The U.S. economy is in an intensifying inflationary recession that eventually will evolve into a hyperinflationary great depression… [at which time] a $100 bill in the United States will become worth more as functional toilet paper/tissue than as currency. The U.S. government and Federal Reserve already have committed the system to this course through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, and gross mismanagement. Words: 3565
There is No Way of Avoiding Financial Armageddon
The U.S. has no way of avoiding a financial Armageddon. Bankrupt sovereign states most commonly use the currency printing press as a solution to not having enough money to cover their obligations. The alternative would be for the U.S. to renege on its existing debt and obligations, a solution for modern sovereign states rarely seen outside of governments overthrown in revolution, and a solution with no happier ending than simply printing the needed money. With the creation of massive amounts of new fiat (not backed by gold) dollars will come the eventual complete collapse of the value of the U.S. dollar and related dollar-denominated paper assets. What lies ahead will be extremely difficult and unhappy times for many.
Defining the Components of a Hyperinflationary Great Depression
Deflation. A decrease in the prices of goods and services, usually tied to a contraction of money in circulation.
Inflation. An increase in the prices of goods and services, usually tied to an increase of money in circulation.
Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless.
7 to 10 Digit Inflation Forecast
The circumstance envisioned ahead is not one of double- or triple- digit annual inflation, but more along the lines of seven- to 10-digit inflation seen in other circumstances during the last century. Under such circumstances, the currency in question becomes worthless, as seen in Germany (Weimar Republic) in the early 1920s, in Hungary after World War II and in the dismembered Yugoslavia of the early 1990s.
Recession, Depression and Great Depression
Before World War II, all downturns simply were referred to as depressions. In the wake of the Great Depression of the 1930s, however, a euphemism was sought for future economic contractions so as to avoid evoking memories of that earlier, financially painful time.
Accordingly, a post-World War II downturn was called “recession.” Officially, the worst post-World War II recession was from November 1973 through March 1975, with a peak-to-trough contraction of 5%.
Here are the definitions:
Two or more consecutive quarters of contracting real (inflation-adjusted) GDP, where the downturn is not triggered by an exogenous factor such as a truckers’ strike.
A recession, where the peak-to-trough contraction in real growth exceeds 10%.
A depression, where the peak-to-trough contraction in real growth exceeds 25%.
On the basis of the preceding, there has been the one Great Depression, in the 1930s. Most of the economic contractions before that would be classified as depressions. All business downturns since World War II — as officially reported — have been recessions.
We are Halfway to Qualifying as a Depression
The current economic contraction is about halfway towards being classified as a “depression,” based on my definitions and GDP accounting. Net of gimmicked methodologies that have reduced CPI inflation reporting and inflated GDP reporting, the U.S. economy has been in a recession since late-2006 and the current outlook does not exclude further bounces and dips in economic activity. As was seen during the Great Depression, in severe contractions the economy can hit bottom and then bounce briefly until it falls again, finding a new bottom. The current downturn, by my numbers, already is halfway to qualifying as a depression.
The efforts by the federal government and the Federal Reserve to prevent a systemic collapse as a result of the banking solvency crisis has started to spike broad money growth and in response to the rapidly deteriorating fundamentals underlying the value of the U.S. dollar, selling of the greenback has been intense, but contained, with brief periods of stability. In the near future, dollar selling should build towards an extreme, with heavy foreign investment in the dollar fleeing the U.S. currency for safety elsewhere. With the domestic financial markets and U.S. Treasuries so heavily dependent on foreign capital for liquidity, the Federal Reserve will be forced increasingly to monetize federal debt. That process will build over time, given the federal government’s effective bankruptcy. Therein lies the ultimate basis for the pending hyperinflation.
Historical U.S. Inflation: Why Hyperinflation Instead of Deflation
What promises hyperinflation this time is the lack monetary discipline formerly imposed on the system by the gold standard, and a Federal Reserve dedicated to preventing a collapse in the money supply and the implosion of the still, extremely over-leveraged domestic financial system.
Aside from minor average annual price level declines in 1944 and 1955, the United States has not seen a deflationary period in consumer prices since before World War II. The reason for this is the same as to why there has not been a formal depression since before World War II: the abandonment of the gold standard and recognition by the Federal Reserve of the impact of monetary policy — free of gold-standard system restraints — on the economy.
The gold standard was a system that automatically imposed and maintained monetary discipline. Excesses in one period would be followed by a flight of gold from the system and a resulting contraction in the money supply, economic activity and prices.
Faced with the Great Depression, and unable to stimulate the economy, partially due to the monetary discipline imposed by the gold standard, Franklin Roosevelt used those issues as an excuse to abandon gold and to adopt close to a fully fiat currency under the auspices of what I call the debt standard, where the government effectively could print and spend whatever money it wanted to. (Sound familiar?)
Roosevelt’s actions were against the backdrop of the banking system being in a state of collapse. The Fed stood by twiddling its thumbs as banks failed and the money supply imploded. A depression collapsed into the Great Depression, with intensified price deflation. Importantly, a sharp decline in broad money supply is a prerequisite to goods and services price deflation.
Messrs Greenspan and Bernanke are students of the Great Depression period. As did Mr. Greenspan before him, “Helicopter Ben” has vowed not to allow a repeat of the 1930s money supply collapse.
Attempting to counter concerns of another Great Depression-style deflation, Bernanke has explained:
“I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States …Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. However, the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” The full text of then-Fed Governor Bernanke’s remarks can be found at: http://federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm.
Where Franklin Roosevelt abandoned the gold standard and its financial discipline for the debt standard, eleven successive administrations have pushed the debt standard to the limits of its viability. The effect of these policies has been a slow-motion destruction of the U.S. dollar’s purchasing power since the gold standard was abandoned in 1933.
The U.S. Government Effectively is Bankrupt
As discussed in the next section, the limits to the unlimited abuse of the debt standard are particularly evident in the GAAP-based financial statements of the U.S. government, which show that, with no ability to honor their obligations, the government effectively is bankrupt.
At such debt levels, the markets soon will recoil from lending Uncle Sam whatever he needs. Major buyers of U.S. Treasuries from outside the United States, including a number of central banks, already are balking. These investors have funded nearly all net U.S. Treasury debt issuance of the last five years, putting to use the excess dollars flushed into the global markets by the United States’ excessive and ever-expanding trade deficit. This practice, however, generated liquidity for the U.S. markets that has helped to depress long-term Treasury yields as well as to boost equity prices, in general.
Although the U.S, government faces ultimate insolvency, it has the same way out taken by most countries faced with bankruptcy. It can print whatever money it needs to create in order to meet its obligations. The effect of such action is a runaway inflation — a hyperinflation — with a resulting, effective full debasement of the U.S. dollar, the world’s reserve currency. The magnitude of the loss of the U.S. dollar’s purchasing power in the last 75 years now has the potential of being replicated within a few days or weeks.
In the present environment, the chances for the collapse in money supply needed to generate a consumer price deflation are nil because:
1. the discipline of the gold standard that helped trigger historical deflations is gone.
2. both from the standpoint of the government’s fiscal irresponsibility and from the Fed’s standpoint of providing the financial system with whatever liquidity is needed to keep it afloat, the U.S. central bank already is pushing broad money growth to new extremes, not containing it.
The near-term outlook is … for extremely strong upside pressure on U.S. inflation. Accordingly, gold prices should continue moving higher, setting new historic highs (and more).
U.S. Government Cannot Cover Existing Obligations
The U.S. Treasury publishes annual financial statements of the United States Government, prepared using generally accepted accounting principles (GAAP), audited by the General Accountability Office (GAO) and signed off on by the Treasury Secretary.
These statements show that the federal government’s finances not only are out of control, but the actual deficit is not containable. Put into perspective, if the government were to raise taxes so as to seize 100% of all wages, salaries and corporate profits, it still would be showing an annual deficit using GAAP accounting on a consistent basis! In like manner, given current revenues, if it stopped spending every penny (including defense and homeland security) other than for Social Security and Medicare obligations, the government still would be showing an annual deficit!
Further, aside from a weakening economic outlook, if the annual deficit is beyond containment through standard fiscal actions, then the United States has no way to grow out of this shortfall.
The GAAP-accounting is what a U.S. corporation would have to show. The Administration’s rationale as to why Social Security and Medicare should remain off balance sheet runs along the lines that the government always has the option of changing the Social Security and Medicare programs. That said, there clearly is no one in political Washington willing to go public with the concept of eliminating or substantially cutting those programs.
Consider that given the current financial condition of the government, various politicians are pushing ever further for expensive cradle-to-grave programs for the electorate, ranging from national health insurance to bailouts of mortgaged homeowners at risk of foreclosure. With no full funding available for any new programs, the government again is showing its willingness to spend whatever money it has to create. The intent going forward is inflation — hyperinflation. This circumstance has evolved with the full knowledge of political Washington and the Federal Reserve.
U.S. Finances Look Like Those of a Banana Republic
Indeed, the U.S. federal obligations are so huge versus the national GDP that the country’s finances look more like those of a banana republic than the world’s premiere financial power and home to the world’s primary reserve currency, the U.S. dollar.
If not for the special position the United States holds in the world, its debt — U.S. Treasuries — likely would be rated as below investment grade, instead of triple-A. Moody’s has even hinted at a longer-term downgrade on Treasury securities. While a three-month Treasury bill should be safe, I would not want to bet on receiving full value on a 10-year Treasury note or 30-year Treasury bond.
Yet most U.S. Treasury issuance has been purchased by investors outside the United States. Not only will these investors been taking a hit in terms of the value of the U.S. dollar, but also they face meaningful default/devaluation risk in the future. It is only a matter of time before this accommodation of foreign investors shifts to flight to safety outside the greenback, and therein will develop the early pressures for the Fed to start becoming the lender of last resort to the federal government.
The U.S. economy is in a deepening structural change that has resulted from U.S. trade policies that have driven the U.S. manufacturing base offshore. As a result, a large number of related, high paying jobs have been lost to U.S. workers.
As the U.S. trade deficit has risen to the highest level for any country in history, U.S. average weekly earnings, adjusted for inflation, have fallen. Even using official CPI for deflation, current real earnings are below their peak back in the 1970s.
The effect of this structural change has been that most consumers have been unable to sustain adequate income growth beyond the rate of inflation and, as such, unable to maintain their standard of living. The only way that personal consumption — the dominant component of GDP — can grow in such a circumstance is for the consumer to take on new debt or to liquidate savings. Both those factors are short-lived and have reached untenable extremes. Debt expansion and savings liquidation both were encouraged by the investment bubbles created by Alan Greenspan; he knew that economic growth could not be had otherwise. Part of what is happening today is payback for those policies.
This circumstance places both the federal government and the Federal Reserve in untenable positions…it can neither stimulate the economy nor contain inflation. Lowering rates has done little to stimulate the structurally-impaired economy, and raising rates may become necessary in defense of the dollar. Similarly, raising rates will do little to contain a non-demand driven inflation.
By the time hyperinflation kicks in, the economy already should be in depression, and the hyperinflation quickly should pull the economy into a great depression. Uncontained inflation is likely to bring normal commercial activity to a halt.
Hyperinflationary Great Depression.
The current systemic bailout by the Federal Reserve and the U.S. government has made the circumstance worse. Pushing recent Treasury funding needs on foreign investors — stuck with excess dollars from the ever-expanding U.S. trade deficit — has created a huge dollar overhang in the markets that already has started to crumble. The more the crisis has been pushed into the future, the greater the potential for pending calamity has become.
Milton Friedman and Anna Jacobson Schwartz noted in their classic “A Monetary History of the United States” that the early stages of the Weimar Republic hyperinflation were accompanied by a huge influx of foreign capital … which, after initial benefit, helped to destabilize the system. “As the mark depreciated, foreigners at first were persuaded that it would subsequently appreciate and so bought a large volume of mark assets …” Such boosted the foreign exchange value of the German mark and the value of German assets. “As the German inflation went on, expectations were reversed, the inflow of capital was replaced by an outflow, and the mark depreciated more rapidly … (Friedman p. 76).”
The Weimar circumstance is closer to the current U.S. circumstance, although, in certain aspects, the current situation is worse. Today’s U.S. economy is languishing in the structural problems of the loss of its manufacturing base and a shift of domestic wealth offshore. In the early 1920s, foreign investors were not propping up the world’s reserve currency in an effort to prevent a global financial collapse, knowing in advance that they were doomed to take a large hit on their investments in Germany. In today’s environment, both central bank and major private investors know that the dollar is going to be a losing proposition. They either expect and/or hope that they can get out of the dollar in time to lock in their profits, or, primarily in the case of the central banks, that they can forestall the ultimate global economic crisis.[Under such circumstances] the U.S. dollar would be open to the potentially of a rapid and massive decline, and dumping of U.S. Treasuries, that the Federal Reserve would be forced to monetize significant sums of Treasury debt, triggering the early phases of a monetary inflation. In this environment annual multi-trillion dollar deficits rapidly would feed into a vicious, self-feeding cycle of currency debasement and hyperinflation.
Lack of Physical Cash.
The United States in a hyperinflation would experience the quick disappearance of cash as we know it. Were there a future run on the U.S. dollar the biggest problem would be getting adequate cash to the depositors. As little as 1.5% of M3 is in circulation in the U.S with the rest of the dollars being used elsewhere. For the system to continue functioning in anything close to a normal manner, the government would have to produce rapidly an extraordinary amount of new cash, and electronic commerce would have to be able to adjust to rapidly changing prices. In terms of cash, new bills of much higher denominations would be needed, but production lead time is a problem. Conspiracy theories of recent years have suggested the U.S. Government already has printed a new currency of red-colored bills, intended for some dual internal and external U.S. dollar system. If such indeed were the case, then there might be a store of “new dollars” that could be released at a 1-to-1,000,000 ratio, or whatever ratio was needed to make the new currency meaningful, but such would not resolve any long-term problems, unless it were part of an overall restructuring of the domestic and global financial and currency systems. From a practical standpoint, currency would disappear, at least for a period of time in the early period of a hyperinflation.
With the vast bulk of today’s money not being physical, but electronic, however, chances of the system adapting here are virtually nil. Think of the time, work and effort that went into preparing computer systems for Y2K, or even problems with the recent early shift to daylight savings time. Systems would have to be adjusted for variable, rather than fixed pricing, credit card lines would need to be expanded daily, the number of digits used in tallying dollar-denominated transactions would need to be expanded sharply. From a practical standpoint, the electronic quasi-cashless society of today also would shut down early in a hyperinflation. Unfortunately, this circumstance rapidly would exacerbate an ongoing economic collapse.
With standard currency and electronic payment systems non-functional, commerce quickly would devolve into black markets for goods and services and a barter system.
During these times, safety and liquidity remain key concerns for investments, as investors look to preserve their assets and wealth through what are going to be the most difficult of times.
a) Gold and Silver
In such a circumstance, gold and silver would be primary hedging tools that would retain real value and also be portable in the event of possible civil turmoil. Also, at some point, the failure of the world’s primary reserve currency will lead to the structuring of a new global currency system. I would not be surprised to find gold as part of the new system, structured in there in an effort to sell the system to the public.
b) Real Estate
Real estate also would provide a basic hedge, but it lacks the portability and liquidity of gold.
c) Off-shore Investments
Having some funds invested offshore — outside of the U.S. dollar — would be a plus in circumstances where the government might impose currency or capital controls.
While equities do provide something of an inflation hedge — revenues and profits get expressed in current dollars — they also reflect underlying economic and political fundamentals. As such, I still look for U.S. stocks to take an ultimate 90% hit, peak-to-trough, net of inflation, during this period.
The current circumstance will evolve into a hyperinflationary depression, then great depression… by 2018.