While waiting our turn during the Medicine X - EDC class last Saturday, Brian and I started talking about the risk of hyperinflation. He asked me "what would hyperinflation look like in the U.S.?" I thought that was a great question, and so I am going to share some thoughts here.
First, let's take a step or two back. In order to understand hyperinflation, we need to understand just plain ol' inflation. Investopedia defines "inflation" as "the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum."
Last month's inflation rate was 1.7%. In the last ten years or so, we've had rates as high as 5.6% back in July 2008 and as low as - 2.1% precisely a year later.
Investopedia describes "hyperinflation" below:
When associated with depressions, hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value.
When associated with wars, hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this by raising their prices.
Pay extra attention to the first sentence in that definition. To have hyperinflation, you need a) a large growth in the money supply which is b) not supported by an increase in the GDP.
To get some perspective on this, let's peek at a couple of charts from Shadow Government Statistics.
First, take a look at the GDP annual growth numbers. To be objective, we'll only look at the red line, as it's the official version. The blue line is the Shadow Government Statistic's alternative calculation; according to their site, this blue line "reflects the inflation-adjusted, or real, year-to-year GDP change, adjusted for distortions in government inflation usage and methodological changes that have resulted in a built-in upside bias to official reporting."
From this, we can deduce that GDP has grown since late 2009. At its highest growth rate since the bottom in early 2009, we were seeing growth as high as 3%.
Now compare that to the money supply chart, also from Shadow Government Statistics.
Look at the blue line. The Shadow Government Statistics calculation of M3 (the largest, most inclusive measure of the money supply) shows the money supply has tracked nearly evenly with GDP over the same time frame since 2010. Thus, hyperinflation is not currently a risk in the short term.
However, with the recent announcement of more quantitative easing and concerns over declining GDP growth, it does raise the specter of a risk of higher inflation in the coming months.
Could we see hyperinflation in the coming months? Matthew O'Brien at The Atlantic argue that we cannot. His basic premise we cannot have hyperinflation like Germany and Zimbabwe have had in the past because we are not Germany and Zimbabwe. He then takes readers through a series of assertions that at a minimum beg for more details in order to make sense:
Second, the United States isn't really printing money. At least not like post-war Hungary. Quantitative easing is usually described as "money-printing" but it's not really. QE involves the Fed buying longer-term bonds from banks. It simply swaps one asset for another -- in this case, cash for longer-term bonds. Unlike Hungary, the Fed isn't directly paying the Treasury's bills. This is a hugely important distinction.
Whatever money the Fed "prints" is stuck in the banks. That money isn't inflationary as long as the banks don't lend it out. What if the banks do start lending at a faster clip? The Fed can still effectively pay the banks not lend by, for example, raising the interest on excess reserves or require the banks to set aside more money. It would be shocking for the Fed not to pursue one of these options.
Note UBS is apparently taking the other side of this argument, issuing a warning over the summer claiming that the U.S. and the U.K. were at risk for hyperinflation.
But do we really need to have hyperinflation in order to feel the negative effects of further rounds of quantitative easing?
Let's look at a chart of inflation rate history over the last 100 years or so:
While we've not seen hyperinflation in the last century, we've seen bouts of inflation well above ten percent and in some cases above fifteen percent. These spikes in the inflation rate certainly did not help the economy or the people living and working in it.
Back to Brian's question: what would hyperinflation look like? To be more helpful, let's simply call it high inflation instead, since we may never hit a true "hyperinflation" level.
First, we'd see spikes in prices in our every day consumables, notably food and gasoline. Wages would likely rise, but slower than the rate of inflation. Housing sales and sales of other big ticket items like cars and durable goods would likely drop as people could not afford the new interest rates associated with new debt. On the flip side, those of us in long term, fixed rate loans would actually come out ahead, since we'd be paying back our loans with dollars worth less than the ones we borrowed to buy the item to begin with. Precious metals prices would likely go up as people look to invest in assets that will preserve their money.
I'm no investment advisor, but here are some ways you can protect yourself from escalating inflation rates:
- If you aren't in a fixed rate mortgage, get one now. Rates will never be this low again. If inflation hits us, you'll be paying off your loan with dollars worth less than they are now. The corollary to that is if you are in an adjustable rate mortgage, get out now. You don't want to be caught in an ARM when inflation hits.
- Invest in things like precious metals. They have traditionally been safe havens for hedges against inflation.
- Stock investors may prefer stocks that pay dividends, as the dividend payments will likely go up with inflation.
- Keep planning. If you're into buying storable foods, do so while inflation is relatively tame.