Hyperinflation is A Small Price to Pay?

The US is hurtling toward out-of-control inflation while the political class tries to convince the hoi polloi that inflation is not a problem. Government-generated CPI data show tame inflation. Federal Reserve Chairman Ben Bernanke claims deflation, not inflation, is the danger to the economy.

Despite government propaganda every shopper knows inflation is already a serious problem. The Financial Times presented annual price increases for various items, which included the following:

  • heating oil +41%
  • copper +59%
  • silver +91%
  • palladium +212%
  • corn +91%
  • wheat +79%
  • cotton +143%
These data indicate that inflation is upon us. The magnitude of these numbers suggests hyperinflation.

The effects of inflation are not limited to the US and not limited to rising prices. Spiraling food costs have been cited as a factor in political upheaval in several countries, including most recently Egypt. The US Federal Reserve, although it may be argued to be a primary driver, is not alone as a producer of inflation. As pointed out by the Daily Bell there is plenty of blame to go around:

Central banks have pumped something like US$20 to US$50 TRILLION into the world's economy to try to reinflate economies that collapsed in 2008.

The divergence between what governments want you to believe regarding inflation and what is painfully obvious grows larger with time. In the US obvious anomalies in government reports, especially unemployment and claims that an economic recovery is underway, make the reports incredible. Few citizens believe that the recession ended 19 months ago. That claim contradicts what they experience every day.

The Federal Reserve has tripled the money supply in an effort to protect the banking system and the economy. Currently, most of this money sits in the banking system as excess reserves which could be lent out, potentially at ten-fold leverage. At some point, these banks will lend these funds out. Then, via the Daily Bell, the Fed must take decisive and rapid action:

As this currency begins, finally, to circulate, price inflation must result, unless such money is quickly removed. Central bankers have continuously claimed that excess currency can be removed from the larger economy before it does its inflationary damage ...

Inflationary damage is already evident as per the numbers above. Unless the removal of these excess funds occurs in a timely fashion, the country runs the risk of hyperinflation.

Mr. Bernanke has stated on many occasions that he is prepared to withdraw these funds before they can create damage. It is not clear what Mr. Bernanke considers damage, but one might think that rising food and energy costs might qualify. Surely uprisings in Tunisia and Egypt should qualify, if in fact they can be attributed to Central Bank policies.

The reality is that Mr. Bernanke is unable to reverse the time bomb he has placed in the banking system. To suggest otherwise reflects either duplicity or unlikely ignorance on the part of Mr. Bernanke. He will not be able to withdraw the funds he put into the banking system for the following reasons:

1. Central banking is not science.

Mr. Bernanke has no way of knowing when and what to do. The uncertainty is not due to personal limitations but results from the complex nature of economic activity and monetary transmission mechanisms. He cannot know any of the following:

  • What the rate of price increases ahead will be.
  • How much of a reduction in the money supply should occur to dampen expected increases.
  • What the effect of such a reduction would do to economic activity.
Even if Mr. Bernanke could know the unknowable, he would still be unable to manage matters because lags in the effects of monetary policy are variable and fickle. Further, monetary transmission linkages are complex, which means Mr. Bernanke cannot know what sectors of the economy might be affected and by how much.

Mr. Bernanke says he admires Milton Friedman, the father of modern monetarism. Yet, Mr. Friedman was against using monetary policy as a tool to manage the economy. In Friedman's opinion any attempt to do so would exacerbate economic problems and cycles. That is why Mr.Friedman advocated a mechanical monetary rule for Central Banks rather than discretionary policy decisions.

Complicating these problems is what appears to be a personal problem. Chairman Bernanke's inability to forecast anything correctly over the past three or so years should make anyone nervous about his judgment. He appears to be living proof that economic forecasting exists to make astrology look respectable.

2. Political interference is never bi-directional.

Politicians never want to remove stimulus. That was evidenced in Europe where Trichet, head of the European Central Bank, recently reversed on a decision to withdraw currency from the banking system. For the political class (and I do include Central Bankers in that group) there is never a good time to remove stimulus.

3. The Fed cannot return the money supply back to reasonable levels.

Of the first two problems, the first is insoluble and the second intractable. Were it possible to overcome them, there is still no way to do what Mr. Bernanke says he will do. The Fed's balance sheet precludes it. 

In rescuing the financial system, the Fed bought junk assets, injecting new money into the banking system. They bought these assets at prices greater than their actual value. To remove the excess funds from the banking system, the Fed must sell these toxic assets back to the private sector.

Unfortunately, no buyers will pay what the Fed did for these assets. They will only pay what they are perceived to be worth ,which is less than when the Fed overpaid for them.

It might be possible to sell Treasuries into the private sector to reduce the money supply; however the Fed doesn't have enough Treasuries to accomplish the task.  Furthermore, the more Treasuries that leave the Fed's balance sheet, the more the Fed's balance sheet becomes a collection of junk assets, jeopardizing the viability and continuity of the Fed.

4. Monetary expansion cannot stop.

The secret behind all of Bernanke's bravado is that monetary expansion cannot stop. Deficits of $1.5 Trillion are the current and expected norm. There is little political will to stop them. Has anyone suggested balancing the budget in a year or making meaningful cuts, probably in excess of $500 billion? (Apparently Rand Paul has suggested this latter number, although he appears to be quite alone in his boldness.)

Without dramatic political action, the Fed will continue Quantitative Easing. Otherwise the Federal government will default on at least some of its obligations. Foreign and domestic demand is insufficient to absorb the new Treasury debt necessary to fund the deficits. Mr. Bernanke, to the extent he even has a choice, will continue to expand the money supply rather than be responsible for a government default. Get prepared for QE3, QE4, ... ad nauseum.

The phrase "lender of last resort" described the intended role of Central Banks. They were created to provide liquidity to assist banks in trouble and prevent bank runs. Today the phrase has taken on new meaning. Central Banks have become the lenders of last resort for insolvent governments.

The Fed is unable to withdraw funds from the economy for the reasons above. They will be forced to continue to add funds to keep the government liquid. We will have hyperinflation because there is no way or intention of withdrawing the excess funds from the banking system.

Mr. Bernanke, regardless of his intentions, now has one client - the Federal Government. It is his duty to keep them solvent regardless of his job description. The myth of government must be preserved no matter what the costs, including a hyperinflationary depression.

Monty Pelerin blogs at www.economicnoise.com.
The US is hurtling toward out-of-control inflation while the political class tries to convince the hoi polloi that inflation is not a problem. Government-generated CPI data show tame inflation. Federal Reserve Chairman Ben Bernanke claims deflation, not inflation, is the danger to the economy.

Despite government propaganda every shopper knows inflation is already a serious problem. The Financial Times presented annual price increases for various items, which included the following:

  • heating oil +41%
  • copper +59%
  • silver +91%
  • palladium +212%
  • corn +91%
  • wheat +79%
  • cotton +143%
These data indicate that inflation is upon us. The magnitude of these numbers suggests hyperinflation.

The effects of inflation are not limited to the US and not limited to rising prices. Spiraling food costs have been cited as a factor in political upheaval in several countries, including most recently Egypt. The US Federal Reserve, although it may be argued to be a primary driver, is not alone as a producer of inflation. As pointed out by the Daily Bell there is plenty of blame to go around:

Central banks have pumped something like US$20 to US$50 TRILLION into the world's economy to try to reinflate economies that collapsed in 2008.

The divergence between what governments want you to believe regarding inflation and what is painfully obvious grows larger with time. In the US obvious anomalies in government reports, especially unemployment and claims that an economic recovery is underway, make the reports incredible. Few citizens believe that the recession ended 19 months ago. That claim contradicts what they experience every day.

The Federal Reserve has tripled the money supply in an effort to protect the banking system and the economy. Currently, most of this money sits in the banking system as excess reserves which could be lent out, potentially at ten-fold leverage. At some point, these banks will lend these funds out. Then, via the Daily Bell, the Fed must take decisive and rapid action:

As this currency begins, finally, to circulate, price inflation must result, unless such money is quickly removed. Central bankers have continuously claimed that excess currency can be removed from the larger economy before it does its inflationary damage ...

Inflationary damage is already evident as per the numbers above. Unless the removal of these excess funds occurs in a timely fashion, the country runs the risk of hyperinflation.

Mr. Bernanke has stated on many occasions that he is prepared to withdraw these funds before they can create damage. It is not clear what Mr. Bernanke considers damage, but one might think that rising food and energy costs might qualify. Surely uprisings in Tunisia and Egypt should qualify, if in fact they can be attributed to Central Bank policies.

The reality is that Mr. Bernanke is unable to reverse the time bomb he has placed in the banking system. To suggest otherwise reflects either duplicity or unlikely ignorance on the part of Mr. Bernanke. He will not be able to withdraw the funds he put into the banking system for the following reasons:

1. Central banking is not science.

Mr. Bernanke has no way of knowing when and what to do. The uncertainty is not due to personal limitations but results from the complex nature of economic activity and monetary transmission mechanisms. He cannot know any of the following:

  • What the rate of price increases ahead will be.
  • How much of a reduction in the money supply should occur to dampen expected increases.
  • What the effect of such a reduction would do to economic activity.
Even if Mr. Bernanke could know the unknowable, he would still be unable to manage matters because lags in the effects of monetary policy are variable and fickle. Further, monetary transmission linkages are complex, which means Mr. Bernanke cannot know what sectors of the economy might be affected and by how much.

Mr. Bernanke says he admires Milton Friedman, the father of modern monetarism. Yet, Mr. Friedman was against using monetary policy as a tool to manage the economy. In Friedman's opinion any attempt to do so would exacerbate economic problems and cycles. That is why Mr.Friedman advocated a mechanical monetary rule for Central Banks rather than discretionary policy decisions.

Complicating these problems is what appears to be a personal problem. Chairman Bernanke's inability to forecast anything correctly over the past three or so years should make anyone nervous about his judgment. He appears to be living proof that economic forecasting exists to make astrology look respectable.

2. Political interference is never bi-directional.

Politicians never want to remove stimulus. That was evidenced in Europe where Trichet, head of the European Central Bank, recently reversed on a decision to withdraw currency from the banking system. For the political class (and I do include Central Bankers in that group) there is never a good time to remove stimulus.

3. The Fed cannot return the money supply back to reasonable levels.

Of the first two problems, the first is insoluble and the second intractable. Were it possible to overcome them, there is still no way to do what Mr. Bernanke says he will do. The Fed's balance sheet precludes it. 

In rescuing the financial system, the Fed bought junk assets, injecting new money into the banking system. They bought these assets at prices greater than their actual value. To remove the excess funds from the banking system, the Fed must sell these toxic assets back to the private sector.

Unfortunately, no buyers will pay what the Fed did for these assets. They will only pay what they are perceived to be worth ,which is less than when the Fed overpaid for them.

It might be possible to sell Treasuries into the private sector to reduce the money supply; however the Fed doesn't have enough Treasuries to accomplish the task.  Furthermore, the more Treasuries that leave the Fed's balance sheet, the more the Fed's balance sheet becomes a collection of junk assets, jeopardizing the viability and continuity of the Fed.

4. Monetary expansion cannot stop.

The secret behind all of Bernanke's bravado is that monetary expansion cannot stop. Deficits of $1.5 Trillion are the current and expected norm. There is little political will to stop them. Has anyone suggested balancing the budget in a year or making meaningful cuts, probably in excess of $500 billion? (Apparently Rand Paul has suggested this latter number, although he appears to be quite alone in his boldness.)

Without dramatic political action, the Fed will continue Quantitative Easing. Otherwise the Federal government will default on at least some of its obligations. Foreign and domestic demand is insufficient to absorb the new Treasury debt necessary to fund the deficits. Mr. Bernanke, to the extent he even has a choice, will continue to expand the money supply rather than be responsible for a government default. Get prepared for QE3, QE4, ... ad nauseum.

The phrase "lender of last resort" described the intended role of Central Banks. They were created to provide liquidity to assist banks in trouble and prevent bank runs. Today the phrase has taken on new meaning. Central Banks have become the lenders of last resort for insolvent governments.

The Fed is unable to withdraw funds from the economy for the reasons above. They will be forced to continue to add funds to keep the government liquid. We will have hyperinflation because there is no way or intention of withdrawing the excess funds from the banking system.

Mr. Bernanke, regardless of his intentions, now has one client - the Federal Government. It is his duty to keep them solvent regardless of his job description. The myth of government must be preserved no matter what the costs, including a hyperinflationary depression.

Monty Pelerin blogs at www.economicnoise.com.

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