Five Things Podcast, The Transcript: Hyperinflation vs. Deflation
Editor's Note: What follows is a transcript of the Five Things You Need to Know Podcast, featuring Professor Kevin Depew and Cory Bortnicker.
Cory Bortnicker: Welcome to 5 Things You Need To Know: The Podcast. I’m Cory Bortnicker, and joining me, as always, is Minyanville Columnist and Executive Editor Kevin Depew.
Kevin Depew: How are you?
Cory Bortnicker: Today we’re going to take a look at five distinct topics, and let’s start out with hyperinflation versus deflation. There’s a lot of talk right now about people trying to discover whether or not we’re experiencing hyperinflation or deflation. Before we get into that, Kevin, can you just kind of talk briefly about what hyperinflation is and what deflation is?
Kevin Depew: Sure. Hyperinflation is an aggressive -- it’s essentially an out-of-control inflation. Economists usually use benchmarks of around, say, 50 percent per month inflation, if you can possibly believe that, or an extended period, say three years, where the inflation rate annualized is around 100 percent.
And those are difficult to imagine. But one of the reasons I wanted to bring this up and talk about it today is because there continues to be a lot of these words bandied about in the media and the feeling that, well, the Federal Reserve is creating all this new credit to give to banks, some 2 trillion dollars so far in bail-outs, and extending FDIC coverage to $250,000 for deposits, and all this is going to require a considerable amount of debt issuance in order for the country to pay for it.
And so there’s this ongoing fear, I think, where everybody’s looking for the currency to collapse. They’re looking for at least very aggressive inflation, if not outright hyperinflation, in some cases. And I just don’t think that is going to happen.
Cory Bortnicker: If this is going to increase the amount of debt, I mean, debt is what sort of got us into this crisis to start with; is that right?
Kevin Depew: Well, the USA is a debtor nation. All of our activities are financed by others, mostly Chinese and Japanese investors. So let’s just think about it for a moment and take these economic terms out of the picture and think about what’s going to happen.
The dollar is not backed by gold or anything other than the government’s ability to tax. That’s what gives the dollar its value is that the government has the ability to issue these notes. We use those to conduct transactions out in the real economy because you can’t go pay for anything with gold. And so the only thing backing that dollar is a promise that the paper is going to be good. Now, how do we get that promise? Because there’s no gold or silver backing the dollar; it’s simply the ability of the government to take tax revenues in.
So if we think about what’s going to happen, if we’re going to be spending all these dollars to bail out banks and the government’s creating all this new debt to bail out banks, and maybe GM and who knows what else, how are they going to finance that? Well, they’re going to have to go to issue debt in the market. And that means that they’re going to make Treasuries for sale for other investors to invest in the debt of the government.
So what happens if everyone sees that, hey, these guys in the , they cannot -- they’re not conducting their economy in any kind of a normal way; they’re taking on more debt than we think they can handle? Well, they’re going to demand a higher interest rate in return for financing that debt. The same way if you or I want to go buy a car and somebody views us as a poor credit risk. We’re going to have to pay a higher interest rate.
So let’s look at what happens. If interest rates skyrocket, say, because no one wants to finance government debt, and they go up from -- the ten-year right now is around 3.6%. So let’s say it goes to 5%, 8%, 10%. What that’s doing is collapsing bond prices. And when you have a collapse in bond prices, virtually, by definition, you have a shrinkage in the amount of credit outstanding. And that’s deflation.
So, on the other side of this, eventually, there may be a point when everyone is so disenchanted and has such an utter lack of faith and confidence in the US dollar that eventually we may get to the point where there is hyperinflation. But just to clarify, hyperinflation is when someone wants to get rid of dollars. They would rather put their money in anything else other than dollars.
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Great article.
My next interesting calculation is going to be whether there is going to be enough money redeemed out of the market to buy our debt next year. It could be an interesting calculation.
Given a deficit of $750M-$1Trillion:
Who will buy it, and at what rate?
-i: The lower the stock market goes the more people are likely to buy treasuries. If your predictions are correct, then it may go so low that there will be no issue. The flood to safety will be a tidal wave. The economy may be weak.
+i: Foreign governments and entities are creating their own sovereign wealth funds, oil is less expensive, and we are not buying as many foreign goods. All reasons not to buy our Treasuries at a low rate
When that happens I will believe we are having real deflation.
I agree we are now in deflation but the fed and treasury will create hyperinflation just as Bernake indicated with the "heliocopter" comment. There is no patience to deal with deflation over the long term in this period in history. The debt of the government and of society will be repudiated through hyperinflation, this will allow a restart of the economy from a basis of zero debt and also allow the government to repudiate all the giveaways to American citizens that have accumilated to the point that our economy cannot survive until this happens. The sooner the better.
Yes, the creditors will eventually want higher interest rates - assuming they actually want more US paper. Will the Chinese, the oil producers et al continue to buy when they already lost a bundle on what they currently hold, and the US consumer is no longer buying their gadgets, or their oil, in quantity anymore, anyway? TIC data didn't look so hot last two months. Maybe the creditor nations will simply find domestic uses for their money. Maybe they won't have a choice but need to deploy their funds at home. Who can tell how this will play out over the coming year or two, here and in other countries? So how will the ever-increasing debt load be paid off? Call me alarmist and let's hope this is totally far fetched: Governments have defaulted on their obligations before……What if we wake up one morning and are told each dollar is worth ten cents of some kind of New Dollar? -- I have relatives who went through currency reform not once, but twice and from what I remember them telling me, it was no fun to start from scratch.
The Layaway plan – hadn't heard about that in a long while. Most everybody has too much stuff as it is.
Standard, quote on quote, has been the house with a double garage and the cars parked out front, because the garage is storage space (well, maybe not in NYC but lots of places). Brings to mind a segment on the Newshour, PBS, last night: a company clearing out foreclosed homes. People leaving everything behind.
Furniture, clothes, nice new everything. Guess it was not paid for anyway, so why worry about it…
Saving versus investing – hmmm. After the internet bubble burst I would have thought too many people were burned by the market to ever get back in. Some did, others chased real estate instead. Will this trauma finally cure people and bring back good old fashioned savings? Only time will tell. As I believe, the elusive bottom is reached when Cramer starts up TheFarm.com, has a MadRanching show and writes about balcony gardening….Fact is, trust in the system as we know it has been shaken and we got a few headwinds ahead yet. Hard to read the crystal ball at this juncture.
Oh Michael, you write about helicopter money above....More Spruce Goose than helicopter, you think? Huge cargo plane that ended up a boondoggle, bringing not much more than embarassement to its supporters.
Cheers to all.
I wanted to thank Kevin, Cory, and the Minyanville staff for doing the transcription. Call me old fashion but I digest this stuff better from the printed text than the podcast.
And Annette; I think you may be onto something. I understand that the Spruce Goose is on display at a place called the Evergreen Aviation Museum in a small town called McMinville in the state of Oregon. Since it is still around, that may be the monetary distribution system of choice for Pilot Bernanke and Co Pilot Paulson. I just hope someone lets them know, before they plan to use it, that it is actually a flying boat.
However, we keep looking at these things from the monetary standpoint, forgetting the the financial economy is supposed to serve the real economy, the economy where people make actual goods. Its the economy of the farm, factory, fishery, forest, and mine. This is the original wealth upon which everything else depends. Its been dying for 30 years, and the financial system is just now getting the word. So rescue the real economy with real jobs, and the financial economy will take care of itself.
What Kevin so sublimely points out is that American society is/will shift away from using a middleman in the transaction, a middleman who has become entrenched in American society and has received way too much interest for a long time. Nice analysis on the short and long term repurcussions, and thank you for this eye opener. Now, I'm ready to go short some more (credit card) banks...
On the other hand, if the supply of goods dries up but the amount of money remains similar, then you can get hyperinflation. For example, if letters of credit don't work any more so that international trade shudders to a halt, and (in my country, the UK) there is insufficient food in the shops because the ships aren't coming in, then you do get hyperinflation VERY quickly - within a month or so it would take hold.
I know that most of the Minyanville professors believe we are in a deflationary negative feedback loop.
But in the back of my mind I have a lurking fear that something will happen to tip the balance the other way, suddenly and without warning. I think others feel the same way which is why it's so hard to buy physical gold at the moment. I believe that Professor Depew is a very smart cookie, Mr. Practical too, and they both think this is deflation, but at the back of my mind there is this nagging fear that your currency (the dollar) and our currency (sterling) are at some point going to become just worthless paper, just like Zimbabwe and the Weimar Republic.
I do hope I am wrong.
Meanwhile, what on earth is the ordinary person really supposed to do? I have sold all our investments except the family home and business, and I don't regret that. I never trusted pension schemes after the Equitable Life disaster, and I never will trust them again. I was brought up to be prudent and save, but now I don't trust the banks which are supposed to hold our family's savings. Usually you make decisions about what to do with your savings and you might get it a bit wrong. But right here and now if you make the wrong call between deflation and hyperinflation you will be utterly wiped out. And please don't tell me to hedge, that's a term of abuse now!
I just got a Credit Union loan for a car. They have strict rules of lending and seem very prudent. Keeping my money with them feels secure vs. under the mattress. I closed the Wells Fargo accounts as the personal service they provided was bad, but their credit card had binding arbitration clauses that left no recourse to their actions whereas the CU card has no clause. And I feel better about the money and where it goes and is used for. Remember that movie with Jimmie S? Here is another good interview.
http://www.kitco.com/ind/GoldReport/oct242008.html
GT
1) My recollection (err, from reading, not personal experience) is that the worst year for the US stock market was 1932, and the best year was 1933. Didn't the deflation in the US around that time occur mainly after 1933? In other words, won't the stock market rebound substantially before the worst of the deflation?
2) What will be the indicator that we are switching (if it happens) from deflation to hyper-inflation? A rapidly falling US dollar? How would we know when to switch investments strategies?
3) Will large personal savings actually lead to economic recovery? Japan, which suffered from deflation in the 1990s, had tremendous personal savings, but it never seemed to lead to much economic activity in Japan. Does government interference in the economy prevent this from happening? Specifically, if governments end up controlling large banks and other companies, would this keep us in a downturn, despite increased personal savings?
4) Are the excess debt problems of today due to events in the last 10 or 15 years, or do we find the source of these problems in the debt that the US incurred for WW II, and in the continued efforts of Western governments and Japan since then to prevent recessions through government borrowing and low interest rates? In other words, is the “bad debt brush buildup” much deeper and thicker than most believe, so that the fire that destroys it will be far worse than most imagine?
5) Will people buckle down and save and enjoy the simple things in live, or turn into the fearful masses that brought us suicides, Hitler, Mussolini, and other political turmoil, ending in blaming other people for our lower living standards and seeking wacko and desperate solutions, including trade wars, international aggression, and ultimately war?
Please excuse me for also posting this in the podcast comments. I hope no one had to read this twice.
Thanks! Bill
