Alasdair Macleod – 13 October 2010
Those who have been exposed to popular Australian and British mythology may know about the fabled oozlum bird, which flies round in ever decreasing circles until it disappears up its own fundament. Under the guidance of our political masters, paper currencies are on course to disappear in the same unusual manner. I have written recently about the increasing possibility of a hyperinflationary slump: economic activity slumps, then prices start rising at an accelerating rate until paper currencies become valueless. To most, such an outcome is unimaginable, except for those who lived through Allende’s Chile or Mugabe’s Zimbabwe; and the idea that this might happen to the dollar, euro, pound and yen all at the same time is unthinkable.
This eventuality is becoming impossible to avoid. For those of us not mislead by contemporary economics it has been clear for years that we are set on this course, and since the credit crunch, the outcome has become more likely as events progressed. To get off this tramline into financial oblivion requires a return to sound money. Sound money and “$£€¥” are as cosy together as church and blasphemy. In all human history sound money has only been gold and silver, and yet again humanity will have to relearn this lesson the hard way.
A planned return to sound money is obviously inconceivable. It is clear that economic recovery is fading and the slump, which is a precondition to hyper-inflation, is on its way: a precondition not only because it is the noun in the description, but because the $£€¥ governments tax revenues will collapse. Furthermore welfare costs will increase due to rising unemployment, and with revenues collapsing budget deficits will escalate rapidly. This means that the $£€¥ governments simultaneously need to raise much more money than currently expected. If governments were to attempt $£€¥ funding without quantitative easing, borrowing costs would go through the roof and bond prices would collapse, alerting everyone to the public sector’s insolvency.
This is why QE is seen as vital, as vital as heroin is to a hopeless addiction.
It has now become apparent that reflation through deficit spending is creating more problems than it solves, and governments will have to retrench to protect their core welfare commitments. David Cameron realises this, and Europe is selectively waking up to it. Ben Bernanke now realises this, hence his warning last week in his speech on Rhode Island, that the course of public spending would either be curbed by “a careful and deliberate process” or by a “rapid and painful response to a looming or actual fiscal crisis”. This is very plain speaking, even to the point of shouting, by the normally boring, soporific Helicopter Ben. The voters in next month’s US elections, who are increasingly sickened by government profligacy also realise it, a message not lost on America’s politicians. So Plan B is shaping up: we are seeing the Keynesians canned, because they have run out of road. It is time to hand over to the central banks, which is Bernanke’s real message.
So it is over to the monetarists, and their analysis is broadly as follows. To have a chance of succeeding, the primary objective of QE2 is to keep borrowing costs for governments as low as possible. It is therefore vital to keep government bonds in a perpetual bubble for as long as it takes. If this is achieved, then economic stability might be preserved, and the chances of a second banking crisis reduced. However, if the monetarists fail, a debt-deflation hell will be unleashed. This must be prevented at all costs or it will amount to no less than the failure of monetarism. The monetarists will not want to find themselves in the same position as the Keynesians are today. This is why Bernanke famously concluded that as a last resort, money will be distributed by helicopter into the economy. Deflation will not be permitted, even momentarily.
In this analysis the monetarists are confusing asset deflation with price inflation. They frequently invoke the ghost of Irving Fisher, who identified the risk of falling asset prices triggering collateral liquidation, turning into a self-feeding financial implosion. This is asset deflation, and printing money at best delays it. However, printing money is the precondition for price inflation, which in dollar terms is already running at over 30% at the input level. So bizarrely the monetarists in the central banks are making the simplest of errors, or perhaps they are turning a blind eye. This is why with regard to inflation, the oozlum is already well on its way to an inner darkness.
So hyperinflation, as a result of current and prospective monetary policies has now become a racing certainty. Investors sooner or later will wake up to this reality, seeking protection, and their first move will be to withdraw funds from over-priced government bond markets. Initially this is bound to accelerate QE further as central banks attempt to support bond prices. Perhaps at this point, the printing of money will be linked in the public’s mind with the inexplicable rise in consumer prices, despite a slump in demand.
The investment alternatives to cash and government bonds are limited, which is confirmed by the experiences from past hyperinflations. Despite attempts to support bond markets, you cannot have zero interest rates and accelerating price inflation. Stocks and shares will suffer: initially they are hit by rising bond yields, and than as inflation gathers pace, balance sheets are undermined by escalating replacement costs. Property is also a bad investment due to the effect of rising bond yields on financially geared assets, and because rentals always lag inflation, if you can find a creditworthy tennant. That leaves commodities, so by a process of elimination the money coming out of government bonds will be headed that way, and the purchasing power of $£€¥ will collapse even further.
All this is confirmed from previous hyperinflation episodes. Precedent tells us it is too late to escape: the debt trap is sprung. For those that have not properly considered these matters, a global hyperinflationary slump is dismissed as highly unlikely. It is the ignorance of the economic and political establishment to these dangers that is extraordinary aspect of all this to those very few of us who have.