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Monday, June 22, 2009

Hyperinflation 2

Chargeless money
As the tendency of money to increase in value diminishes towards zero its velocity around the economy increases because people and businesses become ambivalent about keeping it to store value. Like atoms with no charge these dollars are not attractive, so they don’t settle.

At this stage economic activity - which is measured by the rate at which these dollars are flying around - looks magnificent in all the statistics, but little of it is productive. What is actually happening is that people are ditching their dollars to find a better store of value, so what looks like 'growth' of the dollar economy is - more accurately - an exit.

You can see this happening wherever economic figures reporting in excess of your direct experience, and wherever alternative stores of value start to rise in price.

Repulsive money
The expected central bank reaction to this kind of thing would be to raise interest rates, to bind the issued supply back into savers' pockets.

But this is where the catch is. The raising of rates can only be done when there is low risk of it causing debt servicing problems for large numbers of borrowers, because otherwise different risks arise. After a long borrowing binge consumer debt is high, corporate debt is high and public debt is high, and the increase of rates now risks causing previous borrowers to find their debt burdens unaffordable. This is a big problem, because it has been the demand of all these borrowing consumers which has been keeping the dollar saving habit profitable for decades.

So after polarization into savers and borrowers the monetary system is caught between two very unattractive options. The likely result is a runaway effect in which increasingly repulsive cash is dumped, while the central bank looks on, powerless to raise rates because it would induce previous borrowers to default.

It is made more severe when savers over the whole world have been stockpiling this currency as their reserve too. Hyperinflation needs no printing press if 35 years of surplus money supply has been frozen into savers' bond portfolios.

In such circumstances alternate assets - like the precious metals, cash commodities, well run foreign currencies, or the very few sound equities - rise in price to uncomfortable levels. These rises cause most savers to hold on to dollars in hope, fearful that having lost half their purchasing power already they'll lose another half by panicking out of weak currency into highly priced solid assets.

Towards the end of last year the US sovereign debt increased to $8 trillion - about $80,000 for every US family. The Iranians announced the termination of trading their oil for US Dollars. Russia decided to double its gold reserve. Gold coins minted in China disappeared off the shelves in hours. Gold's price continued to rise aggressively. In dollar terms gold has now much more than doubled from its 2000 lows of around $270. It is already an uncomfortable purchase - but that may be why it is such an important one.

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