Editor’s Note: Chris Martenson of Peak Prosperity explains the mechanics of a hyperinflationary scenario that could
wipe out the savings and wealth of anyone holding a doomed currency. In this
case, Martenson focuses his efforts on the US
dollar by detailing specific historical and modern day instances of
currencies that have either lost favor and been shunned, or were destroyed by
their respective government. Without giving away too much of Chris’
analysis, what this boils down to is that you want to trade out of the dying
currency and hold assets that will not lose value as the currency collapses
– physical goods. Once hyperinflation takes hold it becomes
unstoppable, even though there are moments of hope (as evidenced by the
timeline of Weimar hyperinflation chart provided in the article below.) The
key is to own goods and assets that will preserve wealth or can be traded for
the currency as it becomes necessary (to pay bills or transact locally). The
article below not only provides historic precedent for why hyperinflation
could occur in the United States and to the world’s reserve currency,
but how to identify it when it takes hold.
A question on the minds of many people today
(increasingly those who manage or invest money professionally) is this: How
do I preserve wealth during a period of intense official intervention in and
manipulation of money supply, price, and asset markets?
As every effort to re-inflate and perpetuate the credit bubble is
made, the words of Austrian economist Ludwig Von Mises
lurk ominously nearby:
There is no means of avoiding the final collapse of a boom brought
about by credit expansion. The alternative is only whether the crisis should
come sooner, as the result of a voluntary abandonment of further credit
expansion, or later, as a final and total catastrophe of the currency system
involved.
(Source)
Because every effort is being made to avoid abandoning the credit
expansion process — with central banks and governments lending and
borrowing furiously to make up for private shortfalls — we are left
with the growing prospect that the outcome will involve some form of
“final catastrophe of the currency system”(s).
This report explores what the dimensions of that risk are. It draws
upon both historical and modern examples to try to shed some light on how the
currency collapse process will likely unfold this time around. Plus,
we’ll address how best to avoid its pernicious wealth destroying
effects.
When Money Dies
In the book When
Money Dies by Adam Fergusson, which details
Weimar Germany’s inflation over the period from 1918 to 1923, the most
riveting parts for me were the first-hand accounts from the people caught in
the storm.
So many people left their wealth in the system only to watch it get
eroded and utterly destroyed over time. The reasons were many: patriotism,
inertia, disbelief, and denial cruelly fed by hope every time prices
moderated or even retreated momentarily.
The simple observation is that many people had a blind belief in the
money system. They lost their wealth because they were unable or unwilling to
allow reality to challenge their beliefs. It’s not that there
weren’t numerous warning signs to heed — in fact, they could be
seen everywhere — but most willfully ignored them.
Most mysterious is the fact that in Austria and Germany, where the
inflation struck most severely, there were numerous borders and currencies
into which people could have dodged to protect their wealth. That is,
protecting one’s wealth was a relatively straightforward and simple
manner. And yet…it did not happen.
The Many Types of Inflation
As always, the landscape of inflation needs to be carefully mapped
before we can begin to hope to have a conversation with a destination. Where
the symptom of inflation is rising prices – in fact,
rising prices are the only things tracked by the Consumer Price Index, or CPI
– the causes of rising prices are many, but they always
boil down to the overexpansion of money and/or credit. Knowing the cause is
essential to knowing what to do next.
Here are the main flavors of rising prices that we need to keep in
mind:
Non-inflationary price increases –
These are caused by demand exceeding supply. It happens all the time. A poor
harvest driving up the price of corn is not inflationary, but it will show up
in the Consumer Price Index (CPI). These sorts of price movements reverse
themselves as markets respond by chasing the price and delivering more of
whatever was in short supply. The only exception is when there is some
essential, non-renewable natural resource in sustained depletion —
which means that demand will always exceed supply and prices will rise and
then rise some more. Excessive speculation can also lead to price rises and,
as long as the speculation centers on the item(s) involved and not on
excessive money/credit expansion, it, too, can be (and eventually will be)
reversed.
Simple inflation – This is the
‘textbook’ case of inflation where too much money and/or credit
is created relative to goods and services. Print too much money or make credit
too cheap/easy and prices will rise roughly in proportion to the excess.
Simple inflation operates in the low single digit percentages. Central banks
openly target simple inflation in the 2%-3% range as that level of expansion
allows banks to have healthy profits, prevents past loan errors from swamping
the system, and generally keeps the exponential money system operating well.
Loss of confidence in money – A
more severe stage of simple inflation takes over when enough people lose
faith in the money and seek to actively spend their money on something,
anything, before that money loses value. This type of inflation operates in
the high single digits to low double digits, somewhere between 8% and 15%.
This is just simple inflation on steroids. Not everybody participates in this
game yet, as the loss of confidence has not yet reached criticality, but
enough people do to keep this process locked in a self-reinforcing spiral
that requires aggressive money tightening to halt. Think ‘Paul Volcker’
and ’21% interest rates’ and you get the picture.
Hyperinflation – Further along the inflationary
spectrum is what happens when a critical mass of people within a society lose
faith in their money and the monetary authorities are incapable of reducing
the money/credit supply, either because there’s already too much of it
out there to ‘call in,’ or because they lack the political will
to do anything but print more money in response (i.e., there are no Volckers around). Once this critical mass is reached,
every corner of society is participating, and it is no longer socially taboo
to talk about the hyperinflation or how to escape its effects. Everyone is
wheeling and dealing, speculation runs rampant in everything from stocks to
pineapples, and you cannot possibly spend your money fast enough to avoid the
ravages of inflation. The annual percentage rates for hyperinflation range
from medium double-digits into the hundreds of millions.
Currency destruction –
There is another type of inflation that happens when your state currency is
shunned by the rest of the world. While there may be no additional money
creation and credit may even be dropping, inflation is still a very serious
problem as everything imported goes up in price. There are many reasons that
a currency may be shunned. It could be that other countries lose faith in the
currency due to mismanagement and overprinting. It could be due to acts of
war. Or it could happen at the end of a very long period of excessive credit
and money expansion, when that bubble finally bursts and confidence in the
associated currency unit(s) is lost. There is really very little that local
authorities can do to fix things unless the country imports nothing, a
condition that applies to exactly nobody. Prime candidates to experience this
form of inflation are the US and Japan; the former because of massive
imbalances fostered by its several decades of reserve currency status, and
the latter because of persistent and massive over-printing enabled by
domestic savings and a once-robust export surplus. The dynamic of currency
destruction is for imported items to rise sharply in price first, with
everything else soon following in upward price spirals. Policy responses are
quite limited and are usually ineffectual at preventing a massive amount of
economic destruction and wealth loss for the holders of the stricken
currency.
It is this last type of inflation – currency destruction –
that we’ll explore here, because it represents a severe risk and is
very rarely talked about or analyzed.
Spinning in the Water
A modern case study of a shunned currency is Iran.
For a variety of reasons, Iran finds itself the subject of a sustained
effort by the US to subjugate its nuclear program to international inspection
and curtailment. Already the target of many overt and covert efforts to bring
it to heel — ranging from two highly destructive and invasive computer
worms (Stuxnet and Flame), to stealth drone overflights, to an international ban on oil exports
— Iran now finds that its currency is being internationally shunned.
The impacts are obvious and the lessons instructive.
Already Plagued by Inflation, Iran Is Bracing for Worse
Jul 1, 2012
TEHRAN — Bedeviled by government mismanagement of the economy
and international sanctions over its nuclear program, Iran is in the grip of
spiraling inflation. Just ask Ali, a fruit vendor in the capital whose
business has been slow for months.
People hurried by his lavish displays of red grapes, dark blue figs
and ginger last week, with few stopping to make a purchase. “Who in
Iran can afford to buy a pineapple costing $15?” he asked.
“Nobody.”
But Ali is not complaining, because he is making a killing in his
other line of work: currency speculation. “At least the dollars I
bought are making a profit for me,” he said.
The imposition on Sunday of new international measures aimed at
cutting Iran’s oil exports, its main source of income, threatens to
make the distortion in the economy even worse. With the local currency, the rial, having lost 50 percent of its value in the last year
against other currencies, consumer prices here are rising fast —
officially by 25 percent annually, but even more than that, economists say.
(Source)
There are several factors feeding into the current Iranian currency
crisis, including mismanagement of the economy that has left Iran even more
exposed to imports than it otherwise could or should be, and Iran’s
currency is on the cusp of tipping over into outright hyperinflation. Ever
since the Revolutionary War, when the British printed and distributed
cartloads of Continental scrip, currency debasement has been a useful tool of
war. All is fair in love and war, and whatever corrodes your opponent’s
strength is a potentially useful tool.
Note that in the above quotes, we find that both the speculation
already in evidence plus the 25%+ price increases support the idea that Iran
has already tipped past simple inflation. Whether it can prevent a worsening
condition is unclear at this point, regardless of whether or not
international sanctions are soon lifted.
More from the same article:
Increasingly, the economy centers on speculation. In this evolving casino, the winners seize opportunities to make
quick money on currency plays, while the losers watch their wealth and
savings evaporate almost overnight.
At first glance, Tehran, the political and economical
engine of Iran, is the same thriving metropolis it has long been, the city
where Porsche sold more cars in 2011 than anywhere else in the
Middle East. City parks are immaculately maintained, and streetlights are
rarely broken. Supermarkets and stores brim with imported products, and homeless
people are a rare sight on its streets.
But Iran’s diminishing ability to sell oil under sanctions,
falling foreign currency reserves and President Mahmoud Ahmadinejad’s
erratic economic policies have combined to create an atmosphere in which citizens,
banks, businesses and state institutions have started fending for themselves.
“The fact that all those Porsches are sold here is an indicator
that some people are profiting from the bad economy,” said Hossein Raghfar, an economist
at Al Zahra University here. “Everybody has started hustling on the
side, in order to generate extra income,” he said. “Everybody is
speculating.”
Some, like Ali the fruit seller, who would not give his
full name, exchange their rials for dollars and
other foreign currencies as fast as they can. More sophisticated investors
invest their cash in land, apartments, art, cars and other assets that will
rise in value as the rial plunges.
For those on the losing end, however, every day brings more bad news. The steep price rises are turning visits by Tehran homemakers to
their neighborhood supermarkets into nerve-racking experiences, with the
price of bread, for example, increasing 16-fold since the withdrawal of state
subsidies in 2010.
“My life feels like I’m trying to swim up a waterfall,” said Dariush Namazi,
50, the manager of a bookstore. Having saved for years to buy a small
apartment, he has found the value of his savings cut in half by the
inflation, and still falling.
“I had moved some strokes up the waterfall, but now I fell down
and am spinning in the water.”
(Source)
All of the important lessons you need to avoid a
currency destruction are contained in those passages above.
- Savings are for losers.
- The
more exposure you have to food and fuel price hikes, the worse off you
are.
- First
movers have the advantage. Get your wealth out of the afflicted currency
as fast as possible and then trade back in when needed to make
purchases.
- Paralysis
is a wealth destroyer.
- Fending
for oneself is a wealth saver, so faith in authority is best shucked as
fast as possible.
Be prepared to follow those rules and you will do better than most.
Barter, speculation, and prices that gyrate wildly as formerly
expensive things are traded for basic necessities are all typical features of
the end stages of a currency. Crime, social unrest, and sometimes war are
handmaidens that accompany the death throes of money.
The basic strategies to protect one’s wealth are deceptively
simple. As soon as the process of money destruction has begun, if not before,
all savings have to be moved out of the afflicted currency and into things,
especially things that others with wealth or barter items are most likely to
want.
Turning our attention back to the Weimar episode for a moment, the
Amazon summary for When Money
Dies reads:
When Money Dies is the classic history of what
happens when a nation’s currency depreciates beyond recovery. In 1923,
with its currency effectively worthless (the exchange rate in December of
that year was one dollar to 4,200,000,000,000 marks),
the German republic was all but reduced to a barter economy.
Expensive cigars, artworks, and jewels were routinely exchanged for
staples such as bread; a cinema ticket could be bought for a lump of coal;
and a bottle of paraffin for a silk shirt. People watched helplessly as their
life savings disappeared and their loved ones starved. Germany’s
finances descended into chaos, with severe social unrest in its wake.
The parallels to the Iranian situation are obvious.
Those without the gift of foresight to identify what is coming,
coupled with an inability to take decisive action that cuts against the
social grain (at least early on), will simply lose their wealth and not be in
a position to buy or exchange anything but their own time and labor in the
future. This leads to the assessment that owning or producing things that
people need or want is a good strategy.
Food is always a good play. In the early stages, we’d also lean
towards highly socially desirable real estate and away from middle- and
lower-income housing, as ability to pay always get shredded from the bottom
up. Gold performs well in terms of protecting purchasing power. According to
the article above, Porsches work too. In other words, owning things that
wealthy people will desire is a very good idea.
I know this sounds harsh, elitist, and not terribly egalitarian, but
it also happens to be how things tend to work out. Since I have a desire to
be in a position to be helpful and of assistance in the future, protecting my
wealth is a matter of both self and selfless interest. So I study what works
and begin there, while also seeking a better future.
The cruelest part of a currency destruction is
that it will sneak up on most people, their baselines will shift, and they
will be confused by false hopes along the way. This is completely
understandable and to be expected. There’s a good chance you’re
well acquainted with the chart of the value of German Marks against gold
during the Weimar hyperinflation. I want to take a closer look at it by
focusing on the wiggles instead of the rise:
Imagine yourself there at that time, getting all of your information
from the newspapers and your personal rumor network. Note that from the early
part of 1920, prices fell by a lot over the next six months (note that this
is a log chart, so even a little downward movement in the line represents a
big price drop).
Headlines reported that the corner had been turned and that the
government programs had been successful in bringing inflation under control.
People wanted to believe that story and so they did.
It wasn’t until the end of 1921 that prices began to rise again,
spiking into early 1922 before stabilizing again for approximately eight
months. Again people were calmed by the apparent success of the authorities
in controlling the inflation.
Because there were three pauses and rescues along the way, the price
spike from late 1922 and into 1923 caught many off guard. It was truly
shocking. This is when the critical loss of faith finally happened. Yet far
too many remained paralyzed, certain the government would again get things
under control soon. After all, three times before there had been a recovery,
why not this time too? One must have hope, after all…
In the middle of 1923, with very aggressive government intervention,
there was a three-month dip in prices and a pause in the hyper-inflationary
process. Again, another hopeful moment, but it was the final trap for the
unwary.
To put this in context, imagine if next month (August) gasoline prices
shot up by 300% to roughly $10/gal. But then, between August 2012 and May of
2013 the price of gasoline fell back to $5/gal. I’d be willing to wager
that many of your friends would be telling you that everything was fine and
that “they” have everything under control. Perhaps your
continued concern would be ridiculed or dismissed.
Then, when prices finally did again breach the old $10/gal highs, some
19 months after the first price spike (in February 2014, in this example),
many would have been habituated to the new prices, routines would have been
altered, and many would have already inserted a rationalization process into
their thinking that would have all of this make perfect sense, albeit
uncomfortably.
While not tracking the percentages closely, this example tracks the
time frame.
An important insight here is that baselines will shift,
rationalizations will be formed, and explanations adopted, principally by
those unable to accept that their money is in the process of dying. Avoiding
this yourself will require tuning those people out and trusting yourself.
In Part II:
Positioning Yourself for When Our Money Dies, we identify the most probable markers for identifying when a
full-blown currency collapse is imminent.
What indicators should you watch for? Where should you place your
capital to best preserve its purchasing power? What will a collapse of the US
dollar look like and what will the likely aftermath be? These and other
implications are explored.
Click here
to access Part II of this report (free executive
summary; paid enrollment required for full access)
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