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Is Hyperinflation Looming?                                                                                    

Posted at: Jun/29/2009 : Posted by: mel

Related Category: Economics,

First of all, I am not an economist, I do not work for the treasury. The scope of my economic knowledge is my wallet. In my college days I learned that Inflation is when the price for goods and services goes up, and generally goes up at a rate that exceeds most peoples wage or salary increases. Obviously, “Hyperinflation” would therefore be the extreme case of this. By extreme I mean that when personal income increases by 3% the cost of a loaf of bread could increase by 50-2000%. Some definitions merely stuffgn the subjective and say it is when inflationary actions is considered out of control. Actually, hyperinflation like the declaration of a recession or depression has become the bailiwick of politicians. When politicians are involved when know that despite the hardships regular people may be enduring, that formal declaration may never come. But enough on politicians.

There is absolutely no doubt that we are going through some very trying times right now. Unemployment is up, personal spending is down. Personal credit is virtually non-existent bringing many aspects of our credit driven economy to a standstill. In response to this situation our government has chosen a multi-pronged approach to turning this around. One of the most noticeable of these responses has been the stimulus program. Effectively, the stimulus program is an injection of 700 billion new dollars in a focused manner to compensate for the impact of many trillions of dollars being lost over a very short time. I don’t want to discuss whether on not the stimulus package was a good move or not, for the purposes of this essay….it is simply a fact. The bigger question is what happens next.

There is a common scenario that gets discussed with respect to these facts. At some point the economy begins to turn around. People start to spend, job creation starts rolling, and a significant reason for this is all this is the new money floating around. But with all this extra money in the system the price of goods and services can also start to move up in price very aggressively, this is the inflation, potentially hyperinflation.

Inflation/Hyperinflation is therefore created when paper currency (currency not backed by tangible stuffts) rapidly increases in supply with no connection to economic output. The depreciation of the paper currency is accelerated because of an imbalance in the supply and demand of that currency. The Central Bank will have to either increase interest rates to attract foreigners into buying the depreciated currency or print more currency to meet its obligations. If a Central Bank chooses to print more paper money (our stimulus program) to jump start the economy than many say inflation is inevitable. Hyperinflation would occur if the paper money looses its intrinsic value which is followed by a run on the currency similar to a bank run. Domestic and foreign holders of the currency will seek shelter in hard stuffts like gold or other non-dollar paper currencies. Is this possible, I don’t know how to predict the future, but I hope not.

The ultimate challenge here is the very tricky balancing act that the Federal Reserve will need to pull off. The cure to (hyper)inflation is to remove money from the economy. The issue is that the extra money is a major portion of why things will finally be moving forward. Removing too much money too fast would bring any recovery to a very sudden halt. But removing money too slow will still lead to significant inflation an its related damage. There is another factor that plays into the favor of the United States. Most economist will tell you that US inflation rates are understated because the US Dollar is the global reserve currency. Countries must buy and sell in dollars In order to do business in the global dollarized economy. The greenback’s status as a reserve currency allows the US to export its inflationary pressure. Foreign Central Banks buy US dollars to work with in the dollarized global economy but Foreign Central Banks in East Asia and other countries focused on export led growth buy dollars to be able to trade with the U.S. When this time comes we need to be able to “buy” our way out. This means that American consumers need to start buying products made in those countries holding large blocks of our cash. Optionally we could start producing something everyone want to buy.

Is this getting complicated. The bottom line is that eventually our Federal Reserve will need to very carefully remove the extra money from the system. The extra money that the U.S. Central Bank would buy back could either come from our foreign holders, or the profits of selling something everyone wants. Some folks would say this is pretty doom and gloom, but I disagree for one fundamental reason. We are the consumers to the world, so the worlds manufactures and governments all have a vested interest in our recovery.

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