Hyperinflation and the Government Scare Tactics that use them

By Alfred Yim, Staff Writer

Have you ever heard the news warn of an impending Zimbabwean-like hyperinflation?  Why the US will sooner, rather than later, become the next Greece?  Or that the government is bankrupt and that you should expect the dollar to take a nose dive?

For the layperson who comes across these messages, it would be easy to understand why they may become frightened and mislead.  This article’s purpose then is to analyze some of the more common claims and arguments that serve to perpetuate this hysteria, allowing you—the level headed individual—to analyze opposing views and make informed conclusions regarding deficits, debt, devaluation of the dollar and hyperinflation scares.

 

DEBT AND DEFICITS

“Deficits Lead to Certain Economic Ruin”

Daniel Griswold of the Libertarian CATO institute lends support to the idea that deficits may be misrepresented.  He states that in periods where the current account deficit is worsening, GDP growth has been more substantial than in periods where the deficit is decreasing.  For instance, in the 1980s when the current account deficit declined as a percentage of GDP, the economy grew at a modest 1.9 percent; but when deficits grew moderately, GDP grew at 3 percent; and finally, when deficits were rapidly increasing, GDP grew at 4.4 percent.

Just as interesting, is the fact that rising deficits have been witnessed alongside improving employment numbers; when deficits were at their worst, unemployment fell by 0.7 percent, while unemployment jumped by 0.8 percent per year when deficits were considered to be improving. 

Another Libertarian argument comes from Robert Murphy who, in his article “Perpetual Trade Deficits Can Be Good,” analyzes the apparent danger of deficits.  In the piece, Murphy begins outlining Peter Schiff’s comparison of the US debt situation with 5 Asians and 1 American on a desert Island; where the American, whose job is to eat, pays the Asians for their hard days foraging and hunting with IOUs.

Murphy goes on to say that if a country’s comparative advantage is in intangible financial services, then trade deficits will naturally arise due to other country’s lending in hopes of returns; the cost of growth for the country would then be interest paid rather than physical items imported; this necessarily requires us to put financial cost in context with a nation’s growth metric, that is GDP.

The discussion of historical data necessarily requires the discussion of the purpose or necessity of said deficits.  The reasons for running a deficit should, at the very least, bear as much significance as the size of the deficit.

For instance, Krugman says deficits are needed in the short term to alleviate the problems of the present, echoing Maynard Keynes’ statement that, “In the long run, we are all dead.”  The spending fills in the deficit in private spending and lack of consumption, greatly needed in times of crisis.

Krugman goes on to say that during the Great Depression, what precipitated further hardship in 1937 was the incorrect assumption that the problem was resolved, which lead to the tightening of monetary policy and as a result, prolonged suffering.   In general, deficits are not one dimensional and require a look at the opportunity cost of slashing deficits.

A counterargument to spending usually involves the mention of the potential for asset bubbles and mal-investment.  On the issue of asset bubbles, there is a way to enact spending policies while avoiding the negative corollary-and that is to implement regulation and controls.  In the case of the housing bubble, higher lending standards (i.e. down payments needed) led to a much smaller sub-prime market in Canada, which was only 6% of the market 2006 through 2008, as noted in the Vancouver Sun.

The threat of mal-investment is based on the notion that individuals, faced with the opportunity for cheap money will be incentivized to spend differently than they normally would.

However, as Joseph Heath points out, incentives do not necessarily lead to outcomes that were intuited on the outset.  For instance, one would expect taxi drivers to work longer hours on days with high volume of customers to take advantage of extra income; but on average, these drivers work less hours in these conditions, contrary to what incentives tell him or her to do.

This analogy by Heath shows that the possibility of bad investment due to some kind of incentive shouldn’t preclude quantitative easing altogether.  Not only are incentives more complicated than first seen, other secondary alternatives such as tweaking regulation and rules, as mentioned before, can achieve the same desired outcome of a non-existent bubble.

“Families Can’t Live Beyond Their Means—Neither Can Governments”

This argument is one of the strongest cases for a fiscal tightening of the belt.  Indeed, why should governments have a different fiscal standard than the nuclear family?

Such arguments however, cloud certain realities, in that families DO take loans out on things, such as education and homes, as well as borrowing for consumption.   And this same dichotomy exists for government spending as well.  When expenditures are made with an investment mindset, it’s a wholly different thing from consumptive borrowing.

So to apply the notion of dual usage of borrowed funds, instead of education and housing, the federal governments’ borrowing can bring about boons in the form of more employment and increased production

“Deficit Spending is Wasteful, Let’s Do Without It”

A counterargument to the aforementioned ‘potential benefits’ of leveraged spending, would point to the ineffectual nature of spending in general and that government intervention simply serves to crowd out private investment driving the economy further away from Pareto optimal economic conditions (Pareto Optimal being, a state where changing any one variable would result in a negative change elsewhere).

In response to that, one should consider Lipsey’s and Lancaster’s Theory of Second Best, where in a market/economy with one or more of the assumed conditions in the General Equilibrium Theory are broken, any attempts to move towards Pareto Optimality will actually be worse off than letting 2 seemingly ‘un-optimal’ factors cancel themselves out.

To Illustrate, take a polluting company which possesses a monopoly and therefore and produces less than it could to maintain high prices.  If there is a move to increase the number of competitors, the level of harm would be increased—simply letting the factor of monopoly offset the problem of externalities (pollution) is a better route in this case.

Drawing on this and applying it to deficits and spending, advocating thrift in an attempt to move towards Pareto Optimality, when the market has severe problems of contracted demand and lending reticence by the banks, will not only NOT guarantee a net benefit but can worsen it, as in the case of the polluting company.

“USA Will be the Next Greece … And Soon”

A popular argument for lifting up fiscal bootstraps involves Greece.  It’s easy to relate Greece’s problems to the US, making forthcoming chaos sound quite possible.  That said, this is a scare tactic.  Propaganda.

And at first glance, the comparison seems true.   Debt comparisons between these 2 countries in terms of the public debt are shown in the table.

In absolute terms, US trounces Greece’s interest payment amount.  As a percentage of GDP though, it is actually a smaller amount, largely owing from the fact the US economy is 40 times larger than Greece (14 trillion versus 302 billion).  However, if one takes a look at total debt, including intergovernmental debt, the ratio to GDP is much closer, with both countries around 100% with Greece sitting at 115% and the US at around 94.27%

Despite the apparent parity, the US debt situation has 2 elements that make it different, as discussed by Robert Green:

 

(1) Greece pays higher interest on its debt than the US

The average coupon interest rate for outstanding US debt (Debt To The Public) is just 2.5% (as of March 31, 2010, according to the Bureau of the Public Debt) and the Fiscal year 2011 budget projects an average interest rate for the fiscal year 2011 of just 2.0%.  Confidence in the US is what primarily allows interest rates demanded to be so low.

(2) Greece cannot finance its debt with the printing of money (double-edged advantage)

If push comes to shove, the US can ‘print’ or finance its debt by buying treasuries, Greece cannot.  Hyperinflation is purported to result from any mass printing of money, however inflation requires there to be a willingness to lend (on the banks’ part) and a willingness to take out loans (on the part of consumers), both elements clearly depressed and missing at the present, in Greece.

If this lack of lending and borrowing vigor persists into the future, hyperinflation would likewise be a case of Chicken Little.  However, predictions of sentiment in the future would be speculating at best, just as it would be to attempt to predict the sharp reverse in the US bond market.

 

These factors illustrate the differences one must take into account between Greece and the US debt.  Objections would include the issue of intergovernmental debt and the point in time where social security payments necessitate the agency to reclaim its lent money.  However, the transition period when such redemptions of bonds aside, this debt owed to itself essentially indicates how a portion of debt is more flexible than public debt.

HYPERINFLATION

Printing Of Money & Hyperinflation Scares

Overzealous doomsayers like to prey on misconceptions about just how close hyperinflation is to becoming reality.  One must note however, that the increase in money supply does not necessitate inflation if that money is not being lent, which means at the minimum, hyperinflation will not arise.  Moreover, there has not been a perfect correlation of inflation and the money supply-this is without taking into account any other variables behind the data.

The reason for the lack of more lockstep interaction could be laden in how M2 money supply is defined.   M2 among other things, such as deposits at banks, includes the holdings of cash outside of banks.  In times of great apprehension on the public’s part, there will be a larger amount of dollars held, representing the atmosphere of pessimism.

This in turn, can slightly increase the M2 figure, but what should be focused on is that the willingness of individuals to spend is depressed.  The final link to this argument is the aforementioned other variable which is the velocity of money (amount of economic activity associated with a given money supply); which is weak due to said pessimism.

 

Zimbabwe

Other arguments one should be wary of are those that bring up the printing of money and the hyperinflation in places like Zimbabwe.  Saying a country will become the next Zimbabwe is hyperbole at best, as Zimbabwe’s hyperinflation is a result of extremely poor rule, which is manifested in its management of the economy.

To avoid this state, a country like the United States would need to do the following: drastically reduce its level of democratization, turn youth groups into paramilitary wings, seize farms and run them into the ground, deter foreign investment by using said paramilitary wings to seize assets and terrorize the populace and commit a host of other counter-intuitive actions before any exaggerated statements can avoid being regarded as a monetary equivalent of Godwin’s law.

Many other instances of hyperinflation such as those pre 1980 were accompanied with the fact that fiat money systems were in place; however this fact was always accompanied with a weak central government and civil/social unrest, including war.

What Should You Take Away From This?

Given that such themes of deficit and hyperinflation doom are less apocalyptic than first observed, investing in commodities (gold included) should not be undertaken with overconfidence.  As well, complete divestment from US bonds and cash is unwarranted.

If you are going to make a bet that commodities will continue to benefit from the economic and social climate, then you should do it with a sound rationale.

An example of a more prudent way of going about commodity investment is to invest in broad based commodity ETFs.  The reasoning for this is because commodities have very low correlations with each other.  In addition, research has shown that if there is any possible long run return, in excess of the risk free rate in commodities, it is achieved by holding a portfolio of equally weighted periodically rebalanced commodity contracts (which Erb and Harvey details in their paper “Tactical and Strategic Value of Long run Commodity Futures”).

The implication for the average investor is this: buy a broad based ETF (which holds portfolios of contracts, so that you the investor can avoid the duty of rollover and rebalancing), if you do not have many other assets like stocks or bonds.  Also, buy ETFs which don’t have many commodities when you have other non-commodity assets to speak of.

In all, besides avoiding the arguments which use hard and absolute statements (which are a red light in terms of fallaciousness), one should also take great care in realizing that economics is not perfect; therefore arguments which depend on what may or may not happen are either individuals’ best guesses and/or estimates.  Regardless, having a more pragmatic approach with your money is never the worst choice.

By Alfred Yim, Staff Writer

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The ARB Team
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