EDITOR NOTE: There’s been a lot of talk of hyperinflation recently. Given the Fed’s pro-inflationary framework, it makes sense that investors on the more hawkish side of things might sound the alarm. Although there are clear signals of hyperinflation, the problem in any “early warning” against it is the speed of its trajectory. Right now, the “velocity of money” isn’t flowing very widely. Excess money printed by the Fed won’t mean much if it isn’t circulating. But once velocity does accelerate, there’s a certain undefinable point where hyperinflation kicks in. By then, it’ll be too late for most people to do anything. The victims will be those who rely on savings, bonds, fixed income assets, pensions, social security, and annuities. The victors will be those who own land and hard assets--namely real estate, international currencies (unless their countries are experiencing hyperinflation as well), and most importantly, gold and silver. Don’t wait until it’s too late to hold physical assets. Remember, by the time the signs are evident, the opportunity to protect yourself has already passed.
There’s no universally agreed-upon definition of hyperinflation. But one widely used benchmark says hyperinflation exists when prices increase 50% or more in a single month. So if gasoline is $3.00 per gallon in January, $4.50 per gallon in February and $6.75 per gallon in March and the prices of food and other essentials are going up at the same pace, that would be considered hyperinflationary.
It also tends to accelerate once it begins, meaning the monthly 50% increase soon becomes 100%, then 1,000%, etc., until the real value of the currency is utterly destroyed. Beyond that point, the currency ceases to function as a currency and becomes litter, good only for wallpaper or starting fires.
Many investors assume that the root cause of hyperinflation is governments printing money to cover deficits. Money printing does contribute to hyperinflation, but it is not a complete explanation.
As I mentioned above, the other essential ingredient is velocity, or the turnover of money. If central banks print money and that money is left in banks and not used by consumers, then actual inflation can be low.
This is the situation in the U.S. today. The Federal Reserve has expanded the base money supply by over $6 trillion since 2008, with over $3 trillion of that coming since last February alone.
But very little actual inflation has resulted, or at least very little official inflation. This is because the velocity of money has been decreasing. Banks have not been lending much, and consumers haven’t been spending much of the new money. It’s just sitting in the banks.
Money printing first turns into inflation, and then hyperinflation, when consumers and businesses lose confidence in price stability and see more inflation on the horizon. At that point, money is dumped in exchange for current consumption or hard assets, thus increasing velocity.
As inflation velocity spikes up, expectations of more inflation grow, and the process accelerates and feeds on itself. In extreme cases, consumers will spend their entire paycheck on groceries, gasoline and gold the minute they receive it.
They know holding their money in the bank will result in their hard-earned pay being wiped out. The important point is that hyperinflation is not just a monetary phenomenon — it’s first and foremost a psychological or behavioral phenomenon.
Hyperinflation doesn’t affect everyone in a society equally. There are distinct sets of winners and losers. The winners are those with gold, foreign currency, land and other hard assets. The losers are those with fixed income claims such as savings, pensions, insurance policies and annuities.
Debtors win in hyperinflation because they pay off debt with debased currency. Creditors lose because their claims are devalued.
Hyperinflation doesn’t emerge instantaneously. It begins slowly with normal inflation and then accelerates violently at an increasing rate until it becomes hyperinflation. This is critical for investors to understand because much of the damage to your wealth actually occurs at the inflationary stage, not the hyperinflationary stage. The hyperinflation of Weimar Germany is a good example of this.
In January 1919, the exchange rate of German reichsmarks to U.S. dollars was 8.2 to 1. By January 1922, three years later, the exchange rate was 207.82 to 1. The reichsmark had lost 96% of its value in three years. By the standard definition, this is not hyperinflation because it took place over 36 months and was never 50% in any single month.
By the end of 1922, hyperinflation had struck Germany, with the reichsmark going from 3,180 to one dollar in October to 7,183 to one dollar in November. In that case, the reichsmark did lose half its value in a single month, thus meeting the definition of hyperinflation.
One year later, in November 1923, the exchange rate was 4.2 trillion reichsmarks to one dollar. History tends to focus on 1923 when the currency was debased 58 billion percent. But that extreme hyperinflation of 1923 was just a matter of destroying the remaining 4% of people’s wealth at an accelerating rate. The real damage was done from 1919–1922, beforehyperinflation, when the first 96% was lost.
If you think this can’t happen here or now, think again. As I also mentioned above, something like this started in the late 1970s. The U.S. dollar suffered 50% inflation in the five years from 1977–1981. We were taking off toward hyperinflation, relatively close to where Germany was in 1920.
Most wealth in savings and fixed income claims had been lost already. Hyperinflation in America was prevented by the combined actions of Paul Volcker and Ronald Reagan, but it was a close call.
Today the Federal Reserve assumes if inflation moves up to 3% or more in the U.S., they can gently dial it back to their preferred 2% target. But moving inflation to 3% requires a huge change in the behavior and expectations of everyday Americans. That change is not easy to cause, and once it happens, it is even harder to reverse.
If inflation does hit 3%, it is more likely to go to 6% or higher, rather than back down to 2%. The process will feed on itself and be difficult to stop. Sadly, there are no Volckers or Reagans on the horizon today. There are only weak political leaders and misguided central bankers.
Originally posted on Daily Reckoning