A Quick Tour of Hyperinflation and the Possible Consequences for America

Posted: 03/01/2010 by Lynn Dartez in un

by John Silveira

“No one can predict the future,” I heard a voice say as I walked into the offices of Backwoods Home Magazine. The speaker went on to add, “But there are a lot of reasons to believe we are in danger of entering a period of hyperinflation of the dollar.”

I hesitated because I knew the voice and I followed it to Dave Duffy’s office. Dave’s the guy who publishes this magazine. But the speaker I was hearing was none other than our poker-playing friend from Southern California, O.E. MacDougal.

I walked into Dave’s office and there was the pair of them, Dave and Mac, drinking wine and talking. After greeting me, their conversation seemed to drift to the subject of the steelhead that were making their way up the Rogue River just north of town. But I wanted them to get back to what I’d heard them discussing when I first came in. So I cut in.

“Hey, I heard you saying something about hyperinflation. I know I’ve seen references to it on the Net, but what exactly is it?”

Before Mac could answer, Dave interjected, “Inflation is when prices go up, hyperinflation is when they go up beyond all reason.”

“But how do you know when you’ve gone from inflation to hyperinflation?” I asked.

“There’s no hard and fast rule,” Mac said, “and no exact number for determining when we’ve gone from one to the other – or bad to worse. But it’s been said that inflation is reported annually while hyperinflation is reported more often, like monthly, weekly, or, in extreme cases, daily. It’s not a bad rule of thumb. But let me make a quick comment about what Dave just said.

“It may sound like I’m nitpicking,” he said to Dave, “but I’m not. Inflation isn’t so much that prices go up – because that would imply that groceries and stuff like that have somehow become more valuable. Inflation is when money becomes less valuable so it takes more money to buy a sack of potatoes, a gallon of gas, or hire a babysitter. It’s a distinction most people don’t seem to get.

“In fact, in cases where commodities become more valuable, it’s usually a case of supply and demand. When there’s increased demand for something, or the supply of something we typically use runs short, the price of it goes up. For example, if a bad winter wipes out much of the citrus crop, oranges become more expensive that year. When the crop returns to normal, the next year, the price of oranges returns to where it usually is.

“Inflation, on the other hand, is an increase in the money supply that exceeds the expansion of the goods and services available to buy.”

“That sentence sounds like a mouthful,” I said. “Give me an example I can actually understand.”

“Let’s use an analogy,” he said. “Imagine a bunch of us are stranded on a desert island with a set of poker chips. Our first year there, we decide the poker chips are going to represent the total of goods and services on the island because we want to use them as money. Say some of us harvest coconuts and we decide each coconut should cost five white chips. Next year there’s a bumper harvest of coconuts. If there are too many coconuts, each one is going to be worth less than they were in the previous year because the people harvesting them are going to have a harder time dumping them all, so the price may fall to three white chips apiece to encourage people to buy them. On the other hand, if there’s a bad harvest, it’s going to be harder to buy them, so if consumers want them they’re going to be willing to pay more for them and the price will go up. Maybe they’re going to be seven or eight white chips each. But we expect the cost of a coconut to hover around the average price of five white chips we pay for them in a normal year.”

“What you’re saying is the cost of coconuts depends on supply and demand, surpluses and shortages,” Dave said.

Mac nodded.

“I can see that,” I said in agreement.

“Now,” Mac continued, “let’s take the same island and a raft drifts in with another set of poker chips that’s the same as the first set. So, we effectively double the money supply on the island. What happens to the value of everything?”

I thought a second. “Well, if we accept the second set of chips as part of our money supply, with no increase or decrease in the number of coconuts, the cost of each coconut is going to be doubled because there’s now twice as much money – or poker chips – on the island.”

“That’s right. And think about this: Anyone who’s been saving his poker chips for a rainy day is going to suddenly find his stash of chips have half the purchasing power they used to have. That’s inflation: an increase in the chips or, more generally, in the money supply and a decrease in the value of each poker chip or dollar.”

“So, as more chips are introduced, not only do prices go up, but it discourages saving,” Dave said.

“That’s correct,” Mac said.

“Then tell me if this is right,” I said. “If instead of more chips showing up, half the chips on the island suddenly fall into the ocean and are lost for good, each remaining chip would now have twice the purchasing power they previously had and coconuts would cost half as much, because we said the number of chips represent the value of all the goods and services on the island, including the coconuts. That’s deflation; a decrease in the money supply makes each chip more valuable.”

“You’ve got it,” Mac said. “By the way, a recent real-world example of prices going up due to supply and demand, and not inflation, was caused by a mandate created by Congress a few years ago. It stipulated that a certain amount of our energy had to come from ethanol. To comply with this mandate, fuel producers started buying a large portion of the grain harvests to make fuel. That took grains out of the market and created a shortage of grains available for human and animal consumption. The result was an increased demand on them without a commensurate increase in supply and we wound up with five-dollar loaves of bread as well as more expensive chicken, milk, and steak because it also cost more to feed the animals those grains.”

“So that jump in grain prices at that time had nothing to do with the money supply, but with how much grain was available to make fuel,” I concluded.

“Right again, and later on the cost of grain went down based strictly on market forces. But a lot of people labeled the price jump inflation when it wasn’t.”

“What should it have been called?” I asked.

“There is no convenient word or words in our language to cover the rise and fall of prices based on supply and demand, so we use the word ‘inflation’ indiscriminately.”

“Has this country always had inflation?” I asked.

“This may surprise you, but we’ve only had long-term inflation since the Federal Reserve was established in 1913 and they got control of our money supply. They have steadily increased the money supply faster than the increase in the amount of goods and services that that money will buy. The result is that money has become worth less and less until, today, a dollar has about the same purchasing power as four cents had in 1913.”

“Are you kidding?” I asked.

“No,” Mac replied.

“But that means that a penny in 1913 had the same buying power as a quarter, today.”

He nodded.

“What about before that?” Dave asked.

“Prior to the Federal Reserve, our currency had an amazing amount of stability for more than 100 years because it was based on gold. That is, prices remained pretty steady for over a century. The only thing that really happened is that prices went down as one technological advance after another made life easier, crops more plentiful, and businesses more efficient. There was a blip of inflation during the Revolutionary and Civil Wars, but those passed when those wars ended.”

“People like Congressman Ron Paul want to go back to the gold standard,” I said. “Why’s gold so special?”

“Because it’s rare, pretty, and useful, and we’ve agreed it’s valuable,” Mac said. “All the gold ever mined in the world would form a cube that was only 50 feet on each side. So there’s a limited supply and if money was based on it, currencies couldn’t help but be stable.”

“But consider this,” he added. “If someone suddenly found a pile of gold as big as Mount Everest, the price of gold would plunge until it was all but worthless because it wouldn’t be rare anymore, though it would still be pretty and useful.”

“I don’t mean to cut you off,” I said, “but why do we inflate our money?”

“Oh, there are economic theories that say it’s good, but basically we do it because governments like inflation.”

I was surprised. “Why?”

“Governments like to tax us and inflation is a tax. Most people simply do not understand that.”

“How’s it a tax?” I asked.

“Let’s go back to the analogy of the island. As I said, if a second set of poker chips arrives, as they’re introduced into the island’s economy, the prices of everything on the island will begin to rise to reflect the number of chips. But before they do, the person who found the chips gets to spend them while the prices are still low. In effect, they’re stealing the value out of everyone else’s chips.

“In the same way, when the government increases the money supply, without a corresponding increase in the amount of goods and services, they devalue everyone else’s dollars – they’re worth less and buy less as prices begin to go up. But government gets full value with this newly created money because they spend it first.”

“So, with inflation, they’re stealing value out of every bill I have in my pocket,” Dave said.

“Stealing is exactly what they’re doing. Keep in mind that if introducing more money were harmless, the government wouldn’t care about counterfeiters.”

“So inflation amounts to legalized counterfeiting,” Dave concluded and the three of us laughed at what he’d said.

“You’re catching on,” Mac said.

This concept clearly intrigued Dave.

“What’s worse,” Mac continued, “is that the same people who would scream at a tax hike or a new tax imposed on us, blithely ignore inflation because they don’t understand that it’s caused by the government and it’s another tax. It’s the ultimate withholding tax because it comes out of everyone’s pocket even if you’re in the underground economy. But the worst thing is that it discourages saving and investment, the things that made this country great.”

“But it would still seem prudent to save even in an inflationary economy, wouldn’t it?” I asked.

“We should try to invest our money somehow,” Mac said. “But consider the effect inflation has on some types of savings, say a savings account, a certificate of deposit, or a U.S. Savings Bond. The interest paid on any of these is low. In fact, they’re often lower than the rate of inflation. On that basis, the more you save the further you fall behind in purchasing power. But what makes it worse is that the interest paid is also taxed, that is, part of the imaginary gains you’ve made are taken away from you by the IRS. So, saving that way becomes a loser’s game. The more you save, the further you fall behind.

“Over the long run, even putting money into precious metals is a loser’s game – that is, if you do it honestly.”

“How’s that so?” Dave asked.

“If you invest in gold or silver, it’s a nonproductive investment; it doesn’t even earn you interest. What gold and silver really do is respond to the value of the dollar and other currencies. The price of those metals will go up with the inflation rate so, over the long run, if you hold onto them you should theoretically break even in purchasing power. The problem is that when you sell your gold or silver the IRS sees your gain as a ‘real’ gain and takes a chunk of it by taxing you. Thus, even precious metals are a losing position – unless you don’t report the sale.”

“So you’re against holding gold or silver,” I said.

“Oh, no. As a hedge against inflation they’re terrific, but they’re not making you money in the way stocks, bonds, or savings accounts would in a stable and noninflationary economy.”

Hyperinflation in the past

“Other countries have already experienced periods of hyperinflation,” Dave said. “The result of Germany having to pay war reparations after World War I led to that country’s hyperinflation, and the hyperinflation led to Hitler’s rise to power.”

“The war reparations certainly contributed to Germany’s inflation,” Mac said.

“Were they intentionally inflating it to pay the war debt off with cheaper money?” I asked.

“No. Part of the Armistice agreement said the reparations had to be paid in gold or another stable currency, not the German mark. So inflating their currency didn’t help them pay off the reparations at all. But paying the reparations did create part of the shortfall the German government had in its budget so they tried to make it up by letting the presses at the mint run, and it destroyed the German currency.

“However, hyperinflation alone wasn’t the reason Hitler came to power. His ascendency was sort of a political perfect storm made up of the convergence of several important events, none of which, alone, was likely to produce a dictator. There was Germany’s losing World War I coupled with the terms of surrender, the hyperinflation, the Great Depression, and other factors. There are those who want to say hyperinflation in this country could result in a Hitler of our own. But, again, it would take more than one event to make us that crazy. Not that it couldn’t happen, but it won’t just because of hyperinflation.

“Besides, Germany’s hyperinflation was only one of several hyperinflationary periods that happened in many countries around the world during the 20th century, and none of those others led to the rise of another Hitler.”

“How bad was Germany’s inflation?” I asked.

“The German mark started losing value so fast that people were getting paid two and three times a day and they’d leave work each time so they could spend it before it lost even more value. They’d buy anything: Food, hard goods, knickknacks, who cared? If you didn’t spend it right away, it was going to be worth a lot less in just a few hours. It got so bad that people not only spent their money as fast as they could, they often didn’t bother taking their change.”

“You’re kidding,” I said.

“You know how stores today have those little penny trays on the counter near the cash registers? ‘Take one; leave one?’ You buy something for a dollar ninety-nine and give the clerk a two dollars. He gives you one penny change and you drop it in the tray because a penny is close to worthless, nowadays. Suppose in a hyperinflationary period the price of a loaf of bread goes up to $19,900, something not at all inconceivable, and you’ve given the clerk two $10,000 bills. He gives you back a hundred dollar bill. That hundred dollar bill now has the purchasing power the penny used to have. It’s easy to leave it on the counter and leave, especially because in a few hours it’ll be worth even less.”

“I know what you’re saying is true,” I said, “But I’m having a hard time wrapping my head around it.”

“In October of 1923,” Mac said, “prices in Germany went up over 40 percent a day. Money was so worthless you couldn’t buy heating fuel with it, so to keep warm many people took to burning the paper bills instead.”

“Wow!” I said. “Can it get worse than that?”

“Believe it or not in Hungary, just after World War II, the Hungarian pengö lost its value even faster. Throughout July of 1946, prices tripled everyday. What cost 1000 pengö one morning cost 3000 the next and 9000 the morning after that.”

“People must have been outraged,” I said.

“I agree, but the circumstances also honed their senses of humor.”

“Is this a joke?” Dave asked.

Mac kind of smiled. “There are stories about incidents during hyperinflationary periods that may or may not be apocryphal, but they give you a good idea of how people can find humor even in dire situations.

“The first one involves a man in Germany, during the post World War I hyperinflationary period of the Weimar Republic. He is said to have paid his fare upon boarding a bus. When he reached his destination, he was informed he’d have to pay more to get off the bus because the fares had gone up during the trip.”

“Can they do that?” I asked.

“Who knows?” Mac replied and he looked at me as if I was crazy for asking. “Like I said, I don’t even know if it’s true, but it reflects how people felt about the rapidity with which their currency was being devalued.”

“It sounds like the old Kingston Trio song, Charlie on the MTA,” Dave said. “Charlie couldn’t get off the trolley because the fare had gone up a nickel and he didn’t have one on him.” Both Mac and I thought that was funny because we’re familiar with the song.

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  2. Longknife 21 says:

    Federal Debt : $12.43 trillion
    GDP: 14.29 ” = 87% debt/GDP 60% is failing for the EU

    Federal spending: $3.52 trillion
    tax revenues 2.12 ”
    Deficit (rising) 1.4 ” = 9.8% 3% is failing for EU

    Total assets (Corporate and private) $75.59 trillion
    Unfunded Federal liabilities 107.64 ”

    The federal Gov’t is bankrupt and the Usurper wants to make it worse.

    If you look at the Federal Reserve System, it is even worse.
    Monetary Base $2.09 trillion
    Debt to Foreigners 3.85 ”
    Credit derivatives 643.03 ” (potential liabilities)

  3. Longknife 21 says:

    An excellent article! True Great points:
    1. Since 1913 The Federal Reserve has reduced value of the Dollar to 4 cents!
    2. Gov’t likes inflation, it steals the peoples money.
    3. Gov’t taxes us on the “income” generated by ‘rising prices’ caused by the reduced value of the Currency. Double Theft!
    4. Increasing the money supply by deficit spending is the worst culprit.

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