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Five Things You Need to Know: Why Not Hyperinflation?

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Hyperinflation requires both the means and the motive.

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Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

Almost every day I get notes like the following wondering, "Why not hyperinflation?"

Kevin,

I am still struggling to reconcile the timing between your deflationary stance and others who see the possibility we wind up jumping the shark to hyperinflation. I see and understand both sides; but it seems that many are looking every day for the sign that we have hopped into a real inflationary period....while you see an extended deflationary period that will not soon end.

Is there any way that you can address what seems to be your differences in the timing of entering into a real inflationary period. You seem to agree on the major economic issues and undercurrents that will drive the market; but this big "timing" issue is a glaring difference.

Minyan DT

This is a good question. I'll try and explain why I believe a deflationary debt unwind is now underway, and why I believe it will be many years before we should start worrying about inflation again. In fact, by the time inflation becomes a legitimate concern, I expect the vast majority of people will find it as outrageous to worry about inflation then as found it outrageous last year when I made deflation one of my Five Themes for 2008.

The disconnect at work today that makes it difficult to envision a life without inflation is almost entirely grounded in a failure to see that credit expansion, by necessity, must have two sides; a credit production mechanism, and a debt acceptance recipient. We have as much of the former as the world has ever seen, but none of the latter.

Going back to 1934, whenever the Federal Reserve has made credit available the world has accepted it. While it is true, as those anticipating hyperinflation argue, the Fed and global central banks are making record amounts of credit available, that is only one side of the credit equation. The assumption is that this record-breaking credit expansion means risk assets (stocks, commodities, etc.) will all skyrocket and the U.S. dollar will get destroyed. But what hyperinflationists fail to realize is that for an inflation (of either the tame or hyper variety) to take place, one must have both the means (credit from the fed and banks) and the motive (the desire to take on more debt) for credit expansion. For over a year now we have had record amounts of the former, but none of the latter.

Additionally, in order for hyperinflation to even be a remote possibility here there would have to be at least one economy that is both, stronger than the weakest.S. economic downturn, and larger in size that the state of Ohio's or even California's economy.

Ironically, while smaller emerging markets could potentially find themselves facing a Zimbabwe-esque hyperinflation, that would only make the U.S. dollar and U.S. debt more attractive and secure. Emerging markets are at this point the only place where it seems a possibility that credit could find a willing home and debt an eager taker, but even that is not a certainty. It is more likely that the creeping protectionism that is developing, as countries begin to wake up to the fact that the global system is too big to save, results in a more severe credit contraction globally.

But so what? What if I am wrong about this? What, if anything, is at stake?

One the most remarkable things to me is how the American people have been sold on accepting, even preferring, inflation over deflation. It is truly amazing that government and central banking bureaucrats could successfully instill the belief that lower prices for assets are bad. The reality is that lower prices are only bad for artificially-constructed economies.

Deflation is necessary to restore market and economic stability. It is not without pain. But inflation, even mild inflation, is like an intoxicant that slowly destroys the body over time even as its narcotic properties mask the pain. By comparison, hyperinflation is ruinous. How ruinous? Consider this passage from Adam Fergusson's book, "When Money Dies: The nightmare of the Weimar collapse":

"In hyperinflation, a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano. A prostitute in the family was better than an infant corpse; theft was preferable to starvation; warmth was finer than honour, clothing more essential than democracy, food more needed than freedom."

This is important to understand. The argument against deflation and inflation is both academic and political. Present economic elites benefit from inflation and suffer terribly in deflation. Therefore there is great incentive for the small minority, the 2-3% of wealthy who control the vast majority of assets in this country, to continue to press government and the Fed to maintain the present course of inflation over deflation.

But as Fergusson illustrates, hyperinflation is another matter.

Just as the Federal Reserve and Chairman Ben Bernanke maintain they will do everything in their power to prevent deflation, then the American people, as patriots, should be equally insistent on doing everything in their power to prevent hyperinflation.

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