Tuesday, October 18, 2011

John Mauldin: Can “It” Happen Here?

The beginning of the end of the Weimar Republic was some 89 years ago this week. There is a stream of opinion that the US is headed for the same type of end. How else can it be, given that we owe some $75-80 trillion dollars in the coming years, over 5 times current GDP and growing every year? Remember the good old days of about 5-6 years ago (if memory serves me correctly) when it was only $50 trillion? With a nod to Bernanke’s helicopter speech, where he detailed how the Fed could prevent deflation, I ask the opposite question, “Can ‘it’ (hyperinflation) really happen here?”


“Peter Bernholz wrote the bible on inflation and hyperinflation, called Monetary Regimes and Inflation: History, Economic and Political Relationships. He writes about 29 periods of hyperinflation. What causes such a spectacular increase in prices? Bernholz has explained the process very elegantly.

“Bernholz argues that governments have a bias towards inflation. The evidence doesn’t disagree with him. The only thing that limits a government’s desire for inflation is an independent central bank. After looking at inflation across all countries and analyzing all hyperinflationary episodes, the lessons are the following:

1. Metallic standards like gold or silver standard show no, or a much smaller, inflationary tendency than discretionary paper money standards

2. Paper money standards with central banks independent of political authorities are less inflation-based than those with dependent central banks.

3. Currencies based on discretionary paper standards and bound by a regime of a fixed exchange rate to currencies, which either enjoy a metallic standard or, with a discretionary paper money standard, an independent central bank, show also a smaller tendency towards inflation, whether their central banks are independent or not.

“Bernholz examined twelve of the twenty-nine hyperinflationary episodes where significant data existed. Every hyperinflation looked the same. ‘Hyperinflations are always caused by public budget deficits which are largely financed by money creation.’ But even more interestingly, Bernholz identified the level at which hyperinflations can start. He concluded that ‘the figures demonstrate clearly that deficits amounting to 40 percent or more of expenditures cannot be maintained. They lead to high inflation and hyperinflations….’ Interestingly, even lower levels of government deficits can cause inflation. For example, 20% deficits were behind all but four cases of hyperinflation.

“Stay with us here, because this is an important point. Most analysts quote government deficits as a percentage of GDP. They’ll say, ‘The US has a government deficit of 10% of GDP.’ While this measure makes some sense, it doesn’t tell you how big the deficit is relative to expenditures. The deficit may be 10% the size of the US economy, but currently the US deficit is over 30% of all government spending. That is a big difference.”


Related books:

Endgame: The End of the Debt Supercycle and How It Changes Everything

Monetary Regimes and Inflation: History, Economic and Political Relationships