Courtesy of Mish
Over the past few weeks, many people have asked me to comment on John Hussman’s August 23, 2010 post Why Quantitative Easing is Likely to Trigger a Collapse of the U.S. Dollar.
Most wanted to know how that article changed my view regarding deflation. It didn’t.
Several others went so far as to tell me that Hussman was calling for hyperinflation. They were point blank wrong.
Here is the pertinent section from Hussman’s September 6, 2010 post The Recognition Window.
A note on quantitative easing
One of the things I’m increasingly dismayed to learn is that no matter how much detail, data, and qualification I might include in these commentaries, my conclusions will often be summed up by writers or bloggers in a single sentence that often bears no relation to my point. For instance, my view that quantitative easing will trigger a "jump depreciation" in the dollar has evidently placed me among analysts warning of hyperinflation and Treasury default (a club whose card is nowhere in my wallet).
To clarify once again – I emphatically do not anticipate inflationary pressures until the second half of this decade. As I’ve repeatedly emphasized, the primary driver of inflation – historically and across countries – has been growth in government spending for purposes that do not expand the productive capacity of the economy.
Quantitative easing does not pressure the dollar by fueling inflation. It has a much more subtle effect (but one that can be expected to be amplified if fiscal policy is long-run inflationary as it is at present). Normally, equilibrium in capital flows between countries is achieved through changes in interest rates. As a result, countries with greater capital needs or higher long-run inflation tendencies also have higher interest rates. If interest rates can adjust, exchange rates don’t have to. But notice what quantitative easing does: by sitting on long-term bond yields (and creating a negative real interest rate differential versus other countries), quantitative easing prevents bond prices from acting as an adjustment factor, and forces the burden of adjustment on the exchange rate.
While some observers have noted that the value of the Japanese yen did not deteriorate dramatically over the full course of quantitative easing by the Bank of Japan – from its beginning until it was finally wound down – this argument misses the point. The exchange rate depreciation occurs as a jump adjustment in order to set up a subsequent appreciation over time. That gradual appreciation is needed to offset the lost interest difference caused by the policy of zero interest rates.
In the Octagon
Some of the arguments that people have recently presented for hyperinflation are so silly they are not worth discussing.
Yet, I have been drawn into discussing such arguments because of an unfortunate off-the-cuff statement I made on a recent podcast, and because of a misrepresentation of another statement I made in the same podcast.
A recent guest post by Gonzalo Lira on Zero Hedge, providing a theoretical framework for the arrival of hyperinflation, went viral, generating over 75k views and over 1,000 comments, further confirming that the biggest and most confounding debate in all of finance is what will the final outcome of the Fed’s market manipulative actions be: deflation, inflation or, and not really comparable, hyperinflation (which is a distinctly different phenomenon from either of the above). The post infuriated some hard core deflationists who continue to refuse to acknowledge the possibility that in its attempt to inspire inflation at all costs, the Fed may just push beyond the tipping point of monetary imprudence away from mere target 2-3% inflation, and create an outright debasement of the world’s reserve currency.
One among these was none other than Mish himself, who a week ago recorded a podcast on Global Edge with Eric Townsend and Michael Hampton (link here), in which his conclusion was that Hyperinflation is the endgame, "so it is unlikely."
Hyperinflation Ends The Game
Actually what I said is "Hyperinflation Ends The Game" NOT as Zero Hedge stated "Hyperinflation is the endgame". The difference between those phrases is enormous.
In the podcast I was asked about a guest post by Gonzalo Lira on Zero Hedge. I had seen the article and I made an off-the-cuff statement that the post was so silly it was not worth commenting on.
How Hyperinflation Starts According to Lira
Please consider the following snip as to how hyperinflation starts according to Gonzalo Lira.
So this is how hyperinflation will happen:
One day—when nothing much is going on in the markets, but general nervousness is running like a low-grade fever (as has been the case for a while now)—there will be a commodities burp: A slight but sudden rise in the price of a necessary commodity, such as oil.
This will jiggle Treasury yields, as asset managers will reduce their Treasury allocations, and go into the pressured commodity, in order to catch a profit. (Actually it won’t even be the asset managers—it will be their programmed trades.) These asset managers will sell Treasuries because, effectively, it’s become the principal asset they have to sell.
It won’t be the volume of the sell-off that will pique Bernanke and the drones at the Fed—it will be the timing. It’ll happen right before a largish Treasury auction. So Bernanke and the Fed will buy Treasuries, in an effort to counteract the sell-off and maintain low yields—they want to maintain low yields in order to discourage deflation. But they’ll also want to keep the Treasury cheaply funded. QE-lite has already set the stage for direct Fed buys of Treasuries. The world didn’t end. So the Fed will feel confident as it moves forward and nips this Treasury yield jiggle in the bud.
Debating the Flat Earth Society
Supposedly … A slight rise in oil will cause a "jiggle" in treasury yields.
As a result of that jiggle "asset managers will sell Treasuries because, effectively, it’s become the principal asset they have to sell."
Since when are much despised treasuries the "principal asset" of asset managers? And pray tell, why would the asset managers "have to sell"?
Oil at $140 did not start a chain reaction before. Why would a "slight but sudden rise" in commodity prices start such a chain reaction, now?
I do not know how anyone could keep reading after those statements, but it goes on and on, getting sillier and sillier about who has to sell what and why, and in turn what the Fed’s response will be.
One interesting aspect of Lira’s post is that I agree with his definition of hyperinflation: a complete loss of faith in currency. Yet, Lira never even discusses how a selloff in treasuries causes a loss of faith in the dollar.
However, Lira does go on to say "….That’s why I think there’ll be hyperinflation in America—that bubble’s soon to pop. I’m guessing if it doesn’t happen this fall, it’ll happen next fall, without question before the end of 2011. "
Commenting on the above is tantamount to debating the flat earth society. The premise is so silly it’s not worth discussing, yet here I am trapped into discussion by a mischaracterization of my statement "Hyperinflation Ends The Game".
How Does Hyperinflation Occur?
"FOFOA" hops into the hyperinflation debate with Just Another Hyperinflation Post – Part 1
First of all I would like to clear up probably the most common misconception about hyperinflation. What most people believe is that massive printing of base money (new cash) leads to hyperinflation. No, it’s the other way around. Hyperinflation leads to the massive printing of base money (new cash).
Hyperinflation, in most people minds, conjures images of trillion dollar Zimbabwe notes. But this image is simply the government’s reflexive response to the onset of hyperinflation, which is actually the loss of confidence in the currency. First comes the loss of confidence (hyperinflation), then, and only then, comes the massive printing to keep the government and its obligations afloat.
Zimbabwe vs. Weimar
In the case of Zimbabwe, a loss of faith in currency occurred before the printing occurred. The Weimar Republic is a different story.
In Zimbabwe, the Mugabe government initiated a "land reform" program intended to correct the inequitable land distribution created by colonial rule. Ultimately, Mugabe’s attempt to to bail out the poor at the expense of the wealthy is what triggered capital flight and loss of faith of the currency.
His reforms not only caused a flight of capital and human capital (the wealthy), they also led to sanctions by the US and Europe. In response, Mugabe turned on the printing presses but the loss of faith in the currency had already occurred.
In Weimar Germany, printing for war reparations kicked off hyperinflation. Wikipedia provides a good accounting in Inflation in the Weimar Republic.
It is sometimes argued that Germany had to inflate its currency to pay the war reparations required under the Treaty of Versailles, but this is misleading, because the treaty did not allow payment in German currency. The German currency was relatively stable at about 60 Marks per US Dollar during the first half of 1921.
But the "London ultimatum" in May 1921 demanded reparations in gold or foreign currency to be paid in annual installments of 2,000,000,000 (2 billion) goldmarks plus 26 percent of the value of Germany’s exports. The first payment was paid when due in August 1921. That was the beginning of an increasingly rapid devaluation of the Mark which fell to less than one third of a cent by November 1921 (approx. 330 Marks per US Dollar).
The total reparations demanded was 132,000,000,000 (132 billion) goldmarks which was far more than the total German gold or foreign exchange. An attempt was made by Germany to buy foreign exchange with Marks backed by treasury bills and commercial debts, but that only increased the speed of devaluation. The monetary policy at this time was highly influenced by the Chartalism, and was notably criticized at the time from economists ranging from John Maynard Keynes to Ludwig von Mises.
Hyperinflation is a Political Event
The commonality between Zimbabwe and Weimar is they are both political events. In Zimbabwe a political event triggered capital flight, in Weimar a political event started massive printing, triggering hyperinflation.
Interestingly, FOFOA’s commentary seriously weakens the hyperinflation case once one dives into the politics of the cause.
Can The Fed Cause Hyperinflation?
I do not think the Fed can cause hyperinflation and more importantly I am sure they would not if they could. The reason is "Hyperinflation Would End The Game"
- Hyperinflation by definition would destroy the currency and thus the banks
- Hyperinflation would destroy the wealthy and all their corporate bond holding
- Hyperinflation would destroy the Fed
- Hyperinflation would destroy the wealthy political class
That is what I meant by it would "end the game" and that is why the banks, the Fed, the politicians, and the wealthy would not let "the game" progress that far.
Fiat World Mathematical Model
The above addresses the question of "Would the Fed Cause Hyperinflation?"
"Could the Fed cause hyperinflation?" is a different question. I have my doubts.
To understand how powerless the Fed is, one needs to understand the difference between credit and money, how much the former dwarfs the latter, and what the Fed’s role is in getting banks to lend. I discussed those ideas in Fiat World Mathematical Model.
Unlike Congress, the Fed has no power to give money away. Nor would they do so if they could.
By the way, I did see Quantitative Easing, ZIRP, and various Keynesian silliness in advance and stated they would not work.
October 30, 2008: ZIRP Coming To Fed?
ZIRP did not help Japan and it will not help US banks either. In fact, the rate cuts appear to be counterproductive. However, one cannot rule out the Fed cutting rates to 0% anyway. Bernanke is in academic wonderland and appears to be hell bent on sticking with his models regardless of how poorly those models perform in actual practice.
March 06, 2009: Groping In The Dark’ With Quantitative Easing
Excuse me but has anyone looked at the success rate of Bernanke’s quick slash of interest rates from 5.25 to 0 and the fast $trillions Congress, Paulson, Geithner and Obama have thrown down various black holes?
Of course the Keynesian clowns will always come back with "It would have worked if only we threw money away faster". They do every time. Krugman Still Wrong After All These Years is the perfect example.
January 02, 2009: How "Something For Nothing" Ideas Become Policy
Bernanke Correctly Judged Nothing
Bernanke considers himself an expert on the great depression and on the Japanese deflation as well. Trying to act quickly, Bernanke has come out blazing with 8 new policy tools, including the TALF, TARP, PDCF, ABCPMMMF, CPFF, TAF, and MMIFF to go on top of Open Market Operations, Discount Rate setting, and setting reserve requirements.
The result so far is deflation. The result in Japan was deflation.
There is only one way to defeat deflation and that is to not let the conditions that foster it to build up in the first place. What caused this deflationary bust is the credit boom that preceded it. What caused the great depression was the credit boom that preceded it. Hoover’s policies and FDR’s policies made the great depression worse.
Bernanke’s policies are going to make this depression worse. Yes, I used the word depression. It may not be as big as the great depression, but the word "recession" does not do justice to what we are in and what is coming down the pike.
I agree with Hussman that Quantitative Easing will not cause hyperinflation. Nor will "jiggling" of treasury yields, nor would a "slight but sudden blip" in commodity prices, nor would another $1 trillion stimulus effort.
Kevin Feltes and David Levy, economists for the Jerome Levy Forecasting Center, have come to the same conclusion.
For a discussion of ideas from the Jerome Levy Forecasting Center, please see "Contained Depression"
For Now, It’s Deflation
For a full discussion of where we are today please see Are we "Trending Towards Deflation" or in It?
Unlike hyperinflation, deflation does not "end the game" (destroy the currency). The Great Depression and Japan both provide proof enough.
Given that hyperinflation is a complete loss of faith in currency, tangible goods, any tangible goods must by definition rise exponentially in such a situation. Yet amazingly many hyperinflationists are bearish on housing.
Hyperinflation accompanied by a housing collapse is simply impossible – by definition.
What Could Cause Hyperinflation?
As noted above, the Quantitative Easing will not cause hyperinflation. Moreover, it is doubtful the Fed can cause it at all. The Fed cannot give money away nor can the Fed force banks to lend or consumers to borrow. Those who disagree must still address the difference between theory and practice.
Unlike the Fed, Congress could give money away.
I do not know if giving everyone in the US $60,000 would do it or not, but announcing a plan to give everyone $60,000 a month indefinitely would sure do it.
How likely is that?
The answer is 0%. Congress struggles right now extending unemployment insurance. There is little political will for more stimulus. The next Congress is a guaranteed bet to be more conservative.
To be sure, more stimulus and more Quantitative Easing are coming but the latter does not matter and the former will be in insufficient quantity.
Theory vs. Practice
Please note that banks do not want hyperinflation or even massive inflation. The reason is simple: Banks will not want to be paid back with cheaper dollars, especially worthless dollars, and Congress is beholden to itself and the banks.
Hyperinflation could theoretically come from massive sustained political will to bail out the little guy at the expense of the banks, the wealthy, and the political class. However, unlike Mugabe and Zimbabwe, neither the banks nor the Fed nor the political class wants to bail out the poor at the expense of the wealthy.
Indeed, Bernanke’s, Paulson’s, and Geithner’s actions to date have done the exact opposite!
We have bailed out the banks at the expense of the ordinary taxpayer (keeping the little guy in debt).
This is what it comes down to: In theory, Congress can easily cause hyperinflation. In practice, they won’t, and neither will the Fed. As Yogi Berra once quipped "In theory there is no difference between theory and practice. In practice, there is."