The Road to Hyperinflation
by Alar Tamming, Tavex with Krassimir Petrov Ph.D. March 16, 2010
Inflationism is a slippery road – the road to hyperinflation. The inflationist Bernanke Fed behaves as if they would not be “dialling back” from Quantitative Easing any time soon. They talk the talk, but can’t walk the walk. The inflationary genie is out of the bottle. Taming it back will result in a crushing deflationary collapse. The Fed will never let this happen again. They did it once during the Great Depression, they won’t do it again.
The government’s reaction is typical of a crisis associated with economic collapse and social unrest. Hemingway put it so aptly: “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin."
Three years ago Äripäev, Estonia’s leading daily business newspaper, published Alar Tamming’s article “Great Economic Crisis on the Way”. The article came out during the economic euphoria and the author himself is probably the only one who still remembers the final sentence: “... this time, do not complain that you were not forewarned.”
The economic crisis is well under way. However, there are major differences in predicting how the crisis will end. Yes, “under way”, because most people still think that we will be soon coming out of the crisis, may be even within a couple of months. Economic philosophizers still prognosticate that the economic boom is about re-emerge. Many in the Establishment even declare that the crisis is over. They forecast business as usual – the resurrection of the consumption-based economy, only if the banks were to start loaning again. Unfortunately, this will be impossible.
They are mostly wrong, as suggested by history and chaos theory. Even a superficial introduction to chaos theory leads us to observe that when a self-regulating system has reached the critical point, there is no returning to the previous level. Just like a capitalistic society cannot return back to slavery, or just like slavery cannot return back to the primeval society of hunters and gatherers, so we can no longer return to the capitalistic economic model that is based on consumption.
Development of all complex systems, whether we are dealing with a society, a business, or a human being, always take place in cycles. There is a time of balance (equilibrium), then a period of confusion (disequilibrium), and afterwards the system will be re-organised at a new, higher level, so that the problems that were a source of conflicts at the previous level will be resolved. This is the essence of Hegelian dialectics.
For example, everyone can see these processes happening to their children – how teenagers are full of conflicts during their puberty and how they will grow out of them stronger and smarter than before. Similarly, one can think of the end of the Soviet Era, when the system could no longer react to the external environment, which drove it to chaos; and then a new social order emerged, a qualitatively new system, based on private capital. Every entrepreneur probably remembers the same when thinking about development of his company, and can recall how crises have helped his company improve, if he ever managed to survive. Without proper resolution of internal and external conflicts through development, every system is doomed to fail. This is a basic application of Hegelian dialectics and a basic result associated with complex systems.
However, the current situation is rather complicated. The economic system has gone critical – it has reached point from where there is no turning back. The worst part is that the system cannot self-organise. “Normal” business organisation typically means that if you are doing business and make wrong decisions in a particular economic environment, then you should also suffer the consequences. In other words – if a bank has made bad loans, then we should let it fail. Failure is part of capitalism. Individuals and businesses that have deposited their money in this bank and, therefore, made a wrong decision, should also lose their money. Simple and logical, this is what capitalism is all about.
Unfortunately, governments and central banks do not want to accept that. They think that trying to feed a dead horse will bring it back to life. And if it won’t revive, then it has to be fed even more. They can vividly remember that when the horse was running strong, it had a good appetite. So the endless bailout packages are not going to revive the economy. Unfortunately, the system can no longer recover through normal pain – the Schumpeterian “creative destruction”. Instead, the result there will be a long period of excruciating suffering – a systemic implosion.
Even worse, thanks to the human factor, an even bigger problem awaits. The economy, which is just about to tailspin on one side of the road, will probably tailspin on the other side. This represents the current inflation-deflation debate. Everyone with a racing experience who has felt the car skid off the road knows that trying to countersteer too hard will get you in the ditch on the other side of the road. While the deflationary forces exert strong deflationary pressure, the inflationist Bernanke Fed is trying hard to countersteer with inflation. Some prices are indeed dropping now, but this is just the prelude to the real opus – hyperinflation.
Financial history teaches us that every time a financial crisis has been alleviated by printing more money instead of cutting costs and prices, it has ended up with hyperinflation. Zimbabwe is the most recent example, but the list is almost endless: Bulgaria, Russia, Ukraine, Turkey, Argentina, Mexico – the list goes on and on. We don’t need to add the years behind the crises – everyone can easily find these from the Internet. We refer the reader to our good friend Mike Hewitt, who has created an impressive compilation of such historical follies in his article “Hyperinflation Around the World”.
Hyperinflation goes with economy and finance just like attachments go with e-mails. Here is how the great economist Ludwig von Mises describes it:
„But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”
Currency depreciation is actually quite common. A survey including 120 countries provides evidence that over the past 7 years, the currencies of 90 countries have lost at least half of their value. The thirty countries with relatively more “stable” currencies included mostly developed countries like the USA, Western European countries, Australia, and a few others that represent the “core” of the global monetary system.
However, this time the instability of the system has reached the core. The current economic policies can only lead us to one result – the destruction of the current global monetary system through hyperinflation. The flawed mainstream remedy, based on the failed doctrine of Keynesianism, is that in difficult times the state should intervene aggressively into the economy by spending more (and bailing out everybody) in order to protect jobs. To use one of Peter Schiff’s analogies, this is like poring gasoline on a fire; it only serves to speed up the hyperinflation. If the money for the stimulus actually exists in the government coffers as a result of previous savings, as is currently the case with Saudi Arabia, then this would be all right; unfortunately for the developed world (the “core” – U.S & Europe), this is not the case. And calling the spending without actual savings with fancy terms like “Keynesian stimulus” (or whatever) can’t possibly change the essence of things. The state provides for the stimulus with freshly-printed money that modern central bankers call euphemistically “Quantitative Easing”. It is a textbook example of “monetization” that is rapidly depreciating the currency and later on rendering it practically worthless. If printing more money and providing all sorts of stimuli and bailout packages could solve economic problems, then we would have been living in endless prosperity for hundreds of years, and Zimbabwe and Argentina would have been the economic powerhouses of the world.
Hyperinflation is not yet to be seen at the core, but the internal dynamics of process has its own inner logic and necessarily requires time. When a car backs out of a garage, it first backs up in one direction, before it drives off in the other. It appears for now that the U.S. auto manufacturers are saved, but this is actually a step towards hyperinflation. Eventually, costs will have to go up, then prices, and eventually salaries. In a positive feedback loop, higher wags lead to higher costs and higher prices – the dreaded wage-price spiral begins to speed up. Typically, a shortage of money develops and the social pressure to inflate becomes insurmountable – when inflation is speeding up, the government and business would go through tough times, because the revenues for goods and services sold will never be enough to pay for rising wages and prices of raw materials.
In a normal economic cycle, a profitable business will have more money (profits) after producing goods out of raw materials, so it can buy even more raw materials and grow; however, during hyperinflation business revenues are not enough to cover the rising cost of materials. So every production cycle generates a loss and the company becomes poorer and poorer. This simple concept may be hard to grasp at the moment for those who have never lived through hyperinflation, but when the time comes, it will be perfectly understood by almost everyone in the economy.
As grim as it may sound, there is a glimmer of hope – the beginning of the hyperinflation is also the beginning of the end for the Crisis. Financial assets accumulated by individuals and businesses during the boom years have to be destroyed – the price for our financial folly today will be paid tomorrow. There is no way around it, as the scarce economic resources backing these financial assets have been consumed through the sophisticated redistribution mechanisms of innovative financial instruments and deficit spending. Unfortunately, there is no such thing as a free lunch – the Baby Boomer generation has had an extra lunch today, but will have to skip the lunch tomorrow. The economic crisis is here and hyperinflation is on the way.
In conclusion, let us reiterate: “Don’t say you haven’t been forewarned.” But of course, this warning is just as good as giving a moralizing speech about drinking in a packed bar – no one would listen anyway. However, you have been warned – protect yourself, buy gold!
This article reflects Alar Tamming’s personal opinion on the global economic developments.
© 2010 Krassimir Petrov, Ph.D.