the most sustainable number by several economists. At an inflation rate of 2% companies can increase their revenues fast enough, without the consumers being hit too hard.
The ECB has no problem to expand its balance sheet to the level of 2012, when the total balance was approximately 1000 billion euros higher than where it is today. On top of purchases of asset-backed securities, the ECB will directly pump cash in the banking system by making 400B EUR in 4-year loans available for the banks of the Eurozone at a cost of 0.15% per year. This should lead to an increased spending and increase the inflation rate as well, until the inflation rate is out of the danger zone and is hovering around the 2% mark again.
Not everybody in the board of the ECB is happy with this, and the president of the Bundesbank has openly criticized the ECB for causing inflation. In several interviews, president Jens Weidmann has stated that the ECB shouldn’t really intervene to actually create inflation. One would think that the governing council of the ECB would listen to a man whose country has experienced the worst inflation nightmare of all industrialized countries, less than 100 years ago.
If you look back at the official statistics of the horror-inflation during the Weimar-republic, it’s clearly visible that after a first bump of inflation there was actually a period of deflation before the snowball effect started to work. In a working paper, Steven Webb was able to gather all data from the period 1919-1923, and as you can see on the next image, the period of inflation was paused for a few months when there was deflation. Thereafter, the inflation rate picked up again and actually accelerated to a level of 7100% (yes, more than seven thousand percent) in October 1923.
Granted, the velocity of money, which is one of the key drivers to induce inflation, was much higher back then. But this is also the main reason why we think the ECB is pushing too hard to create inflation and will very likely overshoot its target the moment the velocity of money returns to more normal levels.
Allow us to explain this. The inflation rate is mainly determined by two parameters, the amount of money (‘money supply’) and the velocity of the money. There’s absolutely no disagreement that with the recent rounds of Quantitative Easing all over the world, the money supply has increased by a large factor. The only reason why this money-printing tactic hasn’t showed up in our ‘official’ inflation estimates is because the velocity of the money has been decreasing, which has more or less neutralized the danger of the money-printing. Because the velocity is lower, it will take the ‘new’ money longer to get fully in circulation. And this velocity is still decreasing. There are no official numbers from the ECB, but the following chart from the Fed clearly shows a continuously declining velocity of money.
So the ECB is trying to counter this decreasing velocity rate by printing more money. This is theoretically the correct measure to create the inflation, however, this is a short-term measure. If you look at the longer term picture, the average velocity of money supply is much higher than the current velocity. So even if the velocity would return to normal levels, the ECB and its counterparts all over the world will have printed too much money, and even if the money supply would gradually decline again, this won’t be sufficient to counter the effect of a much higher velocity. This is the main reason why we believe the ECB is on its way to overshoot its target as the velocity of the money supply will return to normalized levels sooner rather than later.
One would think the ECB would listen to Jens Weidmann, that it’s dangerous to create inflation as there are more parameters involved in inflation than just the money supply. As it’s very clear that during the Weimar republic there has been a period of deflation before the inflation rate shot up with triple and even quadruple figure inflation rates, we are afraid the ECB is making the same mistake all over again by increasing the money supply even further.
This case study shows that investors in the precious metals sector shouldn’t dump their holdings in a (short) period of deflation, as historically, deflation has been preceding a period of higher-than-normal inflation. As the velocity of money can’t really be influenced by the ECB, its only possibility is to increase the money supply. However, if the velocity returns to the historical average, the ECB and other central banks will have created a ‘perfect storm’ which could lead to the next Weimar-like inflation in Europe. This means that even in a deflationary period, gold and gold-related assets should continue to be a part of any investment portfolio.
As is evidenced on the previous image, the price of gold in Weimar-marken increased faster than the inflation rate, and in just 5 years time, the value of a gold mark expressed in Reichsmarken increased by almost 1,000,000,000%. Yes, that’s 1 billion percent. It’s also clear that the exchange rate decreased during the deflation period in 1920, which might be exactly what we’re experiencing now. Don’t be scared of gold during short periods of deflation. If the ECB really overshoots its inflation target, your gold-related investments will definitely have an increasing value.
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I recently read a comment where the writer challenged the curious to "bing" or look up the term "Weimar Inflation", some of what I discovered was surprising. Germany had come out of the first World War with most of its industrial power intact, the speed at which inflation suddenly destroyed the currency dovetails with some of my thoughts on currency trading today.
It is possible that inflation "could stem from the lack of faith in a currency, or all currencies, rather then from a lack of available goods". It was amazing how quickly inflation took root in Germany during the 1920s, we must consider how fast it could happen now that we live in an age of instant communication. For a primer on inflation in Germany in the following WWI and some surprising facts about inflation see the article below.
http://brucewilds.blogspot.com/2013/01/surprising-facts-about-inflation....
Inflation is a monetary process, hyperinflation is a psychological event.
And the crazy people are running the asylum....
Ding, ding, ding!
We have (hidden, largely unreported) inflation in fiat currencies (ours being the dollar) in which the users thereof (both here and abroad) have not (yet) lost faith. When they inevitably do, however (probably instigated abroad, as USTs are dumped after sufficient Qinfinity), the stampede begins.
WWWIII, then, to sustain the unsustainable (meaning the American Imperium), after which we either enter a new era built upon the foundation of market-based money (PMs and BTC) or we don't.
Personally, I don't want to be around if we don't and only plan for the interim of do.
Meanwhile, the state, as always, can kiss my ass.
Germany was required to pay everybody's war debts by the Treaty of Versailles.
They couldn't do that, so they printed. Very little relation to current conditions.
Germany was required to pay everybody's war debts by the Treaty of Versailles.
They couldn't do that, so they printed. Very little relation to current conditions.
Quite true but we're at the point in the US where our soveriegn debt looks worse that the German war debt. It won't end well.
nah. the citizens are just paying the banks gambling debts. we're som much better off.
found it. here is the killer argument. lo and behold:
"So even if the velocity would return to normal levels, the ECB and its counterparts all over the world will have printed too much money, and even if the money supply would gradually decline again, this won’t be sufficient to counter the effect of a much higher velocity. This is the main reason why we believe the ECB is on its way to overshoot its target as the velocity of the money supply will return to normalized levels sooner rather than later."
the killer argument is based on the ECB going back to the higher mark. the killer argument is in a future where the ECB still has to print one trillion euros to get there
a future based on the ECB doing what Dr. Krugman was asking the whole time: print one freaking trillion euros...
but print it, dammit, instead of lending it and getting it back!
because you see, "Deflation Is A Precursor Of A Weimar-like Inflation"
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Go Tell The Germans, Stranger Passing By, That Here, Obedient To Their Law, We Lie?
somehow I can't go through the article without stopping at things like this: "So the ECB is trying to counter this decreasing velocity rate by printing more money."
now "printing more money" is usually used for monetization. which is when a national bank buys sovereign bonds of the state to which it belongs
this is actually not what the ECB did. it lent to banks. some of it was used to buy sovereign bonds, yes, and yet...
kaiserhoff is completely right, very little relation to current conditions. though I presume Haus-Thurgyen would possibly chip in that the guarantees that the German Federal Republic gave, together with others, are potentially a similar condition, if the shit hits the fan. imho debatable and contingent on many unlikely concatenations of events
I was happily reading and had to stop to comment first this little thing: "The ECB has no problem to expand its balance sheet to the level of 2012, when the total balance was approximately 1000 billion euros higher than where it is today."
No problem? Well, Draghi is advertising that he has no problem. Markets are very happy to believe him. Yet all this hides a very important fact among many speculations: that the ECB's balance sheet was at one trillion euros higher mark then it is now
reflect for a moment:
- from the other side of the pond, the shouts were for monetization, like the FED was doing. instead, the ECB lent to banks, and received one trillion back
- from the other side of the pond, the shouts were for direct gov help to banks, like the US gov was doing through TALP/TARP. instead, the EU countries gave guarantees
so where are we now?
- US gov spent some 2'000 billions USD to aid banks. EU countries spent...? sure, some, but nowhere that mark
- FED balance sheet grew and... grew. ECB balance sheet grew and... shrunk
the EURUSD went up, and up, and... went down again, allegedly on market's belief in Great Draghi Interventions
so I will now continue to read the article, trying to find the killer argument why a Weimar-like Inflation is in the cards for the net-exporting eurozone
The similarity is that countries are being required to pay promised "social entitlement" costs.
Germany could not inflate away the payments required to be made in gold.
Current governments cannot inflate away the entitlement costs which are inflation adjusting and increase.
Current conditions require the country to pay $15 trillion in short term notes to citizens and foreign countries together. That's a debt that make the post WWI Germany look tame.
Weimar Hyperinflation picked up after France invaded Ruhr cutting Germany from coal revenues.
Today this happens in Ukraine as they lost Donbass coal, they will hyperinflate.
Once US loses its petrodollar scheme it will be equalivent to losing Ruhr by Germany.
Hyperinflation was always preceded by a major shock to real parto of the economy (war, energy supply disruption, food shortages etc).
Not to mention cut off from natural gas this winter---price of coal, kerosene, wood, electricity, blankets, or anything to keep warm will go through the roof.
yes..., if you beat the dog too much, he may just take a piece of you.
According to Ferguson's book, German political leaders made decisions which they fully realized were reckless, because the alternatives were not politically acceptable to the German people.
Although it's called "Weimar" inflation, it was actually Imperial Germany that got the inflation ball rolling.
It was amazing how quickly inflation took root in Germany during the 1920s,
It took root so quickly because
German political leaders made decisions
One of those decisions made BEFORE WW I began was to pay for the war with inflation, reasoning that they could quickly pay off the war debt with income received from their (presumed) newly acquired subject colonies (that they presumed they'd take from their opponents.) Didn't quite work out that way.
Once the war ended, with harsh reparations Germany was in the soup.
Thus Weimar didn't actually cause the inflation - they were victims of it.
Sounds familiar..
SS, Medicare. Medicaid, MIC, what??
http://www.planbeconomics.com/2013/12/christine-hughes-what-inflation-de...