Thursday, October 21, 2010

Hyperinflation Is a Political Process

As the dollar has plummeted, discussions of hyperinflation proliferate. We should keep in mind that hyperinflation is always a political phenomenon, and only secondarily a financial one.

With the Fed's campaign to destroy the U.S. dollar now visible to all, the topic of hyperinflation inevitably arises. Hyperinflation is the endpoint of currency destruction, and with the "race to the bottom" in a "currency war" in the news, then it is a good time to discuss hyperinflation.

There has long been a lively debate underway on the Web as to whether hyperinflation is likely or unlikely. Rather than insert myself into a debate that needs no further voices, I will limit myself to three observations which I consider decisive.

1. Hyperinflation is intrinsically and necessarily a political process. The vast majority of the discussions and debates on hyperinflation seem to assume it is primarily a financial process which proceeds with some sort of inevitability once a tipping point has been reached.

Perhaps, but the policies which lead to that point of no return are political in nature.Currencies do not die of their own accord--they must be actively destroyed by political decisions and policies.

Destroying a currency is not like falling off a cliff; gravity does not take hold until the very end. Rather, the currency must be pushed and manhandled all the way up a long steep incline to the cliff's edge and then shoved off.

At any point up to the final shove into oblivion, the political winds could change and the policy pressure that is destroying the currency would cease.

Currencies are destroyed as a political "unintended consequence" of saving the Status Quo from losing power. Rather than risk a decline in power, or an upheaval in the fiefdoms, Elites and State dependents which support the Status Quo, the Power Elites choose to debauch the currency as the "short-cut solution" to their inherently unsustainable financial woes.

Over the course of history, the usual cause of currency destruction is overindebtedness of the Central State/Monarchy/kleptocracy. Once the State/kleptocracy/Monarchy can no longer service its rising debts (usually incurred to finance war or expansion), then rather than cut expenses (which would deprive the fiefdoms, army, clergy, bread-and-circuses rabble, etc. of their share of the swag) then the status quo elects to print money to service the debts.

This works until the creditors demand gold or equivalent hard money. Then the status quo declares bankruptcy and the creditors get nothing. Usually there is a political revolution which overthrows the court, the nobility, or whatever other Elites led the nation into catastrophe.

For a modern-day equivalent, consider this example. If the Federal government were to announce that all the Social Security recipients receiving $2,000 a month would now get $200 a month, then a political firestorm would ignite.

Rather than risk overthrow, the government Elites debauch the currency so the $2,000 in today's money is soon only worth $200 in purchasing power. The government has de facto reduced the payment by 90% via destruction of its currency. But due to the stealth of this process, the citizenry are blind to the erosion. If you take 10% of their money away every year via debauching the currency, then in nine years they have lost 90%--and all without any political fuss or risk to the status quo.

Once the populace loses faith in the currency, hyperinflation takes hold. That is the shove off the cliff--the loss of faith in the currency. Once again that loss of faith is a profoundly political act.

There is nothing inevitable about hyperinflation. The political Status Quo can either choose or be pressured by mass uprisings to cease destroying the currency.

In the U.S., I consider such a political firestorm as increasingly likely going into 2013-2014. By 2014 I expect Congress to pass a law titled "The Federal Reserve Reformation Act" or equivalent, which basically restricts or eliminates the Fed's treasured independence.

The proximate reason for the congressional control over the Fed will be the widespread recognition that the Fed has failed the nation utterly and completely, and that their policies have acheived nothing but the debauchery of the nation's currency. That debauchery impoverishes every citizen, every enterprise and every agency of government.

I would welcome a political recognition of the Fed's failure and the resulting elimination of the Fed or at a minimum of its reconstitution as a true central bank rather than a rogue private institution with vast destructive powers beyond the reach of democracy or the citizenry.

2. There is a difference between credit and fiat money. In the usual hyperinflation scenarios (Zimbabwe, Argentina, et al.) the central government prints vast amounts of fiat money which is not backed by hard assets. Everyone loses faith in the currency and it becomes worthless. At that point the government falls and/or a new "hard" currency is issued which promptly deprives the holders of the "old money" of their wealth. That usually includes all common citizens, but not the Financial Elites, who manage to shift their wealth to other currencies or hard assets before the collapse.

Once the Elites' wealth is safely out of the country, then the government imposes capital controls.

While the U.S. has a fiat currency unbacked by anything but the promise of future payment of bonds, money is created by the instant creation of credit. Thus the Fed creates $1 trillion and buys toxic mortgage assets from the banks with the funds, and the toxic mortgages are booked as assets while the $1 trillion in credit is booked as a debt.

Now the problem with the hyperinflation scenario is that credit is immobile if people refuse to borrow it. The Fed could create $300 trillion in credit tomorrow but if nobody borrowed any of that credit money, then it cannot flow into the economy.

The Fed could buy every mortgage in the nation and make all sorts of other crazy purchases of assets, but it can't force people or enterprises to borrow and spend/invest money.

By lowering interest rates to zero and pushing liquidity, the Fed is debauching the dollar and thus reducing the purchasing power of everyone who holds dollars--but this still doesn't inject money into the economy.

If the Fed bought every mortgage in the land, then we'd all be sending our mortgage payments to the Fed. The banks would have no toxic assets on their books, but that would not make anyone want to borrow more money from them.

In a nutshell, that is why quantitative easing is doomed to abject, total failure, except as a tool to destroy the nation's currency and thus its wealth.

The Fed's incompetence is so profound, so striking, so painfully obvious that we have to wonder just how willfully blind our political class must be.

3. The debauchery of the currency causes a reduction of purchasing power which mimics but is not the same as classic "inflation." In classic inflation, "too much money is chasing too few goods." With the Fed destroying our currency, then we pay more for commodities, and those higher prices then filter into every nook and cranny of the economy.

There is not "too much money chasing too few goods," there is a national currency being destroyed by political decisions made in the Fed and others in the nation's Financial Nobility.

To actually resolve the nation's financial crises would require a reduction or loss in political and financial power of the Elites as the chickens came home to roost. To avoid that reckoning, the Power Elites are choosing to debauch the dollar as a "short-cut" way of avoiding the political firestorm which would be ignited should the State's fiefdoms, Elites and dependents see their share of the swag reduced.

So the Power Elites in the Fed, Congress and other Central State fiefdoms would rather destroy the citizenry's currency and wealth rather than risk losing their own vast powers.

Special podcast: Steve over at Two Beers with Steve was kind enough to let me ramble semi-coherently for an hour; we had a great time and I think I should have interviewed him.... Check it out if you have an hour of sitting in traffic to invest: Two Beers with Steve podcast.

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