"I'm not upset that you lied to me, I'm upset that from now on I can't believe you" - Friedrich Nietzsche

Even though the US dollar history is like a dishonest Goldsmith Banker issuing more receipts for gold than he has gold, central banks around the world continue to hold US dollars as reserves. The US continues to print more, stealing value from countries around the world with each new dollar printed. It is fundamentally unfair for the US to get real wealth from billions of poor people around the world in exchange for giving them pieces of paper, and then to devalue those pieces of paper by printing more all the time. As other countries realize they are being ripped off because they are using and holding dollars they will reduce their exposure to dollars. When central banks do this they call it diversifying reserves. As this happens the value of the dollar will crash.

Paper vs Gold - US 38 Year Cycle

Below we take a brief look at the history of this cycle and then look at the current situation.

Go to index.

1671

Go to index.

1704 = 1671+33

crying up

Go to index.

1742 = 1704+38

Go to index.

1781 = 1742+39

Go to index.

1819 = 1781+38

Go to index.

1857 = 1819+38

Go to index.

1895 = 1857+38

Go to index.

1933 = 1895+38

Since there was not really enough gold to back all the paper money (only 40%), some people and countries started getting out their gold while the getting was still good. Rather than admit the Ponzi gold scheme had failed, in 1933 President Roosevelt confiscated private gold and no longer let people exchange paper money for gold or own gold. When they took people's gold they paid them $20.67 in paper and then shortly after raised the price to $35/oz (so they really paid people $0.59 for every $1 worth). Foreign countries could exchange gold at $35/oz and for awhile after this gold flowed into the US.

The Fed's paper changed over the years from gold certificates to Federal Reserve Notes backed by nothing. In has been suggested that they be renamed to "Federal Reserve Accounting Unit Devices", or FRAUDs for short.

If the government had not outlawed gold, more and more people would have turned in their paper dollars for gold coins until the Fed either ran out of gold or closed up. At this point the remaining paper money would have rapidly become worthless. This would have been a 3rd period of hyperinflation in American history. Along with the Revolution and Civil War, with between 70 and 80 year spacing. If the US gets hyperinflation in the next few years it should really count as America's 4th hyperinflation, with similar spacing.

Go to index.

1971 = 1933+38

Go to index.

2009 = 1971+38

In the last 12 months the US government has spent $2 trillion more than it took in and printed over $1 trillion. Before this the record deficit was about $0.5 trillion and most of that was borrowed not printed. With this much printing, fewer people are willing to lock their wealth in US dollar debt. When the government can not borrow as much, it will print more.

The people that are still buying government debt are buying short term debt. This means that if interest rates go up the interest payments on the US debt will go up. In the past much of the debt was in 20 year and 30 year fixed rate bonds, but not so much these days. Many of the US consumers have variable rate mortgages. As interest rates go up their payments will go up. This will lead to more defaults. These two problems keep the Fed from letting interest rates rise. But keeping them low means more money printing.

In each of the above American economic collapses there was too much paper money for the amount of gold and people lost confidence in the paper. Today the US paper money dwarfs the US gold. In 1895 the government could be saved with $65 million in gold, today all the US obligations are more like $65 trillion, a million times higher.

Go to index.

Those who cannot remember the past are condemned to repeat it.

"Insanity in individuals is something rare - but in groups, parties, nations and epochs, it is the rule." - Friedrich Nietzsche

"We learn from history that we do not learn from history." - Georg Wilhelm Friedrich Hegel

"The present is a mystery only to those who slept through history." - unknown

"History may not repeat itself, but it rhymes." - Mark Twain

"There is nothing new except what is forgotten." - Rose Bertin

"Problems cannot be solved at the same level of awareness that created them." - Albert Einstein

It is interesting that paper money has a long history of failing, not just in the US. Several failures happened when empires fell. There is no history of paper working well, paper money has always failed.

Is 38 years how long it takes for new generations of Americans to forget the past and trust paper money?

Go to index.

Related Phenomena

Barry Bannister has noticed a cycle in the ratio of stocks / commodities where it goes up for 15 to 20 years and then down for 15 to 20 years. In fact, some of his transition points, like 1933 and 1971, are the same dates used in this article. So a pair of his up and down cycles seems to line up with the 38 year cycle discussed here. This makes sense, because people trusting paper money also trust stocks, and people wanting gold also like commodities.

Similarly Fred Harrison has an 18 year cycle that is also somewhat similar.

In 1925 the Russian author Nikolai Kondratiev published a book called "The Major Economic Cycles" which led to some later authors calling the cycles Kondratiev waves. I like Mish's explanation of K-cycles. In 1938, during Stalin's Great Purge, Kondratiev was tried and sentenced to 10 years in jail, then executed by firing squad the same day the sentence was issued.

The theory of Generational Dynamics has cycles about twice as long as mine. Also see blog. The idea is that the elders of any generation have learned wisdom through experience which helps them to govern society and keep it on the most productive course. As the elders are replaced by the next generation a vast pool of knowledge is lost. Mistakes of old are then repeated anew so lessons can be learned again.

The Schwartz Hypothesis that price instability due to monetary policy causes financial instability fits well with America's historical record. It is tested against many of the same events covered in this article.

In Henry Petroski's book Success Through Failure he notes that there is a 30 something year cycle for bridge collapses. It seems that success breeds hubris and catastrophe nurtures humility and insight. So the longer people go without a failure the more confident they get, till they fail again. And other engineering fields like spacecraft and nuclear power plants have a similar pattern. The patterns of failure go way back.

Dan Denning writes about The End of the Super Cycle in Fiat Money.

The long term Elliott Waves seem to be connected with monetary changes.

Go to index.

US Dollar World Domination

Go to index.

US Stealing from dollar holders worldwide

The government and Federal Reserve have been able to keep economist saying that government printing money makes the economy grow. The truth is the US economy was more stable and grew faster before the Federal Reserve. By printing money the government takes wealth from everyone who has dollar savings, so it helps government grow faster. This is the Inflation Tax. The US was able to extract a moderate Inflation Tax from people all around the world for the last 38 years.

There is a story that if you slowly heat a pot of water with a frog in he will not jump out. But if you heat it too fast he will jump.

Recently the US printing of money has increased to such a rate that the rest of the world is now worried they are losing value too fast by holding US dollars. The dollar has lost nearly half its value compared to other paper currencies in about 10 years and more than 10% in the last few months. With US bonds paying 1% per year and the dollar dropping by about 1% per month, holding US bonds is foolish. When the US prints another $1 trillion, it is stealing this much value from all the existing dollar holders. Over time people around the world will realize the US dollar is in trouble. Countries are starting to realize that a world financial system where the US can steal wealth from all the players is just not fair. As the world gets rid of their US dollars, the value of US dollars will drop more. The more it drops the more people will be in a hurry to dump their dollars. This could result in the dollar falling faster over the next 10 years or in a sudden panic or dollar crash where everyone is rushing for the exits at once.

If there are $6 trillion dollars outside the US and the US inflates the money supply by 10% it has stolen $600 billion from these people outside the US. This is about the level of the US military budget. So a case can be made that the US inflation tax on the rest of the world pays for the US military which can then dominate the world.

It would be a mistake to assume that since the Roman dinar, the Spanish reale, and the British pound each took many years to lose reserve currency status that the dollar fall will be slow. Back then they did not have instant worldwide information flow, computers with automatic trading software, etc. While it would be wrong to say that This Time Is Different, the collapse will probably set a new speed record for reserve currency collapses.

The US ability to quietly take wealth from dollar reserves all around the world was like the Golden Goose. But now they have pushed too far and that golden goose is going to die.

People or countries do not pay any inflation tax on their gold and silver holdings. This is where the frog is free.

A nation-state taxes its own citizens, while an empire taxes other nation-states. By this logic America is an empire, since it collects an inflation tax from much of the world.

If something cannot go on forever, it will stop. --Stein's Law.

Go to index.

US Dollar Multi-Level-Marketing Scheme

But what is in it for other countries that peg to the dollar? What is their angle or incentive to peg to the dollar? In the Caribbean we have the East Caribbean Central Bank that produces the East Caribbean Dollar which is pegged at 2.6882 to the dollar. This uses an Orthodox Currency Board. When they print EC dollars they exchange them for US dollars and then buy short term US treasuries. In this case they always have enough treasuries that they could convert all EC dollars back to US dollars. So the EC dollar can be fully backed this way.

Now the fun part is that the central bank gets to keep any interest they earn on the treasuries. Also, as dollars come flooding into the Caribbean they will get to print more EC dollars and increase the number of dollars they earn interest on (though probably they are worth less each). So the interest the bank earns on the reserves is the "cut" or incentive they get by pegging to the dollar.

When the US holds interest rates down at 1% and the dollar is dropping in value more than that most years, it is much less fun for the other central banks to peg to the dollar than when it was at 5%. If the orthodox method is costing them their nest egg of reserves, they have to look for non-orthodox methods. And watching gold go up in value much more than 1% per year for the last 10 years starts to make the 1% US bonds look foolish. In general with such low US rates, central banks would be better off to leave the US dollar MLM scheme and do something else. They can change their pegs to another currency or basket of currencies where they can earn more interest, or buy gold which is going up in value. Organizations often do what is in their own interest.

Go to index.

Easy Money in Reserve Currency Home Country

Now assuming people around the world still used dollars as their reserve currency and the international trading currency, what would happen? People in the US would on average have more money than people in other countries. People in the US would import lots of stuff from other countries. People in the US would be less motivated to work and want higher wages when they did work. People in the US would spend more money. The US would have a trade deficit as money flowed out to buy stuff from other countries.

Because of this jobs that could be done in another country with cheaper labor would migrate to other countries. So manufacturing jobs and even some engineering and software jobs would go offshore. Only service jobs, that could not relocate, would stay in the US.

There is actually a precedent for this sort of thing. When Spain was taking gold from the New World they were making lots of new gold money. The result was that people in Spain bought more stuff from outside Spain, etc.

When the US makes new money and spends it on Americans it has the same net effect as if they had just mailed it out to people.

Go to index.

Replacing the dollar

Some people have claimed that it would take the Gulf States many years to replace the dollar as the currency oil is priced in. This is a peculiar claim since Iraq and Iran switched to non-dollar sales in short order (Iraq before the war). As should be expected with a dropping dollar, Iran says it profited from switching to non-dollar oil sales. Other countries can see this and switch quickly too.

Imagine that central banks currently had their assets as 60% Dollars and 30% Euros. If the value of the dollar were to drop in half, then they would have equal value in Euros and Dollars without changing anything.

For thousands of years gold and silver have been used as a store of value. Imagine a central bank with 10% in gold and 90% in dollars. If the dollar goes down by 2 and gold up by 5 it could suddenly have most of its assets in gold.

The point is that the dollar could be replaced as the dominant reserve asset even without central banks ever selling their dollars, just by dropping in value. Several times in the past the dollar has dropped significantly in value in a just a few short years.

Go to index.

Currencies pegged to dollar do not have to keep buying dollars

The way an orthodox currency board pegs to the dollar, as explained in the US Dollar Multi-Level-Marketing Scheme, is to print more of the local currency and buy dollars if the local currency gets too high, and use the reserves of dollars to buy up local currency if the local currency gets too low. When they print local currency and buy up dollars they take on the inflation problem that the US should have had, so they have let the US export inflation. However, there are always non-orthodox options for pegging a currency.

One option is to change the peg to some other currency, like the Euro. Another option is to peg to a basket of currencies, like Kuwait does.

Another option is to keep the peg to the dollar, but instead of buying dollars to buy gold. If gold holds value better than dollars then the value of the reserves will be higher than needed. However, if the price of gold in dollars goes down, then the bank would not have enough reserves to fully back the peg. If the central bank was very confident that gold was going up, or the dollar was going down, they could decide to at least partly buy gold instead of dollars.

A counterexample to the claim that pegged countries must keep buying US dollars is China. China basically stopped buying in May 2009 and yet kept their peg till June 2010

Pettis makes a related claim when he says says, "It would be astonishing if, under these circumstances, total Chinese holdings of USD assets declined, and of course it is impossible that they declined faster than the willingness of other foreigners to replace them." There are a couple flaws with his logic. First, foreigners could cash in their holdings as their short term treasuries came due. Since most are short term now, foreign holdings could decline very fast. The Fed would print money to cover each bond that came due. The second is that the Fed could buy them directly instead of another foreigner.

A country that had more reserves than it needed to back its currency, maybe because its gold reserves went up in value or because it devalued its currency, could use some of its central bank reserves. This does increase the risk that if its reserves drop in value it might not be able to maintain the exchange rate peg that it was, but it is not impossible to use the reserves, as Pettis claims.

Go to index.

Global Trading Currency vs Global Reserve Currency

While this is sort of true on a theoretical level, it overlooks important practical reasons that people want to have their reserves in the currency they buy things in. Imagine your reserves are in dollars but you buy things in gold. If the price of gold measured in dollars doubles then the buying power of your reserves is cut in half. You have a big currency risk if you don't have your reserves in the same currency you trade in. It is easier and safer to plan for the future if you are saving in the same currency you are spending in.

The other big issue is that if oil is priced in dollars then the US can buy as much oil as it needs to import by just printing more dollars. This is on the order of $500 billion per year if oil is at $70/barrel and $1 trillion/year if oil is at $140/barrel. Imagine oil and other international commodities were priced in gold and nobody accepted dollars for international trade. In that case the US would need to export enough extra stuff or use up their reserves of gold to buy oil. In this case the demand for dollars and their relative value would be far lower than it is today.

Having global trade priced in dollars makes the demand for dollars as reserves much higher, and so their value much higher, than it would be otherwise. And it makes it far easier for America to pay for imports.

Go to index.

US in a world of hurt when dollar loses reserve status

Go to index.

Three Bubbles and You're Out

It is interesting that Adam Smith noted long ago that governments usually inflate away their debt. Also, high debt levels weaken a country or empire and can even cause it to fail.

This Time is Different: Eight Centuries of Financial Folly shows that after governments bail out banks and other companies one should expect a sovereign debt crisis a few years later.

A bubble pops when the supply of the asset becomes sufficient to overcome demand and lower the price. So in the Dot Com bubble there were lots of new companies selling shares. In the real estate bubble there was huge production of new houses. In the bond and dollar bubble there is record junk bond sales and huge production of new dollars in QE2. At some point this supply will be more than the demand and the value will plummet.

There are those who think gold is a bubble. Gold production only increases the world total holdings of gold by about 1% per year. So while gold prices can go down, they don't have the usual dynamics of production increasing till it overwhelms demand and pops a bubble. It is trivial for the Fed to increase the number of dollars by 10% in one year but it is nearly impossible to increase the amount of gold by even 2% in one year. So it is far easier to pop the dollar than to pop gold.

There is just no way that a 30 year bond at 4% is a good long term investment when they are printing more than a trillion new dollars each year. This bond bubble will pop.

Let me speculate about when the bond bubble will pop. For the last 30 years interest rates have been going down which has increased bond values. I think the bond bubble will pop when interest rates start going up and bond values start dropping. So when will that be? Probably when inflation starts going up. So when will that be? Probably after the dollar starts going down. So when will that be? Don't know, but it could start anytime now.

Economic Theory

Go to index.

Austrian Economists call 3 crashes in a row

Go to index.

Keynesian Economic Theory

We will not have any more crashes in our time

The Austrian Economists vs Keynesians is really private economists vs government economists. The Keynesian theory has a few clear problems, like assuming that investment is fixed so savings does nothing, or that the impact of government spending on the economy is always the same, even if it is spent on bridges to nowhere.

The original Keynesian theory is that the government should print more money and spend more money during bad times but contract the money supply during good times. This is a countercyclical policy. In real life governments find it very hard to run budget surpluses in the good times to pay down the deficits from bad times, and few do that. Now the Post Keynesian Economics Theory, like the Neo-Chartalism think that printing money all the time is good. They go so far as to claim all growth is from government printing money.

Krugman, A Keynesian, tries to downplay Austrian economics by calling it Hangover Theory. However, Mish shows how clueless Krugman is as an economist to not understand how bubbles impact so many different things that when they crash many things are hurt.

Now in 2002 Krugman called for making a housing bubble. He said, To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. So he well knows that the Fed printing money could cause a housing bubble, he recommended it.

This same Keynesian wrote about how economists did not predict the economic trouble but fails to mention that Austrian economists, who think printing money causes troubles, did predict the trouble. It is a bit amazing that in 2002 Krugman can recommend the Fed make a housing bubble and then say nobody could have predicted the bubble would pop.

A good scientists throws out a theory that can not predict results and is contradicted by the evidence.

Go to index.

Unemployment and printing money

If government has a minimum wage rate that makes it so employers can not make money off some people at that rate then those people will be unemployed. Most people think the minimum wage law is helping people, so one should never expect the government to admit that the minimum wage law causes unemployment, but it does. In a similar way, mandated health care, higher taxes, more regulation, carbon taxes, etc. cause unemployment.

When you inflate the money supply you lower the real wages. As the inflated money reduces the real wages more and more, at some point employers will be able to make money by hiring some of the unemployed. So the way printing money reduces unemployment is by reducing the real wages.

It would be far easier on society if they would just lower the minimum wage rate; however, politically that is much harder to do.

Today many benefits, salaries, and wages are indexed to inflation. So this does not work nearly as well as it used to. It also does not work so well because many countries, like China, have their currency pegged to the dollar, so as the dollar goes down so do the other currencies.

Go to index.

Aggregate Demand vs Bubbles

However, people know inflation hurts them and don't want inflation. In fact, the Misery Index is defined as the sum of the inflation rate and unemployment rate. Part of the law governing the Fed requires that they maintain stable prices. So at any sign of inflation, say oil at $140/barrel, causes the Fed to contract the money supply. So if the extra money causes inflation the extra money is cut off. So the extra money can only keep flowing as long as it does not go into things the Fed measures as part of inflation with the bogus CPI. So in the US printing money can't really lower the real wages the way Keynes was thinking.

It is much easier for the extra money to keep flowing if it goes into stocks, or foreign investments, or gold, or oil, or anything that is not currently in the CPI. So taking housing out of the CPI during the bubble helped let them keep printing money.

Go to index.

Chartalism and Modern Monetary Theory

Chartalism is older than Keynesianism and is in fact mentioned favorably in the first few pages of Keynes 1930 book, "A Treatise on Money". The name "Chartalism" derives from the Latin charta, as in chart, paper, or writing. Chartalism advocates paper or fiat money. Even back in the 16th century there were debates between Metalists vs Anti-metalists or Chartalists. The "Modern Monetary Theory" or MMT is a modern Chartalism, so I have them both in the same section here. MMT is attempting to describe the real monetary system in use since any tie to gold was dropped in 1971.

The MMT economists point out that a sovereign government that issues its own fiat currency is never really revenue constrained or insolvent. It can always print more money. The government may have setup rules to limit the printing of money, but those rules could be changed or ignored by the same government. To think about the big picture of what is going on we can ignore the details of the current self imposed constraints. In fact, MMT guys view the creation of fiat money as part of "the government" even if the current rules claim it is not (they hate the term "printing money"). A government that can make fiat money is very different from a normal household that clearly goes bankrupt if it spends more than it takes in for too long.

Since the government can make all the money it wants, the government could operate just fine even if it burned all the money it collects as taxes or from selling bonds. You can also just define the money supply as money outside government so that it is as if it was destroyed when it goes to the government. In the MMT view, the reasons for taxes are to provide demand for the fiat money and to reduce aggregate-demand/inflation.

Similarly, the government selling bonds is not really to raise money, but to temporarily reduce aggregate demand to help control inflation. It is the equivalent of taxing people now and then later issuing them a stimulus check. So the net effect of a bond, or a tax and then stimulus check, is to temporarily reduce aggregate-demand/inflation.

Another way to look at government bonds is to compare them to private bonds. If we imagine that the government burns the money it gets from a bond sale but a private company spends it, then to the extent that savings goes into government bonds, instead of private bonds, it reduces aggregate demand.

In this view debt is not such a feared thing because clearly the government could nationalize the central bank and wipe out the debt by printing as much money as needed. Also, if the government runs a surplus it reduces the money supply and could cause a recession. In fact some would rather not have the government issue any bonds but simply make the money it needed. Some argue that in reality the government is not going to tax our grandkids to pay back the debt, they are going to just create money to pay it off. Some view the selling of bonds as a holdover from before the time of fiat money and something that should come to an end.

So the only limiting thing on government spending is really just the danger of inflation.

The MMT guys view money as being created by government deficit spending. Since governments essentially never pay back debts to the central bank, this is correct. They also say that government deficit spending allows private net savings increases. This is true in nominal terms.

To me the above parts of MMT are just another way of looking at what is the reality of governments with fiat money. It focuses on nominal amounts and not adjusting for inflation but mostly it is just a different way of talking about things, but not really different. Again, I think it is good to be able to see things as MMT people see them.

However, the MMT guys then go on and have some real differences. They look at the equation of MV=PY or total money supply times velocity equals price level times GDP and then say total money supply does not impact prices since velocity can change and GDP is not constant. Well, there can be a little bit of change in velocity or GDP but we have seen government spending going from millions, to billions, to trillions, so price levels have gone up. They also think that there is some full employment level and if the government adds money so all the stuff produced at this full employment level is purchased that it will not cause inflation, but if they go over that level then it causes inflation. Thinking that there is some abrupt change at a particular spending level seems silly. It is not so discrete, much more continuous.

The MMT guys think that with floating exchange rates countries do not need reserves. There are some big problems with this view. Outside the US, which as the international reserve currency is a special case, other countries all feel they do need to keep reserves. Part of the reason is they need to be able to buy oil and other international commodities, without which life in their country could become very hard. The reason many Asian countries have such high reserves now is because they experienced the troubles that not having high reserves can cause during the Asian Financial Crisis. Reserves are an important part of stabilizing a currency and economy.

The MMT guys seem to make a big deal out of the fact that most money is just computer entries and never really printed. I don't think it matters if the money is really printed or just an entry in a computer. If everyone with entries in the computers went down to a bank and took out their money, then the Fed would have to really print the money. This might take weeks or months, but the Fed would print the money listed on the computers. So the fact that they have not yet printed it makes no real difference.

In the end the Chartalists and MMT guys both favor fiscal stimulus for any problems. So their main conclusion is the same as the Keynesians. The difference is that Chartalist/MMT guys favor fiscal stimulus even when there are no problems while Keynes thought the government needed to run a surplus in good times. So in some sense they are even more in favor of printing money than Keynesians, and I will lump them in with other Keynesians from here on.

The place where the Chartalists go wrong is not understanding how a government that prints money goes bankrupt. They say things like, " The overriding point, however, is that a sovereign government can always fund its liabilities as long as they are denominated in the currency that it issues under monopoly conditions". It is true that unlike a corporation or a household it does not run out of money. Saying that a government can always print more money is like saying that a corporation can always print more share certificates. The problem is if they are really bankrupt nobody wants them. The transition during which the market is rejecting a government paper money is called "hyperinflation". At the end of this process the government is clearly bankrupt as nobody takes their money for anything.

Imagine the government payments are supporting 40% of the population, either as employees or welfare/foodstamps. Further imagine that half of that money the government spends is newly printed money. Then if the money they print becomes worthless they can not support that 40% of the population in the lifestyle to which they have become accustomed. The "liabilities" of a government are not just amounts of currency. We call this type of bankruptcy hyperinflation. This happens to governments all the time. Once this starts with the dollar it is probably less than 2 years till the end of the dollar. To help MMT folks everywhere I have written up hyperinflation in MMT terms.

A government that prints money has a very different type of bankruptcy than a household, but not as far different from a corporation. As long as a corporation is doing well it can create and sell more shares of stock, which are like the currency for that corporation. However, when things go bad the currency for that corporation becomes worthless and it can not get any more money by making any more shares. Same thing when people lose confidence in a government currency.

Rodger Wilson notes that after government finances get a bit better there is usually a recession. This is because during a bubble governments collect more taxes than normal and after a bubble pops there is a recession.

MMT is mostly a different way of looking at things. In that spirit I suggest the following. Think of governments that issue currencies like corporations issuing shares. A government tax creates a demand for currency (MMT view). Imagine the company never pays a dividend and only does share buybacks to create demand for their shares (common these days). In this case the goverment currency and corporate shares are really very similar. A company or a government has 3 choices to raise capital:

Make-profits or collect taxes sell bonds issue more shares or currency

In the next section I attempt to explain hyperinflation in MMT terms.

Go to index.

Hyperinflation in MMT terms

In MMT the government uses taxes to provide a demand for the currency and both taxes and bonds as tools to manage aggregate demand and inflationary pressures. In a nutshell, in hyperinflation these two tools fail, inflation gets out of control, and the desire for the currency drops off.

First I would like to point out that in the Wikipedia article on Inflation in the Weimar Republic it say, "The monetary policy at this time was highly influenced by Chartalism, and was notably criticized at the time from economists ranging from John Maynard Keynes to Ludwig von Mises". Many economist could tell Chartalism was leading Germany toward hyperinflation.

Imagine a government that keeps inflation under control by suppressing aggregate demand with bond sales and taxes each equal to about 1/3 of government spending.

Next imagine that bond holders move into short term bonds, and then bond sales drop off. At this point, the government could either cut back spending, create more fiat money, increase interest rates, or raise taxes. Some call the point where it might still be possible to avoid hyperinflation the Havenstein moment. The government has so much debt that trying to improve bond sales by raising interest rates is very painful with the higher interest payments, so that option does not look good. The rules/obligations/politics of the government make it far easier to create more fiat money than to really cut spending or increase taxes enough. It is almost like there is no real choice and it creates more money. As they print more money less people want to buy bonds. If bond sales go all the way to zero then the total fiat money creation per year will have to double and the aggregate demand suppression will have been cut in half.

Now as inflation is going up the taxes people are paying on last years income are not as large in real terms, and the economy may be in trouble, further reducing taxes. So taxes are not suppressing aggregate demand as much as they used to. With no bond sales and reduced taxes, the government would have to more than double taxes to get aggregate demand down to where it used to be. However, this is just not possible. More and more people are in hardship because of the high inflation, so demands on existing government programs are going up.

As people get worried they move from long term bonds into short term bonds. If the bonds are mostly short term they can come due very fast, so the delayed aggregate demand all shows up suddenly. If you think of government debt as a dam holding back demand, hyperinflation can start when this dam breaks. At this point people are all rushing to spend their money before prices go up any further, which shows up as an increase in aggregate demand and higher velocity of money. People and companies are in a panic. However, the government is forced to make more fiat money (probably just adjusting account balances and not real paper) because of all the safety nets etc. It has to make fiat money to cover the full deficit and all of the bonds coming due. The bonds coming due in one year could be several times the total taxes, so it is not possible to increase taxes enough to destroy money fast enough to make up for the new money from paying the bonds.

Maybe the government tries price controls, but that would just create shortages and a huge black market that paid no taxes. The German hyperinflation price controls meant all kinds of businesses could not make money and had to shut down making things far worse. Many people dismiss the German hyperinflation, saying it was caused by war reparations and we don't have those. However, war reparations were only 11.8% of the German governments budget in 1921. Black markets may not use the local fiat currency, so as the economy moves underground demand for the currency could be reduced, further causing the value to go down.

In the MMT view taxes provide demand for a currency. But in hyperinflation taxation has problems. First, imagine there is a 25% income tax but you pay it 4 months after the end of the year. If your salary is going up with inflation at 100% per month then by the time you pay your taxes it is like nothing. Also, as more and more of the economy is in the black market, it is not taxed. The inability to tax means the inability to provide a demand for the currency.

The hyperinflation feedback loop runs out of control. After this goes on for awhile nobody uses the local currency as a "store of value" any longer. And awhile longer and nobody will accept the currency for anything. This is hyperinflation. This is bankruptcy for a government that can print all the fiat money they want.

The math for hyperinflation is the same in MMT as in other theories. But notice this is not the math for normal inflation, so MMT authors who say Hyper-inflation is just inflation big-time are not correct.

A small thing could trigger the initial collapse in bond sales. For example, if Obama were seen reading a book on MMT that might be enough to start a collapse in bond sales.

Go to index.

Common Errors in MMT

MMT folks say, "When inflation starts the government simply has to increase taxes and thereby destroy more money". For regular inflation this statement is simple and true; however, for hyperinflation this statement is clueless and foolish. But MMT people don't usually understand the difference between regular inflation and hyperinflation.

If people stop buying the government bonds then suddenly the government has to print new fiat money to cover the whole deficit as well as all the bonds that come due. If bonds are short term it is easy for this to be several times the existing taxes per year. It is simply not possible to increase taxes sufficiently to destroy money fast enough. Most MMT people just don't get this.

Another common MMT error is, "solvency is never an issue for a government that issues its own currency". At the end of hyperinflation a government still issues its own currency, but nobody will accept it as payment for anything. So this claim is clearly not true.

Another error MMT people make is saying something like to pay off the national debt the government can just change some numbers in a computer, no big deal. It is fun to have a whole new way of thinking and talking about economic issues, but it still needs to fit the evidence of the real world. MMT people seem not to be aware that many other governments have already run experiments on monetizing debt. We know what happens when you do this. If the whole national debt were monetized at once you would get hyperinflation for sure. I think MMT people need to watch this 1 minute Feynman video explaining science.

Another error MMT people make is something like, quantitative easing is just swapping bonds for bank reserves, it is not printing money. Again, MMT people think accounts on computers are different than accounting done with physical paper. If a bank requested to withdraw physical paper money from their excess reserves, the Fed would have to give them paper money. If the Fed did not have enough already, it would have to print more. The fact that they first credited an account on a computer, instead of first printing, does not change the impact of what is going on.

MMT people often count government bonds as money. But they are not the same. A 30 year bond can go up and down in value as interest rates change. In the real world things are priced in money, not 30 year bonds. They point out that a 1 day bond is not much different than money, and even a 3 month bond is not all that different. In MMT terms, a bond is delaying demand, so the shorter the term the less it really does. But if you watch the value of a 30 year bond go up and down relative to dollars, you can't say they are the same. MMT people will say gold is not money because you can't use it at the supermarket. Well, you can't use 30 year bonds at the supermarket either.

Another basic error is that MMT people think the government can get something for nothing by printing money. They believe that the economy can be improved just by printing more money. If you accuse them of believing that you can "print prosperity" they will deny it, but printing to a better economy and printing to prosperity are about the same thing. Their view is that as long as there is unemployment the government can make more money without anything bad happening, like prices going up. Many times in history people have thought this, for example, the Greenbackers could only see good in printing money.

MMT people want lots of new fiat money, but insist that they are not advocating "printing money". They have to do this because most everyone understands that just printing more money can not really create more real wealth and leads to inflation. This is similar to the Fed saying "Quantitative Easing" instead of printing money. The MMT guys argue that much of the money is just accounts in computers and not actually printed. That the Fed is using computers to keep track of accounts without always really printing money does not change the problem. When governments spend more than they get in taxes and from net bond sales they make up the different by creating money. It does not matter if you call it, "money out of thin air", "seigniorage", "making money", "printing money", "quantitative easing", "QE", "issuing fiat currency", "adding to bank reserves", "spending without borrowing", "debasement", "expanding the Fed's balance sheet", "just monetary policy", "monetization", "liquidity operations", "deficit accommodating", or "that thing which will not be named", it lowers the value of the currency.

There are basically just 3 guys pushing MMT. These are Bill Mitchell, Rodger Mitchell, and Warren Mosler. They claim that everyone else gets the wrong answers because they don't really understand how the modern monetary system works. While these 3 don't even agree on what MMT theory is, they seem to think they understand it and nobody else does. It is not that it is just a different language to them, they think others are wrong.

MMT focuses on which account names are debited and credited and misses out on understanding the big picture of what is going on. While talking about accounts being debited and credited they won't mention the obvious fact that new fiat money is being created. They also don't look at the history of previous experiments in fiat money creation, which is a sad history really.

Go to index.

Austrians vs Keynesians

Printing new money in the reserve currency country is different from your typical Keynesian situation. The US actually transfers wealth to the US when they print new money. Imagine that half the existing dollars are inside the US and half are outside the US and the US prints another trillion dollars. With time the existing dollars will be worth less, so half the loss will be outside the US and half inside, but all of the gain will be inside. So there really is a net gain to the US by printing money, but this is not what Keynes was talking about. It is doubtful that the rest of the world will put up with high levels of this forever.

Go to index.

Inflation and Dollar Devaluation

How Much Devaluation

In Jan 1933 the US had $4,279 million worth of gold. With the Fed's "money multiplier" of 2.5 they could have had around $10.7 billion in paper money back then. The Fed no longer reports M3; however, at shadowstats.com they estimate about $15 trillion today. So today we have more than 1,000 times more paper money. Gold is around 50 times more expensive and silver around 20 times more. To get to 1,000 times gold would have to go up by a factor of 20 and silver by a factor of 50. If the dollar became much less of a reserve currency, and gold and silver became important reserve currencies again, these kinds of factors could happen.

John Williams of ShadowStats.com said, " If the methodologies of measuring inflation in 1980 had been kept intact, gold would have to hit $7,150 to be the equivalent of the 1980 record. "

The US monetary base is about $2 trillion. There is about $14 trillion in government bonds. If people did not buy new bonds but wanted cash, then the government would have to print another $14 trillion, raising the monetary base to $16 trillion, or a factor of 8 higher. If there was no fear of future printing, this might just devalue the dollar by a factor of 8.

American workers are paid much higher than many countries. The US GDP per capita is $46,400 while the world average is only $10,400. The world average is brought up by the US, so statistics for the rest of the world alone would be lower still. If the dollar were to keep dropping till US workers were competitive with the average country it might need to drop by a factor of 5 or more.

Using the MZM measure of money supply we have gone from around $1 trillion in 1980 to about $10 trillion now. So gold and silver going up by a factor of 10 from their prices in the 70s seems reasonable. Also about a factor of 40 from when they stopped making silver dollars.

The real problem is that if the dollar devalues by a factor of 5 or 8 it may never be able to stop devaluing. It could enter the hyperinflation currency death spiral. Saving a currency once it enters hyperinflation is nearly impossible.

Go to index.

Devaluation and Trade Balance

From Japan's point of view, having their yen:dollar exchange rate go from 300:1 to 100:1 means the value of their large dollar reserves went down by a factor of 3. It is as if the US repudiated 2/3rds of their debt to Japan. This was not good for Japan. And, contrary to many claims, a factor of 3 change in the exchange rate did not fix the trade imbalance between the US and Japan.

Go to index.

Empirical evidence is increasing money supply causes price inflation

Go to index.

Inflation vs Deflation Debate

Imagine a government prints some money, loans it to someone, then gets paid back, and then burns the money. After this sequence there would be the same amount of money in existence that there was at the start. Understanding this the Real Bills Doctrine that printing money was ok as long as it was loaned out as good debts that would get paid back in a short time period makes sense. The inflation comes only if the bank is printing money and not getting sufficient collateral.

If you do this for large amounts and long periods then during the time the loan is out there is more money in circulation, which is inflation. And when the debt is paid off there would be deflation.

If the person who got the loan never pays it back, then there will be permanent inflation. People understand that the US government will not really pay back the Fed. When the Fed gives money to the Treasury it is viewed as permanently inflating the money supply and called monetizing the debt, which is a type of quantitative easing.

In the 1920s most of the new money went to margin loans to buy stock. As the stock prices went down the amount people could borrow was reduced and they had to pay back part of their loans.

Back in the 1914 to 1933 time-frame for every $1 the Fed had in circulation they had to have $0.40 in gold. If everyone took out their gold there would only be 40% as much money, which is deflation. So stock prices going down and people turning in paper for gold were deflationary.

This time much of the money was loaned out for houses and highly leveraged derivatives that turned out to be bad debt. So the money is not getting paid back to banks. The banks in turn are going bankrupt and not paying back the Fed. So there is not nearly the deflationary pressure this time as during the 30s.

In Bernanke's Helicopter Drop Paper he points out that if a government in a gold money system had a magic machine that could make infinite amounts of gold coins from nothing, and used it a lot, that the value of gold would go down. Almost everyone understands that if gold were not so rare it would not be so valuable and if it was as plentiful as sand it would be cheap like sand. Having a printing press that makes dollars in a fiat money system is just like a magic machine that makes gold in a gold money system. If you make lots the value of each unit will go down.

Imagine lots of criminal organizations with printing presses that can make perfect counterfeit dollars, indistinguishable from government made US paper money. Further imagine that these organizations print/spend trillions of new dollars into existence. What would happen? Clearly the value of the US paper money would drop fast. It is the increase in amount of money that makes it worth less, no matter if the government or counterfeiters print it.

There are those that think that if the total value of all US assets drops by some trillions of dollars that it is the same as if the money supply has dropped by that amount and so deflationary. This is not exactly correct. If a house goes up in value it does not cause inflation and if it goes down in value it does not cause deflation. However, the amount of money that the banks can borrow from the Fed does go up and down with asset values of the collateral they have for the loans on their own balance sheets. So if home owners treat their house like an ATM, then with help from a bank and the Fed, asset values can impact the money supply, but it is not a direct link. But when the economy is bad and people are losing jobs they can not borrow as much money, which can cause deflation. When the Fed buys fixed rate 30 year mortgages at 4% interest, it is not getting good value. If interest rates go to 8% these will lose about half their value. Interest rates will probably go higher than that. So buying these weakens the Fed's balance sheet and so weakens the backing for the dollar. Buying long term debt that will be decreasing in value is a violation of the Real Bills Doctrine. Before 1971 the money of the world had some tie to gold but after then it has not. Under a real gold standard (prior to 1914) people went 100 years without inflation and had times where prices went down some. Given advances in productivity it is reasonable to expect prices to go down. Since leaving gold in the 70s we have had high inflation unlike anything ever seen under a real gold standard. Given that inflation does not extend back into the gold period it seems wrong to expect deflation from the gold period to extend into the fiat period. People who argue we are in for deflation, like Mish, count defaults as deflationary since they reduce the total credit. But if the central bank is not getting paid back then default is not deflationary. Some people argue that since the Fed and banks loan money into existence they can not really increase the money supply if people are not willing to borrow more or the banks are not willing to lend more. People say the banks are just sitting on the cash. Those that argue this way forget that the government has an insatiable appetite for borrowing and spending. In 2008 the Fed started paying banks interest on reserves at the Fed. So the banks can earn interest either from the Fed or from the Treasury. This new Fed paying interest bit has helped confuse most people. One should really view the Fed as part of the government and the banks as lending their cash to the government (either Fed or Treasury). So the truth is the banks loaned their cash to the government instead of private entities, not that they are sitting on it. This is called crowding out. It is not good for business or the economy. Another argument is that although the banks have lots of "excess reserves" they can not really loan out this money as they are capital constrained and not reserve constrained. Since banks are not solvent even if they have extra reserves they are in no position to make new loans. So banks are not able to use fractional reserve lending to increase the money supply. Since banks may make 10 times or more the credit that they have in reserves, it would be inflationary if they made loans, but they are not. Mish presents this argument and it is a strong case for deflation for some period of time. However, the Fed is doing everything possible to get at least some banks to be very profitable. Even letting them "extend and pretend" and "mark to fantasy". So deflation from this seems only for a limited time, ending when the banks start really lending again. Some people argue that we can not get inflation while there is still high unemployment. These people will often babble about "cost-push inflation" or "demand-pull inflation" but inflation is an increase in the money supply and anyone who says different is confused. The US had high inflation and high unemployment in the 1970s, so any claim that you can't get inflation when there is unemployment is contradicted by history and should be either ignored or laughed at. Some people argue that with housing prices and stocks down that the value of the dollar is clearly up. But this is not true either. As interest rates go up the yield on bonds goes up and the price of existing bonds goes down. To have competitive earnings or dividends at the new higher interest rates the price of stocks has to go down, and the P/E down. At first stock prices go down due to increasing inflation. After this initial adjustment period, a long enough time at stable inflation rates will tend to drive stock prices up. Some note that a slowing of the velocity of money can also contribute to deflation. This does not seem to feed on itself in any way or explode into a big problem. So the slowing seems to be a limited impact change that continuous printing of money always eventually overpowers. As Peter Schiff points out if defaulting on a loan destroyed the money then the Fed could let everyone default and pay off all the loans and there would be no problem or change in the money supply. If that really worked you can bet they would be doing it. Peter also points out that if you view gold as the only real money then there is deflation. It takes fewer and fewer grams of gold to buy things as gold gets more expensive in terms of dollars. The Ka-Poom Theory predicts that after an asset bubble pops there is a short period of deflation and then high inflation. There is a limited amount of deflationary pressure and no limit to the amount of money the government can print, so deflation is at most a temporary issue. The longer term danger is high inflation. In fighting the deflation by printing money the government sets things up for high inflation. It is often the case that deflation precedes hyperinflation, for example Germany had 50% deflation right before the start of hyperinflation in the 1920s. Another point is that the prices of different groups of things act differently in hard times or as you head into hyperinflation. People always need to buy food, even if prices have gone up. But some things are optional and people will buy less in hard times. So the prices on the luxuries can drop in hard times. Housing and rents tends to drop in price because people can get by on a smaller house or apartment, or moving in with friends or parents. So housing is a place where people will cut expenses if they have to. So there is a good chance we see inflation in the things we really need and deflation in the optional things. Government statistics lump everything together which will average out the deflationary and inflationary items. So government statistics can easily report less inflation than the average person is feeling on the stuff they really buy. Some people think there are hundreds of trillions in assets losing value, so that the Fed making a few trillion will not be enough to counteract this. The total value of all public companies in the world is only about $50 trillion, so who do they think owns these hundreds of trillions? The problem is that people hear of hundreds of trillions in notional value of derivatives and think this is a real value. It is not. The notional value is the amount that the thing derivative is derived from, but not the value of the derivative. So some insurance of interest payments on a 2 year $1 million loan at 1% might only cost $1000, but the notional value is $1 million. My view is that there is a delay from when they print money till the effects of the monetary inflation result in price inflation. Also, I think that the total pay-down on debt (not counting defaults) is less than the $1.5 trillion increase by the Federal government each year. So I don't think the money supply is really contracting any more. So in the short term there could be some price deflation, in particular for optional things and housing. But that after this period, which I think is less than 4 years, there will be serious inflation, in particular for the necessities like food and energy. But no matter what, I expect gold and silver to become more valuable compared to the US dollars. This is both because of the eventual inflation and because I expect the dollar to have a smaller role as a reserve currency. Go to index. Other theories of inflation In the Fiscal theory of the price level the idea is that unsustainable government deficits will require future inflation. This clearly applies to the USA.

So by the Real Bills Doctrine, or the Quantity Theory of Money, or the Fiscal Theory of the Price Level, the US dollar is headed for inflation.

Go to index.

Inflation and US taxes

Richer people pay a higher percentage in taxes. Inflation makes it look like people are richer, so puts them into a higher tax bracket. So Obama said he would not increase taxes on people making less than $250,000 but he could never get enough money out of the few making more than that. So if he prints enough money then after inflation lots of people will be making more than $250,000.

During the "boom times" when asset values are going up and lots of people think they are getting rich, or inflationary times, government tax revenues do well. Not only does government get to spend the money they print, the side effects of inflation on taxes are good for government, though bad for their subjects. By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. - John Maynard Keynes

Go to index.

Suppressed Inflation

When the US sells bonds to the Central Bank of China it takes some dollars out of circulation. This can hide away some dollars so they can print more without causing trouble. But it is only temporary, as the Chinese will some day turn in the bonds for cash.

In particular the country with the reserve currency can sort of write checks that are not cashed for a long time but when they are cashed it is very painful.

Go to index.

Contrarian Dollar Investing

Also, there is still many trillions of US dollars out there, so in no way can you say "everyone has already sold their dollars". And the 30 year bond is around 4%, which it won't be when everyone is really negative on the dollar.

On TV most people are saying gold is a bubble or that it is dangerous to buy gold after it has gone up so much. The truth is most people these days have never even seen a gold coin, let alone invested in gold. So contrarian investing would still be to buy gold.

One evidence people have used to claim there is a gold bubble is all the "cash for gold" parties going on. But at these the public is selling gold to a buyer. In a bubble the public would all be buying something, not selling.

The real bubble is in US government debt. As interest rates go up (where else can they go from zero on the short term to 4% on the 30 year) the bond values will go down.

Go to index.

Devaluation even if people don't like it

First off, there is a problem with any asset that only seems valuable if nobody sells it. The value is not real. It is probably a bubble that is about to pop. You really don't want to hold something that you can not sell.

The problem with this logic is that even if one country does not sell, other countries can. In particular, even if one does not sell, the US will still be printing and spending another trillion every year. So the longer they wait the less value they will get when they sell. For Russia, or Brazil, or Saudi Arabia, or any country, retirement fund, etc. the sooner they sell the better. Each is much better off to be the first to sell than the last to sell. In this situation it is more rational to sell than to wait.

This is a bit like the Prisoner's dilemma. In this prisoners would be better off if they all kept quiet, but that is not what happens.

Go to index.

Can the Fed quit printing any time?

The Fed saying they can stop printing any time is just like an alcoholic saying they can quit any time.

The truth is that the Federal budget is out of control. In October of 2009 the federal government spent $2.30 for every $1.00 they took in. There will be more than a trillion dollar deficit every year going forward. The Federal government will sell bonds for the amount of the deficit plus any bonds coming due. Investors have gotten out of long term bonds, mostly buying short term, so many come due all the time. The Fed will buy any bonds not bought by anybody else. If they did not, the Federal government would change the laws governing the Fed or the people running it till they did.

The government spending is out of control and the Fed will keep printing as fast as the government needs.

Go to index.

Delay between printing money and rising prices

The delay even makes sense. Initially as the central bank prints money and buys bonds they are forcing the interest rate down. As Hussman shows, lower interest rates result in a lower velocity of money. Using the equation of exchange we can see how initially the lower velocity of money can sort of compensate for the higher quantity of money, so prices may not go up much. However, a substantial increase in the money supply that is not followed by an exit strategy will eventually result in price inflation. Then the central bank will try to fight inflation by not printing so much money. But if they are not printing money and buying bonds the interest rates will go up. And as the interest rates go up the velocity of money goes up (again Hussman). This time the equation of exchange shows, an increasing velocity of money will tend to push up prices. So it can be hard to "put the inflation genie back in the bottle".

Milton Friedman explained that a central banker that did not understand the delay between printing money and inflation could act like a fool in the shower. If you just look at the current inflation rate you may think it is ok to print more money even though so much has already been printed that high inflation is coming.

Keynesians reason about what happens when they print more money with the assumption that most people don't understand what is going on. In the 1920s and 1930s, when people's parents and grandparents had been using gold money, this was clearly true. You had people in German with piles of money who could not understand why it was worthless. But today, when people's parents and grandparents lived through the 1970s, people know that if you print too much money it will not be worth as much. If people have piles of US dollars they will understand that the Fed printed too much money. So Keynesian reasoning seems fundamentally flawed.

Go to index.

Debt Money vs. Simple Fiat Money

A central bank is supposed to only loan out money, so it can theoretically get all the money back and not cause any permanent inflation. In fact, since it is charging interest it can pull in lots of dollars as interest payments. Clearly a bank that can charge interest and print money out of thin air will be very profitable, and so able to pull in lots of dollars. So it is much easier to maintain the value of paper money when all money is only loaned out. In fact, theoretically there are not enough dollars out to pay back both the loan and the interest, since the dollars printed is only equal to the loans created. So as the central bank makes more and more on interest the dollars should become scarcer and scarcer and so more valuable. So deflation is at least theoretically an easy thing to get with a central bank system.

Where this central bank system breaks down is when the central bank loans new paper money out to banks, companies, governments that go bankrupt and don't pay back. These dollars are then out in the wild and inflationary. Buying toxic assets that can not be sold for the price paid is a similar thing. The biggest breakdown is that the government is not really going to ever pay the loans back.

Go to index.

Hyperinflation

When a government's debt level is over 80% of GNP and the deficit is over 40% of government spending it is probably headed for hyperinflation. What happens is that people are not confident of the long term prospects, so move into short term debt. Then some people stop rolling over their bonds and get cash as the bonds come due. This causes the government to need to print more money. But the more money it prints the less people want to hold its bonds. But the less people want to holds its bonds the more money it has to print. So you get into a positive feedback loop called hyperinflation where things get out of control. As things progress it not only has to print money for the full deficit, but also for any bonds that come due. This can be a huge amount of printing. With a large deficit and lots of bonds coming due it is not possible to increase taxes enough or reduce spending enough and so the government is forced to print. Once a government is in a situation where it is forced to print significant quantities of money it can get hyperinflation. This is a common occurrence even in modern times. The math for hyperinflation is not very complex. There are typical stages hyperinflation goes through.

Most people can't imagine the USA having hyperinflation. However, many great nations have had hyperinflation. Even America has had it twice already, first during the revolution and then in The South during the civil war. There are good reasons to expect the US will get hyperinflation again soon. It seems the US has gone so far down the path toward hyperinflation that it will not be possible to avoid it.

In most countries the central bank has some kind of reserves to support the currency. So if the currency is too low, they buy up some of their own currency, using their reserves, to support the value. The US reserves are mostly in bonds. The problem is the Fed has moved into long term bonds which can drop in value as interest rates go up. So the value of the bonds can drop so that they do not have the ability to buy back as many dollars as there are out there. If other countries stared to unload their dollars there is nothing the US could do to that would support the value of the dollar. At that point it will be like rats leaving a sinking ship.

With unusually low interest rates the interest on the US national debt was $454 billion in 2008 while total taxes are about 4 times that. So around 25% of the taxes are needed just for the interest, even at these amazingly low interest rates. If interest rates double or triple it would be clear to everyone that the US has no chance of using taxes to pay down the debt.

Peter Bernholz wrote a book called Monetary regimes and inflation: history, economic and political relationships . Bernholz studied 29 cases of hyperinflation and says that hyperinflation follows after the debt gets over 80% of GNP and deficit gets over 40% of spending for a few years. You can see some of Bernholz information here.

There are many routes to get into the hyperinflation positive feedback loop (war, dictatorship, democracy, revolution). But once in it what do you have to do to stop it? Bernholz page 193 says, “A necessary condition to stop hyperinflation is to end money creation for the purpose of financing budget deficits of the government, its agencies and the losses of firms owned or controlled by it. For this purpose a strict limitation of these deficits is necessary.” If the only way to stop hyperinflation is to stop printing for the deficit, it seems very clear what the core problem is in hyperinflation, printing for the deficit.

Once it becomes more obvious, the US will probably have a few budget cuts and some hyper-taxation of "the rich" to try to hold off hyperinflation, but it won't work. Most of the US budget is mandatory spending, so it is not possible to cut enough. The taxes are already so high that, as the Laffer Curve explains, raising rates will not increase revenues much. Interesting to note that back in 1901 J. Shield Nicholson said the same thing as Laffer. Higher taxes will also cause more capital and rich people to flee the US. By hurting bond sales and lowering GNP this helps bring on hyperinflation.

Someone has noticed that if we called it Super Hyper Inflation Trauma the initials would be interesting.

One of the most common claims is "the powers that be would not make hyperinflation because it would be bad for them". There are two problems with this. First, hyperinflation is when events cause government money printing to get out of control. I don't think any of the 100+ cases have been planned ahead of time. Second, actually, if someone knew for sure there was going to be hyperinflation, they could make very good money. Never attribute to malice that which can be adequately explained by stupidity.

Another claim is that people were predicting hyperinflation last year and it did not happen so they are wrong and should be ignored. However, with bonds paying about 0% per year and having the prospects of losing 90% of their value very quickly in hyperinflation, getting out years early is better than being at all late.

Go to index.

Capital Flight and Hyperinflation

Capital flight and hyperinflation go together. As the capital flees a country the government is no longer able to borrow money and has to start printing.

Go to index.

US Hyperinflation destroys much of world reserves

The currencies can catch themselves after they devalue compared to gold to where the central banks gold reserves can match the currency issued. In many banks the gold reserves are only like 5% of their reserves, so the currency would have to devalue by a factor of 20 before the gold could support the currency. The US claims it has around $300 billion in gold. They have fought any audit of this so there is some doubt that they really have it. The US has been known to loan gold to companies that go bankrupt. However, if they had it and held onto it till the price of gold went up by 20 times or more then they could use that gold to support the US dollar. If they use the gold earlier they would just lose all the gold.

Go to index.

Hyperinflation Workarounds

In India, where so many people buy gold, the average person will seem much richer compared to the world average, after worldwide hyperinflation. It will be much easier for them to start using gold as money, since it is so widely held.

Go to index.

Hyperinflation Stages

Government spending gets out of control to where deficit is 40% or more of spending and debt is over 80% of GNP. If this is for a war that the markets believe will be won and ended so that the government can make drastic cuts in spending then there is some wiggle room in these numbers. This goes on for a couple years and investors move towards shorter term bonds. It becomes clear the deficit is not going back down. The central bank starts buying up government debt with newly made money. If they are not naturally inclined to do this the government changes the laws or people running the central bank. For the rest of this section I will write as if the central bank were just part of the government and ignore bond certificates printed by the government and handed to the central bank as these will become worthless anyway. With this simplification I will just say, "the government prints money". There is capital flight out of that currency and bond sales fail. If the government let bond interest rates rise to attract bond buyers the interest payments on the debt would be huge compared to taxes collected, so they keep interest rates down by printing more money. However, the private investors become less and less inclined to "roll over" their government bonds. Government is forced to print money to cover their budget and inflation picks up. The more bonds coming due the worse the printing is. Many short term bonds can make for huge amounts of printing, even more than the regular budget. Some people notice prices going up and spend their money before prices go up more, even for things they don't need yet. The velocity of money picks up. People start to realize that the local currency is not a good store of value, though still used for transactions. Some people start to use foreign currencies or gold as a store of value. So many people take money out of their bank accounts and exchange it for a foreign currency, or gold, or just buy something that banks are in danger of going under. So the government often freezes bank accounts. This is very bad for the account holders, both because times are hard and they can't get their money and also because by the time they are able to get it their money it is worth much less. Wages and prices become indexed to something more stable, like a foreign currency or gold. Wages become paid more often, like weekly or daily instead of monthly. The velocity of money picks up more. People start to use a foreign currency or gold as store of value, even though government may forbid it. The black market starts in currency exchange. Interest rates are very high and loans are for much shorter periods. Hyperinflation makes for hard times and many people are forced to sell their their land or house. Because of these things the real prices drop in terms of something like gold. for real estate financing real estate is much different during hyperinflation and normal times. People start to use barter or a foreign currency or gold for trade, even though government forbids it. This is a growing black market for commerce. If you trade a fish you caught for some potatoes your friend grew, neither of you is paying any taxes on the deal. In general once people are breaking the law by using a foreign currency for trade they don't pay any taxes on trade either. The black market is tax free. Being tax free and with better store of value the black market eventually grows larger than the legal market. People no longer worry about the government requirement to use local paper currency, enforcement is impossible. People start to not want to accept the local paper money. Regular taxes are down because hyperinflation has devastated the economy and much of the economy is now in the "black market". The government is finding it hard to buy things by printing money, as so much of the economy has moved to the black market. It is finding it hard to pay employees enough for them to live comfortably even though it keeps printing more all the time. The government is losing economic power. Tax collectors may be skipping work to tend to their own vegetable garden. There is a very real risk of the government failing at this step. At this point the government has some hard choices if it is not going to fail. It needs to do something so that the "black market" is legalized and taxable and deficits are nearly eliminated. It could just legalize a foreign currency or gold. But then it would forever give up on collecting any "inflation tax". It could get rid of budget deficits and stop printing money. However, people will still fear that it could start again at any time and so be hesitant to use that money. I think the most frequent end to hyperinflation is by making a new fiat money but with enough governmental changes that deficits and inflation are under control and people will use the new money. If they switch to a new currency then old money is no longer used as a store of value, or unit of account, or even for transactions. It has died.

For more details on the stages of hyperinflation, and historical examples, I highly recommend Monetary regimes and inflation: history, economic and political relationships by Peter Bernholz.

Go to index.

Math for Hyperinflation

Printing lots of money causes high inflation. With high inflation people don't want to hold money as long, since they lose more the longer they hold it, so the velocity of money goes up. The higher the inflation the faster people will spend their money, because they are losing faster. High inflation is bad for GNP. This is because planning for the future, or borrowing money for a company, becomes really hard. Prices for some things, like gas, could go up fast and slow production of other things. If people are having a hard time paying for necessities they cut back on the optional things, so companies in those areas can fail and lower GNP. Also, governments usually try price controls which cause shortages and reduce production. Price controls can make it impossible for an entrepreneur to make a profit, so he is better off to just shut down his business and invest his money in gold till the hyperinflation is over.

If you understand the above 3 points, then simple math and a standard economics formula shows how these 3 factors combine to cause prices to go up much faster than the money supply alone. The effect of printing money on prices becomes non-linear in hyperinflation. A 10% increase in money does not mean just a 10% rise in prices, it becomes much more. This non-linear effect is why hyperinflation is so "out of control".

Another non-linear change is when governments go from "rolling over" existing bonds and funding a large part of their budget deficit with new bonds to having to pay off bonds that come due and not being able to sell new bonds or "roll over" bonds. This is particularly painful if most of the bonds are short term so they come due quickly. This makes a sudden and drastic increase in the amount of money the government must print.

Go to index.

Hyperinflation Feedback Loop

Loss of confidence in currency/government leading to flight from currency. Higher prices leading to loss of confidence. Loss of confidence leading to bond sales failing. Bond sales failing leading to loss of confidence. Supply shock lowers real GNP which results in higher prices. Higher interest rates result in higher velocity of money. Bond sales failing requiring government to print more money. More money printing leading to bond sales failing. Currency devaluation on international markets leading to higher international commodity prices. Higher commodity prices leading to higher general prices. Printing money leading to currency being devalued. Higher prices leading to lower real GNP. Price controls leading to shortages and lower real GNP. Higher velocity of money leading to higher prices. Higher prices leading to higher interest rates. Rising prices leading to higher velocity of money. Capital flight leading to lower real GNP. Lower currency value leading to "oil shocks" and other supply shocks. Higher oil prices leading to higher prices in many other things. Lower real GNP leading to higher prices. Higher prices mean government employees need higher pay so more money is printed. Higher inflation leading to bond sales failing. High deficit leads to high money printing. High debt level means government wants to keep interest rates low. In order to lower interest rates government prints more money. Government attempts to artificially lower interest rates result in bond sales failing. High debt and deficit lead to bond sales failing. Yearly taxation during hyperinflation fails to collect meaningful tax amounts. The growing black market is not taxed in hyperinflation.

Go to index.

Blame for Hyperinflation

Speculators. Whenever there is financial troubles governments love to blame speculators. China. They may try to say it is China's fault for selling their US dollars, or maybe some other country. Counterfeits. They could try to blame dollar counterfeiters for the surplus of dollars. Part of the revolution hyperinflation with The Continental was due to British counterfeiting of it. Previous administrations. If Obama is still president, he may blame Bush.

Go to index.

People

Ben Bernanke

The reserve currency of most of the world is really controlled by a single human being, Ben Bernanke. It is pure lunacy to have a system that puts so much power in a single human. After enough different humans are tried over the years we are bound to find one who ruins the currency. So given the situation, it is worth looking at who that human is.

In 2004 during the real estate bubble, Bernanke gave a speech titled "The Great Moderation" where he praised the Fed for doing a good job. As the trouble approached Bernanke had no idea the current mess was coming. As late as Apr 2008 Bernanke said, "A recession is a technical term. I'm not yet ready to say whether or not the U.S. economy will face such a situation." He was Incredibly, Uncannily Wrong. Having 1,000 Keynesian economists working for him just helped him be wrong. Mish put it well with, "The result of Bernanke's blind allegiance to mathematical gibberish is that in spite of his PhD, he could not see a housing bubble that was obvious to anyone using a single ounce of common sense." When asked about the danger of a housing bubble he said that " we have never had a decline in housing prices on a nationwide basis". A student of the Great Depression should have known this was not correct. There is a page with much more on Bernanke.

A common flaw that generals make is "fighting the last war". Since the generals studied what happened in the last war, they tend to use the strategies and tactics that worked well back then. The problem is that when the situation has changed the methods of dealing with it must change as well.

Anna Schwartz says Bernanke is fighting the last war. Bernanke has agreed that the Fed caused the Great Depression. He said, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." Bernanke gives the impression that the gold standard and not printing money fast enough was the problem in the Great Depression. If you read his papers he says the miss-managed "inter-war gold standard" of $2.5 paper dollars for $1 gold but convertible at 1 for 1 was the problem. That was not a real gold standard but a Ponzi-gold-standard.

The root problem of the Roaring 20s and Great Depression was a Ponzi scheme by the Federal Reserve where they only had $0.40 worth of gold for each $1 in paper and said each $1 in paper was redeemable for $1 in gold. The increase in money led to a stock bubble. When people tried to exchange their paper in the Ponzi-gold-standard for gold the government had bank holidays and then made it illegal for people to own gold. So it was the Fed pushing bad money on the USA and then the government stealing the people's gold that caused the trouble, not a real gold standard or printing money too slowly.

For many years now the Fed has been printing money and the government has been borrowing huge amounts. Now with Obama it has exploded. The Fed is buying up toxic assets for more than they are worth. When the Fed increases the money supply this way they do not get an asset that could be later sold to reduce the money supply. So they are devaluing the money. When the Fed is devaluing the money it makes sense to borrow money from the Fed and convert it to other currencies and invest outside the US. Loaning dollars out that will be repaid later with cheaper US dollars is not as sensible. Once again the Fed has mucked up our money, but this time not by a small factor.

Bad money causes huge problems for the economy. The Fed is again printing money fast and making bad money. A problem caused by too much bad money will not be fixed by making more bad money. Bernanke seems to always want to print more money, so he does not seem like the ideal person to be controlling the worlds reserve currency.

Go to index.

Barack Obama

Obama ran as the candidate for the common man. But once in he has given hundreds of billions of dollars to rich bankers in poorly run or crooked companies while taxing honest and decent folks more. Rich people can invest so that inflation does not hurt them, but poor people will see their wages not able to buy as much. Middle class will see their variable rate mortgages go up so that their monthly payments go up. The coming inflation is really the most regressive tax possible. As Daniel Webster said, "Of all the contrivances devised for cheating the laboring classes of mankind, none has been more effective than that which deludes him with paper money." The anti-business rhetoric and actions drives investment away, dropping the value of American companies and real estate. This hurts retirement funds and job opportunities for all Americans. It is not because of Bush that the market crashed when it looked like Obama was going to win.

Obama is taking America down the The Road To Serfdom that Friederich Hayak wrote about in 1944. More and more government control leads to less and less freedom till eventually you have tyranny. The statist ideas of government controlling the economy have been tried many times under names such as Fascism, Communism, or Socialism. America should learn from the sad results of these other experiments and not repeat them.

The private sector has to pay for the government in one way or another (taxes, bonds, inflation). The bigger the government gets as a percentage of the total economy the harder it is on the private sector to support the government. As a country's government gets bigger, the overburdened private sector becomes less attractive as an investment, so capital flows away to better countries. An overburdened private sector also means the future ability of the government to pay its bills without printing money becomes more doubtful. Both of these hurt the value of the currency for that country. An important study shows that cutting government spending and cutting taxes help an economy grow.

A big reason the Great Depression lasted so long and that the current mess is looking so bad is regime uncertainty. In a capitalist system investors know the rules and can invest based on reasonable predictions of the future. Today many CEOs can's stand Obama. When a government is frequently changing the rules it is better to invest someplace else. Like Hoover and FDR, Obama is "working hard to fix the economy", and in doing so he is messing it up. It was only after the government focused on WW2, and stopped troubling the economy so much, that the US recovered from the Great Depression.

Many people have criticized Obama for being against capitalism. He has claimed he supports capitalism while 77% of investors surveyed think he is anti-business. Obama's defense is claims like, "The auto bailout is a very politically unpopular decision that was made that, from my vantage point, is pro-business". This shows a fundamental misunderstanding. This type of thing is not "pro-business", it is "pro-AIG" and "pro-GM" but is not good for business in general as taxes/inflation/debt will go up. After this taxes on banks and anyone making over $250,000 per year went up (small business owners). When the government takes money from productive parts of the economy and gives it to poorly run or crooked companies it hurts the overall economy. Giving taxpayer money to AIG or GM is certainly not capitalism, it is corporatism as in the New Deal. I think Obama is a corporatist. The government needs to put those using fraud to take billions of dollars from people in jail, not give them more billions.

Obama's cabinet has the least private experience by far. They don't understand that small business owners are troubled by high taxes, regulations, red tape, etc. produced by government since they were never in that position. They don't seem to even listen to business people, just try to vilify them and add health care and carbon tax to their already heavy load. Most new jobs are created by successful small business owners, but these guys typically make over $250,000 per year, so they are right in Obama's cross-hairs. Not understanding what they are doing, the Obama team will be surprised when no private jobs are created.

Forbes makes an interesting case for Obama being an anti-colonial fighting the fight of his father against the capitalist imperialist powers.

Go to index.

Milton Friedman

However, when it came to money and business cycle theory Friedman believed in governments printing money almost like a Keynesian and claimed the theory caused harm. Friedman thought Keynes was a better economist than Mises. Friedman did not understand that the Fed created the bubble economy of the 1920s which resulted in the crash. It seems he did not understand that the 1914 to 1933 rules for the Fed limited it to $2.5 dollars for every $1 worth of gold it had and thought the Fed should have just printed more money during the recession.

Friedman is in stark contrast to the real capitalist economists, the Austrian economists, who see the government messing with the money supply as causing both the bubbles and the crashes. They advocate sound money. Because, when the price of money is rigged, the market isn't free.

Rothbard explains that Friedman supported government in macro-economics and capitalism in micro-economics, which is sort of half support of capitalism.

It is a sad legacy for Friedman that hyperinflation is probably coming because Bernanke is such a fan of Friedman. It is ironic that the US government is destroying the currency, the economy, and capitalism in America using advice from someone who is thought of as a great supporter of capitalism.

Very late in his life he said that he thought Bernanke was good but that you should not have an institution that depends on one man being good, that his first choice would be to end the Federal Reserve.

Go to index.

Gold Money

Remonetization of Gold for International Trade

An honest money is one that people can not just randomly make more of. Gold and silver are the natural candidates for this as they have worked for around 5,000 years.

Gresham's Law says that "Bad money drives out good under legal tender laws". If creditors have to accept paper money as equal payment to that of gold money, then the gold will be used somewhere else where it can command a higher value.

In a free market Gresham's law works the other way, Good money drives out bad. People would rather hold a stable currency than one that is dropping in value. Sometimes they do so even when it is illegal.

In the US Ron Paul introduced the Free Competition in Currency Act in 2007 and again in 2009. If private money became legal in the US, it would probably drive out the government paper money.

Between countries there is no legal tender law forcing people to use bad money. They can choose whatever they want to use as money. In this situation it makes sense for them to switch from US dollars to gold. No country wants to have their wealth stolen from them when they can prevent it.

John Law explained in 2006 why gold would remonetize. I recommend reading what he wrote. John Law is not the author's real name, John Law is famous for a failed French experiment in paper money. The author seems to also write as Mencius Moldbug and has written a more recent paper on the same topic and also has a blog called unqualified-reservations.

Game theory predicts that central banks will move to gold and remonetize it. This will drive the price up in terms of dollars.

Go to index.

Sound Money

Gold and silver are sound money. If one country is holding some gold they don't have to worry about some other country printing more and stealing the value of their gold. If gold is used between countries to settle payments then no single country gets to print currency and buy as much international goods as they want without exporting stuff of a similar value. The current world imbalances would not happen if gold was used as money between countries.

In the US, from 1933 to 1974 it was illegal to own gold. These 41 years broke most Americans from thinking of gold as money. However, the 5,000 year tradition of gold as money was not so badly broken in the rest of the world.

There is a reason that people say as good as gold.

Go to index.

International Balances

Under the current system where the US has the Exorbitant Privilege of being able to print paper money that is used all around the world, there is no natural balancing force. The US can keep printing money to pay for imports and never run short.

But the more money the US prints, then the more people in the US have. The wages inside the US then seem very high compared to the rest of the world. So the printing of paper money inside the US drives jobs overseas. Gold does not do this (except when Spain took lots of gold from the New World).

The balance of payment issues don't get so out of balance if gold is used between countries. If money is gold, then you can't keep buying things if you are not also selling things.

Back in the 1960s Robert Triffin explained why using a national currency as the international reserve currency would fail. This is now called the Triffin Dilemma. The basic problem is that more and more money will be created till at some point people will lose confidence in it. The issuing country, the US, gets real stuff by printing money, so they print more and more till other countries get fed up and put an end to it. But this instability does not happen if gold is used for international payments.

So the US imbalances are large. In 2006 about 6.5% of GDP. At 5 or 6% of GDP this imbalance is around 20% of exports. So the US is importing 20% more than it is exporting. This is unsustainable.

Go to index.

Banks

Why Banks Go Bust

Easy government credit makes asset bubbles.

Government setup credit rating cartel

Not requiring sufficient down payment (at least 20%) puts the bank at risk even if the house goes down a little. With government playing with the money supply, asset prices are not as stable as they would otherwise be.

Government requirements to loan to low income people.

Another way to look at fractional reserves is as "creating money". Demand deposits count as money. People assume they can spend it at any time. If a bank sold a 5 year bond for $100,000 and then made a 5 year loan for $100,000 it is not creating money. But in fractional reserve banking things are different. Imagine a bank gets a $100,000 demand deposit and loans out $90,000 on a 10 year loan and the person that gets the loan puts it in another bank as a demand deposit. In this situation both the $100,000 demand deposit and the $90,000 demand deposit count as part of the money supply. So the bank has sort of increased the money supply by $90,000. Note this could be repeated many times. There is a fraud in this system though. With demand deposits everyone is theoretically allowed to take out their money at the same time, but there is not enough money for everyone to take out their demand deposits at the same time. In that situation everyone expects the Fed to print lots of money and "provide liquidity" to the banks (loan them lots of money). This is part of what happened recently.

The government has a reserve requirement that they can change at any time. This requires the bank to keep a certain amount of money sitting around unused, maybe 10%. But since it can change, it really keeps banks from doing the safe thing of 100% matching of the duration of their deposits and loans. So once again we see that some government law has unintended consequences.

Sometimes people say "debt is money". I don't say that because if debts were funded by deposits of the same duration debt would not be involved with money creation. However, if all debts come from fractional reserve banks making long term loans from demand deposits, then the total amount of debt can tell you how much money the banks have created.

I think the right way to look at bank crashes is as an FAA agent, or Engineer, or Programmer would. Figure out why bank crashes happen, locate the design defect (lending long term on short term deposits) and fix the core problem so it does not happen again. A new law saying that all loans much be against deposits of the same duration would fix it. Of course this is not how US government changes to financial regulations worked at all.

For more information see a detailed explanation of the mystery of banking.

This leads to a pattern of trouble that repeats over and over in history:

Banks take in demand deposits and loan most of them out long term like 10 or 20 years At some point banks get into trouble because there is always some amount of withdrawls from the demand deposit accounts that they can not handle. This is called a "Banking Crisis". Government bails out the banks. Government gets too much debt and gets into trouble = "sovereign debt crisis". Central bank bails out the government = monetizing debt = printing money. Currency Crisis

Go to index.

Solvency vs. Liquidity

A "solvency crisis" on the other hand is when the total value of the loans is less than the total value of the deposits.

Anna Schwartz says the current problem is a solvency crisis, not a liquidity crisis. The problem is that so many loans have gone bad that banks can not cover their deposits, even if all the remaining loans paid off. A liquidity crisis can be handled by the Fed loaning the bank money which can then be paid back. However, in a solvency crisis money given to banks can not be paid back. When the Fed gives money to banks that is not paid back it is inflationary. But people are treating the current mess like it was a liquidity crisis.

Go to index.

Stock Market

Why Stock E/P ratio tracks bond Earnings

Imagine that $100 million company had higher earnings than $100 million in bonds did. Then you could sell some bonds, buy the company use part of the company earnings to pay the bonds and pocket the rest. This is a Leveraged Buyout.

Imagine that people were paying more for a company that earned $10 mil than for bonds that earned $10 mil. Then you could form a company that sold shares and bought bonds. It would then have better earnings than companies of its market cap and yet lower ris