Hyperinflation? Not in America.

Discussion in 'Economy' started by Toro, Jun 19, 2009.

  1. Toro
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    OK, it is time to put an end to this silliness. Certain people who believe every conspiracy that comes down the pike believe that America's future is Zimbabwe, where hyperinflation hit 79.6 billion percent. In fact, by one estimate, inflation in Zimbabwe hit an annualized return of 430,000,000,000,000,000,000,000,000,000,000,000,000%. I don't even know how to pronounce that number.

    Now, it should be apparent why comparing America to Zimbabwe is pretty silly. Unfortunately, alarmists pray on the gullible, and sometimes the gullible can be persuasive to the less gullible. Normally I don't go to all the time and effort to do this, but since I've been called out, I thought it would be appropriate to do so.

    The reason why people believe hyperinflation is coming is because of the rapid expansion of the balance sheet of the Federal Reserve, particularly graphs that look like this.

    [​IMG]

    This is a graph of the monetary base. The monetary base is also known as "high-powered money." It is the total amount of currency in circulation, bank reserves and central bank reserves. Reserves are the base upon which loans are made in the economy. In a fractional banking system such as ours, if reserves rise, then there is more money to lend. This, all else being equal, is inflationary. Here is a graph of excess reserves in the banking system.

    [​IMG]

    These are the non-borrowed reserves of the banks, that is not borrowed from the Fed and other banks.

    [​IMG]

    This is why some believe high inflation is coming. A massive increase in reserves should equal a massive increase in the money supply and thus a massive increase in inflation.

    Looks pretty scary, doesn't it? And it is, all else being equal. But as we will see, all else is not equal.

    Now, notice in the graph immediately above. See how it dips to more than -$300 billion? We will return to this in a bit.

    But first, let us look at what has actually happened to the money supply. With the massive increase in reserves, has there been a corresponding increase in money?

    This is a graph of M1. M1 is all the currency, checking accounts and travelers checks. As you can see, M1 has risen but not much more than it did in 1987 or 2002.

    [​IMG]

    A broader definition of money is M2. M2 is M1 plus deposit accounts, overnight repurchase agreements, overnight Eurodollar deposits, small time deposits and retail money market funds. This is a graph of M2.

    [​IMG]

    Now, M2 has risen, but it has not risen as much as it did in 1983 or 2003.

    M3 is the broadest definition of money. M3 is M2 plus large time deposits, institutional money market funds, large long-term repurchase agreements and large Eurodollar deposits. Unfortunately, the Fed stopped publishing this data a few years back. The conspiracy theorists say they did this to hide the inflation in the system. The conspiracy theorists may be right. However, M3 has tracked the directional change of M1 and M2 plus a some percentage change more. It is not rising at an astronomical rate that would have to occur to think hyperinflation is coming. Here is a graph of institutional money market funds, which is a component of M3.

    [​IMG]

    Institutional money funds are rising at a faster rate than M2, about 25% per year. However, that is not much faster than M1. And as we see in the M1 and M2 graphs, the money supply often increases around a recession, which is typical monetary policy by the Fed to fight a recession.

    So, has inflation come?

    Consumer Price Index Summary

    Inflation has fallen 1.3%. We have deflation, not inflation.

    Why is that? Because a collapse in asset prices, whether that is in stocks, bonds, housing, or whatever, is deflationary because a fall in asset prices destroys the credit used to finance the rise in asset prices. In a fiat monetary system, the supply of money is a function of the amount of credit in the economy. When credit collapses, as it has over the past two years, prices fall. That is how it always works.

    "But the actions of the Fed are planting the seeds of future hyperinflation" is what they will say. Yes, that is true, all else being equal. But things are not equal, and this is why.

    First, what is known as "monetary velocity" or the money multiplier has collapsed.

    [​IMG]

    Monetary velocity measures the rate at which money circulates in the economy. Think about an extreme example. Let's say the money multiplier fell to zero. That would mean that all transactions stopped. What would happen? The economy would collapse and prices would implode. When the money multiplier falls, it has a deflationary effect.

    So why is it falling? Remember those graphs of the banking reserves above? It is because banks are hoarding money. And why are banks hoarding money? Because they believe there are more losses to come and they will need the reserves to cover the losses.

    http://www.advisorperspectives.com/...-Bank_Write-offs_are_at_the_Halfway_Point.pdf

    So all those reserves are being held to pay future costs. This isn't inflationary because that money will disappear. In fact, the $1 trillion in estimated losses approximates the expansion of the Fed's balance sheet.

    FRB: H.4.1 Release--Factors Affecting Reserve Balances--June 11, 2009

    The Fed has increased its reserves to inject reserves into the banking system to cover the losses. The Fed is merely replacing credit in the economy that has been destroyed.

    Bank credit has fallen

    [​IMG]

    But more importantly, the shadow banking system has collapsed. What is the shadow banking system?

    shadow banking system Definition

    The shadow banking system is enormous.

    Reducing Systemic Risk in a Dynamic Financial System - Federal Reserve Bank of New York

    I tried to find some data on losses in the shadow banking system. A couple of bond investors whom I spoke with thought it ran in the trillions.

    So we have $1 trillion in losses in the banking system and "trillions" in the shadow financial system. Yet, the Fed has expanded its balance sheet by $1 trillion, trillions less than what has been lost. The expansion of the Fed's balance sheet has not been enough to replace the credit destroyed in the private economy. Thus, the expansion of the Fed's balance sheet is not inflationary. It cannot become inflationary until the credit that has been destroyed is replaced by new credit.

    And when will credit start expanding in the private economy? Only when the economy starts improving. For the economy to start improving, for credit to expand, and for inflation to start rising, the following must happen.

    Employment, Interest, and Money: A Long Way to Inflation


    Capacity utilization is sitting at an all-time low.

    [​IMG]
    As long as there is excess capacity, i.e. capacity utilization is low, there will not be any inflation, as you can see in this graph.

    [​IMG]

    The savings rate is rising.

    [​IMG]

    If inflation were coming, then the yields for Treasury Inflation-Protected Securities (TIPS) would be off the charts. They are not. This is the yield for a 30-year TIPS bond.

    [​IMG]

    Corporate bond rates would be going through the roof if hyperinflation was imminent. They are not.

    [​IMG]

    [​IMG]

    So there is no evidence, nor is there any reason to think that hyperinflation is coming. It is shrill hysteria to think so.

    Is inflation coming? Probably. There will be no inflation if the government starts withdrawing liquidity, i.e. reserves, from the financial system. Historically, however, there has usually been a lag between when monetary policy should and does work. Thus, it is likely that the Fed will wait too long to start tightening the money supply, which would lead to inflation down the road.

    5% inflation, or maybe 10% inflation. But not 79,600,000,000% inflation.

    Now, if you have read this entire post, congratulations. You are probably the only one.
     
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    Last edited: Jun 19, 2009
  2. Oddball
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    Where's the chart that contrasts demographics with unfunded promises to pay??
     
  3. Toro
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    Feel free to post it.
     
  4. Paulie
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    Paulie Platinum Member

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    I know I've personally learned a lot about monetary policy in the past year especially. I was once a doomsdayer who called for hyperinflation. At this point, I expect there to be inflation down the road. Probably bad, but also probably nothing we haven't already seen in this country.

    I do wonder though, how the government plans on covering their massive liabilities, namely the three big entitlements. Most likely, it will have to be printed. We're talking tens of TRILLIONS in liabilities. You can't tax that much money out of us, we don't HAVE it.
     
  5. Toro
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    The liabilities will be met primarily by changing the liabilities.

    And probably some inflation.
     
  6. Paulie
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    Changing? They haven't changed YET. I've seen zero indication that leads me to believe they ever will, either. It makes for great campaign rhetoric, but of course nothing ever comes of it.

    The REAL change has to come from the voters. We need to wise up and throw the mainstream politicians out on their asses and try something we've never tried before. It can't possibly end up any worse than what we already have.


    I won't hold my breath.
     
  7. Toro
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    You can wipe out most of the liabilities by raising the retirement age to 72. There is no reason not to do this. When Social Security was changed in the 60s, the average expectancy was 65. The amount actually paid out wasn't that large. Today, the average life expectancy is 77. So we will change it to 72.

    The reason why we will do this is because the other option is inflation, which will erode the value of Social Security anyways. Seniors live on fixed incomes. Inflation is bad for them. So they will have the option of inflation or changing social security.

    But that is a different issue. It will not cause hyperinflation even if we have all these liabilities.
     
  8. jreeves
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    What will this do to confidence in the US dollar? How will China feel about us changing our liabilities? Do you really predict that a politician will tinker with the entitlements, when it would be their political suicide?
     
    Last edited: Jun 19, 2009
  9. Toro
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    Not the bonds. The liabilities for social security and Medicare. The US will not default on their bonds.

    I believe that eventually the politicians will have no choice but to address social security. I come from the cradle of socialism in North America, and the people there gored sacred cows to save their political future. I see no reason why America will not.
     
  10. jreeves
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    I guess we will see, but I don't see anyone in Washington DC having the courage to take on the problem seriously. Especially considering over the next 10 years will add another nearly 9 trillion dollars on the national debt....:cuckoo:
     

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