Hyperinflation, Part II: What It Will Look Likehttp://www.zerohedge.com/article/guest-post-hyperinflation-part-ii-what-it-will-lookI usually don’t do follow-up pieces to any of my posts. But my recent longish piece, describing how hyperinflation might happen in the United States, clearly struck a nerve.
It was a long, boring, snowy piece of macro-economic policy speculation, discussing Treasury yields, Federal Reserve Board monetary reaction, and the difference between inflation and hyperinflation—but considering the traffic it generated, I might as well been discussing relative breast size in the porn industry. With pictures.
Essentially, I argued that Treasury bonds are the New and Improved Toxic Assets. I argued that, if there was a run on Treasuries, the Federal Reserve—in its anti-deflationary zeal, and its efforts to prop up bond market prices—would over-react, and set off a run on commodities. This, I argued, would trigger hyperinflation.
The disproportionate attention my post garnered is indicative of people’s current fears. As I’ve said before, people aren’t blind or stupid, even if they often act that way. People are worried—they’re worried about the current state of affairs: Massive quantitative easing, toxic assets replaced by the full faith and credit of the U.S. government in the shape of Treasuries, fiscal debt which cannot possibly be repaid, a second leg down in the Global Depression that seems endless and only getting worse—people are scared. Many readers gave me quite a bit of useful feedback, critiques, suggestions and comments on the piece—clearly, what I was discussing touched on a deeply felt concern.
However, there were two issues that many readers had a hard time wrapping their minds around, with regards to a hyperinflationary event:
The first was, Where does all the money come from, for hyperinflation to happen? The question wasn’t put as baldly as that—it was wrapped up in sophisticated discussions about M1, M2 and M3 money supply, as well as clever talk about the velocity of money—the acceleration of money—the anti-lock brakes on money. There were even equations thrown around, for good measure.
But stripped of all the high-falutin’ language, the question was, “Where’s all the dough gonna come from?” After all, as we know from our history books, hyperinflation involves people hoisting bundles and bundles of high-denomination bills which aren’t worth a damn, and tossing them into the chimney—’cause the bundles of cash are cheaper than firewood. If the dollar were to crash, where would all these bundles of $100 bills come from?
The second question was, Why will commodities rise, while equities, real estate and other assets fall? In other words, if there is an old fashioned run on a currency—in this case, the dollar, the world’s reserve currency—why would people get out of the dollar into commodities only, rather than into equities and real estate and other assets?
In this post, I’m going to address both of these issues.
Apart from what happened with the Weimar Republic in the 1920’s, advanced Western economies have no experience with hyperinflation. (I actually think that the high inflation that struck the dollar in the 1970’s, and which was successfully choked off by Paul Volcker, was in fact an incipient bout of commodity-driven hyperinflation—but that’s for some other time.) Though there were plenty of hyperinflationary events in the XIX century and before, after the Weimar experience, the advanced economies learned their lesson—and learned it so well, in fact, that it’s been forgotten.
However, my personal history gives me a slight edge in this discussion: During the period 1970–’73, Chile experienced hyperinflation, brought about by the failed and corrupt policies of Salvador Allende and his Popular Unity Government. Though I was too young to experience it first hand, my family and some of my older friends have vivid memories of the Allende period—vivid memories that are actually closer to nightmares.
The causes of Chile’s hyperinflation forty years ago were vastly different from what I believe will cause American hyperinflation now. But a slight detour through this history is useful to our current predicament.
To begin: In 1970, Salvador Allende was elected president by roughly a third of the population. The other two-thirds voted for the centrist Christian Democrat candidate, or for the center-right candidate in roughly equal measure. Allende’s election was a fluke.
He wasn’t a centrist, no matter what the current hagiography might claim: Allende was a hard-core Socialist, who headed a Hard Left coalition called the Unidad Popular—the Popular Unity (UP, pronounced “oo-peh”). This coalition—Socialists, Communists, and assorted Left parties—took over the administration of the country, and quickly implemented several “reforms”, which were designed to “put Chile on the road to Socialism”.
Land was expropriated—often by force—and given to the workers. Companies and mines were also nationalized, and also given to the workers. Of course, the farms, companies and mines which were stripped from their owners weren’t inefficient or ineptly run—on the contrary, Allende and his Unidad Popular thugs stole farms, companies and mines from precisely the “blood-thirsty Capitalists” who best treated their workers, and who were the most fair towards them.
Allende’s government also put UP-loyalists in management positions in those nationalized enterprises—a first step towards implementing a Leninist regime, whereby the UP would have “political control” over the means of production and distribution. From speeches and his actions, it’s clear that Allende wanted to implement a Maoist-Leninist regime, with himself as Supreme Leader.
One of the key policy initiative Allende carried out was wage and price controls. In order to appease and co-opt the workers, Allende’s regime simultaneously froze prices of basic goods and services, and augmented wages by decree.
At first, this measure worked like a charm: Workers had more money, but goods and services still had the same old low prices. So workers were happy with Allende: They went on a shopping spree—and rapidly emptied stores and warehouses of consumer goods and basic products. Allende and the UP Government then claimed it was right-wing, anti-Revolutionary “acaparadores”—hoarders—who were keeping consumer goods from the workers. Right.
Meanwhile, private companies—forced to raise worker wages while maintaining their same price structures—quickly went bankrupt: So then, of course, they were taken over by the Allende government, “in the name of the people”. Key industries were put on the State dole, as it were, and made to continue their operations at a loss, so as to satisfy internal demand. If there was a cash shortfall, the Allende government would simply print more escudos and give them to the now State-controlled companies, which would then pay the workers.
This is how hyperinflation started in Chile. Workers had plenty of cash in hand—but it was useless, because there were no goods to buy.
So Allende’s government quickly instituted the Juntas de Abastecimiento y Control de Precios (“Unions of Supply and Price Controls”, known as JAP). These were locally formed boards, composed of loyal Party members, who decided who in a given neighborhood received consumer products, and who did not. Naturally, other UP-loyalists had preference—these Allende backers received ration cards, with which to buy consumer goods and basic staples.
Of course, those people perceived as “unfriendly” to Allende and the UP Government either received insufficient rations for their families, or no rations at all, if they were vocally opposed to the Allende regime and its policies.
Very quickly, a black market in goods and staples arose. At first, these black markets accepted escudos. But with each passing month, more and more escudos were printed into circulation by the Allende government, until by late ’72, black marketeers were no longer accepting escudos. Their mantra became, “Sólo dólares”: Only dollars.
Hyperinflation had arrived in Chile.
(Most Chileans, myself included, find ourselves both amused and irritated, whenever Americans self-righteously claim that Nixon ruined Chile’s economy, and thereby derailed Allende’s “Socialist dream”. Yes, according to Kissinger’s memoirs, Nixon did in fact tell the CIA that he wanted Chile’s economy to “scream”—but Allende did such a bang-up job of fucking up Chile’s economy all on his own that, by the time Richard Helms got around to implementing his pissant little plots against the Chilean economy, there was not much left to ruin.)
One of the effects of Chile’s hyperinflation was the collapse in asset prices.
This would seem counterintuitive. After all, if the prices of consumer goods and basic staples are rising in a hyperinflationary environment, then asset prices should rise as well—right? Equities should rise in price—since more money is chasing after the same number of stock. Real estate prices should rise also—and for the same reason. Right?
Actually, wrong—and for a simple reason: Once basic necessities are unmet, and remain unmet for a sustained period of time, any asset will be willingly and instantly sacrificed, in order to meet that basic need.
To put it in simple terms: If you were dying of thirst in the middle of the desert, would you give up your family heirloom diamonds, in exchange for a gallon of water? The answer is obvious—yes. You would sacrifice anything and everyting—instantly—in order to meet your basic needs, or those of your family.
So as the situation in Chile deteriorated in ’72 and into ’73, the stock market collapsed, the housing market collapsed—everything collapsed, as people either cashed out of their assets in order to buy basic goods and staples on the black market, or cashed out so as to leave the country altogether. No asset class was safe, from this sell-off—it was across-the-board, and total.
