Tuesday, June 21, 2011

The Depression You Better Hope We Have… [update 2]

_Kris_SayceGuest post by by KRIS SAYCE from Money Morning Australia 

We’re often asked why hasn’t the U.S. suffered hyper-inflation… what with the trillions of dollars printed by the U.S. Federal Reserve.

The answer is quite simple.  Although we’ll admit we overlooked it at first…

With a gold standard, a nation owed money (creditor nation) by another nation (debtor nation) can demand payment in gold.

But without a gold standard, the creditor nation can only receive paper or electronic money… money created by the flick of a switch.

That’s when inflation troubles begin.

But still, it doesn’t explain why Weimar Germany and Zimbabwe had hyper-inflation whereas today the Western world doesn’t.

Here’s the key: hyper-inflation only takes hold if a nation expands the money supply much faster than other nations… and if creditors have real alternatives to the inflated money.

That’s why Weimar Germany and Zimbabwe had hyper-inflation.  And why the Western world doesn’t today.

Let me sum it up for you…

Why hyper-inflation happens

Following World War I, Germany had to pay compensation to the victors in gold or foreign currency.

But because Germany didn’t hold enough gold or foreign currency, it had to print new money to swap it for gold and foreign currency.

Clearly when your intention is to devalue the currency, working fast is critical.

Because as soon as the market gets wind of the plan, holders of the money will look to get rid of it as quickly as possible in exchange for something else.

That explains the speed of Weimar Germany’s inflation:

Source: Wikipedia

In a matter of months, one gold Mark (money convertible into gold) had increased in value from 1,000 “paper” Marks to one trillion “paper” Marks.

The story is similar for Zimbabwe.  Once the central bank began printing money, creditors stopped accepting Zimbabwe dollars – because they knew they were being devalued.

They preferred a better store of wealth – such as the U.S. dollar!

But while hyper-inflation is bad, what the Western world is experiencing is much worse.  Because there isn’t a fixed conversion for paper money into gold for any currency, all central banks and governments know they can inflate the money supply.

As long as they don’t go too crazy.

That’s the main reason many central banks publish an inflation target.

They don’t do it for information purposes.  And it isn’t to try and cap inflation.  It’s there as a form of price-signalling… showing other central banks how much they can increase their money supply without causing a run on the currency.

As long as every central bank knows the limits, they can engineer a globally co-ordinated period of inflation… without fear of causing hyper-inflation.

And boy, has it worked.

How the misery is spread far and wide

Trouble is, it punishes the whole world – not just one nation.

And because gold is demonised as a “barbarous relic”, and even blamed for past depressions, most people – even pro investors – don’t realise the value of their money is being eroded.

That’s the “good” thing about hyper-inflation.  You’re in no doubt what’s happening.  You can see your wealth destroyed right before your eyes.

But with slow burning inflation caused by central bankers, the effects are near impossible to notice at the time.  It’s only years later you wonder how you can earn three times as much as you used to, yet you’re still no better off.

You can see the difference clearly in these two charts.  First, this chart from the Bank of England showing the annual inflation rate since 1790:

Source: Bank of England

And second this chart showing the U.S. inflation rate from 1914:

File:US Historical Inflation.svgSource: Wikipedia

When gold was considered as money, you can see inflationary periods followed by deflationary periods.

Wealth erosion didn’t happen over the long run.  And purchasing power was broadly constant.

But once the monetary system removed gold and silver, there have been no periods of deflation.

Even during economic downturns, there hasn’t been deflation… only more inflation.

Why the worst is yet to come

During the past two years the U.S. Federal Reserve has created almost $2 trillion of extra money to keep the U.S. from collapsing.

And what has it achieved?  According to Bloomberg News:

“The US economy will grow 2.5 per cent this year, down from 2.8 per cent projected in April, the IMF said today, citing higher commodity prices and bad weather in the first quarter and a weak housing market.”

The U.S. economy got a temporary inflation boost.  And now the impact has gone.

If central banks want to postpone the overdue depression, it can only do one thing: and that’s print more money.  Given a choice between that and allowing the global economy to collapse on their watch we know which they’ll choose.

The fact is, as strange as it sounds, the world needs a depression.

It needs to purge the economy of all the past mistakes.  Sure, you can sit there and hope it doesn’t happen.  But that’s just accepting you’re happy for your wealth to be destroyed by slow-burning inflation…

This is much worse than the quick shock of hyper-inflation.  But the slow-burn can’t and won’t last.

Our guess is that time is fast approaching.  And that means inflation – even though it may not be hyper-inflation – is set to soar.

Cheers.
Kris Sayce
Money Morning Australia

RELATED POSTS at NOT PC:

UPDATE 1: A contrary opinion on the coming calamit(ies) here:

  • Permanent Gold Backwardation:The Crack Up Boom – Keith Weiner,  Z E R O   H E D G E
    ”I agree that one way or the other we will get a depression, and the sooner the less severe. But for the rest, well I published this paper on a different theory of hyperinflation…”

And … “Anyone who thinks ‘inflation’ is about rising prices, and hyperinflation is about hyper rising prices needs to read this article [as well]. It is about the increasing tensions around insolvency and what happens when a debtor cannot pay. Picture this happening to country after country, bank after bank.”

UPDATE 2: The latest Casey Daily Dispatch links to a relevant wee video.

“It's a 1933 propaganda piece promising to bring the United States out of the Great Depression with inflation. Most of our readers will find this funny - especially the part about higher commodity prices. However, this video also reminds me of propaganda's changing face. The message is essentially still the same today, but Washington has become more subtle in presenting its views.”
1933 Inflation Propaganda Video (YouTube)

US Government Inflation Propaganda - 1933

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