This post is a continuation from my last post on Debt and the Future state of the Global Economy. That post using hard numbers outlined the very grave danger were in. This post will outline strategies on how to prepare for what is likely to come based on a model of inflation.
(Disclaimer: It is my opinion that inflation will be very low to non-existent over the next 5-10 years, hyperinflation is extremely unlikely and that deflation will be the primary phenomena among the G10 nations. See my more recent article on The Case for Deflation and how to prepare for it.)
The Case for Inflation
“The banks are terribly afraid of deflation. If they lend you 95 per cent of value of your home and the property drops by 10 per cent, you owe them more than what they could sell it for, and it strikes fear in the hearts of bankers. The Federal Reserve has stated: ‘We will not let deflation happen in the U.S.’ It happened in Japan with devastating results.” (Source)
This is why the speculative housing bubble was so very brutal on the economy. Banks lent out money to overpriced homes on a massive scale. USA, Canada, Australia, China, Norway, Sweden are all guilty of housing bubbles. Now banks stand to default. In fact, banks are holding on to foreclosed homes, and not putting them on the market, for fear of bursting the bubble faster than it already is. Homes in the USA stand to lose another 50% of their total value…and thus banks stand to lose equally as much. Scary!
According to the above logic, as well as what the federal reserve in the US has said, governments typically don’t consider deflation an option. They appear to be paranoid of a deflationary spiral. “A deflationary spiral is a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price.” Inflation appears to be the lesser of two evils regarding the economy. Thus governments will opt to just print more money to pay off their debt and cause inflation. (On a potential counter-side note laws were passed that allow states to default in the US…before it was illegal?)
“Beginning in October 2008, the FED has reacted just as he said it would. Hard-money deflationists say the FED cannot reverse price deflation. Bernanke said they are wrong.”
But 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. . . .
Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.
(source for above quote)
How Inflation Occurs – The entry of money into an economy
Inflation only occurs when people have excess money and can spend it on stuff. Inflation is measured by the CPI. If lots of people don’t have enough money in their hands to buy stuff such as the necessities then the prices of said goods will NOT inflate. Inflation fundamentally is dictated by supply and demand of money for necessities.
Currency comes into an economy in two ways:
- The Central Bank prints money. This is hard cash and accounts for on average 1-10% of currency in circulation.
- Banks loan money into existence. This accounts for 90-99% of currency in circulation.
Now central Banks in all major countries have been printing money like crazy, on the billion-trillion dollar scale. Most of that money is being loaned to national banks? However that money has been just sitting in bank vaults doing nothing. Banks can’t lend out more because interest rates are already at rock bottom. Thus inflation at the consumer level does not occur.
There appear to be only two ways in which inflation on a large scale will occur:
- Central Banks/Governments print money and mail it to people
- Central Banks give money to the government to pay its people/loans.
The first option isn’t too likely, but the second option requires further inquiry. When the Fed in the US starts buying government treasury bonds SOMETHING CRAZY is happening. According to this source the Fed is buying 70% of US Treasuries. This is also known as quantitative easing. Not only that, the Fed is buying home loans as well. This appears to be the primary inflationary mechanism at work in the US economy, and it will be something to keep a close eye on.
How Inflation is actually measured and the trickiness of it all:
(Monetary Inflation vs Goods Infaltion)
Inflation is measured by the CPI. CPI is made out of necessities, staple food, gas those types of things. The price of a basket of goods is tracked and the more those goods cost the higher the inflation. This is based on the theory of supply and demand. For example if people have lots of money the price of goods will increase because business’s can squeeze more money out of people since they can afford to pay more. If people have less money, demand drops and business’s lower their prices and deflation occurs. This is generally how it has occurred for the last 60 years and prices have inflated for all goods across the economy, however this is mostly due to people having more money because they took out more and more debt, instead of trying to spend less. Supply & demand was skewed by unnaturally high debt forces.
Now something even more bizzare is happening that puts a bigger wrench in the standard supply & demand model of CPI and what inflation means. The world is starting to run into natural limits in terms of oil & food production. The price of food & oil is rising not because people have more money and business can squeeze them, but because were running low on those resources and business’s are forced to raise prices because production costs more.
So now inflation is rising not because greater money supply, but due to running into hard natural limits. In this way people will lose even more money as the basic neccesities cost more, and the risk of defaulting will rise even more, which leads to deflation. This has never really happened before because food and gas have always been in abundant supply and quite cheap. This really is uncharted territory.This leads to a funny conclusion.
- Inflation due to printing more money, making debt easier causes true monetary inflation and maybe even hyperinflation.
- Inflation due to prices of goods rising from running into natural limits, causes….deflation. That’s just weird!
Case for Hyperinflation
Hyperinflation has 2 fundamental causes:
- Rapid Increase in the money supply. Caused by government printing excess money.
- Increase in the velocity of money. Loss in confidence in the national currency as people try to spend as fast as possible.
Hyperinflation is typically defined as inflation >50% per year.
Hyperinflation occurs after prolonged inflation. A government inflates it’s currency on avg 3-7% per year. In 10 years that is a 15-30% worth of inflation (due to compound effect). The scary thing about hyperinflation is that it happens very, VERY quickly. Once people lose faith in their government/currency for fear of losing the value of their savings, they buy as much stuff as quickly as possible. They try to get rid of all their cash and convert it to hard assets. All of the sudden everyone tries to liquidate their savings. What make this more frighting than any time in history is social media and the speed with which information flows. The fear of hyperinflation and social media could exacerbate the problem as the fear feeds on itself quickening the process of dumping cash. Hyperinflation feeds on itself growing exponentially.
The only stop-gap I see to hyperinflation is that most people in western society are up to the hilt in debt. The vast majority are living from paycheck to paycheck and thus have no actual cash to liquidate. The only people who have lots of cash to liquidate are the richest 1%. As most of a countries currency now a days is in the form of debt…I am not sure if hyperinflation is really possible. (The case was quite different in Germany circa 1920 where credit cards didn’t even exist yet.) Hyperinflation is only possible if the government starts sending you cheques/ free money in the mail! Interest rates are near 0% and can’t go any lower!
Hyperinflation also appears to be strictly a policy decision. Thus a nation’s central bank would have to knowingly create hyperinflation in order for it to occur. It could hyper-inflate its way out of debts, but then would have to start from scratch again after subjecting the economy to enormous volatility and pressure. The vast majority of the world governments are unlikely to do this. The most likely scenario is inflation rates of 10-30%. This means if you plan on going into debt, it may be a good time now, because in 3-5 years it may be very easy to pay it off. That is if you still have a job….
Currency wars may erupt as inflation devalues a currency relative to others and increases trade advantage, other countries may retaliate by inflating their currency. When inflation has a double benefit of increasing trade AND paying off debt you know things could get very ugly.
Hyperinflation appears to be a psychological phenomenon as people lose faith in their countries currency. As that occurs inflation rises exponentially in a very short period of time, which may not be linked to the gov’t printing a bunch of money at said time. Supposedly hyperinflation is impossible to predict. Hyperinflation is a way of the currency catching up for the underlying inflation that has gone on for years.
Bailouts ARE Inflation:
Governments on the verge of defaulting can simply print more money to pay off their debt. Now individuals and business’s don’t quite have that luxury…..but they sort of do in in a round about way via bailouts. Banks are massive holders of individual and business debt. In fact they hold about 30x more debt than they do cash. They are literately leveraged out the wazooo. Now if a large bank is on the verge of collapse due to the massive un-payable debt it holds that its customers are defaulting on due to a recession, it could bring down the entire bank and trillions of dollars would disappear. Once one major bank goes down, it causes a domino effect and ALL the banks globally will begin to collapse since they are all indebted to each other. You can see very quickly why from a government point of view this simply isn’t an option. Printing a few hundred billion dollars out of thin air is a much rosier alternative than triggering systemic collapse. Hence “too big too fail”. Thus increased rates of inflation are almost guaranteed.
What makes the bailout-bank scenario particularly scary is that governments strapped for cash barely being able to pay the interest on their own debts, all of the sudden may have to come up with hundreds of billions to keep its national banks afloat. The only way to do that is to print more money, and to print lots of it very quickly. This in of itself could cause hyperinflation. Needles to say large companies such as GM got bailed out by the American government as well. So governments may create more money to bail out the corporate sector as well.
Hyperinflation is tricky because it seems almost impossible to predict. High rates of inflation are guaranteed whether this leads into hyperinflation and when is a tough call. Let me know if you think you can!
Two Primary Strategies of Dealing with inflation:
It appears that currencies in the western world will undergo moderate deflation and then go into inflation and suddenly will be poised for hyperinflation which can occur in the span of days. Thus no matter the way you look at it it seems prudent to plan for hyperinflation if major rates of inflation are seen. The best way to determine which countries are most likely to inflate first when troubles begin is those countries with the highest total debt to gdp ratio. Those currencies will be ones you will not want to have any cash in. The two best strategies to deal with inflation appear to be:
- Transfer your money into a currency that won’t massively inflate
- Transfer your money into hard assets aka. stuff. Land, Gold, Silver, Precious metals, Food, etc.
The best strategy in my opinion is to do both. The worst is to hold onto cash.
Secondary Strategy of Dealing with Inflation
Possible Investment Strategy….Stocks, Bonds….ties in with the first primary strategy.
1. Currency Transfer Strategy
The currency that is likely to be the most stable and has the least risk of serious inflation is the country with the least total amount of debt. Total debt to GDP is a good ratio and determiner of the risk of inflation because federal debt alone doesn’t account for the bailouts governments will give to their provinces/states business and people and thus the amount of money they are likely to print. In addition cascading debt crises will have a domino effect from country to country. A individual sector debt risk analysis of the countries would be ideal.
Australia ~ 2.1 trillion………..total debt to GDP is >300% Canada ~ 4.6 trillion…………. total debt to GDP is 283% USA ~ 56 trillion……………… total debt to GDP is 365%
Other countries that are on my radar are:
New Zealand (total debt to gdp > 336%) Singapore (free floatish) >debt to gdp Really high…huge hinancial sector therefore huge debt South Korea (total debt to gdp >333%) Hong Kong/China (pegged-ish to USD) Switzerland (total debt to gdp >313%) Norway (Norwegian Krone) debt to gdp > 400% Sweden (Swedish Krona) debt to gdp > 400%
- Caribbean Countries…such as
Cayman Islands (no good…pegged to USD)
- Emerging Economies (China, Russia, India, Brazil)
Most European countries obviously don’t make the cut due to troubles with the Euro. USA & Canada are both in bad places fiscally. And developing nations usually are quite debt laden and may get hit hard with economic troubles…plus even if their currency doesn’t devalue, it won’t do you much good unless you want to move there in order to use it. The natural outcome of this strategy would be, one most likely would have to move to the given country in which you wish to transfer your currency to.
*On a side note it may be possible to open up say a Swiss bank account and hold all your money in Swiss francs, and then use a Swiss credit card to make purchases in your given currency. This way your cash doesn’t lose value and you can still buy things in your home country via the given instantaneous exchange rate which would be adjusted for inflation. Modern technology will change the dynamics of how this next crises will occur. Germans in the early 1920’s didn’t have off shore bank accounts with internet connected credit cards…
The inherent problem with the currency transfer strategy and the ease it can be done with using modern technology. For example in the past Switzerland with its lucrative currency had to put a stop-gap and threatened to buy lots of lower value currency in order to debase its own currency as so many people found its currency lucrative.
2. Asset Transfer Strategy
So if you don’t want to transfer your money into another currency and subsequently move to said country, then transferring your cash into hard assets is your next best bet. The most common hard assets hawked are:
- Other Precious Metals
- Oil, Gas
- Water, candles, fire wood, guns, bows and arrows, art, diamonds, other stuff, etc.
An analysis of some of these assets will follow shortly. Hyperinflation has occurred in the past most famously in Germany. So these historical case examples will give us a good idea on strategies. People did get rich during these tough times, and deciphering how they did it will help us to be better prepared.
Gold is the number one commodity that is hawked by all the survivalists out there. It is beyond obsessive. People think they are going to get rich off it, that it will save them and that it will become the new currency after the current ones fail. Mountains of books have been written on the subject and dozens of websites are all on the gold bandwagon. It has such hype, that I think the hype alone may cause the price to escalate. Is gold really that good? I remain highly sceptical…chiefly because of the hype and also because I am a contrarian. Gold is extremely volatile, and is subject to enormous speculation. Also gold is priced in US dollars. Once the US currency hyper-inflates, so will the price of Gold. Once the US currency fails, so will the price of gold. If the world descends into anarchy how much is gold going to do for you? Wouldn’t water or food, or farm-able land have more worth?
“There is no government-fixed price for gold today. Therefore, any argument based on the price of gold during the Great Depression, when gold coins were still money, is not just ill-informed; it’s deliberately deceptive.”(source)
Secondary Investment Strategy
After following the first strategy and transferring your money into another currency you have to decide what to do with it. Those countries still have inflation. You could hold it, invest it, or buy hard assets.
- What sectors to invest in? Resources? Food?
- Inflation Adjusted Bonds (Real Return Bonds)
- Companies that are preparing for Inflation
- Companies that do well under inflationary conditions…analysis of this
- Peter Schiff – Inflation Guru
- How Deflationary Forces will be turned Inflation
- Shadow stats, inflation much higher than stated