[Discussion prompted by the commentary below continues to evolve and may yet enlighten us sufficiently to produce some useful conclusions about the banking system’s looming endgame. Hyperinflation, or deflation? At this point, I’ll concede that it could be either that brings us to economic ruin. But I will nonetheless argue in a forthcoming essay that the dollar could collapse without triggering a hyperinflation. Under this scenario, it would not be a question of paying $1,000 for a barrel of oil, or $100 for a carton of eggs; rather, those in a position to supply such basic necessities would simply stop taking dollars. This clearly implies that we would move rapidly to barter, abandoning a currency system that might conceivably have become useless overnight. (The spectacularly bullish implications this holds for gold are impossible to miss). To drive the discussion toward a conclusion, I would urge readers to immerse themselves in this idea. You can skip the commentary itself if you’d like, since whatever insights it might provide at this point pale in comparison to the gems that have turned up in the forum. Simply click on the “Comments” link above to enter the forum.
When you jump into the fray, argue not from theory but from the logic of how you imagine your life would proceed in the wake of a collapse of the banking system and the dollar. You might pretend that the catalyst for the collapse was a Treasury auction at which the Fed was the only buyer amidst wholesale dumping of U.S. paper by…everyone. To heighten your acuity and stimulate the imagination, make this catastrophe a personal one. Pretend, for example, that it is the first of the month, that your employer and your $100,000 job are unexpectedly in dire jeopardy, and that you are about to send your mortgage lender a check for $2000 drawn on an account with $10,000 in it. The evening news is filled with reports that the Federal Reserve will do everything in its power to keep the system liquid, but they note as well that the dollar has fallen steeply relative to other currencies. All interest rates have soared spectacularly, threatening to send your ARM in the same direction. RA]
First, let me say that I’ve long enjoyed reading the rants of over-the-top inflationists like Jim Willie, but also the relatively subdued essays of Gonzalo Lira — even if the latter sometimes comes across as the kind of guy who could wear out a mirror. I feel a comradeship with both because, predictions about the financial endgame aside, I agree with much of what they have said — most particularly about the robust defensive role that bullion seems likely to play no matter what happens. But that is not to say that I agree with all of Lira’s and Jim Willie’s arguments. Some background is in order. My instincts concerning deflation were hard-wired in 1976 after reading C.V. Myers’ The Coming Deflation. The title was premature, as we now know, but the book’s core idea was as timeless and immutable as the Law of Gravity. Myers stated, with elegant simplicity, that “Ultimately, every penny of every debt must be paid — if not by the borrower, then by the lender.” Inflationists and deflationists implicitly agree on this point — we are all ruinists at heart, as our readers will long since have surmised, and we differ only on the question of who, borrower or lender, will take the hit. As Myers made clear, however, someone will have to pay. If you understand this, then you understand why the dreadnought of real estate deflation, for one, will remain with us even if 30 million terminally afflicted homeowners leave their house keys in the mailbox. To repeat: We do not make debt disappear by walking away from it; someone will have to take the hit.
Expanding on that point alone, I could dismiss Lira’s entire argument with a wave of the hand, invoking the killer question that blogger Charles Hugh Smith has asked of overheated inflationists, to wit: Why would the rich and powerful men who control the Federal Reserve, and who would be wiped out by hyperinflation, allow such a thing to happen? The obvious answer is that they wouldn’t. And won’t. I’ve made this point myself many times before and in many ways, sometimes asking rhetorically whether we should expect Joe Sixpack and tens of millions of other underwater homeowners to be able to retire their mortgages using the confetti money that a hyperinflation would produce. Mortgage lenders would be big losers, of course, but so would anyone hoping to ever own a home — or to borrow money, for whatever purpose.
Unbearable Cost of ‘Escaping’ Debt
One of the best places to find the inflation vs. deflation argument deconstructed to a fine science, and to confront the horrific – and, as I am about to argue, unbearable — cost of “escaping” debt via hyperinflation, is the 1993 book The Great Reckoning. Co-authors Jim Davidson and Lord William Rees-Mogg went to great lengths to refract every aspect of the debate. It was this book, and a subsequent dialogue that I had with Jim Davidson, that hardened my deflationist ideas, convincing me – as they likely would many of you, though perhaps not Lira — that a deflationary path would at least be less ruinous than a hyperinflationary one. To be sure, vast amounts of real wealth would be destroyed in either case. But deflation would have the virtue of inflicting pain on debtors more or less in accordance with their sins, bankrupting those who most deserved it. That said, one needn’t drag in moral baggage to explain why the powers that be are extremely unlikely to pursue a hyperinflationary course.
And “pursue” is the correct word here, since, as The Great Reckoning made clear, hyperinflations don’t simply happen; they can only occur following the willful and deliberate decision of a sovereign government to hyperinflate. We need only consider the catastrophic consequences of hyperinflation to understand why such a scheme is so very unlikely to be promoted and effected by the Masters of the Universe. For starters, savers and lenders as a class would be wiped out, since their financial assets would become as worthless as the dollar itself. Bond markets and all other institutional conduits of saving and investment would cease to function in the absence of trust – trust that would take many years for capitalists to earn back. From day one, a darkening economy would subsist on cash transactions, which in turn would bring on the hardest of times, little economic growth, and a drop in the standard of living so steep that it might take a generation to rekindle even a glimmer of the American Dream.
Deflation’s ‘Virtues’
Deflation, on the other hand, would leave the bond and stock markets intact, sparing those with little or no debt from its worst ravages. For those who owe, a tidal wave of bankruptcies would mete out punishment commensurate with each borrower’s sins of profligacy and/or greed. Businesses would be starved for credit, but whatever savings were available would go to the most promising of them. Most advantageously for an economy on-the-mend, it would be many years before capital would be hijacked by the paper-shufflers and feather merchants. In both the public and private sphere, Americans would be forced to live within their means.
I won’t belabor Lira’s arguments where he attempts, not entirely without success, to “slice and dice” my logic when it is at its weakest. But his main criticism — that I have not made a case for deflation, only one against hyperinflation – is disingenuous. For in fact, I have stated the case for deflation thus: Someday very soon, following the precipitous failure of the world’s banks and securities markets, we will all be too broke to push the price of anything sky-high. Hyperinflationists assume we will have vast piles of cash at-the-ready, physical or digital, to exchange for real goods in a panic or along the way to hyperinflation. But will we? Read Lira’s smug hit-job a dozen times and you will find no mention of how that cash will get into our hands, much less into our hands if the banking system should go blotto. He avers only that, well before a collapse, via quantitative easing, the government will “ram” money “into the economy.” As if that hasn’t been tried to death already.
No Middle Way
If you believe that one or the other, deflation or hyperinflation, will eventually do us in, then you may find yourself won over by my argument simply on the evidence I muster against hyperinflation. Read on and judge for yourself. For what it’s worth, Lira’s ruinist essays suggest that we do see eye to eye on one thing – that there is no “middle way” that might allow us to avoid the catastrophic liquidation of a global debt bubble whose notional value has been estimated as high as a quadrillion dollars.
Let me dwell for yet another moment on this idea that Americans could go broke overnight. Lira apparently believes this unlikely, if not impossible, and he could be right. But not very, since it is beyond conjecture that the day-to-day economy would grind to a halt quickly if digital money were thrown into chaos and disrepute for more than a few days. And it’s not as though Americans are so very confident in electronic money’s soundness at this point that the banking system could withstand even a minor crisis. Unfortunately, and as we all know, there are no minor crises any more, especially in the financial realm.
We’ll All Be Broke
So, broke is what most of us will be when the dust settles, and it is perhaps only a matter of the rate at which we go broke that divides inflationist from deflationist. How quickly could the financial system come tumbling down? Last May’s “flash crash” on Wall Street demonstrated that it could occur in a trice. Picture the Morning After the next flash crash, but assume that, this time around, the Plunge Protection Team has been unable to arrest its spread into bond markets and other securities markets around the world. Hardly a stretch, right? But it’s a big stretch to imagine a hyperinflation arising from the smoke and rubble of the creditless world that would result.
Will we have gone broke without having had the chance to pay off our mortgages in snide? I say yes; Lira, for his argument to hold, is obliged to say no. I hope he’s right. Then again, maybe hyperinflation will unfold so slowly that we’ll all have time to trade piles of shrinking dollars for real stuff currently owned by…fools?
Whatever happens, I wouldn’t put much store in Lira’s assurance that even small branch-banks keep scads of cash around. Try to withdraw $25,000 from your own branch if you want to find out the truth. He’ll probably say that the banks, with a nod from Uncle Sam, could refill everyone’s account with digital money overnight. I say, think about that for a moment – about the economically fatal traffic jam this would create instantly in the world of real transactions.
Deflationary Gas-Bag
Lira’s arguments, although certainly not his ungentlemanly, preening condescension, are at their weakest when he attempts to explain how quantitative easing will inject a hyperinflationary sum of dollars into the real economy. He says our bankrupt government will simply spend limitless quantities of funny money into the “wider economy.” If it were that easy, why are home prices still falling after trillions of dollars worth of “stimulus”? And why have wages failed to rise? Granted, fuel and grocery prices have been going up. But how long can that trend continue with incomes stagnating and household discretionary cash plummeting? (That was not a problem in 1922 Weimar, by the way, for reason that I shall explain shortly.) And how many seats will the airlines fill this summer if prices stay above $500? With respect to the inflation of stock-market prices, we’ll let Lira shoot himself in the foot if he wants to argue that Wall Street’s cosmic gas-bag is other than a deflationary juggernaut waiting to implode. Meanwhile, a vastly larger gas-bag in the form of a global derivatives bubble is set to implode with irresistible force. Hundreds of trillions of dollars’ worth of collateral are destined to shrink to the vanishing point. That is the true measure of deflation’s force, and when it starts to snowball again as it did in 2008, no puny multitrillion-dollar monetization by the Fed will even begin to counteract it.
Finally, we cannot let Lira evade the question of how, specifically, the government will “ram” (his word) QE3/QE4/QE5 money into the economy, especially when the state and local governments who in earlier times would have been the most eager and efficient conduits for these sums have begun to refuse them, knowing as they do that each new stimulus dollar will only create more debt for future taxpayers. We’d like to believe that the common sense of Republican and Tea Party governors and legislators alone will suffice to smother any inflation that might otherwise seep into the economy via supercharged outlays of cities, counties and states. In fact, the deflationary opposite is happening as local and state governments expand layoffs and pare budgets to the bone. Which leaves only the private economy to receive a wage stimulus sufficient to catalyze hyperinflation. On that score, just as we’ve asked hyperinflationists to wake us when we can sell our home for a quadrillion dollars, we’ll ask them now to send us a job application when GM is paying assembly-line workers $800 an hour.
When Money Dies
Big employers effectively did so in Germany, allowing weekly wage settlements with then-pervasive trade unions to track hyperinflation almost step-for-step. But you’ll need to read Adam Fergusson’s book about the Weimar hyperinflation, When Money Dies, to understand exactly why the U.S. is legally and practically constrained from duplicating Germany’s dubious feat. If you believe otherwise — believe, as Lira evidently does, that the Fed could somehow put a google of dollars into circulation on demand — then you should be buying real estate hand-over-fist right now. When Money Dies is a great read even for those who’d rather not be disabused of the notion that today’s USA, economically and financially, is not 1921’s Weimar. I particularly recommend a chapter that recounts how the most extreme periods of German hyperinflation occurred while the country’s money-printing presses were idled by strikes. Turns out, some of Weimar’s largest employers had been authorized by the government to print scrip in the event that crates of official money didn’t arrive in time to meet payroll. Imagine what such a policy could do for Detroit! For the whole world!
Rather than argue that this couldn’t happen, we’ll say only that if it did, it would be but a momentary blip in a deflationary collapse in real estate that Lira doesn’t even mention. Just wait till the incipient collapse in commercial property values hits full-bore. This is yet another deflationary juggernaut that the arrogant and pompous Lira has conveniently failed to notice. He will soon, though, and the shock of it may yet distract his attention from an inflation that so far has barely overflowed the lettuce bin.
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With a central bank’s ability to create money out of thin air (legal counterfeiting), we will have deflation of real estate and wages, and at the same time, inflation of prices for consumer goods. The entire argument above for deflation does not make this distinction because of the lack of attention paid to the act of creating money out of nothing – this is inflation of the currency and a hidden tax. What a buyer is willing to pay for a house is not necessarily tied to the inflation in the system. This is called the transfer of wealth (real estate) from middle class to the elite. A concurrent asset deflation and price inflation. Please don’t waste any more time arguing for one or the other when they both will occur. It depends on what asset class you are talking about.