A lot of people agree that America is heading for a second “Great Depression”. A lot of people disagree as to whether the next economic depression will be deflationary or hyperinflationary.
In both alternatives, an economic depression would cause rising unemployment, business failures, and increasing poverty over a prolonged period.
But, in a deflationary depression (like the Great Depression of the 1930s) the money is deflated and becomes more valuable. What you might buy for $100 today might sell for $80 next year and $60 the year after that. Prices fall, the purchasing power of the dollar rises, and “cash” becomes “king”.
A deflationary depression is dangerous because falling prices make it difficult for businesses to make a profit. A manufacturer might pay for the parts, materials, tools and labor to build a product which he expects to sell for $100 and make a $20 profit. But if he can’t sell that product almost as soon as he manufactures it, his expected price of $100 might fall to $90 or even $80 before he can sell it. If he gets caught in that deflationary price squeeze, his accounting will show that he’s selling products for less money than they cost to build, and he’ll therefore go broke.
If the manufacturer goes broke, his workers become unemployed, there’ll be less money in the economy, and the prices for remaining goods and services will sink even lower.
Because America lived through a deflationary depression in the 1930s, we tend to think of deflationary depressions as “traditional,” predominant and perhaps the only kind of depression that we might ever see again.
But that’s not necessarily true.
• We’ve also seen hyperinflationary depressions in Germany in the 1920s and Zimbabwe in the 2000’s.
Hyperinflationary depressions and deflationary depressions are similar in that both are characterized by rising unemployment, slowing business activity, and increasing levels of poverty. However, these two kinds of depressions differ in terms or what happens to the value of their currencies.
During a deflationary depression the value of money rises and “cash is king” (a little money can buy a lot).
During a hyperinflationary depression the value of the currency falls dramatically and “cash is trash” (a lot of currency may buy almost nothing).
That hyperinflationary “cash is trash” phenomenon is why it required a wheel barrel full of German Marks to buy a loaf of bread in the 1920s and, in the 2000s, Zimbabwe posted signs on public toilets warning people not to use Zimbabwean paper dollars as toilet paper (Zimbabwean dollars didn’t dissolve and therefore clogged the sewers). The Zimbabweans’ use of their currency as toilet paper is the ultimate example of hyperinflating cash becoming “trash”.
• In the event of another US depression, it’s important for American investors to anticipate whether that depression will be deflationary or hyperinflationary. Why? Because, depending of the kind of depression, the investors’ “cash” might become “king” or might become “trash”.
I.e., if we’re sliding into a depression and an investor wants to at least preserve and possibly increase his wealth, it’s critical that he know whether the depression will be deflationary (when the value of “cash” will increase) or hyperinflationary (when the value of cash will plummet). If the next depression is deflationary, the smartest investment you could make is save up a huge stack of paper dollars and wait for them to become more valuable. If the next depression is hyperinflationary, the value of paper dollars will be decimated and those who save dollars now will be ruined.
So, will the next depression be deflationary or hyperinflationary?
Investors who answer that question incorrectly will lose their assets. But even small investors who answer that question correctly could become fabulously wealthy.
• Assuming that we’re heading into an economic depression, how might we predict whether that depression will be deflationary or hyperinflationary?
Well, as the Anglo-Irish statesman, author, and philosopher Edmund Burke (A.D. 1729-1797) famously observed, “Those who don’t know history are doomed to repeat it.”
Burke implied that: 1) history runs in cycles where economic and political circumstances that occurred previously will, in a general sense, tend to occur again; and 2) a primary means of anticipating and coping with the future is to know the past.
For example, we know that most people lose their wealth in an economic depression. We can therefore anticipate that if there’s another depression, most people (including you and me) will lose their wealth and standard of living—unless they study the history of depressions to learn why most people tend to lose their wealth. If we can learn from history, we can learn how to avoid our predecessors’ mistakes and preserve or even increase our own wealth in the next depression.
I haven’t yet studied all economic depressions. I’ve only looked superficially at three: that of Germany in the 1920s; that of the US in the 1930s; and that of Zimbabwe in the 2000s.
Even so, my cursory examination of history has revealed a common denominator which I suspect may reliably predict whether our next depression will be deflationary or hyper-inflationary: the nature of our currency.
• Let’s review:
In the 1920s, Germany’s “Weimar Republic” suffered a hyperinflationary depression wherein the economy collapsed and the Mark’s value fell so rapidly that it required a wheel barrel full of German Marks to pay for a loaf of bread.
In the 1930s, the US suffered the Great Depression where the economy collapsed but the dollar became increasingly valuable. What cost $10 last year might only cost $8 today and $6 a year later.
According to Wikipedia, in Zimbabwe’s depression of the 2000s, their hyperinflation rate peaked in November of A.D. 2008 at 89,700,000,000,000,000,000,000%. Lessee—lemme count the sets of three zeroes—we have hundreds, thousands, millions, billions, trillions, quadrillions—what comes after quadrillions? “Sextillions”? I don’t recall. But Zimbabwe had a peak annual inflation rate of almost 90 thousand quadrillions!
There are just over 31 million seconds in a year. If we divide Zimbabwe’s peak annual hyperinflation rate (90 thousand quadrillions) by the 31 million seconds in a year we learn that Zimbabwe’s peak hyperinflation was running at nearly 3 quadrillion percent per second. In the time it took to say, “I’ll give you 5 billion Zimbabwean dollars for that Snickers bar,” the price could’ve risen by several quadrillion times. That’s not “inflation,” or even “hyper-inflation”—that’s a kind of economic madness on speed and LSD.
• The first lesson to be drawn from comparing these three episodes of economic depression is that during the deflationary depression of the US, “cash (especially savings) was king” but during the hyperinflationary depressions of Germany and Zimbabwe, “cash (especially savings) was trash”.
If you had a decent job, a fixed income, or adequate savings, you might be able coast through a deflationary depression since the value of your earnings, subsidies and savings was constantly growing.
On the other hand, during a hyperinflationary depression, your savings and fixed incomes (pensions, welfare, etc.) would be quickly wiped out. Under a 100% inflation rate, after a year, your $100,000 in savings would purchase only $50,000 in goods and services. After two years, $25,000, etc. If the inflation rate was 1000%, the purchasing power of your $100,000 in savings would be $10,000 at the end of one year, and only $1,000 at the end of two years. At the end of three years, the purchasing power of the $100,000 you spent years struggling to save would be reduced to $100—barely enough to take your wife and kids out for a cheap dinner and a movie.
If you relied on So-So Security or some other retirement or welfare program to support you during a period of hyperinflation, your monthly $1,200 check from So-So Security would be quickly reduced in purchasing power—as would your standard of living.
If you relied on the (fairly) “fixed” income from a regular job, you’d also be quickly impoverished by hyperinflation. Suppose you were making $50,000 a year when 100% hyperinflation began—by the end of that year, your $50,000 income would only purchase $25,000 in goods and services. 100% annual hyperinflation could cut your annual income by half. Can you live on half of what you currently earn?
During hyperinflation, the only way to even survive is to spend every nickel that falls into your hands just as fast as you can. If you saved anything (rather than spent immediately) in the medium of your hyperinflating currency, your savings would quickly disappear.
Thus, we can see that during a deflationary depression, “savings (denominated in the currency) are king”—but during hyperinflation, “savings (denominated in the currency) are trash”.
The only way to survive hyperinflation is to hustle, hustle, hustle, every moment of the day. You must increase your prices every day, every hour, every minute. You’d have to be geared mentally and morally to rob everyone you met by paying less for what they wanted to sell and demanding more for whatever you were selling. (They’d try to do the same to you.) Or you could become a bank robber or cat burglar to rob others. (Others would also become crooks to rob you.) Then, you might survive. However, if you were too old, weak, cowardly, ignorant or unintelligent to “hustle,” you’d slide into poverty or premature death.
When the hyperinflation finally ended, you’d be exhausted and you’d have absolutely no savings denominated in your national currency.
How can anyone run a “capitalist” economy, if the capital has been wiped out by hyperinflation?
• The big lesson to be learned from the history of the German, US and Zimbabwean depressions is glimpsed from Wikipedia’s description of the German hyperinflation of the 1920s:
“The hyperinflation in the Weimar Republic was a three-year period . . . between June 1921 and January 1924. . . . In order to pay the large costs [debts] of the First World War, Germany suspended the convertibility of its currency into gold when that war broke out.”
In A.D. 1914, Germany suspended the Mark’s gold backing. The Mark became a fiat currency. Hyperinflation didn’t begin until seven years later (A.D. 1921). But note that Germany’s hyperinflation occurred in relation to a fiat currency that was not backed by gold or silver.
“Because reparations [post-WWI debts] were required to be repaid in hard currency [gold or silver] and not the rapidly depreciating Papiermark, one strategy Germany employed was the mass printing of bank notes to buy foreign currency which was in turn used to pay reparations.”
In the 1920s, Germany “mass printed” fiat Marks in order to avoid paying its reparation debts in gold or silver.
Today, the US government—which has run up a national debt of between $17 and $200 trillion—has been “mass printing” and inflating the fiat dollar in order to avoid paying that debt in full.
In the 1920s, Germany could “mass print” Marks because they were fiat and unbacked by gold or silver.
Today, the US can “mass print” dollars under Quantitative Easing because the dollar is a fiat currency.
“During the first half of 1922, the Mark stabilized at about 320 Marks per Dollar. . . . inflation changed to hyperinflation and the Mark fell to 800 Marks per Dollar by December 1922. . . . By November 1923, the American dollar [which was still backed by gold] was worth 4,210,500,000,000 German marks.”
The fiat Mark’s value fell from 320/gold-backed-dollar to over 4 trillion/gold-backed-dollar in just 18 months. The mere thought of such extraordinary change in monetary value is chilling.
• According to Wikipedia,
“The economy of Zimbabwe shrunk significantly after 2000, resulting in a desperate situation for the country and widespread poverty and an 80% unemployment rate.”
As was 1920s Germany, 2000s Zimbabwe was in a depression.
(Coincidentally, the US is currently in a recession and may slide into a depression. Some claim we have already entered into another depression.)
“The participation from 1998 to 2002 in the war in the Democratic Republic of the Congo set the stage for this deterioration by draining the country of hundreds of millions of dollars.”
Just as Germany in the 1920’s was deeply in debt due to World War I, Zimbabwe in the 2000s was also deeply in debt due to a war in the Congo.
(Coincidentally, today, the US government is also deeply in debt some of which can be attributed to our recent wars in Afghanistan and Iraq.)
“Hyperinflation has been a major problem from about 2003 to April 2009, when the country suspended its own currency.”
Hyperinflation killed the German Mark that existed immediately after WWI. Hyperinflation also killed Zimbabwean dollar. Zimbabwe still has no national currency, but relies on foreign currencies to conduct domestic transactions.
(Coincidentally, the US dollar has lost 95% of its purchasing power over the past 40 years. This loss was caused by inflation rather than hyperinflation. But we are left to wonder how much time remains before a currency that’s lost 95% of its former value loses the remaining 5% and dies.)
“Zimbabwe’s peak month of inflation is estimated at 79.6 billion percent in mid-November 2008.”
There are almost 2.6 million seconds in a 30-day month. If we divide the 80 billion percent hyperinflation rate of November, by the 2.6 million seconds in that month, we see that during the height of the Zimbabwean inflation, prices were rising at the astonishing and incomprehensible rate of roughly 30,000 per cent per second. The mind boggles. How is that possible? How is that even conceivable?
Germany’s hyperinflation rate also reached the tens of billions level in the 1920s.
Once hyperinflation begins, it can quickly rocket to levels that are not only incomprehensible, but seemingly impossible.
• Wikipedia described causes for Zimbabwean hyperinflation as follows:
“A monetarist view is that a general increase in the prices of things is less a commentary on the worth of those things than on the worth of the money. This has objective and subjective components:
“Objectively, that the money [actually, “currency”]has no firm basis to give it a value.
“Subjectively, that the people holding the money [“currency”] lack confidence in its ability to retain its value.
“Crucial to both components is [government] discipline over the creation of additional money.”
Hyperinflation is an expression of the public’s loss of confidence in the persistent value of their currency. That confidence is lost because:
1) the currency has “no firm basis” (gold or silver backing) “to give it value”; it is a fiat currency.
2) the government lacks monetary discipline and prints too much currency. The currency can only be “mass printed” if it’s fiat.
Gold imposes a “discipline” on the creation of money and government spending because governments can’t “print” gold. Governments hate monetary discipline. That’s why they hate gold-based money and delight in fiat currencies.
(How much monetary “discipline” can be attributed to “Helicopter” Ben Bernanke or “Whirlybird” Janet Yellen?)
Common Denominators: When comparing the German hyperinflation of the 1920s to the Zimbabwean hyperinflation of the 2000s, we see:
1) Both nation’s governments had recently emerged from a significant war.
2) Both nation’s governments were deeply in debt.
3) Both episodes of hyperinflation were so intolerable that they were fairly brief and lasted only 3 to 6 years.
4) Both nations’ hyperinflation killed their national currency.
5) Both nations’ currencies were fiat—neither was backed by gold or silver.
US Deflationary Depression of the 1930s:
1) Deflation was predominant for most of 10 years.
2) The US dollar not only survived but increased in value.
3) The US dollar was backed by gold domestically until A.D. 1933 and by silver until A.D. 1968. The US dollar was not a fiat currency during the Great Depression.
1) Hyperinflation follows war.
2) Hyperinflation follows great governmental debt.
3) Hyperinflationary depressions occur when the national currency is fiat and is not backed by gold or silver.
4) Deflationary depressions occur when the national currency is backed by gold or silver.
1) The US government has recently emerged from wars in Afghanistan and Iraq.
2) The US government is the biggest debtor in the world owing at least $17 trillion, and perhaps over $200 trillion.
3) The US dollar is a fiat currency. (It’s not backed by gold, silver or anything tangible.)
4) The US dollar has already lost 95% of its former value.
IF a US depression is coming:
1) It will be hyperinflationary (because the US dollar is a fiat currency and government’s debt is overwhelming) rather than deflationary (which requires a gold or silver-based monetary system).
2) Those who store their wealth in the form of cash (fiat dollars) or US bonds will lose most or all of that wealth.
3) Those who rely on Social Security or other retirement programs denominated in US dollars will see their incomes slashed by 50%, 80%, maybe more.
4) There’ll be exceptions, but those who store their wealth in the form of paper equities (stocks) denominated in fiat dollars will almost certainly lose most of their assets.
5) Those who have brains enough to store their wealth in the form of physical gold and silver should see their wealth at least preserved and probably increased dramatically.
• There’s a story of a boy who worked as a bellhop in a German hotel prior to the hyperinflation of the 1920s. One day the boy received a one-ounce gold coin as a tip from a rich hotel patron. The boy saved that gold coin. Later, during Germany’s hyperinflationary depression, the boy bought that entire hotel for the one-ounce gold “tip”.
I don’t know if that story is true or apocryphal, but it illustrates what can happen during a period of hyperinflation for those who store their wealth in the form of gold and silver. During a hyperinflationary depression, such people may be fantastically enriched.
Depressions are deflationary if the money is backed by gold or silver and hyperinflationary if the currency is fiat.
The US dollar is fiat. Therefore, if we see another depression, we should also see hyperinflation.
Hyperinflation is virtually impossible with a gold-based money. Hyperinflation is virtually inevitable with a fiat-based currency.