Opinion

Felix Salmon

Why I’m not worried about hyperinflation

By Felix Salmon
March 23, 2010

The smartest reaction so far to the Kinsley-Krugman hyperinflation debate comes from Ryan Avent:

The pain of hyperinflation is every bit as bad as and worse than the pain of tax increases, or spending cuts, or default. No politician would risk it, and even if the politicians were willing to, America’s independent Fed wouldn’t let them.

The truth about hyperinflation is that it isn’t so much an economic phenomenon as a political one; it corresponds to the complete breakdown of a country’s political institutions…

To get from America’s current situation to one in which hyperinflation is a realistic possibility, one must pass through an intervening step in which America’s political institutions utterly collapse. And I submit that if Mr Kinsley has reason to believe that such a collapse is imminent, he should be writing columns warning about that rather than the economic messes which might follow.

It’s also worth expanding on what Ryan’s hinting at in his reference to “America’s independent Fed” — and that’s a neat little rhetorical sleight-of-hand on the part of Kinsley. Consider:

The Federal Reserve is independent, but Congress and the White House have ways to pressure the Fed. Actually, just spending all this money we don’t have is one good way.

Compared with raising taxes or cutting spending, just letting inflation do the dirty work sounds easy. It will be a terrible temptation, and Obama’s historic reputation (not to mention the welfare of the nation) will depend on whether he succumbs. Or so I fear.

Kinsley continues:

Hyperinflation is the result of explicit policy choices by public officials… There are reasons to worry that our political leaders may opt for inflation even if there is no economic evidence of it happening naturally.

The logic here is that simply running large fiscal deficits is an “explicit policy choice” by officials who “opt for inflation”. Just by spending money, the government is pressuring the Fed to, um, what, exactly? Keep interest rates too low? Print money?

It’s true that the Fed isn’t looking particularly independent these days, but that’s largely because inflation isn’t a problem, and therefore the Fed is rightly concentrating on the second part of its dual mandate, which is reducing unemployment through loose monetary policy. Fiscal policy and monetary policy should both be pulling in the same direction right now — which is the direction of trying to extricate the country from the deepest recession in living memory.

It’s also hard to see the dynamics by which hyperinflation — or even plain old ordinary high inflation, for that matter — could emerge. If there’s a panicked run away from the dollar and dollar-denominated assets, that would hurt both the stock market and the bond market, hitting wealth hard. It would also send the cost of imports up. But the US doesn’t import so much that import-price inflation would pass through into domestic hyperinflation. And with the markets in turmoil, weak unions, and unemployment surely rising, I don’t think that workers would be in any position to ask for double-digit wage increases on an annual basis. In any case, to have any hyperinflation you need a maniac helming the printing press, and Ben Bernanke is not a maniac. Yes, he’s expanded the money supply significantly, but only when disinflation was the greatest risk facing the economy. It’s almost impossible to imagine the Fed continuing to print money once consumer prices start rising sharply on Main Street — and, frankly, it’s hard to imagine the Obama administration putting pressure on the Fed to do so.

As Krugman notes, it’s instructive to take a hard look at Japan, which ran enormous deficits for many years and which still has no sign of any inflation any time soon. Deficits, in and of themselves, do not cause inflation. And while Kinsley is right that there’s no obvious way out of America’s current fiscal problems, he’s wrong that politicians can simply choose inflation as an option. Just as the Treasury secretary does not control the value of the dollar, the president does not control the trajectory of consumer prices. So in order for his fears about hyperinflation to be remotely justified, Kinsley first has to explain how the Fed is going to transmogrify into the Reserve Bank of Zimbabwe. And he hasn’t come close to doing that.

Comments
16 comments so far | RSS Comments RSS

The only way we will see inflation is if China decides to devalue the dollar relative to the renminbi. Fortunately for most people outside of China, they’re not going to do that. Politicians should stop whining about China’s undervalued currency, and send thank-you notes to the workers there who are willing to work so hard to support the middle class in America.

Federal budget deficits as large as the ones we are now running would normally create inflationary pressure, but given that overall consumption is down and that most other industrialized nations (the ones whose currency matters, anyway) are also running deficits, there are no economic forces that would drive up inflation (beyond a major disaster or artificial price increase in a core cost component, like energy or food). If every nation is printing money, then no one currency will lose value relative to another.

Japan didn’t have inflation because they were also running huge trade surpluses. They could finance their public debt from profits on exports.

And about the Fed not looking independent these days – they weren’t very independent when bush was president, as they gladly carried out his “lend money cheaply to anybody who is breathing” policy, which was the basis for the imaginary growth during six years of his regime.

Posted by OnTheTimes | Report as abusive
 

A big drop in the dollar would cause the stock market to drop in foreign currency terms, but likely not in dollar terms. At least to my recollection the Argentine stock market went up in peso terms when they devalued by a factor of 3, though you might have better resources to check on that than I currently do. That this is what jibes with what I would intuitively expect may be reason to mistrust it, though.

Posted by dWj | Report as abusive
 

There is alot of regular inflation between here and hyperinflation.

We can see inflation if financial institution balance sheets begin expanding and the Fed fails to shrink the amount of excess reserves that it holds by selling securities that it holds.

The current problems in the economy have been debated endlessly (or so it seems) almost everywhere.

Rarely, however, do I see it asserted that SOME inflation would be of significant benefit. I believe there are a number of reasons this would be the case. But first, we must define what we mean by “inflation.” In this case, it is not actually INFLATION but a REFLATION, in particular of real estate. The purpose of such a reflation would be to reduce the amount of bad loans on the books of financial institutions by reducing the number of real estate mortgagees who are upside down.

Even in mainstream Monetary Economics, it is asserted that SOME inflation is beneficial, acting as it does, as the “grease” of the economic wheels.

Those who are overly afraid of inflation have valid points, as well, notably that it is difficult to put the genie back into the bottle. However, they seem to forget that Deflation too is a genie, and a particularly evil one, at that.

Looking at Japan, the government has been borrowing to stimulate via spending unsuccessfully for the better part now of 20 years. So too, did the United States stimulate via deficit spending in the 1930s, generally unsuccessfully (much debate possible here, of course).

So, ladies and gentlemen, let us welcome some inflation if not as a cure to our ills, at least as a cure to some ills (deflation).

JH

Posted by jhains2 | Report as abusive
 

Kinsley is a smart guy, but he’s not an economist, and his use of the term “hyperinflation” incorrect — 13% inflation is not hyperinflation in any professional lexicon. Ryan’s comments, while correct, are addressing Weimar, not Kinsley. Institutions don’t have to collapse to have 13% inflation; all you need is Jimmy Carter and some Arabs plugging a well. Hyperinflation is not a possibility in the US. Another round of Jimmy Carter is.

Posted by maynardGkeynes | Report as abusive
 

What the President and Congress can do, and which they pretty much have been doing, is to build a doomsday machine in which the amount of debt built into the system is greater than an amount that can be paid back in present money.

Then the Fed is forced into a choice. The debt can be inflated away or there can be mass defaults and deflation. It is not rocket science to guess that the Fed will choose door number one, since that is what the Fed has done for the last 75 years, and the world has not ended.

Felix, you are right that genuine hyperinflation is unlikely. After a few years at, say, 10% inflation, even the most enormous debt overhang begins to resolve itself.

Posted by DanHess | Report as abusive
 

One difference between the United States and other countries that issue their own currency is that with most other countries, there is a hard currency alternative to the local currency.

If a nation’s residents stop believing in their own currency, and there is a hard alternative (for Zimbabwe, the US Dollar), the real private-sector economy can suddenly shift to hard currency, making a hyperinflation almost inevitable. The psychological shift can happen very fast. The government is left with a currency abandoned by the most of the productive part of the economy. There is no way to raise enough revenue to maintain the government from the private sector, which has effectively gone underground by shifting to a hard currency. The government must then print and maybe buy a little time and or cease functioning right now.

Did Weimar Germany have hyperinflation as its goal? Of course not. But once the population lost faith in the Mark and found an alternative, hyperinflation was inevitable.

Is there any hard alternative to the dollar that would make such a switch possible? Many say no. How far off are the Yuan, gold, etc.?

Posted by DanHess | Report as abusive
 

Actually, the history of Weimar Germany does not bode well for us. Why?

They mainly didn’t jump to a hard currency. Instead, they sought all manner of tangible goods and moved largely toward barter. As faith was lost in the currency, economic activity moved away from the reach of government. As unemployment increased, revenue collapsed as well.

The government, faced with an utter collapse in revenue and no external source of funding, had printing as its only viable revenue source. Apparently during the process, 99% of revenue came from printing and 1% came from taxes.

The printing wasn’t even the half of it. Much of the inflation came from increases in velocity of money, led money multipliers orders of magnitude higher than normal. Folks who did not trust the money were very eager to spend it.

While this circumstance may seem unlikely, I can’t think of a hard proof that it cannot happen here. If external funding simply dried up, the United States would have to cut spending by what, 40%?

This alone would cause a depression.

Posted by DanHess | Report as abusive
 

The commenters who argue that Weimar Germany did not choose inflation or explain Weimar Germany’s hyerinflation from the development of a barter economy seem to be missing some history. Even the comment that it would take a maniac to pursue hyperinflation is not quite right– the President of the Reichsbank circa 1922 was considered an enlightened, conservative fellow.

The Weimar hyperinflation was a direct response to Germany’s political decision to default on reparations. It was a rational calculation to show the Allies that Germany could not afford to pay. It’s most rapid phase coincided with the German government’s policy of noncompliance and strike against the French occupation of the Rhineland. Ryan Avent’s original comment was most correct: hyperinflation is a political, more than economic, event.

Posted by Beet | Report as abusive
 

John Mauldin had an interesting bit on the velocity of money a couple of weeks back.

http://www.investorsinsight.com/blogs/th oughts_from_the_frontline/archive/2010/0 3/13/the-implications-of-velocity.aspx

The point is, velocity of money is its own separate money multiplier, completely apart from printing. Recently, printing has been substantial while velocity has collapsed, balancing things out.

Suppose there is a moderate loss of confidence in the dollar and velocity doubles. It has, after all, seen doublings and halvings during the last century. That would mean 100% inflation. Where does that fall on our scale?

In hyperinflations velocity has typically increased 1000%. That would mean inflation of 1000%.

Remember, this is not printing but a loss of confidence in the money.

If that weren’t enough, movement of some portion of the economy to alternatives (other currencies, Gold, barter) would free up dollars and would act like printing.

Gee, now I don’t feel safe from inflation at all! It should be noted that deflation has commonly preceded inflation.

Posted by DanHess | Report as abusive
 

INFLATION ALREADY HAPPENED. It was just in real-estate and credit related items and not something captured by the CPI. If an inflation ‘hawk’ was not screaming during the housing bubble, their screams today are worthless. Investment banks increased leverage, effectively creating money. That expansion crumbled…and was larger than the fed’s efforts since 2008. You can think of the fed counteracting the deflation that would have occurred because of the popping of the housing/credit bubble. Had the fed not acted, we would have seen deflation, which would have made the recession worse.

Posted by winstongator | Report as abusive
 

Frankly, anyone who uses words like “pay back” when referring to our national debts doesn’t deserve to be taken seriously. A bit of simple math shows that the key to bringing debt under control as a percentage of GDP is simply the rate of future GDP growth; if you increase the rate GDP growth without increasing fiscal deficits, pretty soon the magic of compounding does the work for you. That’s why spending a bit more now to ensure growth is such an attractive proposition, and it’s also why strong politicial instituations will also insure that hyperflation will not take root.

An example: Current GDP is about $14.5 trillion, and total debts (note: not the debt held by the public) outstanding is about 85% of GDP. If, until 2025, we get 3.0% GDP growth (on average) and fiscal deficits run 9.1% in 2010, 7.25% in 2011, 6% in 2012 (these are the Bloomberg consensus forecasts), 4% in 2013, 2.5% in 2014, 2% in 2015 and 1.5% thereafter (my assumptions), what do you think the total debt as a percentage is in 2025? The answer: 87%, just 2% points higher than currently and well below the 101% 2013 peak. And we never even balanced the budget! Given the same deficit scenarios and increasing GDP growth to 3.5% reduces the peak to 99% and the end amount to 81%.

Posted by MitchW | Report as abusive
 

“But the US doesn’t import so much that import-price inflation would pass through into domestic hyperinflation.”

The US imports $2.5 trillion worth of good each year:
http://en.wikipedia.org/wiki/Economy_of_ the_United_States#International_trade

I guess I would throw myself in the Kinsley Camp. A currency crisis can cause inflation so its not all in the Fed’s hands.

http://www.econtalk.org/archives/2009/12  /hamilton_on_deb.html

Posted by SamG | Report as abusive
 

Mitch –

I want some of what you’re having! Those are some very happy assumptions.

A growth of 3.0% over the next 15 years, coupled with conquering the currently massive fiscal deficits would be wonderful! And yet even under this idyllic scenario, debt grows slightly.

Unfortunately, there may be some rain falling on our parade:
* Large debts themselves typically pull GDP growth downward, since savings must go to making interest payments on that debt
* In the administration’s current budget of $3.8 trillion, there is a deficit of around $1.5 trillion. This means that only around 60% of federal spending is paid for, and this is before baby boomers retire en masse, drawing massively on Social Security and Medicare. There are two ways to cut balance this budget, drastically curtailing spending and drastically raising taxes. Neither of these are at all helpful for growth.
* Interest rates have been remarkably low of late. Should they head upward, this is strongly negative for growth.

If all we can muster is a few percent growth with the most massive stimulus in history, that does not bode well for growth when the stimulus is removed.

Like I said, Mitch, I would love to have some of what you’re having because reality is making me depressed.

Posted by DanHess | Report as abusive
 

As implied by a few comments above, we don’t need to speculate about distant lands or fancy hypotheticals to understand what inflation in the U.S. would look like – we can just look back at the 70s. The result is chaos in import/export-driven sectors and financials. People default on nominally-based contracts that are highly unprofitable in an inflationary setting. Industries set up to be profitable in a stable-money setting flail to adjust. Financials with a lot of fixed-rate assets and floating liabilities blow up. You don’t need 1000% inflation – 10% will do it. Think about how much credit risk people are taking right now to earn 10% over 30 years. Imagine if they start to earn 0% real returns – do you think that’s going to be a comfortable economic situation?

It’s well-agreed on the left and the right that the monetary adjustments to get inflation under control in the 80s were difficult (setting aside all the battles about other Reagan-era policies). Do you see the same willingness to make hard choices and the ability to effectively accomplish difficult tasks in today’s political and economic leaders? Do you see anything like the secular tailwinds created by the collapse of the Soviet empire, cheap energy prices and massive emerging tech, pharm, and telecom industries of the 90s?

Posted by najdorf | Report as abusive
 

Does hyperinflation really always correspond to a complete breakdown of a country’s political institutions (with the comforting implication that therefore “it can’t happen here”)?

While this may certainly have been true of recent examples like Zimbabwe and Slobodan Milosevic’s rump Yugoslavia, it it true in general? For instance, Brazil in the 1980s and early 1990s had chronic hyperinflation peaking at 84% a month, with multiple failed attempts to cure it until the Plano Real in 1994, but during this time its democratic political institutions were only strengthening (transition to civilian rule in 1985, constitution in 1988, etc).

Arguably, even Weimar Germany provides a counterexample. Its political institutions survived the hyperinflation of the early 1920s, and didn’t collapse until a decade later as a consequence of the Great Depression.

In any case, the recent bitter partisan gridlock would seem to indicate that even the complete breakdown of political institutions is no longer utterly unthinkable. But I don’t agree that this is a necessary condition for a chronic, tolerable, “new normal” Brazilian-style hyperinflation to take root.

Posted by anon242 | Report as abusive
 

If there is 12% inflation for a decade, the dollar loses 3/4 of its value. While we might not think of 12% as the wheels coming off the wagon, the dollar loses most of its value very quickly.

If we allow ourselves to acknowledge that such levels of inflation are a kind of hyperinflation (in the sense that most of the value of cash and long bonds disappears in just a few years) we realize that there have been hundreds of instances of this spanning almost every nation in the world. Deflations by contrast have been exceedingly rare and comparatively mild.

I think the odds of avoiding an inflationary bout sometime in the next decade or two are about the same as the odds of Cornell taking it all. Go Big Red! Those Wildcats have nothing on you!

Posted by DanHess | Report as abusive
 

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