HYPERINFLATION – IT’S MORE THAN JUST A MONETARY PHENOMENON

HYPERINFLATION – IT’S MORE THAN JUST A MONETARY PHENOMENON

“Inflation is always and everywhere a monetary phenomenon.” – Milton Friedman

Hyperinflation is poorly understood. As its name might imply, most people believe hyperinflation is merely inflation on steroids. But that’s not necessarily accurate. Inflation can and does occur in a perfectly healthy economy. In fact, since 1913 when the Fed was founded inflation in the USA has consistently risen at 3.5% per year on average. One might assume that this means the country has experienced some great injustice, but the truth is that the 1900’s were characterized by the greatest economic expansion and wealth creation the world has ever seen. Despite the common citation that “the $USD has lost 90% of its value” Americans experienced an unprecedented period of prosperity during this inflation. In fact, the prosperity became so gross in the 1990’s that Americans felt entitled to second homes, second cars, and just about every other luxury good known to man. What has not occurred is hyperinflation, which is a very different animal than inflation. Hyperinflation is a disorderly economic progression that leads to complete psychological rejection of the sovereign currency.

Contrary to popular opinion, excessively high deficit spending and exorbitant government debt levels are not the actual cause of a hyperinflation. In most cases they have been the result of other exogenous events such as ceding of monetary sovereignty, war, rampant corruption or regime change. It is these exogenous events that result in the public’s rejection of the currency, a collapse in the tax system and the government response of printing more money to fill in the confidence void. Ultimately the confidence void cannot be filled and the currency is fully rejected by the public in the form of hyperinflation.

In my treatise on the monetary system I discuss the importance of this unspoken agreement between the private sector and public sector:

“What backs these notes we created? What gives them value? Ultimately, these notes represent some amount of output and productivity. The notes in and of themselves have no intrinsic value, but serve as a medium of exchange that allows the citizenry to exchange various goods and services. The willingness of the consumers in the economy to use these notes is entirely dependent on the underlying value of the output and/or productivity and my ability to enforce its usage. The government cannot force its value on its citizens. The value of these notes is ultimately determined by the goods and services that are produced by the citizens and the value that other citizens are willing to pay for these goods and services. Therefore, government has an incentive to promote productive output. Otherwise, they risk devaluing the currency. Paying its citizens to sit at home doing nothing, buy cars they don’t need or purchase homes they can’t afford are unproductive forms of spending (sound familiar?). If government is corrupt in its spending and becomes an institution that is mismanaged and detracts from the private sector’s potential prosperity then it is only right that the citizens revolt, denounce the sovereign currency and demand change.

The United States Secret Service was in fact created specifically for this purpose – to protect the US Dollar. There is arguably, nothing more important to government stability than maintaining the value and faith in the sovereign currency. As long as an economy is productive, the sovereign nation can enforce the use of said currency, and as long as we don’t issue excessive currency there should always be demand for it. In other words, trust in the national currency is safe as long as the rule of law is maintained, corporations are productive and I maintain my ability to tax you. If my government becomes corrupt, spends well in excess of productive capacity or mismanages the economy then there is an increasing chance of currency collapse (hyperinflation). In essence, this occurs when the citizenry lose faith in the sovereign currency and slowly refuse to transact and produce in that currency.”

The users of the currency can always reject that currency. And I believe they should reject the currency if it is not being utilized in a manner that furthers private sector prosperity. This rejection occurs in the form of a collapse in the tax system. When the sovereign loses the ability to tax the game is up. This occurred in Russia in the 90’s, in several Euro nations in the 1920’s (no, Weimar was not the only country that suffered hyperinflation) and most notably in Zimbabwe in recent years.

A Historical Review

A quick review of the modern economic cases of hyperinflation show striking similarities. Most notably, they involved war (the losing end of a war), regime change or foreign denominated debt. All resulted in catastrophic hyperinflations.

(Figure 1)

But it’s important to note the cause and effect here. These hyperinflations were not merely monetary events. It was not just “high inflation” or excessive government spending. It was a full blown rejection of the sovereign currency. This is a dramatically different set of circumstances than a gradual increase in inflation or a consistent inflation. The citizens rejected the currency due to these exogenous events.

But why does the hyperinflation occur? As I mentioned above it generally occurs due to extreme exogenous events. Hyperinflations have generally occurred in nations with rampant corruption, war, productive collapse, or other extreme exogenous factors. The “money printing” that generally results is not actually the cause of the hyperinflation. It is merely the result of this exogenous event.

The Case of Weimar

The Weimar Republic is the most notable hyperinflation. But it was not the only case of hyperinflation that occurred in Europe at the time. In fact, several European nations were ravaged by the war, war reparations and regime changes that ensued. In the case of Weimar the country was already in a fragile state after Germany lost WWI. To add insult to this injury the allied nations demanded punitive war reparations resulting in foreign denominated debt. Mises elaborated on the insurmountable pressures this caused for Germany:

“The German government has no alternative way of covering its reparations obligations. It would have no success if it tried to raise the sums demanded by issuing bonds or raising taxes. Given the way matters currently stand with the German people, a policy of compliance could not count on the stand with the German people, a policy of compliance could not count on the consent of the majority if its economic consequences were clearly understood and they were not deceived as to its costs. Public opinion would turn with elemental force against any government that were to try to fulfill the obligations undertaken toward the Allied Powers completely.” (Mises 1923, p. 31)

In his excellent book, “When Money Dies” Adam Fergusson described how hyperinflation is more a psychological event than a purely monetary event:

“To ascribe the despair entirely to inflation would be misleading. Undoubtedly, though, inflation aggravated every evil, ruined every chance of national revival or individual success, and produced the conditions in which extremists could raise the mob against the state. It undermined national resolution when simple want might have bolstered it.

Money is no more than a medium of exchange. Only when it has a value acknowledged by more than one person can it be used. Once no one acknowledged it, the Germans learnt, their paper had no value. The discovery that shattered their society was that the traditional repository of purchasing power had disappeared and that there was no means left of measuring the worth of anything.

When life is secure, society acknowledges the value of luxuries, those enjoyments without which life can proceed but which make it much pleasanter. When life is insecure, values change. Without warmth, a roof, or adequate clothes, it may be difficult to sustain life for more than a few weeks. Without food, life can be shorter still. At the top of the scale, the most valuable commodities are water and air. For the destitute in Germany, whose money had no exchange value, existence came very near these metaphysical conceptions. It had been so in the war. In All Quiet on the Western Front, Müller died ‘and bequeathed me his boots—the same that he once inherited from Kemmerick. I wear them, for they fit me quite well. After me, Tjaden will get them: I have promised them to him.'”

In the above quote from “When Money Dies”, Fergusson was describing the depression that arose in the Weimar Republic in the 1920’s when they suffered their hyperinflation. The Weimar Republic was a war torn region with a government in turmoil. Economic upheaval compounded the problems as the war reparations from the Treaty of Versailles and the foreign occupation of the Ruhr placed severe strains on the Republic’s ability to prudently manage their domestic economy/finances. All of this combined to create a scenario that was highly unusual and combustible. German Financier Carl Melchior nicely summed up the situation in Germany in 1921:

“We can get through the first two or three years with the aid of foreign loans. By the end of that time foreign nations will have realized that these large payments can only be made by huge German exports and these exports will ruin the trade in England and America so that creditors themselves will come to us to request modification.”

Melchior was ultimately proven correct as the global economy collapsed in spectacular fashion in the late 20’s. But the hyperinflation was well underway when Melchior spoke these famous words and it was not solely due to the government printing presses, but rather a complex (and unusual) series of events that reduced private sector aggregate demand, shattered the public’s faith, led to extreme government intervention in currency markets and ultimately resulted in the failure in the national currency.

Severe (and unusual) exogenous circumstances lay the groundwork for the hyperinflation to begin, these severe (and unusual) exogenous circumstances initiate the cycle, severe government ineptitude furthers the hyperinflation, severe public mistrust exacerbates it and government ultimately completes the cycle when they desperately crank the presses in an attempt to flood the market with an unwanted currency. What’s important to note here is that the printing press exacerbates and ends the cycle rather than actually initiate it. What lays the groundwork for the hyperinflation is severe exogenous forces or a highly unusual environment that government responds to ineffectively or inappropriately.

So Weimar Republic was not merely a case of “money printing” gone wild. In fact, it was the regime change, fragile state of mind, foreign denominated debts and productive collapse that resulted in the excessive “money printing”, collapse in the tax system and hyperinflation.

The Case of Zimbabwe

The other often cited case of hyperinflation is Zimbabwe. This is another extraordinary circumstance. To call these events “rare” and “severe” is a vast understatement. Zimbabwe is an utter economic catastrophe. GDP has declined 40% since 2000, unemployment has risen as high as 95% and hyperininflation has ravaged the country. The issue is far more complex than I have the time or space to deal with here, but in essence, Zimbabwe has proven a highly inefficient and corrupt nation for several decades. This was another case of fragile emotional state due to rampant government corruption, regime change, productive collapse, foreign denominated debts and an eventual collapse in the tax system. The Mugabe government is one of the most controversial in the world and has proven to be financially incompetent. A former government minister of Rhodesia, Denis Walker nicely summed up the environment in Zimbabwe in 1989:

“Zimbabwe’s government, already morally bankrupt, will decline towards economic collapse.”

Like Melchior before him, he was proven correct. But unlike Germany’s war torn economy the Zimbabwean economy is a sad story of centuries of racist regimes followed by incompetent leadership. The situation in Zimbabwe has largely arisen from the controversial land reallocations which sliced up their largest export and domestic form of productivity into the hands of the agriculturally incompetent. As internal production of food collapsed the government was forced to rely on the kindness of strangers. The Grecian “beggar thy neighbor” policy began as Zimbabwe started to rely on foreign imports of food. Unemployment increased, civil unrest increased and the government lost control of its internal finances and the currency ultimately collapsed as the citizenry voted “no confidence” in the government currency. Allow me to repeat what I said above:

“Severe (and unusual) exogenous circumstances lay the groundwork for the hyperinflation to begin, severe (and unusual) exogenous circumstances initiate the cycle, severe government ineptitude furthers the hyperinflation, severe public mistrust exacerbates it and government ultimately completes the cycle when they desperately crank the presses in an attempt to flood the market with an unwanted currency. What’s important to note here is that the printing press exacerbates and ends the cycle rather than actually initiate it. What lays the groundwork for the hyperinflation is severe exogenous forces or a highly unusual environment that government responds to ineffectively or inappropriately.”

The Cause & Effect

What is consistent among cases of hyperinflation is a number of rare exogenous circumstances:

  • A ceding of monetary sovereignty (usually in the form of foreign denominated debt, a currency peg, etc).
  • Extraordinarily unusual social circumstances (loss of war, regime change, etc.).
  • Very low levels of faith in government during regime change (high public mistrust).
  • Rampant corruption.
  • A collapse in the domestic economy.
  • A breakdown in the tax system.

The most notable environments involving hyperinflations are war, regime change, government corruption and a ceding of monetary sovereignty.

Wars are particularly disruptive for a society for obvious reasons. Being on the losing end of a war is not only disruptive, but catastrophic. It’s not surprising that hyperinflations tend to occur in war torn nations because the tax system tends to fail when the citizens begin to question whether or not their government will exist in the coming years. Civil wars have tended to result in hyperinflation as the tax system collapses and the currency issuer continues to spend to finance their losing cause. The American civil war and the Confederacy is exhibit A.

Regime changes are equally disruptive. While they can be highly beneficial in the long-run regime changes have tended to coincide with hyperinflations due to the fact that a new government is greeted with skepticism. The uncertainty in such an environment is extraordinary. This was most notable following WWI when several regime changes in Europe ultimately led to hyperinflations.

Rampant government corruption is a highly destructive environment. A currency is based on an agreement between the public and private sector. If one party of this agreement is seen as corrupt the other party is likely to want out of the agreement. Zimbabwe is the modern day poster child of corruption and mismanagement of a domestic economy.

A ceding of monetary sovereignty is another primary culprit in hyperinflations. This is generally due to government incompetence (such as the current Euro arrangement), productive collapse or corruption. Notable cases include Argentina, Zimbabwe and the Weimar Republic. A ceding of monetary sovereignty via a pegged currency or accumulation of foreign denominated debt is a sure sign that a government is increasingly unstable and at risk of currency collapse.

Is Hyperinflation Coming to the USA?

While some of these ingredients exist in the modern day United States (to a very minor degree) I would argue that we are a long long way from experiencing the type of environment and downfall that is consistent with past hyperinflations. The most important aspects of currency collapse simply do not exist in the United States today:

  • We do not rely on the kindness of strangers (no foreign denominated debt).
  • We are not experiencing any sort of extraordinarily unusual social circumstances or severe exogenous forces (losing war, regime change, government corruption, etc).
  • We are not lacking confidence in the sovereign nation. If there is one thing that Americans are known for it is their resilience and borderline arrogance with regards to the strength of their country.
  • We are not experiencing a collapse in the domestic economy (not yet at least).

In sum, if you’re betting on hyperinflation in the USA I believe you’re effectively betting on the existence of a highly unusual and severe circumstance that happens to coincide with dependence on foreign denominated debt (of which there is none), an economic collapse in the United States (not happening yet), a dramatic decline in Americans’ confidence and ultimately the destruction of the world’s reserve currency. I do not believe that the current environment is consistent with the disorderly economic environments that are generally consistent with hyperinflations. Don’t get me wrong – we have big problems in the USA, but I think they are more manageable than many presume. Could the US government become corrupt and incompetent to the point of resulting in a rejection of the sovereign’s currency? Sure, but I don’t think that’s a very realistic outcome given the current environment. Thus far, markets have tended to agree with this as USA CDS remain among the lowest in the world and bond yields remain near their all-time lows.

Conclusion

In sum, hyperinflation is not merely high inflation. Hyperinflation is a disorderly economic progression that leads to complete psychological rejection of the sovereign currency. While government debts and deficit spending can exacerbate a hyperinflation they have not generally been the cause of hyperinflation, but rather the result of exogenous events. The excessive and incompetent monetary response is generally the result of severe exogenous forces at work such as war, regime change, corruption, or a ceding of monetary sovereignty.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Dan Dell

    really good stuff. fwiw, i would distinguish those that fear from 1970s-like inflation from the “hyperinflationistas.” i think that when discussing inflation nowadays, many tend to overstate their case for (or belief in)future inflation. many truly do not know the difference, but some who are really in the inflation camp just hyperventilate just enough to appear to be hyper-i prognosticators.

    btw, the 1970s help create such inflation partly through the mistaken belief that a little less unemployment could be traded for a little inflation. doesn’t the Fed use some iteration of the philips’ curve today? there is no way i can understand the evolution of the math that distinguish the traditional and modern forms of p-curves, but since you may know, i thought that i would ask.

    again, good stuff.

  • Dan Dell

    one more thing: it is also tough to differentiate between hyperinflationistas and those that believe in the inevitable demise of the dollar- it is an instrinsically overvalued currency, at least relative to asian currencies, generally speaking… different concepts obviously, but to the layman, whether it be reflected through Zimbabwean or lost purchasing power terminology, devaluation and inflation “appear” to be the same thing given the ultimate effect…

  • LVG

    This is a robust and impressive piece of work Cullen. Thanks for clarifying so much of the misconception out here.

  • Mkebe

    What was the cause of the Hyperinflation in Yugoslavia in the early 1990’s ?

  • LVG

    Civil war.

  • http://www.3spoken.co.uk Neil Wilson

    The inability to enforce taxation is key to all this. You could argue that the current Greek situation is more about the lack of taxation capacity than anything else.

    The other issue is destruction of productive capacity. Zimbabwe took a functioning agricultural sector and halved its output. You then get massive supply side inflation.

    I don’t know how much productive capacity of Japan has been destroyed by the current Tsunami. It may be too small relative to the rest of the economy to have an impact, but it will be interesting to see if you can detect any supply side restrictions that result in price rises of certain goods and service.

  • Non tax paying tea partier

    Cullen, you are clueless to what is going on. First off Warren Mosler’s examples of the currency having value he always says you are in a room with a guy with a GUN (irs man) and the only way to get out of the room his to get some of his business cards (currency) Now Warren is down in the USVI paying 3% tax rates, so he probably isn’t as mad as some people – how much tax are you paying Cullen?

    I just got back from a “save america” convention. Many people there are not paying thier taxes, they are not filing them either, richard hatch, tax cheat tim geithner, and wesley snipes are just the tip of the iceberg. There were police officers and sheriffs there who said they will not enforce US government laws and calling for nullification of many laws and letting state soveriegnty take over. Look up an organization called the “oathkeepers”

    There were military brass there saying if IRS agents come for our fellow citizens for non tax payment, they have special forces and military and veterans ready to defend non tax paying citizens and not let them be arrested.

    Judge Napolitano was there as well, and he also said it was time to do like 200 years ago with the founding fathers and if agents of the king start coming to your house to take your stuff, gonna be some gun battles. Really that you can be so Ignorant Cullen to the counter culture that is going on all around you of people not paying or even FILING thier taxes makes you a very uninformed fool.

    http://saveamericaconvention.com/

    There are too many to lock up by IRS agents, while all these other people are NOT paying thier taxes, you are the sucker that is – LOL! Even Warren only pays 3%.

  • Helix12

    Love your work Cullen. Could the next black swan or exogenous event be planet Nibiru, which is now very close to crossing our orbit. NASA calls it a comet and is named ELEnin (code for Extinction Level Event) & nin (code for Noah and story of the great flood). It is not a comet but a planet and orbits the sun every 3,600 years. By 31st October 2011 it will cause polar shift, result in Mt Edna, Mt St Helens, Mt Pele etc to erupt and when we catch the tail as it moves away will rain meteorites on us as foretold by the Bible, Edgar Cayce Saint Hildergard, Hopi Indians etc May God have mercy on our souls…

  • Adam

    Bill Mitchell recently wrote a blog on the inflation problems that plagued the Civil War South…

    http://bilbo.economicoutlook.net/blog/?p=13834

    He points to inability to enforce taxation and currency acceptance and non-industrialized region to support the output.

  • V

    Are you confusing the issues of prosperity brought about by technological innovation and mass production, with the issue of the currency losing x% of value?

    Isn’t it possible for technological innovation and productivity to occur, with money retaining it’s value, hence enhancing everybody’s wealth? Rather than inflation which effectively transfers wealth?

  • Mogens Tholstrup

    I the case of Zimbabwe’s hyperinflation, a decisive contributor was Mugabes distrubution of fresh bank notes to his veteran soldiers and other cronies. They were not tax receipts but a large unbalanced expansion of the moneytary base.

  • BK

    Great article Cullen, really excellent stuff

  • Greg

    Wow Cullen! Best piece you or anyone has written on this subject that I’ve ever seen.

    Thanks

  • Joe

    TPC, Thanks for the precise definition for hyperinflation. Precise definitions should allow for precise cures of economic problems but too often those in leadership lack precise, clear thinking; which leads them to prescribe the wrong cure for our economic ailments which brings us precisely to the confused economic state we are in.

  • The Dork of Cork

    Good article , Ireland is half way down this road although under the unique circumstances of the euro regeime.
    Our debt to a large extent is foregin based and private in nature(although a large domestic deposit base still exists).
    However it is denominated in the “domestic currency”.
    Very little private credit is being produced so the interest bearing debt is rising exponentially relative to a static or declining M3.
    Our “sovergin” debt is not expanding fast enough as the ECB has put us on a starvation diet here.
    People are losing confidence in domestic banks but less so the physical currency – this was precipitated by a withdrawal first of corporate deposits when the ECB decided to back off from their duty.
    (although confidence was shaken first by the nature of the bank bailout)
    Its not all bad however as the various vultures who relied on the banking spigot are also under pressure and cannot fly without the artificial updrafts that were created in the past.
    But does it not reduce a countrys liabilties when a corporation withdraws deposits and the Irish central bank fills the hole with unbacked fiat ?
    I have seen a interesting proposal that basically gets the ICB to create 200 billion or so and pays off the holders of Irish sov / private debt and we continue to pay the interest to ourselves via the Irish central bank over lets say a 100 year period (at least officially the equity of that Bank is owned by the state although I have my doubts that its culture has the interest of the state at heart.
    Anyhow what do you think of this proposal ?

  • KB

    Cullen,

    You would not argue that US is very different from all the above-mentioned examples. I would not discuss “Hyperinflations have generally occurred in nations with rampant corruption, war, productive collapse” – this is correct, and some would argue it’s happening here…..
    There are two key questions. First, how to quantify these negative developments in order to proclaim that here and now is the threshold after which hyperinflation starts. And, secondly, what are the agents of “complete psychological rejection of the sovereign currency”. You think it is citizenry. I am not so sure. In our specific case it might be failure of dollar to remain the reserve currency on sovereign/multinational corporate levels.
    And yet another important thing about hyperinflation – when it starts, it is way too late to try to get any protection against it….

  • Peter D

    KB, regardless of when it starts, the point is, the problem is not hyperinflation itself. Hyperinflation is just a reflection or a symptom of much deeper problems. It might exacerbate those problems, sure, but if you focus on fighting symptoms, then you’re missing the wood for trees.
    If your taxation system breaks, if your productive capacity rapidly shrinks, if your citizenry doesn’t trust the government anymore, then hyperinflation is almost a side show. You won’t be able to solve it without addressing the underlying issues.

  • dehbach

    I think you just won the internet.

  • El Viejo

    When I went to Scotland in the 70’s they had sodium vapor lights. We in the US still had mercury vapor. Yellow light was proven by B.F. Skinner to be the light of high contrast and the reason behind yellow fog lamps. Blueish light has lesser contrasting ability.

    To contrast one circumstance against the other is the best teaching method.

    Thanx

  • Mark

    OK Cullen – if every citizen of the US suddenly had an extra $1,000,000 (as Warren Buffet proposed), we would see NO increase in inflation? Really!?

    Milton Friedman was not referring to HYPERINFLATION, but rather the good-old-fashioned kind the US is so good at generating as we did in the 1970s – when we monetized massive amounts of debt. Sure glad we don’t do that anymore!

    By the way all you MMTers, where are your Nobel Prizes for economics? I know, I know, be patient. (They only hand them out for REAL achievers you know, like your current Prez.)

  • KB

    Peter,

    I am looking at this in very down-to-the-earth manner – I want to be protected and/or to profit in the case it happens. Thus, I am trying to identify catalysts leading to it, and early indicators showing increased probability of it.
    If it is a symptom of something else, then we need to identify this “something else”. Mistrust in the government is different from taxation system failure or from external debt issue. By the way, I know many countries with failed taxation system and pretty stable currency…..

  • El Viejo

    If a country’s population dynamics are mostly boomers in their 50’s with an average 401k of $89,000 and they were given $1,000,000 where would they put their money? What products would they buy? A bigger house? Fancier car? Or would they in uncertain times put it in the 401k or bank? Keeping interest rates low and driving stock prices up. Would too much money invested cause instabilities in the market? Would the economy look like Japan? Was Peter Peterson right in his book The Gray Dawn?

  • Peter D

    Mark, even under this proposal, you’d probably see a one time adjustment in prices. Inflation is a continuous upward trend. A one time adjustment doesn’t cut – yes, everything gets more expensive, but you have more money too.
    That said, nobody is saying give everybody $1M – any system can get out of whack with such unbalanced injections. What you need is enough to close the output gap. How much is enough? Nobody knows for sure, but you can start with lowering taxes (see Warren Mosler’s full FICA holiday) and initiating productive projects.

  • Misthos

    You left out one important factor that is involved in hyperinflation:

    Hyperinflation can only exist in a fiat monetary system.

    And please don’t make an assumption that I am pitching a gold standard, or austerity, or that the US will experience hyperinflation. Just please only address the point I made, that is, it can only take root in a fiat system.

  • Angry MBA

    Isn’t it possible for technological innovation and productivity to occur, with money retaining it’s value, hence enhancing everybody’s wealth?

    Do you like getting raises at work? My guess is that you do.

    Do your neighbors and coworkers like to get raises? I don’t know them, but I’ll bet that they do, too.

    That’s where most inflation comes from — it’s wage growth. Inflation is a reflection of our desire to get more. It isn’t possible to increase workers’ wages and avoid inflation simultaneously. In aspirational societies, people want their lifestyles to improve, and money is a way to both keep score and to motivate output.

  • Peter D

    KB, fair points. It is possible that enough people foolishly convince themselves, for example, that the US is broke and this triggers a collapse of the system, regardless of validity of MMT etc. That’s why the MMTers are trying to educate as many people as possible.
    I don’t know how to answer your question and I don’t think anybody does. If one hangs out with Tea Party or Austrians, one is liable to get a very differnet read on our political dynamics than one hanging out with the MMT crowd, say.

    “By the way, I know many countries with failed taxation system and pretty stable currency…..”

    Maybe. This is not a sufficient condition for hyperinflation, but I think a necessary one. Which countries are those, by the way?

  • Peter D

    It is true, maybe. Just as reaching speeds of 140 mph is only possible with a car and not a horse-driven cart. This shouldn’t be a reason to switch to horse-driven carts, shouldn’t it?

  • Mimiq

    I read this post and will read it again. As a citizen, not a finacial professonal, this explanation is cold comfort. Looked to me before reading we are in for rough weather. After reading this I can find only weak support for a positive outlook. I am also mortal so maybe my timeline is too short.

  • Angry MBA

    Hyperinflation can only exist in a fiat monetary system.

    The monetary component of the Weimar inflation was caused by the government printing more marks that it hoped to exchange for dollars, which it could exchange for gold that would be used to pay reparations.

    Ultimately, it was a combination of political pressure and the gold standard that caused the hyperinflation, as it served as an indirect currency peg for the mark, with which it could not possibly hope to keep up. If the reparations debt had been dominated in the local currency and/or could have been canceled via a default, there would not have been any need for hyperinflation.

  • wh10

    Where does the wealth transfer? If by and large inflation channels through rising wages, then it seems even if the dollar loses value, net wealth isn’t negatively impacted that much for those employed (most people). Kind of like a stock split.

  • Misthos

    Gold standards are not adopted by choice, as they represent limits on the sovereign. Gold standards have been re-introduced after a breakdown either in trading relationships, or currency destruction, or political upheaval, or a combination of factors.

    No country will voluntarily, ever, choose a gold standard. Thus, the debate on the adoption of a gold standard is moot. It won’t happen until the current system breaks down.

    What I have been focusing on in my comments here are the limitations of fiat, and the dangers that exist in a fiat system.

    True, a horse-driven cart won’t go 140mph – but would you rather crash in a car going 140 mph, or a horse-driven cart going at its max speed?

  • Angry MBA

    Where does the wealth transfer?

    Motivated workers are inspired to be more productive, which causes them to produce higher output (GDP) than they would otherwise.

    Conversely, if there was no wage-based inflation, workers would work less, which would result in slower economic growth.

    We can’t have our cake and eat it, too. We couldn’t possibly have had the greatest period of prosperity growth in the history of man without paying people wages that they could use to enjoy and partake in that prosperity.

    Money is like fuel — it is meant to be used, and doesn’t do you a whole lot of good if you aren’t willing to burn any of it. That doesn’t mean that you should use too much of it or assume that there is an infinite supply of it, but at the same time, the car isn’t going to go anywhere if you won’t use some of it.

  • Peter D

    I would rather use the car and make sure I am not going 140 mph. Gold standard and other pegged regimes are inherently inferior to fiat just as horse-driven carts are inherently inferior to cars. The fact that with more flexibility and power comes more potential both for good and bad is neither here nor there. You cannot stop progress this way.

  • Angry MBA

    What I have been focusing on in my comments here are the limitations of fiat, and the dangers that exist in a fiat system.

    Your comments illustrate the limits of a gold standard-based system. In the case, it was the pressure to convert the mark into gold that caused the hyperinflation, not the mark itself. You’re confusing the symptom with the cause.

  • Boston_AL

    Your inflation? My inflation? Everyone seems to have a definition for inflation,but what truly is the definition (cause) of inflation??

    Let’s look at what a real expert in this area has to say…

    “The True Meaning Of Inflation”
    John Tamny, 01.25.10, 12:00 AM EST
    Prices are NOT an accurate measure.

    Seeking to provide clarity as to the true meaning of inflation, the late Nobel Laureate Milton Friedman helpfully described it as “always and everywhere a monetary phenomenon.” At first glance Friedman’s definition is hard to improve on–from post-WWI Germany to the 1970s in the United States and modern-day Zimbabwe, inflation has always been a monetary symptom of collapsing currency values.

    The problem, however, is that Friedman was actually defining something quite different. In the monetarist model that he practiced, money growth beyond a pre-set point was inflation. Friedman’s point was that money quantities themselves always told the inflationary tale. But did they?

    The Federal Reserve is empowered by Congress to keep inflation in check, but its definition is even more wanting than the monetarist view. According to the Fed’s leading lights–including Chairman Ben Bernanke–inflation is a function of too much economic growth. This impoverishing definition is even easier to discredit than the monetarist description.

    In an increasingly interconnected global economy, shortages of labor and manufacturing capacity in any one country cannot be inflationary. They can’t because, as we’ve regularly seen with U.S. companies, they have always accessed the world’s supply of labor and capacity when producing the goods we buy. Even if we assume–as the Fed seemingly does–that the U.S. economy is closed the Fed’s definition still wouldn’t pass the most basic of scrutiny.

    Neither Labor, Prices nor supply and demand can accurately explain inflation. Only one thing can “GOLD”… ..and a currency’s value against it verses the same Government’s control of the currency printing presses.

    So what is true inflation? It seems the answer resides in the price of gold. Used as a money measure for thousands of years, gold achieved its purely monetary role precisely because its role in the productive economy is so minuscule. As a result, nearly every ounce of gold ever mined is still with us, which means gold’s real price is hard to alter thanks to a great deal of gold stock in existence relative to new discoveries.

    *** “When the price of gold moves, gold’s price isn’t moving; rather it is the value of the currencies in which it’s priced that is changing.” ***

    Gold is the objective indicator of inflation: When its price in any currency rises substantially, that means the unit of account is weakening and that we’re inflating.

    What does this mean for the economy? Broadly it means that when the dollar weakens such that the price of gold spikes, what is limited capital seeks safe-haven in hard, unproductive assets like gold, oil, art and property. Physical assets least vulnerable to monetary debasement win out over less tangible investments of the innovative or knowledge variety.

    Getting back to inflation, rather than a measure of prices that change for various reasons that have nothing to do with currency policy, inflation is at its core the painful process by which capital flows to the hard assets of the earth and away from innovative, wage-creating industries. As individuals we don’t so much hate inflation for the rising prices as much as we balk at it because our chances to capture good jobs and good wages are compromised for capital essentially hiding.

    As the rising price of gold has revealed throughout the decade we’ve been inflating, “no matter what the more quiescent government measures of consumer prices have been telling us. A weak dollar explains our economic unhappiness because a weak dollar is what has made capital disappear.”

    http://www.forbes.com/2010/01/24/inflation-prices-gold-standard-opinions-columnists-john-tamny.html

  • Misthos

    And many also blame the Great Depression on the gold standard while ignoring the massive credit expansion that preceded it. Murray Rothbard described this as the development of a fractional gold standard.

    Look, I am not pitching a gold standard for this discussion. I’m saying that it will happen one day when the current system breaks down. We can debate about the merits of any system, but in the end, systems are adopted due to geopolitical constraints, not as the result of research by egghead economists. The eggheads’ theories are chosen as a convenience after the fact, when a crisis needs to be addressed.

    The US ended Bretton Woods because it wanted to continue to overspend and overconsume. The debt for trade system that followed allowed the financialization of the US, and world economy. We’re only in the middle of the game, there are several more innings left.

    In the end, it will implode.

    This system is only 40 years old. It’s too early to celebrate this new found “evolution” of money.

    And so my argument, in a nutshell, is that the current system will not last. Not because there is something better out there, but because the current system allows imbalances to grow much faster and much bigger than any other system can.

    Here’s a question that I have posed many times before, and not one MMT’er will address it:

    Does a sovereign or more importantly, a banking system prefer a commodity backed currency with low seignorage, or an electronic fiat currency with high seignorage? Why? And what are the results of that?

    Can anyone please just answer that simple question? And then, think it thru to its logical conclusion. Because that’s where we are right now. Most don’t realize it yet.

  • Misthos

    But who’s really driving that car? Government is behind that wheel, and if the Government knows it can go 140 mph, I guarantee you, it will.

  • troll

    “…deficit spending and high government debt levels…[in most cases]… are the result of other exogenous events…”

    In case you haven’t noticed, our spending is out of control and our debt levels are straining to break the gravitational pull of the earth. According to you, this is a result, not a cause.

    If an exogenous event did not cause our government’s high government spending and debt levels, then what did? Or is it the result of endogenous events? And, if that were so, why didn’t you develope any theories involving these events? Or, is it possible that a new, insidious type of inflation has invaded our fiat monetary system? One that is perhaps built on a private sector debt level that cannot be balanced by an expanded governmental balance sheet?

    Maybe this time, things ARE different.

  • Angry MBA

    I am not pitching a gold standard for this discussion.

    I don’t understand the defensiveness. You posed a question and I answered it by telling that you are confusing symptoms with causes. I understand that this doesn’t match your thesis, but I obviously don’t agree with your thesis.

    The US ended Bretton Woods because it wanted to continue to overspend and overconsume.

    The US ended Bretton Woods because it required the United States to hand over an ounce of gold to foreign countries at a price of $35 per ounce, even though gold was worth more than this. The US ended Bretton Woods for the same reason that Starbucks doesn’t sell coffee for a nickel — it simply did not make sense for the US government to subsidize the sale of gold at massive discounts to foreign governments.

    Here’s a question that I have posed many times before, and not one MMT’er will address it:

    Does a sovereign or more importantly, a banking system prefer a commodity backed currency with low seignorage, or an electronic fiat currency with high seignorage? Why? And what are the results of that?

    I’m not an MMT’er, so I won’t act as one of their representatives.

    As for myself, the answer is: neither. Your question is a straw man, as it creates a false duality that does not exist.

    Commodity-based currencies don’t work, because they we can’t create commodities fast enough to make them work. The Industrial Revolution was the nail in the coffin of the gold-standard system, and in any case, a gold standard is the obsolete vestige of mercantilism, a system based upon colonialism that we were supposed to have scrapped over 200 years ago.

    The seigniorage argument doesn’t work, either, because the primary goal of a functioning monetary system is to motivate output, not to extract wealth from its citizens, per se.

    An MMTer would go further than I would, in that they would argue that taxation funds government at all, hence your point would be completely moot. I don’t personally buy that argument at all, so I’ll let them articulate that on their own behalf.

  • Angry MBA

    To correct a typo above, an MMTer would go further than I would, in that they would argue that taxation **does not** fund government at all. (Sorry about that.)

  • Peter D

    Government is who you elect. It is not some uncontrollable entity. Right now thee government wants to reduce its spending and thus kill the recovery. It is doing the opposite of what you’re saying.
    Most government spending is approved by majority of voters. There is some waste, especially having to do with wars and other defense spending. The healthcare is a separate issue facing the entire economy and is not driven by excessive govt. spending but by our broken system.

    Does a sovereign or more importantly, a banking system prefer a commodity backed currency with low seignorage, or an electronic fiat currency with high seignorage? Why? And what are the results of that?
    Can anyone please just answer that simple question? And then, think it thru to its logical conclusion. Because that’s where we are right now. Most don’t realize it yet.

    I say it is the opposite. If the electorate actually understood the monetary system and what the real constraints are, then we would be better protected fromt he current abuses of the system.

  • Peter D

    Troll, the government debt is the accounting offset of the non-govt sector’s desire to hold net financial assets. Most of the government spending is approved by the majority of voters.

  • Misthos

    “The US ended Bretton Woods because it required the United States to hand over an ounce of gold to foreign countries at a price of $35 per ounce, even though gold was worth more than this. The US ended Bretton Woods for the same reason that Starbucks doesn’t sell coffee for a nickel — it simply did not make sense for the US government to subsidize the sale of gold at massive discounts to foreign governments.”

    Bad analogy – Starbucks simply raised the price of its coffee, the US could have done the same with gold. But you also have the issue of Triffin’s Dilemma in a gold standard.

  • Peter D

    Angry, as I understand it, MMT does recognize that taxation funds government, but it doesn’t need to pre-fund it because a sovereign govt can always post-fund itself thru increased GDP or proactive taxation. The difference is like driving a car based on what you think the road conditions will be as opposed to driving according to road conditions as they occur.
    See Interest Rates and Fiscal Sustainability by Scott Fullwiler.

  • troll

    I don’t understand how that answers any of my questions. (Remember, I am an economic ignoramous who only asks questions that beg to be answered).

  • Angry MBA

    Bad analogy – Starbucks simply raised the price of its coffee, the US could have done the same with gold.

    By dumping Bretton Woods, the US government allowed the market to set the price of gold. Any other price would have been artificial, whether it was artificially high as it had been when the US dumped the gold standard in 1933-4, or whether it was artificially low, as it became by the late 60’s.

    I thought that free marketeers were supposed to like the idea of the market setting the price of things, rather than leaving that to the government. Bretton Woods wasn’t some noble market ideal, it was a necessary evil to cope with the aftermath of that mass destruction party we called World War II. By the late 60’s, much of the world had rebuilt itself, Bretton Woods had served its purpose, and it was scrapped when it outlived its usefulness.

  • Peter D

    Troll, you said “our spending is out of control”, and I say bullsh!t (it is actually not enough.) Our spending is what we as a nation want it to be.
    You said “if an exogenous event did not cause our government’s high government spending and debt levels, then what did? Or is it the result of endogenous events?”. I am not sure what is your definition of “exogenous” and “endogenous” here?
    Keep trolling :)

  • Misthos

    I’m not being defensive – it’s just that in the past, others have not addressed my concerns directly, and instead attacked the gold standard. I’m not looking for a lecture on gold, I just want to point out my concerns with the current system. No system is perfect.

    But I do appreciate your answers, though I don’t agree with everything. But I do agree with you that people should know and understand the system we have.

  • Dimm

    Here is why moderate inflation is a GOOD thing:

    1. The least intrusive way a government can encourage investment:
    If tomorrow the FED credibly promised 0% inflation, the capital will flow from low risk( bonds,CDs, savings, some stocks) to no risk (cash, checking or equivalents);

    2. Safety margin from deflation and its vicious cycle;

    3. It reduced the prior debt burden.

    “Hyperinflation is always and everywhere a psychological phenomenon” – Cullen Roche
    Absolutely. Imagine that US secretly prints 14 trillion dollars and keep them in a safe somewhere. Will that trigger a hyperinflation?
    Now imagine that the US announces that there are 14 trillion dollars printed and they will enter the economy in x amount of time.
    Which one will trigger inflation? The monetary or the psychological course of action?

  • Angry MBA

    As I interpret it, MMTer’s believe that taxation serves as a monetary management lever, not as a provider of funds per se. (That’s integral to their currency monopoly argument, which I also don’t agree with.)

  • Angry MBA

    I just want to point out my concerns with the current system. No system is perfect.

    All systems are imperfect. Personally, I think that we should borrow from Peter Drucker, who suggested that companies reinvent themselves periodically so that they could adapt to change, and do the same with economic systems.

    The reason that some of us get prickly about the gold standard because it has already proven to be a failure. Not only does it not work, but it can’t work – a modern economy is completely incompatible with a currency based upon an asset that cannot be produced as quickly as the economy grows. The internet goldbugs treat gold as if it is somehow impervious to human foible or corruption, even though it is inherently flawed and a recipe for massive deflation.

    The only reason that we would ever have a mass retreat to the gold standard would be if the world geo-political system imploded. And if that happens, gold and economic growth will be the least of our worries — at that point, we would be in such deep s**t that we’ll be more concerned about hoarding food and ammunition than we would about the nature of the money supply or economic esoterica.

  • Peter D

    But this is just a different side of the same coin. I use the word “funding” liberally. Basically, it is true that in MMT view that the govt could spend regardless of taxes. The problem would be ultimately if the economy did not grow sufficiently you’d get demand-pull inflation (and if it did – then there’d be no demand-pull inflation.) If inflation is to be avoided, then the govt will have to raise taxes. In that respect you can call it “post-funding”. The “magic” of MMT is that such post-funding is only contingent on your economy not growing enough.

  • Angry MBA

    But this is just a different side of the same coin.

    I don’t think it is, and I don’t think that they would, either.

    Those of us who are more traditional on this point believe that governments need to tax and/or borrow in order to fund spending. Spending is a need that is constrained by a nation’s ability to collect taxes or incur debt, which can be mitigated to a point by money printing, but only to a point.

    MMTers believe that governments don’t need to either tax or borrow in order to fund spending, because both spending and taxation are counterweights to private sector activity. They believe that the accounting identity offsets explain this, as they see public sector activity as a necessary balance to private sector activity.

  • Peter D

    “Those of us who are more traditional on this point believe that governments need to tax and/or borrow in order to fund spending”

    But you know that tomorrow we could pass a law that the Treasury can simply have an overdraft at the Fed, right? In that case at least for those next few periods it wouldn’t be true that “governments need to tax and/or borrow in order to fund spending”, right? So, operationally MMT is correct.
    You say is that it could do it “only to a point”. That’s right, to a point where you start getting unwanted demand pull inflation. In which case every MMTer starting with the “high priest” Warren Mosler would say that a tax hike or reduced spending is in order.

  • first

    “Inflation can and does occur in a perfectly healthy economy”? Sounds like saying fever can happens to perfectly healthy persons. Some·what healthy but not perfectly healthy. As long as the economy is in the “reaction-free period.” its nor visible. The squeeze between stagnant or modest consumer demand and higher material cost to business will start to show in the coming months.

  • Angry MBA

    But you know that tomorrow we could pass a law that the Treasury can simply have an overdraft at the Fed, right? In that case at least for those next few periods it wouldn’t be true that “governments need to tax and/or borrow in order to fund spending”, right? So, operationally MMT is correct.

    This isn’t on point. Those of us who hold the more traditional view believe that taxes are a **fiscal** phenomenon. MMTer’s believe that taxes are a **monetary** phenomenon.

    These views are fundamentally different. They lead Keynesians and MMTer’s to the same place during periods of threatened deflation, but they get there via a different path.

  • first

    A normal psychological reaction to an inevitable future consequence.
    The psychological effects only accelerate what would eventually happen.

  • Peter D

    “Those of us who hold the more traditional view believe that taxes are a **fiscal** phenomenon. MMTer’s believe that taxes are a **monetary** phenomenon.”

    Hm, I guess this is a nice way of putting it. But what are the practical differences? Under what circumstances do you see the difference bearing different outcomes in terms of policy?

  • troll

    Read the article. The second paragraph leads with a statement concerning causality that doesn’t make sense to me. If deficit spending and high debt are caused by hyperinflation (and not the other way around), then why do we already have high deficit spending and debt? If hyperinflation didn’t cause it, and all the listed exogenous events didn’t cause it, then doesn’t it stand to reason that something else caused it? And if something else did cause it, it is not theorized in this article what this something else is.

    I said I was economically ignorant – I didn’t say I was a moron. I think I have a valid question.

  • Angry MBA

    But what are the practical differences?

    During periods that aren’t deflationary, quite a few.

    The MMTer’s mesh today with Keynesians because of the disinflation/ deflation threat. But during good times, the MMTer’s sound a lot more like supply-siders, more interested in keeping government from interfering with growth than they would be in managing deficits.

    During good times, a Keynesian would build surpluses to prepare for future downturns, like squirrels storing nuts for the winter. An MMTer doesn’t worry about surpluses or deficits, per se, and therefore wouldn’t argue for paying down debt during the positive part of the cycle.

    During good times, a neo-Keynesian would borrow from monetarism theory and call for raising interest rates in an effort to control the money multiplier. An MMTer wouldn’t believe in the money multiplier or in using interest rates as a lever, and would keep rates permanently low.

    There’s more, but bottom line, they’re not really the same thing, and there are fundamental differences in the approach.

  • http://www.pragcap.com Cullen Roche

    Right. And wages are sticky for good reason. You don’t accept being paid in 2008 dollars for work that is now 3 years improved upon. Unless your talents are moving backwards you should demand to be paid higher for more productive work. So it’s not even remotely unusual for a productive economy to experience wage increases and modest inflation as a result.

  • http://www.pragcap.com Cullen Roche

    Sounds like corruption to me.

  • http://www.pragcap.com Cullen Roche

    DOC,

    I am honestly not familiar enough with the Irish economy to voice an opinion. Sorry.

  • Peter D

    Troll, the article says “In most cases they have been the result of other exogenous events such as ceding of monetary sovereignty, war, rampant corruption or regime change.”
    “They” refers not to deficits, as you seem to think, but to hyperinflations. I know the previous sentence reads “deficit spending and high government debt levels are not the actual cause of a hyperinflation”, and this may have confused you, but the next one starts with ” It is these exogenous events that result in the public’s rejection of the currency…”, which should have put you back on track.
    So, your question “If deficit spending and high debt are caused by hyperinflation (and not the other way around), then why do we already have high deficit spending and debt?” is based on false reading of the article. Of course you can have eficit spending and high debt not caused by hyperinflation.

  • http://www.pragcap.com Cullen Roche

    KB,

    I think the key to avoiding hyperinflation is to avoid these exogenous events. Don’t get involved in a war that you might not win. Don’t cede monetary sovereignty. Don’t allow govt to become corrupt. Maintain a healthy checks and balances on govt so as to avoid the potential of a regime change.

    In many ways, it is our responsibility to ensure that our govt does not corrupt our monetary system. We should end these ridiculous wars. We should hold our govt more accountable. We should end the Fed. Etc.

  • http://www.pragcap.com Cullen Roche

    Mark,

    If you read the piece you’ll notice that I said: “government has an incentive to promote productive output.”

    Can deficit spending lead to reduced faith in the currency? Sure. Unproductive spending most certainly can. If our govt is corrupt in giving money to bankers and other people who do not deserve it then people will begin to question that currency.

    I have noted this moral hazard on many occasions. Do I think it is destabilizing to the point of creating hyperinflation? No. But if it persists we are setting the foundation for a country that is going to demand real change at some point….people are tired of seeing the bankers bailed out and the losers winning. I am not saying that this sort of environment cannot lead to hyperinflation, but it would be a first. I think if we better understand our monetary system we can avoid this sort of corruption in the future and let these loser banks lose, etc.

  • Peter D

    Thanks, Angry. Yes, even during good times MMT would say that building surpluses is a dangerous thing. MMT views surpluses similar to unstable equilibria, where every little push will result in displacement. That’s because MMT believes that govt deficit offsets private sector’s desire to hold NFAs, so, proactively removing NFAs from the economy leads to private sector’s leveraging. MMT is not against running surpluses when economy overheats, but not for the purposes of “storing nuts for the winter”.
    Still, it seems to me that the difference is not between seeing taxes as funding spending vs. demand regulators. Because seems to me that even in your paradigm if you assumed that “winter” never comes, you would agree that surpluses are unnecessary. It is rather your belief that taxes might not be able to regulate demand in time and effectively enough that causes you to seek surpluses. Am I correct?

  • Angry MBA

    You don’t accept being paid in 2008 dollars for work that is now 3 years improved upon. Unless your talents are moving backwards you should demand to be paid higher for more productive work. So it’s not even remotely unusual for a productive economy to experience wage increases and modest inflation as a result.

    That’s right. What the Austrians completely fail to understand that unless we run trade surpluses, it is simply not possible to give a growing population increasing amounts of money without incorporating some amount of inflation.

    And of course, unless we start trading with Mars and Jupiter, there is no way for everyone on planet Earth to do that, as the world necessarily runs a trade balance net-net. If we’re going to live as we do now, exporting money every year in order to support our lifestyles, then that money to pay wages has to come from somewhere, and that somewhere is from the monetary system.

    The monetarists have figured out this need for modest inflation. Where the monetarists fail miserably is what to do on those occasions — like now — when we’ve hit the zero bound and nobody wants to lend (or borrow, depending upon how you look at it.)

  • http://www.pragcap.com Cullen Roche

    This is not really true though. Hyperinflation can and does occur in commodity based monetary systems also. Spain and Rome are notable cases. Remember, hyperinflation is essentially the death of the currency. It is a death of the regime in charge of that currency. Corruption was rampant in Rome when they devalued their money.

    This doesn’t mean fiat money is perfect. Far from it, but we have seen commodity based monetary systems fail for good reason. In most cases it involved a nation trying to defend its citizenry during war. And no matter what anyone says there is never a logical argument that justifies the belief that a country should not be able to defend itself just because it doesn’t have enough gold bars in its vaults….For instance, you might not have enjoyed the fiscal policy of the Confederacy during the American Civil War, but the truth is that they were willing to do anything and everything to win that fight. Even if it meant going bankrupt. Hundreds of thousands of deceased American soldiers clearly agreed and gave their lives for the cause they believed in.

  • Widgetmaker

    What an ignorant and irresponsible rant! People such as this might consider themselves as “patriots”, but what they are in essence are parasites on society, receiving the protections and benefits of what this country has to offer and refusing to contribute anything towards the common good. There is a lot of waste going on with the government, as there is within any large organization, but that is no excuse not to contribute. These are small minded people who have allowed their selfish greed to rationalize why they shouldn’t pay like the rest of us law abiding citizens.

    Taxes are the price we pay for a civilized society, and there is not a single developed country that has a tax burden significantly lower than that in the USA, so count your blessings. Tax cheats deserve to go to jail and in my opinion the government isn’t doing enough to enforce the rules. Why should I shoulder your burden? These so called tax protesters are pathetic and should find somewhere else to call home if they think they shouldn’t have to participate in the system. See how you like it there.

    God bless America.

  • The Dork of Cork

    Fair enough
    But check out this excellent blog if you have the time.
    Its from a guy named Lorcan Roche Kelly !

    It seems just a logical extension of existing policey withen the ICB

    http://blog.cornerturned.com/2011/03/14/big-picture/

  • troll

    Your point is valid if the word “they” is replaced by the words “hyperinflationary periods”. Thank you for the carification.

  • Angry MBA

    Because seems to me that even in your paradigm if you assumed that “winter” never comes, you would agree that surpluses are unnecessary. It is rather your belief that taxes might not be able to regulate demand in time and effectively enough that causes you to seek surpluses. Am I correct?

    In my case, no.

    I have my own heterodox views on things. The closest analogy is that I would liken government to being like a company — unlike a consumer household, a government is not a consumer per se, but more akin to a producer. Just as a company would issue stock in order to support its value, a government issues money.

    As would a company, a government is compelled to keep doing useful things in order to be successful, and like a company, it can use leverage effectively to fund growth, but only to a point. So debt is fine to the extent that it motivates output, but bad when it begins to crowd out output (which is certainly not happening right now.)

    My personal view borrows from the monetarists during good times (mission: temper inflation) and Keynesianism during bad times (mission: create growth where the private sector won’t), but with concerns for the extremes that can be created by the depths of bust cycles (think Mandelbrot and Fisher.) As a result, I end up overlapping with the MMTers to a limited extent, but I think all of these schools see money as being more of a tool for creating output than as a store of value.

    I am vehemently anti-Austrian and I loathe supply-side, as I see both of them as being more driven by politics than by economics. While the Austrians have a point in their concerns about credit, their approach to it is totally wrong, and I therefore feel compelled to reject it as vehemently as possible. And although I may borrow from monetarism, Friedman’s notion of inflation being strictly a monetary phenomenon is so clearly wrong and easily debunked by real world examples that it isn’t worth debating.

  • KB

    Well, I am just a humble investor. I am not involved in any war and would as a voter be against all the things you mentioned. And I am for ending the Fed! :)
    What I can do, though, on my humble level, is to protect my capital. So, after going to anti-war strike, I should get back to work and look for signs that hyperinflation might coming. The signs/catalysts you mentioned are quite good, although I am not sure about causation. They might be coincidental – say loosing the war because of lack of funds to finance it; or they might actually cause hyperinflation – a government rampant corruption and fraud to conceal huge losses of some banks, leading to loss in confidence in the government, leading to…..
    I think we both agree that there is no sings of hyperinflation now, and its quite unlikely for next one or two years. Let’s see what will happen then.

  • http://www.pragcap.com Cullen Roche

    I think you’re taking the comments a bit out of context. Most people look at hyperinflations and say that the high debt caused it. But that’s simply not true. In general, some other event caused these excessive debts and severe economic strains. War, regime change, corruption and a ceding of monetary sovereignty are the notable cases. It was not merely the money printing that causes it. Rather, the money printing is the result of a severe exogenous event.

    Are we suffering any of these events? No. We are suffering a Japan style balance sheet recession and our high deficit spending is necessary to counteract the deleveraging. This is a very important distinction and one that hyperinflationists have missed for years….

  • effem

    “Can deficit spending lead to reduced faith in the currency? Sure. Unproductive spending most certainly can.”

    It would seem to me the only market-driven way to enforce productive spending is to have a reasonable cost of funds (i.e., real interest rate). That rate is currently negative. The problem with unproductive spending is that you often don’t realize it at the time. I would argue that we are spending massive sums on projects with low ( or negative returns) – wars, much of our healthcare, etc. That can only go on for so long before it causes big problems and potentially a loss of confidence in your currency. We need to normalize interest rates immediately.

  • http://macronomy.blogspot.com Martin

    “What the Austrians completely fail to understand that unless we run trade surpluses, it is simply not possible to give a growing population increasing amounts of money without incorporating some amount of inflation.”

    Trade deficit is not important, look at Luxemburg or Switzerland…

    What matters is the current account deficit. A rapid depreciation of the current account has more serious implications relating to inflation than just a trade deficit.

  • Peter D

    “It would seem to me the only market-driven way to enforce productive spending is to have a reasonable cost of funds (i.e., real interest rate).”

    I think this is wrong. First, the govt should invest in projects with very uncertain or unquantifiable ROI because only it can do so. Second, even companies who face real cost of funds constraints fail all the time – so, having reasonable cost of funds is not a panacea and we don’t want a govt to fail. This means that you need other mechanisms, such as better educated electorate and political constraints. Third, if the govt behaved like a company then it would lose the ability to act countercyclically.
    You said “the problem with unproductive spending is that you often don’t realize it at the time.” Normalizing interest rates would not solve this inherent alternative. It would rather cause government to be either super conservative or super irresponsible.

  • Peter D

    Above I meant to say “Normalizing interest rates would not solve this inherent limitation.”

  • krb

    Cullen,

    Good piece.

    While “Non tax paying…..” may be extreme, I think your calm conclusion is also misplaced. The “cause” in this case, in my view, is coming directly from your list………
    “# Ineffective government response or rampant corruption. # Combustible political environment.”

    If interest rates were to begin rising the TBTF and politically connected banks would quickly become insolvent again, due to their breathtaking levels of interest rate sensitive derivative exposure. The exposure is so large, and Bernanke, Geihtner and OBama seem loathe to ever make them suffer the consequences of their silly bets, we are destined to pursue this strategy of artificial rate suppression for another decade……..protecting the guilty at the expense of the innocent middle and lower classes……making them even poorer with the strategy. Protecting the guilty at the expense of the innocent is corruption by any definition……why can’t we come out and call it what it is?

    The public is slowly becoming aware, it would be happening faster if our media wasn’t so captured, but it is happening. And the effects are beginning to be seen…….many countries are now conducting trade in denominations other than the US dollar in statistically significant numbers for the first time, states have begun taking action to protect themselves and their residents from federal financial activity for the first time. I fully expect the next steps by federal govt…..domestically, intervention to stop acts of self-protection, eventual heavy restrictions on or outlawing of state banks, outlaw conducting trade using precious metals, outlaw private ownership of precious metals, eventual requirement of 401k accts to hold some percent of govt.

    I don’t find the comfort you do in “Thus far, markets have tended to agree with this as USA CDS remain among the lowest in the world and bond yields remain near their all-time lows.” CDS costs and bond rates are only where they are directly because of the govt manipulation at the root of the corruption. To then cite those stats as evidence that everyone is still calm seems like shaky circular logic to me. Thanks, krb

  • http://macronomy.blogspot.com Martin

    “The US ended Bretton Woods for the same reason that Starbucks doesn’t sell coffee for a nickel — it simply did not make sense for the US government to subsidize the sale of gold at massive discounts to foreign governments.”

    This not accurate Angry MBA:

    Context of the Nixon Shock of 1971:

    “By the early 1970s, as the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. was running a balance of payments deficit and a trade deficit, the first in the 20th century.
    The year 1970 was the crucial turning point, which, because of foreign arbitrage of the U.S. dollar, caused governmental gold coverage of the paper dollar to decline from 55% to 22%. That, in the view of Neoclassical Economists and the Austrian School, represented the point where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits.”

    “In 1971, the U.S. government again printed more dollars (a 10% increase) and then sent them overseas, to pay for the nation’s military spending and private investments.”

    The privileged status of the US which was granted under the Bretton Woods arrangements, made it possible for the US to run a deficit that would never disappear while the dollar standard prevailed. Jacques Rueff, one of France’s greatest economist, concluded that this privileged status would inevitably lead(dollar standard and associated deficits) to a global economic crisis that would end in tears, an event akin with the Great depression. This is the situation we are currently going through.
    For Jacques Rueff, the only solution to remove the great current imbalances, would have been to reform the system and avoid a currency like the US Dollar to play the role of the world’s leading currency or any other currency.

    Both Rueff and Keynes did not want the US Dollar to be the prevailing currency. They both understood the risks.

    The United States has had the luxury of being in a position to avoid economic adjustments due to the status of the Dollar, in spite of its deficits for too long.

  • krb

    “…..eventual requirement of 401k accts to hold some percent of govt BONDS.”

    Sorry for not proof reading before sending! krb

  • http://www.pragcap.com Cullen Roche

    KRB,

    No offense, but whenever someone begins their argument with “If interest rates were to begin to rise”… it is clear that they are not connecting the dots and instead working from a false premise. Before we continue you must explain exactly why int rates will rise. That is the key to your argument so skipping over the cause nullifies your conclusion.

    See my point?

  • Vol Trader

    Cullen – awesome piece. Nicely done.

  • Vol Trader

    What luxury does the reserve status offer? Countries hold huge amounts of foreign reserves because we are the world’s largest exporter of currency. If countries want to hold reserves of dollars then that’s their decision. It is a function of their desire to save in US dollars – not some legal mandate.

  • Boston_AL

    Looking at Inflation with this understanding and relationship to GOLD, one quickly sees that (inflation | hyperinflation) in the USA has grown from a price of ~$550/oz five years ago to ~$1425/oz today.

    That’s in increase in the price of gold = ~159% !
    That equates to a compounded annual growth rate (CAGR)of ~25% over the past 5 years.

    Hyperinflation coupled with High Debt will indeed produce an economic scenario like the one Japan has ha for the past 20 years. Namely, a nearly no growth country economy. I suppose you have never been to Japan so you have no idea how expensive it is to live there? The average worker is not creating wealth for themselves as they are paying such high taxes just to keep the the kettle from tipping over.

    (See Gold Charts for multiple currencies: http://goldprice.org/30-year-gold-price-history.html)

  • Angry MBA

    That doesn’t contradict my point at all. The US government had maintained the same fixed price of gold for decades.

    When the $35 price was established under FDR, that was a nice price premium, which spurred foreigners to dump their gold in exchange for dollars.

    By the era of the Vietnam guns-and-butter deficits, the dollar had lost value while other western economies had rebounded out of their war losses, by which time that same price of gold had become artificially low. Given the low price of gold, it became more worthwhile to hold an ounce of gold than $35 in US cash.

    If your local supermarket had a sale on filet mignon for $0.25 per pound, you’d see a flight to steak now, just as we saw a flight to gold then. The US’s fiscal issues posed a threat to the dollar, but that didn’t changed the fact that gold at that price was a steal.

  • http://www.pragcap.com Cullen Roche

    Gold is not a measure of inflation. It is a measure of the outstanding investment perspective of that particular asset.

    Using this flawed belief that gold is a measure of inflation one would have also had to conclude that there was negative rates of inflation in the 80’s and 90’s. That’s clearly not true.

  • http://macronomy.blogspot.com Martin

    Vol Trader,

    “What luxury does the reserve status offer?”

    As I stated above, the luxury of running twin deficits without consequences at the expense of everyone else. It also offered the USA the luxury of being in a position to avoid economic adjustments for a very long time.

  • Vol Trader

    You’re not explaining your point. Just saying something doesn’t make it so. Can you tell us exactly how the reserve status awards the USA some great luxury?

  • Misthos

    I disagree. Spain and Rome had severe inflation, not hyperinflation. Rome’s denarius devalued over centuries, but it still had some silver content. A wheelbarrow full of denarii (sp?) in Rome would still be worth more than a wheelbarrow full of paper Deutsche Marks in Weimar Germany.

    In a true hyperinflation scenario, you have severe, successive parabolic devaluations. So severe in fact, that in theory, the silver content in a coin under Rome in a hypothetical hyperinflation would have been miniscule: .000001% for example – that’s hyperinflation. To me, that’s no longer a commodity backed system – that’s fiat, with a negligible microscopic trace of silver.

    But even then, using only coins (and not paper) can not create the circumstances for a hyperinflation. Think about why the US government has made it illegal to melt pennies. There is always inherent value in a coin, regardless of precious metal content.

    The parabolic devaluation in a hyperinflationary system is really a fiat phenomenon. And an electronic or paper one at that – that is, most of the currency is either paper or electronic and not coin.

  • effem

    Peter D,
    I agree that interest rates will not “solve” the problem of wasteful spending…there will always be some wasted spending. However your solution – “better educated electorate and political constraints” – strikes me as coming straight from some alternate universe. I have zero faith in the political process to ever produce intelligent outcomes.

    Many of the best companies invest counter-cyclically…and the best investors certainly do. Obviously ROI’s go up, not down, during crises. Second, I disagree that the govt should invest in anything with a negative ROI. However, I do agree that the ROI may be hard to calculate (but the private sector faces the same challenge and overcomes it).

    Sitting around and hoping that voters/politicians get smarter is not my idea of fixing things.

  • http://www.pragcap.com Cullen Roche

    I am not so sure about this. Over the period 218 to 268 A.D. the silver content of Roman coins declined to one five thousandth of its original level. But let’s not get off topic. The fact is, even in a pure commodity system there can be rampant corruption and misallocation of resources.

    But more importantly, I think we have to balance the pros and cons of fiat vs non-fiat. I think history proves that non-fiat places restrictions that lead to persistent recession or depression. The Euro is exhibit A of a single currency system at work and what it does to particular trade deficit nations. To me, that is case closed. We cannot and should not accept persistent depressions just because we claim that it offers price stability.

  • http://macronomy.blogspot.com Martin

    It does contradict your point Angry MBA:

    The reason why the system broke down, was that both France and Switzerland, were concerned about the money printing in the US to finance the Vietnam war. Both decided to call the US hand. In this huge poker game, these two countries called the bluff of the US and asked gold in exchange of US dollars, siphoning the US gold reserves at a very fast pace which . The agressive demands coming from France had been initiated by the advisor of General de Gaulle, Jacques Rueff.

    “Switzerland redeemed $50 million of paper for gold in July 1971. France, in particular, repeatedly made aggressive demands, and acquired $191 million in gold, further depleting the gold reserves of the U.S. On 5 August 1971″

    President Kennedy
    :
    “Efficient expansion at home, stimulating the new plant and technology that can make our goods more competitive, is also the key to the international balance of payments problem. Laying aside all alarmist talk and panicky solutions, let us 1961 State of the Union Addressput that knotty problem in its proper perspective.

    It is true that, since 1958, the gap between the dollars we spend or invest abroad and the dollars returned to us has substantially widened. This overall deficit in our balance of payments increased by nearly $11 billion in the 3 years–and holders of dollars abroad converted them to gold in such a quantity as to cause a total outflow of nearly $5 billion of gold from our reserve. The 1959 deficit was caused in large part by the failure of our exports to penetrate foreign markets–the result both of restrictions on our goods and our own uncompetitive prices. The 1960 deficit, on the other hand, was more the result of an increase in private capital outflow seeking new opportunity, higher return or speculative advantage abroad.

    Meanwhile this country has continued to bear more than its share of the West’s military and foreign aid obligations. Under existing policies, another deficit of $2 billion is predicted for 1961–and individuals in those countries whose dollar position once depended on these deficits for improvement now wonder aloud whether our gold reserves will remain sufficient to meet our own obligations.

    All this is cause for concern–but it is not cause for panic. For our monetary and financial position remains exceedingly strong. Including our drawing rights in the International Monetary Fund and the gold reserve held as backing for our currency and Federal Reserve deposits, we have some $22 billion in total gold stocks and other international monetary reserves available–and I now pledge that their full strength stands behind the value of the dollar for use if needed.

    Moreover, we hold large assets abroad–the total owed this nation far exceeds the claims upon our reserves–and our exports once again substantially exceed our imports.

    In short, we need not–and we shall not–take any action to increase the dollar price of gold from $35 an ounce–to impose exchange controls–to reduce our anti recession efforts–to fall back on restrictive trade policies–or to weaken our commitments around the world.

    This Administration will not distort the value of the dollar in any fashion. And this is a commitment.”

    Kennedy was committed not to distort the value of the dollar, when the US started printing money, France and Switzerland had no choice but to call the US bluff and exchange their depreciating newly printed dollars for gold.

    I quote you:
    “By the era of the Vietnam guns-and-butter deficits, the dollar had lost value while other western economies had rebounded out of their war losses, by which time that same price of gold had become artificially low.”

    Gold was not artifially low, the dollar was being increasingly depreciated. This is completely different.

    Kennedy added in his 1961 State of the Union Address:

    “Prudence and good sense do require, however, that new steps be taken to ease the payments deficit and prevent any gold crisis.

    …In short, whatever is required will be done to back up all our efforts abroad, and to make certain that, in the future as in the past, the dollar is as “sound as a dollar.””

  • krb

    Fair point Cullen. My base assumption is that fed interventions at the increasing levels it will take to have the same effect on depressing rates will eventually meet their forced political, or inflationary, end. On the other hand, are you arguing that rates can remain at zero in perpetuity? Or if not in perpetuity, then for the 5-15 years it will take for the derivative exposure to be mitigated? By the way, thanks for the education this site has provided me. Thx, krb

  • Don Levit

    PeterD wrote:
    Government debt is the accounting offset of the non-government sector’s desire to hold net financial assets.
    If that is true, can you provide credible statistics on the breakdown of those net financial assets?
    Or, is it only a desire, a dream, a wish?
    Don Levit

  • http://www.pragcap.com Cullen Roche

    Yes. I do think the govt can keep rates permanently at zero. The Fed has the power to control long rates in the same manner that they control short rates. They just need to name a target rate. This was the crucial flaw in QE from the beginning and it is why rates have only gone up under the program.

    If the US govt really wanted to keep rates low they would simply name the long rate and challenge bond investors to try to bet against them. And every time some big swinging dick from Goldman Sachs tried to move int rates higher the Fed would come in and slam their face against the concrete. After a few go arounds the traders would all learn their lesson and kneel at the altar of the Fed just like they do at the short end.

    You could argue that even under the current environment that Fed is still highly influencing the long end. After all, long rates are really just an extension of short rates. So, if inflation ticks higher it’s likely that the Fed will raise short rates and long rates will move accordingly. Currently, the market is expecting low inflation and no move from the Fed in the coming year and that’s why rates are near their all-time lows.

  • Peter D

    “I have zero faith in the political process to ever produce intelligent outcomes.”

    I think you and I are living on different planets then. As much as I am discouraged by a lot of what’s going on…
    But regardless – and sure we could go back and forth with examples supporting our views – if interest rates won’t solve the problem – to what extent you see them as mitigating the problem (without creating problems of their own)? Where do you see wasteful spending right now? Say, wars? Do you really think that high interest rates can prevent our country from going to war? Then we not only live on different planets, we live in different galaxies.

  • Angry MBA

    Gold was not artificially low

    Of course it was. We know this because when the price of gold was decontrolled, it went up.

    Gold was very attractive when the US government was essentially giving away large amounts of it. Artificial price caps have a way of driving up demand.

  • http://macronomy.blogspot.com Martin

    “You’re not explaining your point. Just saying something doesn’t make it so. Can you tell us exactly how the reserve status awards the USA some great luxury?”

    Vol Trader, the “dollar hegemony” meant to some extent a great luxury to the USA compared to the rest of the world, namely less volatility.

    Couple of points to explain the reserve status luxury discussed above:

    Free-Floating exchange rates of currencies made speculative attacks on many currencies a regular occurrence around the world (GBP, etc.). To prevent speculative attacks on their currencies, central banks must acquire and hold large dollar reserves.

    After the 1973 Middle East oil crisis, oil became denominated in dollars:

    “When oil is denominated in dollars through US state action and the dollar is a fiat currency, the US essentially owns the world’s oil for free. And the more the US prints greenbacks, the higher the price of US assets will rise. Thus a strong-dollar policy gives the US a double win.”
    Henry C K Liu
    http://www.atimes.com/global-econ/DD11Dj01.html

    Deregulation of global financial markets backed by the most important reserve currency in the world, the dollar.

  • http://macronomy.blogspot.com Martin

    “We know this because when the price of gold was decontrolled, it went up.”

    Angry MBA the reason why the price of Gold shot up was not because it was artifically low but because their was a strong lack of confidence in the US dollar. Gold’s only purpose is as storage of value. It is the devaluation of the dollar that caused the price of gold to go up.

  • krb

    I hear what you’re saying, but I think we’re dancing with each other a little bit. In my comments I started from the position that the fed wouldn’t be able to keep this up forever…..your paragraph 2 makes a reasonable argument that they could. But then your paragraph 3 seems to validate what I was saying……the fed interventions and zero rates will come to either a political end or inflationary end (your paragraph 3 scenario, if the political end doesn’t come first)…….timing we can debate, but an end to zero rates will come, in my view. No offense taken by the way, I enjoy the mature discussion. Thanks, krb

  • Vol Trader

    Less volatility? You’re not fooling anyone pal. The trade weighted dollar has gone from 75 to 120 to 75 in the last 20 years. That’s just as volatile as any other currency.

    The reserve currency status is a function of other nation’s desiring to save in US dollars. That’s it. There’s no great luxury in it. We’re just a huge economy with a huge trade deficit. If these other countries don’t want to trade with the USA then they don’t have to. If OPEC doesn’t want to keep sending oil to their largest customer then they can stop. But they won’t for obvious reasons and that means they’ll keep accumulating dollar reserves as a result.

    You’re acting like the reserve status is some legal mandate and not the result of natural forces.

  • Angry MBA

    Angry MBA the reason why the price of Gold shot up was not because it was artifically low but because their was a strong lack of confidence in the US dollar.

    If it was simple as that, then the dollar would have lost reserve status and we would be trading commodities with D-marks.

    That obviously didn’t happen. There was no complete abandonment of the dollar, not by a long shot.

    The price of gold was fixed for over three decades. Unless you think that there had been zero inflation for that period of time (and given the level of rising prosperity, that would obviously not be possible), then of course the price of gold should have been rising, just as did the price of just about everything else. Why should have gold remained exactly the same price that it had during the Great Depression when a loaf of bread or an hour of labor did not?

  • effem

    I do think higher interest rates could cause us to forgo wasteful wars, albeit not directly. Right now there is virtually no penalty for the borrow/spend/get votes doctrine. Yes, there is a bit of political pressure on the issue but hardly enough to change behavior. Plus, that pressure goes away every time there is a whiff of an economic slowdown. A reasonable cost of capital would impose some disclipine on the government as there would actually be a drawback to spending (higher interest payments). A living expample of this was the PIGS govt-expenditures post the Euro. As the euro brought down borrowing costs government spending exploded. And we are now finding out that way too much of it was wasted…shocking. The government should have to weigh pros/cons of spending…right now they only weigh pros because there are no cons.

  • http://www.pragcap.com Cullen Roche

    Good. Some people take my tone as condescending, but it’s hard to get tone across in text so my apologies if I ever sound like it. It’s not my intention.

    I agree that zero rates will end, but I tend to think they’ll end for reasons that inflationists disagree with. I think the Fed will raise rates when they are comfortable with the economic growth as opposed to some exogenous force moving rates higher against their will. So long as the Fed stays at 0% and the economy looks fragile I think the long bond will have a lot of trouble getting over 4%….

  • http://macronomy.blogspot.com Martin

    Vol Trader:

    “The reserve currency status is a function of other nation’s desiring to save in US dollars.”

    The dollar became a fully ‘fiat currency,’ backed by nothing but the promise of the US federal government, following the final collapse of the Gold Standard in August 1971. The dollar became therefore the sole backing of currencies as well as a reserve currency, meaning central banks had no choice but to hold dollars.

    “You’re acting like the reserve status is some legal mandate and not the result of natural forces.”

    Bretton Woods system was an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar. It wasn’t natural force to begin with.

    As Henry K Liu explained in the link I provided:

    “The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold.”

    Therefore, yes, less volatility for the US, the US having the privilege of issuing dollars, used by the rest of the world to buy things such as oil…

  • Adam

    Just curious, what are you including in your return on investment? Private and public returns?

  • Mediocritas

    I like to phrase it as: “Hyperinflation is always and everywhere a political phenomenon disguised as a monetary one”.

    Hyperinflation cannot be properly understood without “following the power”. TPC clearly understands this.

    Nice job CR and commentators.

  • Adam

    If 500 years of double entry bookkeeping are correct then it is a matter of accounting identity – meaning it must be so. If double entry book keeping is wrong then nobody knows what’s on their balance sheet for real.

  • http://www.pragcap.com Cullen Roche

    Oooh, that’s a better quote.

  • Angry MBA

    This guy is an Austrian. He’s going to “predict” inflation every day of the week, except on those days that don’t end with a “y”.

  • Adam

    @ Martin…

    “The dollar became therefore the sole backing of currencies as well as a reserve currency, meaning central banks had no choice but to hold dollars.”

    NO Central bank is FORCED to hold dollars, that is why we have FOREX markets. They can sell their dollars for any other currency they want.

    “Gold was not artifially low, the dollar was being increasingly depreciated. This is completely different.”

    Why do so many people get so hung up on nominal values. Who cares if the value of the dollar is depreciated against any single commodity (that’s a failing of any commodity currency). Did not and has not the purchasing power of parity and the real outputs of the US economy grow? Do American’s now (or when the US closed the gold window) live better lives on whole? Everyone wants to complain about the US and the value of the dollar declining without even complaining about EVERY OTHER fiat currency out there? Give me a break!

  • http://macronomy.blogspot.com Martin

    “Why should have gold remained exactly the same price that it had during the Great Depression when a loaf of bread or an hour of labor did not?”

    Angry MBA: Real Bill doctrine.Gold did not remained at the same price during the Great Depression – Franklin Roosevelt raised the dollar/gold price to $35 per ounce from $20.67 by executive order in 1934.

    The Great Depression was not caused by the Federal Reserve making dollars scarce relative to gold.

    “Money, in its simplest form, is non-interest bearing debt of the government. To acquire more money, economic actors give up “goods” or “assets,” which is why gold and sensitive commodity prices react first to changes in the demand for dollar liquidity.”

    “The central function of money is to have as a standard unit of account. The decline in a standard reflects not its rise or fall in value but its deteriorating stability, credibility, and constancy.”

    “Inflations and deflations only can be understood as process phenomena. When President Franklin Roosevelt raised the dollar/gold price to $35 per ounce from $20.67 by executive order in 1934, the general price level took two decades to catch up with gold. This is because contracts had to unwind in a gradual inflationary spiral between capital and labor. When the debt structure of an economy is mature, it takes a long time for the process to be completed. The same is true of deflation.”
    Jude Wanniski –
    http://www.nationalinvestor.com/Experts–Wanniski.htm

  • http://deleted Don Levit

    Adam:
    I had a feeling you or PeterD would cite the formula.
    With total debt of $14 trillion, we know that over $4 trillion of that is debt the government owes itself.
    There are probably some other shenanigans going on where a separate buyer and seller are not matched up, particularly if we’re creating money out of thin air.
    Don Levit

  • jt26

    Nice piece. Really, you should write a book (you could call it “Too Simple for Congress to Understand”).

    re: controlling rates at the long end.
    You’ve stated your disdain for QE2 as well as emphasizing it’s ineffectiveness in reducing long rates. But, you also say here that the government can control long rates.
    So,
    – why did the Fed fail with QE2? Was it really just commitment? Why would the Fed be so half-hearted in moving long rates down via an announced target?
    – why doesn’t the Fed manage the whole yield curve more (historically); or what’s so special about the short end? The corollary, would be managing duration …
    – why have more or less TIPs issuance in MMT, and why not QE2 that as well, to influence inflation expectations?
    Cheers.

  • http://www.pragcap.com Cullen Roche

    Hi JT,

    The Fed did not announce a target because I think they really thought a quantity for QE2 would suffice. I also think they were scared about the ramifications. Announcing an open ended QE has unpredictable consequences. Nonetheless, we’ve seen the consequences in the form of this crazy speculative ramp in all assets….

    As for managing the whole curve – good question. I don’t know. For some reason it appears politically acceptable to control the short end and not the long end. You know, the long end is where the “free marketeers” play their games so God forbid we intervene in the “free market”. Some people (austrians in particular) recognize the hypocrisy in these actions and have correctly called for it to end. I fully agree. The Fed should just get out of the int rate setting game altogether. They’re not good at it.

    I am not sure that more or less TIPS would really matter. It’s all just a reserve drain to help the Fed hit an overnight rate. The form of the debt issuance matters little. It could be a 1 month tsy for all I care. The most realistic change to the current system is likely to merge tsy and Fed, set short rates permanently at 0% and allow the market to set long rates. It would be a fairly subtle difference, but the primary difference would be that we end the FOMC and their ridiculous meetings, end Fed commentary and its impact on markets and essentially let a computer system play the role of Fed Chief.

  • Angry MBA

    Franklin Roosevelt raised the dollar/gold price to $35 per ounce from $20.67 by executive order in 1934.

    That’s right. FDR did that in order to kill off the gold standard, by replacing overseas gold stores with dollars.

    This goes back to what I said — when the gold price was initially set at $35/oz, it was above market. By the time that Nixon closed the gold window, it was below market.

    During that same period, the buying power of a dollar fell 2/3rd’s, but US GDP had expanded six-fold. The trade off for economic expansion was a bit of inflation.

    Unlike everything else in the economy, the price of gold had not been allowed to float, because of Bretton Woods. Once the price was decontrolled, the price corrected to its market value.

    Had Bretton Woods fixed the price of a can of Coke, we would have seen a similar phenomenon. When goods are kept artificially cheap, it isn’t surprising what happens to demand.

  • krb

    While you’ve been critical of the fed, I suspect you still hold them in higher regard then I do…….”I think the Fed will raise rates when they are comfortable with the economic growth ……”

    My version would be….. “the fed will raise rates when they are comfortable that the TBTFs have sufficiently distanced themselves from rate sensitive derivative exposure….” And until that day comes, we can expect to NOT have sustainable economic growth….because of the amounts of financial support that has been and will be diverted to the TBTFs, as well as the unbalanced legislative support, govt measures, etc that continue to be provided, and the distrust it spawns.

    Are you familiar with the levels of TBTF interest rate derivative exposure? I have seen some breathtaking numbers. And it is the basis of my belief that our current fed strategy is only an economic growth strategy to the extent they believe the economy tanks if the TBTFs go down on even a slight interest rate rise……this is all about keeping them afloat, in my view. And the exorbitant level of resources (approaching $4 trillion) directed at that effort instead of more productive activity will keep us in this on-going malaise until it stops.

    It is my belief, unfortunately anecdotal at this point because we can’t get anyone to seriously debate it, that if that level of support were directed at insulating the rest of the economy from the fall out of a dissolution of the TBTFs, and all gimmickry in accounting standards, govt stats, etc we now allow were to be removed to restore transparency and trust, we would be pleasantly surprised at how rapidly the remaining parts of our economy would begin growing again, providing us a chance to grow our way out of some of the other imbalances that still need correcting. What we currently call “growth” is a complete fiction; in an environment where asset values, interest rates, inflation rates, unemployment rates, etc. are simply pulled out of thin air to perpetuate some other myth we are encouraged to believe. Bernanke and Geithner, having been party to the TBTF vulnerabilities arising in the first place, will forever stand in the way to considering alternate routes to recovery.

    I think the debates between Austrians, Keynesians, MMTers, etc are futile exercises because none of them will ever be purely practiced……..which of those theories captures the diversion of $4 trillion to prop up a very small percent of the total population or economy because they are politically connected? So it just allows them all to claim their theory didn’t fail, because it was never completely tried……and would have succeeded had it been tried. Sorry to vent after your respectful responses, but its frustrating to watch from out here in the real world. Thanks for your discussion forum, krb

  • http://macronomy.blogspot.com Martin

    “Who cares if the value of the dollar is depreciated against any single commodity?”

    Ask Joe Six pack if he cares having to fork more dollars to fill up his SUV…US average price for gas is now 3.556 USD per gallon.

    Gasoline prices since last August in the US have gone from 2.65 USD per gallon to over 3.556 USD per gallon. 50 Billions USD hit for the already struggling US consumers.

    “For example, in late 2010 consumer fuel expenditures amounted to 9.1% of wage and salary income. In the past year, the S&P GSCI Energy Index advanced by 14.6%. Since energy demand is highly price inelastic, it seems there is little alternative to purchasing these energy items. Thus, with median family income at approximately $50,000, annual fuel expenditures rose by about $660 for the typical family. In late 2010, consumer food expenditures were 12.6% of wage and salary income. In the past year, the S&P GSCI Agricultural and Livestock Commodity Price Index rose by 40%. If we conservatively assume that just one quarter of these raw material costs are ultimately passed through to consumers, higher priced foods will have added another roughly $626 per year of essential costs to the median household budget.”

    Van Hoisington and Dr. Lacy Hunt.
    http://www.hoisingtonmgt.com/pdf/HIM2010Q4NP.pdf

    Who cares right Adam?

    “Do American’s now (or when the US closed the gold window) live better lives on whole?”

    Yes Adam, mostly thanks to FED President Volcker, breaking the back of inflation at the beginning of the 80s…

    Do you remember the decade of Stagflation in the 70s?

    Adam, I am not complaining about fiat currencies out there, I was discussing with Vol Trader and Angry MBA, the dollar hegemony and what it meant for the US in general and the rest of the world in particular.

  • Angry MBA

    Perhaps the goldbugs amongst you could explain something to me:

    Assuming we moved to a gold standard and eliminated fractional reserve banking, I’d like to hear how we’re supposed to support $75 trillion in annual global GDP and a 2-3% average annual growth rate, when the total amount of gold in the world is worth less than $15 trillion.

    To put it another way, in order to make this gold standard system work, I’d have to convince the world’s producers to cut their prices by about 60% which presumably means that everyone (except me, of course) is going to have to take about a 60% pay cut.

    I would like to hear exactly how you’re going to do that.

  • Angry MBA

    I should have also mentioned that the world’s gold supply lags economic growth rates (it’s about 0.5% per year). So I’d also like to hear how we’re supposed to encourage economic growth, when the anticipated expansion in the gold supply can’t create enough gold to pay for it.

  • http://macronomy.blogspot.com Martin

    Angry MBA first FDR made it illegal for Americans to own gold: Executive Order 6102 then raised the price of gold to 35 USD an ounce. The resulting profit that the government realized funded the Exchange Stabilization Fund established by the Gold Reserve Act in 1934.

    The limitation on gold ownership in the U.S. was repealed effectively on December 31, 1974 by President Gerald Ford.

    “The trade off for economic expansion was a bit of inflation.”

    A bit of inflation: Inflation reached 13.5% in 1981.

    “When goods are kept artificially cheap, it isn’t surprising what happens to demand.”

    When there is loss of credibility in a currency you can have inflation, and when you have total collapse of trust in a currency, you can then have Hyperinflation.

    Gold went up not because of demand but because of a loss of credibility in the US dollar. Gold’s acts as a storage of value. When Volcker succesfully crushed inflation, Gold fell rapidly from its height of 850 USD.

  • Angry MBA

    The resulting profit that the government realized funded the Exchange Stabilization Fund established by the Gold Reserve Act in 1934.

    It’s frankly hilarious that you would view the government has having made a “profit”. The US government doesn’t need to sell gold to get dollars, they can just print them.

    But for another thing, you completely miss the point: the US government was buying gold for $35 when it was worth at that time about $20. The US government was deliberately overpaying for gold, in order to stop others abroad from hoarding it.

    The FDR plan was designed to kill off the gold standard in overseas markets. Guess what — it worked.

    A bit of inflation: Inflation reached 13.5% in 1981.

    You do realize that 1981 occurred after 1971, don’t you? (Take notice of the time period that we were discussing.)

  • Angry MBA

    That gave me a chuckle.

    I just don’t understand how anyone can make this “profit” argument with a straight face. If Sam pays Dave $15,000 for a car that is worth $10,000, why would anyone think that Sam is making a profit on that? Shouldn’t it be obvious to everyone that it’s Dave in this example who is the one who is scoring big, and that it’s (Uncle) Sam who is doing Dave a favor, not the other way around?

  • Gerald P

    The military “forces” and police will not have any income if the taxes are not paid. Then what do they accomplish?

  • http://macronomy.blogspot.com Martin

    The dollar was devalued from 20.67 USD per troy ounce to 35 USD per troy ounce. By doing this, the Treasury saw the value of their gold holdings increased overnight.

    FDR was constrainted by the Gold Standard. He could not simply print dollars at the time because they needed to be backed by gold. By making it first illegal to detain gold, then by devaluing the value of dollars versus gold, he instantly made a profit.

    Inflation was at 3.36% in 1971
    Inflation rates were below 4% at the start of 1973, but reached 9% by the start of 1974 to peak in 1981. Inflation was unleashed following the Nixon shock of August 1971.

  • Angry MBA

    The dollar was devalued from 20.67 USD per troy ounce to 35 USD per troy ounce.

    You really don’t follow at all what happened.

    The $35 price was set arbitrarily high to pull gold out of the hands of overseas markets. At that point, there was no gold exchange — the US was swapping out dollars to take gold in, expressly so it could sit in a vault and do a whole lot of nothing.

    There was no profit — the government paid too much for it, and there was no market in which to sell it!

    The whole thing was engineered to remove gold from the economy and to disconnect from currencies. It worked — the gold standard disappeared throughout the world, and hasn’t been seen since.

    The problem was that the US government continued to honor the $35 price long after the FDR era. In effect, every currency in Bretton Woods was pegged to gold, and the holders of foreign currencies were able to get too much gold for their money. When Bretton Woods was ended, that fantastic discount at Uncle Sam’s gold emporium disappeared with it.

    If you earnestly believe that the US government earned a profit on overpaying for gold, then you really don’t understand it at all. If $35 wasn’t an attractive price to holders of gold abroad, then there wouldn’t have been any takers, which should make it obvious that the $35 price was simply a tool used by FDR to pull the gold out of the world market and into the US, not a means of creating a profit for the Americans.

  • Angry MBA

    To correct (another) typo: In effect, every currency in Bretton Woods **except for the US dollar** was pegged to gold…

  • http://macronomy.blogspot.com Martin

    “The whole thing was engineered to remove gold from the economy and to disconnect from currencies.”

    The Secretary of the Treasury’s regulations prohibited during FDR’s tenure prohibited banks from paying out gold or gold certificates or permitting any withdrawals of currency for hoarding purposes.

    Thanks for asking Angry MBA, I do follow what has happened.

    The USA in 1971, were in the same situation Great Britain was in September 1931, they could not maintain the Gold Standard, due to economic difficulties stemming from their deficits.

    “the $35 price was simply a tool used by FDR to pull the gold out of the world market and into the US.”

    Nope, it was to prevent the gold from leaving the US and making sure Banks deposits increased as well so that they could borrow against these assets from the Federal Reserve banks. With less and less gold, the USA on the gold standard would not have had enough backing for credit to industry and agriculture to enable the USA to restart its economy.

    In 1931, Great Britain suspended convertibility of Sterling into Gold. Putting additional pressure on the US Gold reserves. Their Gold reserves had already fallen from 44.4% of World reserves to 35.9% in 1931. France were the biggest beneficiary with their percentage of Gold world reserves increasing from 8.2% in 1923 to 23.9 in 1931. At the same time Gold reserves in Great Britain fell from 8.6% in 1923 to 5.2% in 1931.

    The US had no choice but to suspend Gold exports. They set up capital control and devaluated from 20.67 USD to 35 USD.

    Bretton Woods fixed the value of the dollar against gold at 35 USD an ounce.
    The post-1971, dollar-based monetary system allowed the US to issue dollars and never have to redeem them in gold.
    At first, the inflation caused by the build up of dollars was pleasant.It reduced the cost of labour. Between 1974 and 1984, real wages fell as much as 30%. That’s what inflation did.

    “the $35 price was simply a tool used by FDR to pull the gold out of the world market and into the US, not a means of creating a profit for the Americans.”

    When you confiscate gold at 20 USD and devaluate at 35 USD soon after effectively it is not to create a profit for the Americans. But if you managed to confiscate assets and then devaluate, given the monopoly of issuance of dollars for the Central bank, suddenly your gold reserves in dollar terms look much better.

  • first

    “the gold supply can’t create enough gold to pay for it’ and the fiat system tends to create to much paper to pay for it.

    Practically speaking Gold is to be purchase with paper currency not the other way around but it only works as long as its a “valuable” paper.

    Its all about discipline as to the quantity the alchemist Gods are printing as a ratio to GDP.

    Some do think that Gold forces discipline since it can not be printed but that does not make sense since a commodity such as Gold is only one of several products of an economy. It’s a strange measure that is not finite and can be more or less abundant as a natural resource from country to country. This is the case for oil for example but we do use oil and transform it every day for productive function. Gold is mostly passive and stored at a cost. This would be like paying to have our medium of exchange.

    Paying once is enough. The idea that money as no intrinsic value seams to scare some people. They do not appreciate that the value of a medium is in the quantity of goods it can purchases and not in the medium’s own valuation.

    Think of it this way. When you purchase shares of a public corporation are you worried that the paper certificate is not Gold or are you looking at the underlying valuation of the shares.

    That is why ideally a modern currency needs to have the least possible valuation wile maintaining the best purchasing power.

  • Peter D

    Don, it is true, but in my comment I used a somewhat ambiguous phrase “non-government sector’s desire to hold net financial assets.” this desire is not directly observable. At each period the total govt debt outstanding is by definition the non-govt total holdings of NFAs. You’re right that a large portion of debt is held by the govt itself. Ignore that debt and concentrate only on real debt held by the public and the foreigners. This should be somewhere in $8T out of total $14T, if I recall correctly. Now, it is possible that the non-govt sector desires less or more of the NFAs to hold. To find out you’d have to watch demand-pull inflation. If it starts picking up, this means the planned or desired holding of NFAs is less than actual – in other words the govt just overspent or undertaxed. A lot of fiscal correction can be done via automatic stabilizers, such as transfer payments, Job Guarantee programs and inflation-targeting taxation.
    On statistics on Govt debt – I am sure there are links on the internet, but I like The Levy Institute brief “Deficit Hysteria Redux” very much, even though it is slightly more than 1 yr old. Go to page 6 for some breakdown.

  • Angry MBA

    The USA in 1971, were in the same situation Great Britain was in September 1931, they could not maintain the Gold Standard

    That would be an interesting point, except that the United States didn’t have a gold standard in 1971.

    What the US had between FDR and Roosevelt was a program to buy and sell gold to foreign governments at the price of $35 per ounce, irrespective of how much an ounce was worth. As a result, it grossly overpaid at the beginning of the program, and was giving the stuff away toward the end.

    Nope, it was to prevent the gold from leaving the US and making sure Banks deposits increased as well so that they could borrow against these assets from the Federal Reserve banks. With less and less gold, the USA on the gold standard would not have had enough backing for credit to industry and agriculture to enable the USA to restart its economy.

    You’re talking in circles. The US exited the gold standard under FDR and wanted to eliminate the ability of gold to serve as a substitute currency. The US was dealing with a depression and wanted there to be money velocity, not gold hoarding. Nobody is arguing about the US government’s motivation to support a dollar that didn’t have gold attached to it — it’s a bit obvious to everyone, I would hope.

    But if you managed to confiscate assets and then devaluate, given the monopoly of issuance of dollars for the Central bank, suddenly your gold reserves in dollar terms look much better.

    If it was a simple matter of inflation, as you would like to believe, then the US couldn’t have used a $35 price to turn gold holders into dollar holders.

    Between this and your reserve currency argument, you don’t seem to comprehend that some people like to use and hold dollars. If they didn’t like dollars, they use an alternative. I suppose that you may be hoping for the euro to serve in that role, but if so, I wouldn’t hold my breath.

  • Peter D

    I don’t know a lot about PIIGS, but was it the Euro that caused the wasteful spending? As far as I know they went on a credit binge as much as we did and found themselves unable to adjust to recession, because they surrendered their monetary sovereignty. Regardless, we don’t have much wasteful spending in the US. That we do is a myth perpetuated by deficit scaremongers. Every time anybody tries to identify this oh, so wasteful spending they end up with some crumbs here and there. Here, for example, the conservative Heritage Foundation is shutting down pretty much the entire federal government (except for Department of Defense, naturally) and managing to cut only about $300bn or less than a quarter of the deficit. And this does not take into the account what would happen to the economy if all those cut were implemented. When Mike Norman went on Fox Business, the best Varney could do to indict the stimulus package was 72000 dead people and 17000 inmates receiving $250. This is what, 22 million out of 800 billion? 0.003%? Find me another program less wasteful than this.
    The problem of wasteful spending is political. The governments will restrain their spending only insofar as they are concerned about achieving their political agenda. I bet you there was never a war or other stupid adventure avoided because a govt was concerned about fiscal ramifications. But if you follow out latest adventure in Lybia, the only reason we’re as timid as we are is not because we care about shooting hundreds of missiles $736,000 each, but because the political fallout from the Iraq war is still with us.

  • V

    Why couldn’t the alternative be that a job pays what it pays, and over time the cost of goods and services decreases at say 3-5%?
    Sure you’re not getting a nominal pay increase but in real terms you are.

  • JWG

    Very educational thread; my head is still spinning. The only thing I can say is that although MMT “works” operationally and the sectoral balance analysis “works” from an accounting perspective, MMT-ers might discount too heavily the possibility of a sudden loss of faith in the dollar that leads to a huge increase in velocity, a currency crisis and major inflation, although clearly not Weimar level inflation. Think of 25%-30% headline CPI instead, in a short period of time. This shock could be exogenous. The fall of the House of Saud in an Islamist tide and a radical repositioning of Middle Eastern energy markets is one hypothetical.

    An infinitely elastic fiat currency is only as good as the people running it and the economy supporting it; it’s a matter of faith and mass psychology. Right now, the people running the Fed and Congress are errand boys for the TBTFs and the US economy supporting the dollar has deep structural problems that are being papered over by the Fed and Congress without any fundamental plans for economic reform or restructuring. It appears and “feels” unsustainable, and sometimes perception is reality in the markets, regardless of operational realities and accounting identities.

  • Peter D

    As far as I know the inflation in later 70s was a result of oil supply shock due to the Arab embargo.

  • Peter D

    No inflation of Sabbath, then :)

  • Peter D

    And although I may borrow from monetarism, Friedman’s notion of inflation being strictly a monetary phenomenon is so clearly wrong and easily debunked by real world examples that it isn’t worth debating.

    I wonder if he talked only of demand-pull inflations? Even then, his mistake was ignoring velocity of money, right?

  • Angry MBA

    Even then, his mistake was ignoring velocity of money, right?

    It would certainly seem that he failed to properly account for either velocity or for the role of credit.

  • Angry MBA

    the inflation in later 70s was a result of oil supply shock due to the Arab embargo.

    It was a combination of the OPEC cartel (combined with the lack of an effective US energy policy), the blowback from Nixon’s wage and price controls, and the budgetary problems caused by the Vietnam War. Ultimately, that combined with the fact that Bretton Woods effectively barred the US from maintaining monetary policy in the sense that we have it today, so there was no way to use monetary policy to correct for the fiscal policy errors of the 60’s, namely cutting taxes while trying to fight a war.

    The end of Bretton Woods itself didn’t cause inflation. The end of Bretton Woods was more of a symptom of that regime hitting the wall than a cause of anything else in particular. A $35 gold window and universal-but-for-the-US currency peg was unsustainable over the long run.

  • Angry MBA

    To correct one more typo: What the US had between FDR and **Nixon** was a program to buy and sell gold to foreign governments at the price of $35 per ounce, irrespective of how much an ounce was worth.

    To add to that, the US bought $4 billion in gold from international markets between 1934 and 1936, at the $35/oz price. Do the math, and you’ll see that’s over 114 million ounces of gold. Obviously, that must have been a decent price for that $35 figure to have attracted that many sellers.

  • Max

    A key insight of MMT is that the fundamental underpinning of fiat money is taxation. Without taxation, the currency could collapse to its inherent value (zero) even if the quantity of money is fixed forever (so claims that hyperinflation can be stopped by not creating more money are false…zero times anything is still zero!)

  • Rich

    Cullen

    You mention that there is no reliance on strangers for foreign denominated debt. I would argue there is a complete reliance on strangers. If foreigners step away from buying the Treasury debt (as they appear to be starting to), and the Fed becomes the only real buyer (via QE programmes as we are seeing), does that not cause a lot of instablitity and risk?

    Separate question – it seems the Treasury books the Fed’s revenue as revenue for itself. So when the Treasury pays interest on its debt, it pays the Fed, who then pays the Treasury. Rather like me booking as income the interest payments on my home loan. What would Treasury finances look like if we take out these phony revenue items?

    Would love to hear your comments on this.

    Thanks – Richard

  • http://www.pragcap.com Cullen Roche

    We dont need to sell debt to foreigners, but we allow foreigners to buy debt at auction because there is enormous demand for these countries to save in USD. This is primarily due to the large surpluses that many nations run with us. They can’t use these dollars for any purposes except purchasing US denominated assets. And they can’t “get rid” of these dollars. They can trade them to someone else, but equilibrium shows that all securities outstanding are always held by someone. So China can’t get rid of its US denominated savings. It can trade them to someone else, but it can’t eliminate them. Plus, if you study the bond auction data you’ll notice that the PD’s can always take down the entire auction. This isn’t a mistake. It is designed that way as a reserve drain. So, if foreign players left the market entirely (which won’t happen due to the huge trade deficit) we’d still be able to sell all the bonds to the PD’s. So, if China decides they want to stop buying UST’s then who really cares. Screw them. It’s their lost income.

    Fed pays all income after expenses to tsy so don’t pay any attention to the fact that Tsy is paying Fed interest on the bonds held.

  • Rich

    You say that PD’s can always take down the entire auction. At the moment, I believe they are only happy to fulfill this role when they know they can offload to the Fed via QE2. Zerohedge shows evidence that PD’s are on-selling their debt often only 2 weeks after taking it down at Treasury auctions. If QE ended due to political pressure (separate argument), could this not cause PD’s to baulk at holding long dated Treasury debt at current low interest rates? They might decide to reneg on their PD obligations, no?

  • Mediocritas

    If the PDs renege on their Fed-defined obligations, then the Fed can, and does, revoke PD status. That’s not something a PD would ever want given the easy money on offer.

    I know ZH paint it as some sort of conspiracy that PDs buy and then offload to the Fed a short time later. It’s not. This process is deliberate and transparent. What ZH and so many other fail to understand is that auctions are NOT a fiscal financing operation, they are a monetary operation and are tightly controlled.

    Easy commission to PDs is also a mechanism to ensure that PDs retain Basel II compliance thereby (supposedly) ensuring greater stability of the financial sector.

  • http://www.pragcap.com Cullen Roche

    Nope. If you go back in history you’ll notice that this has always been the case. The Fed hunts down the reserves and ensures that the PD’s can take them down via auction. QE didn’t change any of this. PD’s are required to make a market in govt debt. That’s part of the deal in being a PD. If you say you don’t want to do it the Fed will kick you out of the circle. So no, PD’s have no incentive to tell the Fed to screw off.

  • Mediocritas

    Exactly. Which is why a gold-backed system always morphs into a paper system backed by a gold fraction that must continually decline as the economy grows. Eventually someone runs the system and cleans out all the gold, causing all confidence in any remaining gold backing to disappear. At that point, it is realized that there is no need to have gold backing at all, in fact it’s more of a hindrance than a help.

    Which is why I get so annoyed with these Austrian economists who demand a return to a precious-metal backed currency, or even a commodity-basket-backed currency. We’ve already tried it and it doesn’t work!

    They want us to take two steps back on the path of monetary evolution…only to run into the same problems again and be forced to retread an already beaten trail!

  • Rich

    So basically the US can go on issuing debt at this frenetic pace and we are all gonna be ok, albeit at a slower pace of growth as money is diverted away from productive causes and into paying off wasteful debt? Nothing to worry about in debt markets then?

  • Mediocritas

    …plus the strength of unions in the 70’s was high enough to trigger a wage-price spiral. The unions of today’s USA are likely far too weak to do so again.

  • http://www.pragcap.com Cullen Roche

    No, that’s not what I’m saying. But it’s incorrect to assume that we are going to have some sort of “funding” crisis. Excessive govt spending can and does cause inflation and malinvestment which can lead to imbalances and recession. That’s why I have been very hard on this administration about many of the spending programs. The risk is not debt mkt collapse, but hyperinflation caused by destroying the publics faith in the govt money. Personally, I don’t see much risk of hyperinflation currently.

  • Non tax paying tea partier

    but what they are in essence are parasites on society, receiving the protections and benefits of what this country has to offer and refusing to contribute anything towards the common good.

    What you just said ABOVE is an excellent paragraph about the banksters, as Warren often says, 90% of the financial sector is a PARASITE on the real hard working patriots of this country and others. Who are YOU widgetmaker to question the MMT monetary god Warren Mosler and his ideas of ending the power and waste of these 90%?

  • Non tax paying tea partier

    Yes going to jail, you need to read up on Sheriff Mack of Arizona, he refused to follow FED orders, and sued the administration and won. So there may be laws on the books about arresting citizens for doing wrong, but if the military, police, and sheriffs don’t enforce them, you Cullen, as a true patriot of following existing federal IRS law will pick up your gun and come after me the well armed patriot waiting for you right? You should have heard what Judge Napolitano said about our current federal governments total ruination of our country with thier police state mandates, the Judge is probably a little more familiar with LAW than you are and he is talking about it being time to bust up the federal governments OVERREACH. He is high profile too Cullen, better known than you, disregard him and other judges like him at your own financial peril.

  • http://www.pragcap.com Cullen Roche

    Do you really think our govt is that corrupt and overreaching? If so, can you explain why exactly? Thanks.

  • Non tax paying tea partier

    KRB, unsecured lending to other nations is even something Warren says is possibly illegal actions by the Fed. As a lowly joe 6 pack, it kinda upsets me that some euro boyz can get my money through unsecured lending, and I can’t vote in elections to control thier political process, this is wrong. I just saw some new story today about frank-dodd being stalled so they can get some foreign oversight splashed with black paint so it we can’t see what is going on – didn’t Obama promise trasnparency?

  • Non tax paying tea partier

    I have read a christina romer paper that said the fed hasn’t really helped with unemployment or recessions if you look at those events before and after the founding of the fed. So if the academic research proves them impotent, why keep those guys around? In fact I think her paper showed that it could be argued the fed was more destructive and a negative force.

  • Non tax paying tea partier

    Judge Napolitano said there was a bill Bush passed in 2003 that redefined what a “financial institution” was and gave all kinds of NEW powers to the federal government. The post office, the restaurant where you eat, the broker/dealer, he listed many more that were now considered “financial institutions” that grossly expanded fed government power and the states need to “nullify” this overreach. He talked about in the founding fathers days, the real problem he had from a legal perspective was that agents of the king were able to write thier own search warrants and come into your house without any judge or peer review or oversight of any kind. He said that was a key reason the war of independence was fought. He referenced some new laws that are now allowing that same thing today, fed agents basically writing thier own search warrants without any true checks and balances and oversight and is going to probably have similar consequences as 200 years ago – armed revolt. The judge went on to talk about raymond davis shooting 2 human beings in the back in cold blooded murder, but through sharia law paying a blood price and that BS is coming to america and we have to stop this out of control federal government that mandates you and I buy insurance and other things, etc etc – go order the DVD if you want the specifics, Judge napolitano and many of the other people there gave great examples of why our countrymen 200 years ago split from the king, and why we should do it today, and many judges and much case law showing the fed government has grown to powerful and needs to be scaled back.

  • Non tax paying tea partier

    I think many realize those pension assumptions of 8% annual returns probably are going up in smoke anyways, and the purchasing power of thier future dollars won’t even buy them bullets to go to the target range. In florida where the convention was held, there are new laws being talked about asking the police officers to start taking 5% out of thier salaries to help contribute to thier pension funds – they are not happy about this.

    Many of the military guys and vets at the convention were very religous and say they believe the love of thier fellow man as god instructed, even the IRS man with a gun will ultimately prevail and things will be fixed before they have to shoot each other. Many of these people are willing to die before they continue paying taxes though, I don’t think there is enough jails to lock up all the people who from tax cheat timmy on down aren’t paying. They have to do an edward bernays propoganda arrest of a few wesley snipes to try and keep the populace in check, but that is deteriorating. Napolitano talked about how state legislatures used to send agents to the federal government, that kept a good checks and balances system between the states and the Fed government, but now that we vote on the fed congress directly, that checks and balances has been removed and gives far too much power away from the states to the federal government.

  • Non tax paying tea partier

    Cullen I am glad you brought up population growth. I have talked to many academic types and demographers, the global population BOOM we saw the past 50 years – the percentage rate increase will NEVER be experienced on this planet again. From 1 billion to 7 billion or so, that was a ONE TIME boom, and too many financial projections were made on that trend that is not sustainable. Japan is going down because they will not import mexicans like we will. China by 2015 or so will have maximized its growth in its working population numbers, so no more worker growth there. I offered to marry warren’s daughter Sada Mosler and give her about 20 babies to try and fight this trend but she didn’t jump on board :) No wage growth for J6P the past 30 years, and population growth is about to go down. Some group at that convention – Agenda21 – some UN resolution to take the world back down from 7 billion to 1 billion to keep things sustainable and happy for future humans was some other speakers talk. I told them heck, I like driving my MT900 mosler supercar on roads that aren’t too congested, so I am cool with taking down the numbers, they didn’t like me much after that.

  • http://macronomy.blogspot.com Martin

    “If it was a simple matter of inflation, as you would like to believe, then the US couldn’t have used a $35 price to turn gold holders into dollar holders.”

    I never said it was a matter of inflation. I said that the gold reserves in the USA were being depleted due to the fixed exchange rate implied by the Gold standard, hence the need for capital control and preventing gold from leaving the USA. The lack of confidence in the international monetary system, and a desire to counter their troubled economies, encouraged many countries to recall their gold, depleting further US deposits.

    The Smoot–Hawley Tariff was also a major reason for implementing capital control and preventing gold from leaving the USA due to deflation:
    “U.S. imports decreased 66% from US$4.4 billion (1929) to US$1.5 billion (1933), and exports decreased 61% from US$5.4 billion to US$2.1 billion, both decreases much more than the 50% decrease of the GDP.”

    “According to government statistics, U.S. imports from Europe decreased from a 1929 high of $1,334 million to just $390 million during 1932, while U.S. exports to Europe decreased from $2,341 million in 1929 to $784 million in 1932. Overall, world trade decreased by some 66% between 1929 and 1934.”

    “Unemployment was at 7.8% in 1930 when the Smoot-Hawley tariff was passed, but it jumped to 16.3% in 1931, 24.9% in 1932, and 25.1% in 1933″.

    “To add to that, the US bought $4 billion in gold from international markets between 1934 and 1936, at the $35/oz price.”
    FDR controlled both the nation’s gold stock and monetary policy. The 4 billion USD purchased sharply increased bank reserves and the monetary base. the required reserves jumped from 2.7 billion USD in 1935 to 4.6 billion in 1936.
    This was the US first “Quantitative Easing” to fight deflation initiated in the US.
    http://research.stlouisfed.org/publications/es/10/ES1017.pdf

    At that time, the amount of credit the Federal Reserve could issue was limited by the Federal Reserve Act, which required 40% gold backing of Federal Reserve Notes issued. Any reduction in gold in its vaults had to be accompanied by a greater reduction in credit. The 4 billion USD purchase was made to increase the availability of credit in the US economy.

    You stated “The $35 price was set arbitrarily high to pull gold out of the hands of overseas markets.” Between 1923 and 1931, it did not happen.

    Following WWII, many countries swapped their Gold for dollars. This led to a major shift in the balance of payments toward larger deficits and the ultimate collapse in 1971.

    “Between this and your reserve currency argument, you don’t seem to comprehend that some people like to use and hold dollars. If they didn’t like dollars, they use an alternative. I suppose that you may be hoping for the euro to serve in that role, but if so, I wouldn’t hold my breath.”

    Yes indeed, you suppose. Where did I mentioned I was hoping the euro would serve as an alternative to the role of the dollar?
    At the moment, there is no alternative to the US dollar, and I do comprehend this is the reason why people “like to use and hold dollars”.

  • Mediocritas

    I’d add that mild inflation is also necessary to maintain velocity and that because velocity is an indicator of trading activity and trade is the key enabling factor for economic development, therefore some inflation is necessary to encourage economic development.

    Of course, it can go too far. Trading for trading’s sake does not promote development. Excessive inflation impedes velocity as traders refuse to accept the currency in settlement. All things in moderation.

    Any way you look at it, the current economy is very sick.

  • troll

    I realize that your article was about hyperinflation, but I’m seeing something more insidious happening which has never occurred before. Our (and much of the world’s) debt is extreme. We have economic problems which seem to be able to be solved by governmental spending even though our government has a poor efficiency rating on its spending. However, I don’t see a way out except to for the government to spend more. This means our debt will go even higher. At some point, people will balk. Then, either the government will be forced to stop spending (an economical nightmare) or loss of faith in the monetary system will ensue. We are in uncharted waters and I am justifiably concerned.
    I feel like what King Faisal stated in the movie, Lawrence of Arabia, is true: “We need what no man can provide, Lawrence – we need a miracle”.

  • Peter D

    Ah, Strawberry picker! I was wondering where you disappeared from Warren’s site. You got banned?

  • Adam

    Don,

    When the government collects taxes it destroys financial assets (money). When it spends it creates financial assets (money). The net of teh destruction and the creation is net new financial assets or the accounting deficit. While MMT says that the government does not have to issue offsetting bonds for the deficit operationally the US government does.

    The assets already reside on somebody’s balance sheet the moment the government spends them into existence. The fact that the US treasury issues bonds is irrelevant or more correctly it is only a conversion of the type of asset already held. The issuance of the bond is only converting the dollar or bank reserve asset into an interest baring asset – like moving money from your checking account to a CD. Likewise, when the FED or any other government entity buys government debt, all they are doing is replacing the interest baring asset with a non-interst baring asset or cash.

  • Adam

    This is a great post!

  • Andrew

    Please explain why the ability to tax is so important. Are you saying that it allows the government to get rid of money? Or are you saying that the taxation allows the government to redistribute money?

  • troll

    Please correct me if I misunderstood what you’ve just stated. You seem concerned about excessive government spending. However, the present trend of government spending seems as if it is the only way of holding up asset prices. It looks to me as if the spending is going to continue. You presently don’t see government-caused spending as a current hyperinflationary worry. When does it become one? What do think will be the signs of the destruction of faith in the USD?

  • Don Levit

    Max wrote:
    A key insight of MMT is that the fundamental underpinning of fiat money is taxation. Without taxation the currency to collapse to its inherent value (zero) even if the quantity of money is fixed forever (so claims that hyperinflation can be stopped by not creating more money are false… zero times anything is still zero)!
    Max, this makes a lot of sense.
    For taxation to be the underpinning of fiat money, shouldn’t taxes bear a certain minimal relationship to spending?
    Don Levit

  • Angry MBA

    I said that the gold reserves in the USA were being depleted due to the fixed exchange rate implied by the Gold standard, hence the need for capital control and preventing gold from leaving the USA.

    One more time — the US used the $35 gold price to increase the quantityof its gold holdings from outside of the United States.

    Obviously, $35 was a good price, otherwise nobody would have bothered selling it to the United States. Given the choice between holding gold and holding dollars, more gold holders chose to hold dollars.

    By the time that the US entered WWII, it held over half of the world’s gold reserves. And you want to think that the US had a problem getting gold out of international hands and into a vault?

    You stated “The $35 price was set arbitrarily high to pull gold out of the hands of overseas markets.” Between 1923 and 1931, it did not happen.

    You might try using a calendar. Between 1923 and 1931, a dollar was 1/20th of an ounce of gold. The $35 price didn’t begin until 1934. Your comment has nothing to do with anything.

    At the moment, there is no alternative to the US dollar

    At the moment, the market has decided that there is no acceptable alternative to the US dollar.

    As others have mentioned in this thread, the US can’t force everyone to use dollars. They choose to use them. As a gold bug, you can’t possibly fathom that there are many who don’t agree with you, but look at markets and you’ll find everywhere.

  • Peter D

    Hm, as I understand it, this is the insight of Chartalism, while MMT, being a nickname Neo-Chartalism, has the additional insight that combines the operations of Treasury and the Central Bank.

  • Angry MBA

    Which is why I get so annoyed with these Austrian economists who demand a return to a precious-metal backed currency, or even a commodity-basket-backed currency. We’ve already tried it and it doesn’t work!

    This is the problem with ideologues — it makes no difference to them that their pet ideas have already proven to be a failure. They just keep rewriting and ignoring history until it succeeds…

  • http://www.pragcap.com Cullen Roche

    Austrian economics is a political school of thought disguised as a monetary theory.

  • first

    When you control the supply of a currency debt is not the problem but the currency certainly can be.

    The main reason that the dollar is low is because BB keeps rates at a disadvantage for investors vs other countries borrowing rates. If rates where to move up by 1% tomorrow the dollars would bounce right back. BB seems to likes sending money to fund other economies and it may also keeps the money supply lower then it would other wise be.

  • Peter D

    Ausrians remind me of some religious cults that reject medical treatments as contrary to the will of God. For Austrians the economy will always right itself in the long run, according to some perverted view of cosmic justice.

  • Non tax paying tea partier

    Warren says today in our fiat floating FX regime, taxing helps regulate aggregate demand. So if a few government cronies at the top decide me and my j6p buddies are buying too many guns and drinking too much beer and listening to too much christian music, they can tax that stuff to the high heavens to stop our consumption right? :)

  • Non tax paying tea partier

    LOL! Warren has tried to ban me for years, but through anonymous proxy tricks I always got through his IP blocking so he finally gave up and probably realized dissenting comments help expand horizons instead of nonexpanding groupthink memes that don’t challenge themselves, no the reason I have not been posting there recently is because I am now on an IT network that is behind an education firewall – the Florida Department of Education. They ban sites at their local routers like youtube, twitter, youporn, etc etc to protect the young innocenet minds of our children from getting really educated, and this is causing a block problem on warren’s site that his IT people “claim” they still cannot resolve, of course this would be a good excuse to not let me post there anymore eh? :)

  • Non tax paying tea partier

    http://www.businessinsider.com/seiu-union-plan-to-destroy-jpmorgan

    Again Cullen, more people in the counter culture plotting the downfall of the current structure, we have financial civil war going on, wake up!

    Also over at business insider Fed Guy Hoenig just admitted the fed is anti-capitalist propping up all these loser banks and companies. Change is in the wind!

    Cullen I want your thoughts on the arrest of Richard Hatch – he was the first winner of that TV Show – Survivor – he caught fish in that show and was a very resourceful and resilient human being, unlike some of the other welfare state gimme gimme losers on that show. But he was NO MATCH for mr IRS man and his gun and they gave him 3 years, and now because he cant pay the 2 million in penalties and such, he is going to get another 9 months, don’t you think that is a bit excessive Cullen for winning a tv show about being a survivor? Don’t you agree that arresting richard hatch is doing an edward bernays propoganda HIT PIECE on that poor sucker? Wake up Cullen! You are halfway there to being thomas jefferson 2.0, we just have to give you a little more push, time to stop the crony corruption and make the world a better place, you can do it Cullen, warren already admits that 90% of the financial sector needs to go BOOM, join the cause.

  • http://macronomy.blogspot.com Martin

    “As a gold bug, you can’t possibly fathom that there are many who don’t agree with you, but look at markets and you’ll find everywhere.”

    I am always amused by the ability of people in discussions to put labels on others for the sole reason of justifying their arguments, how simple and comforting. It is caused fallacy.

    Argumentum ad hominem.

    Discussing ideas doesn’t mean I have an ideology.

    Pathetic response.

  • Alchemist

    The power to tax is important because it creates demand for an otherwise worthless piece of paper. Think about it from the perspective of the oil market. Obviously, there are differences, but it may provide some insight. The dollar is used for transactions of oil throughout the world. This creates a demand for dollars that would not be present if some other currency, say the yuan, was used for said transactions. Therefore, the dollar has more ‘value’ than in the alternate yuan-denominated example.

  • Anonymous

    I am always amused by the ability of people in discussions to put labels on others for the sole reason of justifying their arguments, how simple and comforting.

    You’re the one who cited Jude Wanniski as an authority. Wanniski supported a gold standard.

    You are also prone to the rhetoric of the goldbug crowd and make positive references to Austrian economics, which further suggests that you are a gold bug.

    Since it’s fairly clear that you want a gold standard, then go ahead and address my question below, and explain exactly how $15 trillion worth of gold, with its supply expanding at an annual rate of 0.5%, is supposed to support a $75 trillion economy that is expanding annually at 2-3%.

  • http://macronomy.blogspot.com Martin

    “You’re the one who cited Jude Wanniski as an authority.”

    Did I write Jude Wanniski is an authority?

    Just because I put a quote from Jude Wanniski doesn’t make me a gold bug or an advocate to the return of the gold standard. You just find comforting putting a gold bug/Austrian label on me to disqualify me and my arguments. It is an old rethoric trick. Might work for some people but not with me.

    Let me guess, if I start quoting Keynes, for a few posts that we will make me Keynesian? If I quote Kennedy it will make me a democrat? If I quote Ron Paul, does that makes me pro-life? How easy it is to use sophisms and to label people.

    “Since it’s fairly clear that you want a gold standard.”

    I challenge you to find in my previous posts my clear proposal for a return to the gold standard. I never did.

  • Angry MBA

    Just because I put a quote from Jude Wanniski doesn’t make me a gold bug or an advocate to the return of the gold standard

    It certainly looks that way when you quote Wanniski in your efforts to rebut my point that the $35 gold price was simply a tactic used to transfer gold away from world markets and into US gold reserves, and when Wanniski’s comments match your own arguments.

    The US government didn’t need to pay more than $20.67 for domestic gold, because under the gold standard, a dollar was 1/20th of an ounce of gold. The $35 price was the US’ international price for gold. FDR eliminated the domestic market for gold altogether, so there was no domestic price beginning in 1934, since it wasn’t legal to buy or sell it within the United States.

    All of your arguments are standard goldbug arguments. If it walks, talks and quacks like a duck…

  • http://macronomy.blogspot.com Martin

    “All of your arguments are standard goldbug arguments. If it walks, talks and quacks like a duck…”

    Keep digging that hole.

  • Angry MBA

    Keep digging that hole.

    It more closely resembles a duck pond.

  • Boston_AL

    Dear Sir,

    I would argue against your statement. Why can there not be negative inflation?
    That would be a period of either great economic value increase to the US dollar and/or or a reduction in the real quantity of currency relative to the total economic increase. The later is most likely the reason.

    In the ’80s, gold was worth approximately $200 – $300/oz. Down from an all time high of ~$800/oz during the “Stagflation” period that Fed Chairman Volcker tamed using exceptionally high interest rates (and a significant Fed recession).

    I’m surprised at you for not pointing out that we had two major negative economic events in both of those periods you sited (recessions)!

    ’81-82 (10%+ unemployment) and a major S&L disaster in the ’90’s that led to many many bank failures (~1000+?) that both forced people and industry to de-leverage and sure up their personal and business balance sheets.

    As for Japan, they are suffering from “Stagflation”, not “Hyper-inflation”. It does not take hyper-inflation to destroy a great economy. High inflation and High debt (taxation) will do a very nice job and for a lot longer thank you. (For Japan it has been ~20 years as you so aptly point out)

  • Max

    “For taxation to be the underpinning of fiat money, shouldn’t taxes bear a certain minimal relationship to spending?”

    Yes, but it depends on the demand for money. Deficit spending is not inflationary if people want to increase their holdings of money (money = government bonds, bank reserves, and paper/coins). This is why Japan can run massive deficits without an inflation problem – because they are just accomodating the desire of the private sector to save.

  • http://www.pragcap.com Cullen Roche

    We’ve lived thru this before. Look at the 1800’s. They were characterized by long periods of deflation and very high unemployment and depressions every 15 years.

  • Angry MBA

    Why can there not be negative inflation?

    Well, I suppose that we could just make up our own words, and pretend that there is such a thing. But as of today, there is no such thing as “negative inflation.” We refer to an environment of falling prices and wages as being “deflationary.”

    What you don’t understand is that the Austrian penchant for believing that gold is money is wrong. Gold is not money, it is a traded commodity, in the same way that natural gas, orange juice and hogs are traded commodities.

    “Inflation” is a measure of consumer prices. The fact that gold could fall in price by 2/3’rds during the early 80’s while consumer prices simultaneously increased is a rather obvious indication that gold prices and the inflation rate do not directly correlate. Gold can serve as an inflation hedge over the long run, but the price of gold does not move with consumer prices over the short run and therefore is not the equivalent of inflation or deflation.

    As for Japan, they are suffering from “Stagflation”

    I’d like to see a source for that claim.

  • Peter D

    Ah, Angry, don’t waste your time. It is simple. The guy is an Austrian, right? For them inflation is increase in money supply, which Japan had. And it has stagnation. So, voila, you get stagflation according to Austrian definition.

  • http://deleted Don Levit

    Max wrote:
    Deficit spending is not inflatinary if people want to increase their holdings of money. This is why Japan can run massive deficits without an inflation problem – because they are just accomodating the desire of the private sector to save.

    I understand 95% of Japan’s debt is financed by its people.
    In addition, while they are traditionally known as huge savers, i understand the savings rate is now 2%.

    Contrast that with who has financed our debt in the past, and who is financing it now more than ever – not the citizens.
    Don Levit

  • Peter D

    Don, it doesn’t matter who finances your debt. As long as they want to save your financial assets, your spending is not inflationary. If anything, foreigners face more restrictions in consuming in domestic currency than citizens, so, less potential inflation coming from abroad.

  • http://deleted Don Levit

    PeterD:
    I have heard that in the near future the Fed will be financing 70% of our debt.
    Is that “true”? If so, how does that financing of debt compare to outsiders, like the public?
    Don Levit

  • first

    Stranger than Truth.
    High salaries do not cause inflation it only displaces money.
    Inflation does however cause salary to increase as a compensation.

    Inflation is Good ???

    More generally, a 2004 study of 73 episodes of deflation from sixteen different countries dating back to 1820 indicates that only 8 of the 73 episodes of deflation involved recession or depression. It also indicates that 21 of the 29 depression episodes involved no deflation. (The authors of this study, Andrew Atkeson and Patrick J. Kehoe )

    During the nineteenth century, a dollar purchased 27 percent more in terms of goods in 1913 than it did in 1800. It did not impede economic growth in the U.S. In fact, deflation coincided with the spectacular transformation of the United States from an agrarian economy in 1800 to the greatest industrial power on earth by the eve of World War One.

    During the most rapid growth in U.S. history we find that the years from 1880 to 1896 prices fell by almost 30 percent, or by 1.75 percent per year, while real “income rose by about 85 percent”,

  • JWG

    Quoting TPC: “The risk is not debt mkt collapse, but hyperinflation caused by destroying the publics faith in the govt money.” In matters of mass psychology and the madness of crowds, it is risky to place all of your bets on one thesis, even if that thesis objectively “works”, as MMT does.

  • http://www.pragcap.com Cullen Roche

    I am not saying there can’t be anomalies. But history shows that currency collapses are not consistent with the environment in the USA currently….

  • Peter D

    When the Fed monetizes the debt, as it does now in QE, what happens is that holdings from Security accounts at the Fed are shifted into Reserve accounts at the Fed, analogously to public shifting money from CDs and saving accounts into checking accounts. The important part to realize is that those holdings are already out there – they are a result of vertical spending by the government, or injection of NFAs in MMT-speak. That is, no new NFAs are created in debt monetization. MMT believes that it is NFAs that matter for the economy in terms of consumer and business being able to spend confidently. Right now we’r in a period of balance sheet recession where the consumers are up to their ears in debt and need to deleverage before they can start spending. The lack of demand in turn forces the businesses to cut down on investment and spending. Therefore MMT suggests injections of NFAs into the economy to help the consumers to deleverage. Debt monetization doesn’t help in this regard: the increased reserves in the banking system don’t make it easier for the bank to lend – they can lend as much as they want regardless of their reserve positions, since they can always acquire reserves after the fact.
    Now, the closer we get to total debt monetization, the closer we are to the MMT-proposed solution of “no-bonds” regime, in which the Treasury stops issuing bonds and simply funds all its spending out of its account at the Fed with unlimited overdraft. This is very close to debt monetization, since Fed remits all the profits from its US Treasury Bond holdings (net of operations and dividend for the member banks) back to the Treasury anyway – so this is a wash. Without the need to go into the idiotic dance of debt issuance to cover its spending, the Tsy will be free to spend according to the Congress’ appropriation process. No danger of hitting stupid debt ceiling and paying interest on debt.

  • Peter D

    “If so, how does that financing of debt compare to outsiders, like the public?”

    As you can infer from my previous answer, it doesn’t matter much. US bonds holders are mostly savings vehicles like pension funds, foreigner that want to earn interest on their dollar earnings and other savers. The holders of US debt want to save. If there is no debt issued by the Tsy, these savers would have to find other vehicles into which channel their savings: state and muni bonds, corporate bonds, mutual funds etc. Transition to no-bonds regime could be done gradually so that all the inflationistas out there have time to absorb the reality and not freak out.

  • beowulf

    MMT is not against running surpluses when economy overheats, but not for the purposes of “storing nuts for the winter”.

    Peter, it seems the NeoKeynesian ideal is a balanced budget across the budget cycle, while the MMT ideal is a balanced budget at full employment (and zero trade deficit, otherwise that demand leakage would still have to be filled to reach full employment).

    Carl Christ, of Johns Hopkins University, had the brilliant insight that should an economy ever reach stationary equilibrium, all stock variables as well as all flow variables would be constant; and that if all stock variables, including government debt, were constant, government receipts would have to equal government payments… There is an obvious shortcoming to the original Christ formula in that it applies only to a closed economy. This defect is easily remedied by adding exports to government expenditure (injections) and imports to taxes (leakages)
    http://findarticles.com/p/articles/mi_m1093/is_n1_v41/ai_20485331/

  • http://deleted Don Levit

    And why are we still in an environment in which the public, as a mass, should still have faith in the full credit of the U.S. Government?
    Don Levit

  • Boston_Al

    I never suggested “the sky is falling” and the USA economy would collapse. A lost decade or two due to Stagflation would be more than enough to wipe out the future prospects of an entire generation of Americans.

    I’m not a hyper-inflationist.

    I only foresee great hardship and Stagflation if we continue down the road this and the past administration have put on with high debt and massive expansion of the money supply. A strong economy is one with a strong currency. The Germans learned this well after their own Hyper-inflationary period! (And their country did not collapse though it took a huge step backward for quite a period of time before recovering.)

    I think some of your published viewpoints are quite narrow and lack a real historical experiential perspective or validation in certain cases. You see more focused on black and white answers or persuading readers to your conclusions based on a viewpoint backed by academic theory and props that support your conclusions instead of sharing a situation and multiple viewpoints and trying to illicit real learning through shared dialog and discussion of multiple possible viewpoints or causalities.

  • Tom Hickey
  • beowulf

    “A lot of fiscal correction can be done via automatic stabilizers, such as transfer payments, Job Guarantee programs and inflation-targeting taxation…”

    Of course it’d make life easier if Congress allowed the Fed to use fiscal policy to finetune the econoy. In fact, they kind of already have. To backtrack a moment, UW-Madison Economics professor Edgar Feige has suggested a system of bank transaction fees to replace the federal income tax.
    http://www.scribd.com/doc/25299549/Feige-APT-Presentation-to-Tax-Reform-Panel-2005

    What’s interesting is that everything Feige suggests be taxed is already subject to Federal Reserve transaction fees, “in accordance with the requirements of the Monetary Control Act of 1980, which requires that, over the long run, fees for Federal Reserve priced services be established on the basis of all direct and indirect costs”. Since Fed earnings are refunded to Tsy General Fund anyway, the economic effect of Fed transaction fees is the same as Feige’s proposed Tsy transaction tax.
    http://edocket.access.gpo.gov/2010/2010-27697.htm

    Without a system of reserve drains (in other words, taxation), our banking system is inherently inflationary. On the other hand, if the govt drains too much reserves by overtaxation, the economy will the aggregate demand to reach full employment. To meet its dual mandate obligations, the Fed could readjust their transaction fees periodically– raising fees (either economywide or at particular sectors to pop bubbles) to target the indirect cost of excess inflation and lowering them to target the indirect cost of excess unemployment.

  • http://www.pragcap.com Cullen Roche

    No need to make it personal. I encourage open and honest debate. I am always open to alternative perspectives and yours is not convincing. If you can convince me otherwise (by actually proving me wrong as opposed to opining about my approach) then I’m all ears. I’m wrong all the time. I never said I had all the answers….

  • KN

    I find your article insightful, but here’s a question – if not hyperinflation, what in your mind, will be the real implication if/when China and others stop buying US debt? What if the bond markets don’t want us anymore? Already, numerous funds are dumping treasuries. Isn’t that a sign that Americans aren’t confident in the dollar?

  • Peter D

    Well, with the idiocy gripping both parties (but the Republicans especially) there is indeed a danger of the US defaulting on its obligations. But I am guessing you’re not asking about that, are you?

  • http://www.pragcap.com Cullen Roche
  • http://www.pragcap.com Cullen Roche

    Don, why should we be losing faith?

  • KN

    Sir, you are brilliant, but with Obama at the helm and too many politicians not taking a firm stance against government spending, we are at a critical level. Entitlement reform must occur, but the earliest I see that happening (if it happens) is 2013. And despite how much people are scared of the national debt, the fact is discussing entitlement reform is dropping the proverbial turd in the punchbowl. Look at what happened to Bush the 2nd – he mentioned social security reform and boom, for all intents and purposes that marked the end of his presidency.

    It’s just at the end of the day, something has gotta give. Just wish I could sleep better at night knowing that the U.S. I know and love will be around a VERY long time.

  • KN

    Also Sir, what about if another major country starts pegging against the USD – do you think that could have any ripple effects? What about the Japan earthquake?

  • Peter D

    We don’t need no stinking entitlement reform. Deficit Impasse: What Should We Cut?
    The idea that we have a national debt problem is a myth.

  • Pokemon Cards

    Angry MBA had it right way up there. Banking systems prefer high seignorage mediums because they are run by political interests and lobby groups that embezzle a lot of money (bankers, oil companies, biopharms, the list goes on…). Money is power, and by rigging the casino, and encouraging stupid actors in the system (eg. purposely propagated by the dismal state of education in the USA) and then buying out the media and distracting those human (barely) vegetables with stupid hollywood gossip they have an army of unwitting peons at their disposal to further their control. The american dream drives them forth to earn their piddly dollars, while their masters roll in the dough.

    If everybody still had chunks of gold in their pockets and would dig it up from the ground, hoard it, and weight it, picking people’s pockets of their hard-earned cash becomes a LOT more difficult. I speak not about MMT or fiat vs non-fiat. Non-fiat is obviously more effective at inducing productivity in societies, it is atrocious however at encouraging fairness and valuing the work that somebody puts into earning his keep.

    Mr Joe cobbler who spends 12 hours a day behind his desk making shoes and then gets shit on by Goldman sachs exec #2354 who clicks a couple of buttons on his PC, drives the price up on his soles because they’re made of oil, and then takes home a 10K bonus is not worth the same in the eyes of the lord. We have to admit to ourselves that members of this society that are parasitic and don’t solve REAL problems or create REAL output in their day to day activities do not deserve that privilege.

    We essentially live in a communist society, except there are two communes. A commune filled with self-entitled parasitic assholes that acquire their wealth on the backs of others and the rest who do the work.

    I propose we turn the freeloaders into soylent green crackers.

  • Brick

    Actually I think you have just about nailed the reasons for hyperinflation on the head, but I would have some minor quibbles. Firstly on the issue of whether the US relies on the kindness of strangers, I am not so sure it is as straight forward as that especially since the dollar is a reserve currency. Perhaps you should redefine a currency as an agreement between the public who trade using the currency and the private sector. Global perceptions do matter through trade and currency value and can affect local perceptions, with deficits playing a part. Secondly I am not sure whether there are not some unusual social circumstances in that the government and bank interations, handling of house reposessions and state austerity measures could be perceived as corruption. I would agree that the US is not there yet, but suspect there are a few more ingredients available than you have outlined. The question is what weighting do you give to each of these and will the risks increase. Personally I think the risk is more akin to what happened with the UK currency revaluation and IMF interventions.

  • Boston_AL

    Gold is a form of currency (exchange for goods and services).

    I can buy almost anything for gold, anywhere, anytime.

    The exchange rate may not be perfectly stable, but you cannot get me to believe that gold will not buy goods and services as easily as paper money.

    Even paper money fluctuates (thus the rise and fall of prices daily of goods and services).

    There is an emotional component to all trade value assessment that causes this based on security and other outside factors, but is that a reason to 100% reject a concept. You don’t do that for your own position do you?

    I am very surprised someone who puts MBA in their moniker can put forward a statement that gold is not a global currency.

  • watt

    Thought ‘When Money Dies’ was by Niall Ferguson not Adam Fergusson

  • Angry MBA

    I can buy almost anything for gold, anywhere, anytime.

    You must live in a third world country.

    In my first world country (the US), the local supermarket wants dollars. If I tried to pay the cashier with gold bars, I’d get a funny look. They’d call the manager over, who would advise me that he is sending me home without my groceries, and the people who waited in line behind me would be irritated as hell that I slowed down their shopping.

    Again, you don’t know what “money” is, therefore you don’t understand what inflation is, which would explain why you’re inclined to make up jargon out of thin air such as “negative inflation”. Gold prices and inflation don’t directly correlate, and no one who knows what inflation is believes that they do.

  • http://www.pragcap.com Cullen Roche

    You most certainly cannot buy anything you want with gold. 95% of local stores and shops will absolutely not accept gold as payment.

  • katie cannon

    I know this is way off topic, but why do MMTers like the idea of getting rid of the Fed?

  • MamMoTh

    A currency peg is not a cause for hyperinflation, unless the anchor currency experiences hyperinflation.
    A currency peg is usually the antidote to hyperinflation (see Argentina).

  • http://www.pragcap.com Cullen Roche

    Because they don’t do anything positive for the economy. They help the banks bankrupt everyone and largely just contribute to the confusion and malinvestment in the world.

  • http://www.pragcap.com Cullen Roche

    A currency peg is generally used because of some other deficiency.

  • MamMoTh

    Let me rephrase it.
    A currency peg never causes hyperinflation.
    Hyperinflation is usually ended with a peg.

  • Andrew P

    The Fed held long rates at 2% or less during WW II.

  • Andrew P

    I can foresee one (and only one) way for the USA to have a currency collapse. Peak Oil driven political change. If the current Mideast revolutions result into the combination of most oil exporters into a single nuclear armed Caliphate (probably after a small nuclear war or two), then a single Islamic superpower will have an absolute monopoly on oil. Purely out of geopolitical and religious convictions, they would then seek to break the USA – possibly in concert with covert alliances with China and Russia. They would demand that all oil be only paid for in gold. The USA could not print gold, and thus would be forced to print incredible amounts of dollars to acquire the gold needed to buy oil. The USA would try to ration gasoline, but it would not be enough. The cost would spiral out of control and lead to total economic collapse. If transport of food from the US breadbasket broke down from lack of fuel, complete sovereign collapse of the USA is not inconceivable. The key ingredients are monopoly control of ever scarcer oil under a hostile nuclear armed power who is willing to suffer some pain to break the US. I guess this does kind of fall under the “losing a war” definition in the article, although this would be an unconventional war loss.

  • Andrew P

    What if we could no longer buy oil with dollars as a result of global political change? Suppose gold and only gold would be accepted in exchange for oil?

  • http://www.pragcap.com Cullen Roche

    We’d attack Saudi Arabia and kick them out. Seriously. It would lead to WW3 & the boys with the biggest toys (the USA) would win.

  • Non tax paying tea partier

    China needs oil too, they have nukes, so do many other countries, why do you assume the USA would win a ww3 nuclear missle global catastrophe? All my girlfriends and ex’s made sure to damage any possessions I had if they were not going to keep them in our split up – cars, houses, goldfish :( It was not too long ago that kennedy and 1 other person on this planet held all the rest of our lives in the buttons in thier hands, I don’t like that a very few people at the top can nuke you and me and everyone else. Not to mention all the articles I have read about nuclear material stolen and sold (especially from russia) and all the potential suitcase nukes out there for the poor people to detonate. It was nice knowing you CR, life was too short.

  • Non tax paying tea partier

    Hmm, but I hear ron paul wants to audit the fed, and possibly end it while Senator Al Franken parodies them on SNL, and I hear that from christina romers academic paper that the fed perhaps has actually HURT the level and length of recessions since thier founding instead of helping but certainly her data showed it could be a wash. Mish wants to let the market set the rates, Mosler says the natural rate of Int is 0. I have heard lots of other people ready to alter or end the fed too and the way everything has worked. So let me ask you grand wizard, if their aint no fed anymore or no fed like the old fed, then what does it matter to be a PD under the fed? Huh? Your whole flow of logic and entire arguement seems to base on the fact that the fed is an unchaging all powerful monolith that will never morph and the PD system will always remain the same and bow down eternally. There have been so many examples in history where people get tired of bowing down, just human nature ya know.

  • Boston_AL

    How is this any different than walking into a supermarket or store in Paris, Frankfurt or Tokyo with US Dollars??

    I submit: The fact that some store clerks are so stupid as to know the value of a currency (US Dollar, Yen, Euro or Gold) doesn’t make any of them any less a real currency!

    Where did you two go to school?

  • Boston_AL

    While I concur with TPC that hyperinflation is not at all likely, I would not go as far as to say that it is not possible!

    Below is an opposing view on Hyperinflation copied over from Zero Hedge:

    “Can HyperInflation REALLY Hit the US?”

    I know that many deflationists believe that we cannot experience hyperinflation in the US due to our obscene debt levels. The belief here is that all the money thrown into the US financial system will be swallowed by another round of debt deflation.

    The problem with this belief is that it doesn’t understand how currency crises work. Inflation occurs when a currency falls in value relative to other currencies. And as noted by other astute commentators, hyperinflation occurs when a currency is abandoned all together.

    Yet it would be wrong to see the hyperinflation of 1923 as a simple consequence of the Versailles Treaty. That was how the Germans liked to see it, of course…All of this was to overlook the domestic political roots of the monetary crisis. The Weimar tax system was feeble, not least because the new regime lacked legitimacy among higher income groups who declined to pay the taxes imposed on them.

    At the same time, public money was spent recklessly, particularly on generous wage settlements for public sector unions. The combination of insufficient taxation and excessive spending created enormous deficits in 1919 and 1920 (in excess of 10 per cent of net national product), before the victors had even presented their reparations bill… Moreover, those in charge of Weimar economic policy in the early 1920s felt they had little incentive to stabilize German fiscal and monetary policy, even when an opportunity presented itself in the middle of 1920.

    A common calculation among Germany’s financial elites was that runaway currency depreciation would force the Allied powers into revision the reparations settlement, since the effect would be to cheapen German exports.

    What the Germans overlooked was that the inflation induced boom of 1920-22, at a time when the US and UK economies were in the depths of a post-war recession, caused an even bigger surge in imports, thus negating the economic pressure they had hoped to exert.

    ***At the heart of the German hyperinflation was a miscalculation***

    Link to Full Article:
    http://www.zerohedge.com/article/can-hyperinflation-really-hit-us

  • Boston_AL

    Do you speak from fact or just speculation??

  • http://www.pragcap.com Cullen Roche

    That argument isn’t far off from mine. It essentially argues that a breakdown in the tax system leads to hyperinflation. I totally agree. Plus, I have never said hyperinflation is impossible in the USA. I said it is unlikely to occur given the current circumstances.

  • http://www.pragcap.com Cullen Roche

    Al,

    Does your local grocer accept gold bars? No.
    Can you put gold in the local gas pump? No.
    If you order a pizza tonight will the delivery guy accept gold as payment? No.
    When you pay your utility bill do you mail them a bar of gold? No.
    When you pay an online bill do you insert gold into your computer? No.

    The fact is, most of our daily transactions cannot be done with gold. You need to first exchange your gold into dollars.

  • Boston_AL

    Can I walk into a mom and pop store and offer the owner gold in exchange for food?
    …I sure I could find a savvy owner who would go for this.

    Can I walk into an owner run car dealer speak with the owner and offer him gold for a car?
    …again, I sure I could find a savvy dealer to take the deal

    A house? A boat? Etc… Yes, I believe I could find someone.

    Worse case I could find someone who is savvy enough to exchange my gold for US Dollars (or Yen, or Euros, or Swiss Francs, etc) to provide me local currency to buy things.

    Again I submit, that it is NO DIFFERENT than walking into any store in just about any foreign country with US Dollars looking to by something in the store priced in any major foreign currency! Does this situation make the US Dollar a fiat currency?? I think NOT.

  • Boston_AL

    Cullen… Thanks! Great debate on some opposing ideas.

  • Peter D

    I think Randall Wray sorts this all out. BAsically , there are “money things” used in exchange etc, all denominated in the money using of account:

    Some money things can be used as media of exchange for purchases and means of payment to retire debt; all can be used as stores of value (albeit some are more risky than others). We can think of a hierarchy of money things, with the government’s own IOUs (central bank notes and treasury coins, but also central bank reserves—taken together these are called high-powered money or the monetary base) at the top. Just below that would be the deposit liabilities of banks and other financial institutions with direct access (or indirect access through correspondent banks) to the central bank. Other (nondeposit) short-term liabilities of financial institutions would be below that, then would come the short-term liabilities of nonfinancial corporations. Finally, at the bottom would be the short-term liabilities of households and small businesses. Taking this approach, one would be following Hyman Minsky , who always said that anyone can create money (things), the problem lies in getting them accepted.

  • http://www.pragcap.com Cullen Roche

    We live in very different worlds then. I cannot buy gold at most of my local stores and ALL brand name retailers will reject gold as payment. Until we begin seeing gold signs replacing the Mastercard and Visa signs on shops I am afraid you are not correct about this one….

  • http://www.pragcap.com Cullen Roche

    Exactly right. Gold would fall somewhere near the bottom of this hierarchy. Good store of value, not a great medium of exchange.

  • Angry MBA

    How is this any different than walking into a supermarket or store in Paris, Frankfurt or Tokyo with US Dollars?

    It’s easy to find a bank, bureau de change, etc. that will swap your dollars for euro or yen. Or, easier still, you can go to an ATM, which will immediately convert your US dollars into local currency. It’s a simple, low-cost transaction.

    You can’t do that with gold. Virtually nobody in the retail world wants it, and the few who would are unlikely to pay you the “market” price for it — if you want to sell quickly, you’d suffer a price hit, just like the guy who needs to sell his car at a quick discount in order to pay his bills.

    You can’t buy most things, most of the time directly with gold. You’d have to sell the gold in order to convert it into local currency. And its value could rise or fall considerably during the interim.

    Now, here’s the clincher — the reason that it’s easier to deal with cash than it is to deal with gold is because on the whole, people in the business world prefer to have money. If backed by the right economy and government, cash is king, and gold comprises just a small piece of a portfolio.

  • Greg

    To say gold is just another asset like sugar or salt; with a price determined by investment demand is just plain SILLY!!!! You may be an MBA; and I can see you have swallowed the line.. you do not understand human nature…. That takes many years. Show a large lump of pure gold to your girlfriend…wife…and watch the eyes, then show her the dollar value of that lump on a ledger… watch the eyes…. Haaaa, an education! PS; my major was Finance, but learned more later…

  • One time

    Okay in my industry people are making the same wages as their fathers were in the 70’s however the cost of everthing has gone up taxes included! This is why people are losing faith. Now we find ourselves unable to afford college for our children with the only alternate being indebted for a generation. This is crazy and unsustainable.

  • Greg K

    Yes; it called being a colony….we export raw materials and import finished goods…..

  • Aestuo

    Hey,

    Would you say our current government is corrupted? I am sure there is a bunch of people in office right now who are in it for the money, not for Americans. I also find it worrisome and alarming that Obama wants to frivolously spend more, and therefore raise our debt even further!

    The debt has to go somewhere, right?

    It is comforting to know that the current US economic state may not be bad enough to experience hyperinflation, but at the same time if the spending continues at the rate where we cannot even sustain them (pay back)… Could it eventually lead to hyperinflation and perhaps something even more worse?

  • Boston_AL

    …yes indeed: “Stagflation”!

    Ahhh the late ’70’s. What a wonderful time that was. An OPEC oil embargo with gas lines 2 blocks long, 21% car loan rates at its peak, 13% money market rates, leading banks to buy Junk Bonds because they were upside down (lent long at 5% paying 13% short-term to deposit holders) leading to a massive number of Savings and Loan bank failures (paid for by the tax payers), and all the while… no job creation and flat pay wages.

    Just makes you long to experience it all over again, huh?

    Well my friend, that is just the road the Obama Administration, Congress and The Fed are taking us all down.

  • Boston_AL

    I’m right with you on your point here, Greg.

    That’s why they call it “The GOLDEN Rule”!

  • Nathanael

    Actually, the Federal Reserve as “lender of last resort” can always force rates *down* at a bank-to-bank level by providing low-interest rate loans, but I don’t see that it has any mechanism for forcing rates *up* if the “natural” rate chosen by bankers is lower. Surely rates can only be forced up by banking regulations?

    Also, I do have to ask about the “transmission mechanism”. While the Federal government could certainly force mortgage rates down by direct lending, as long as it *doesn’t* engage in direct lending to anyone but banks, it has no mechanism to prevent the banks from keeping consumer/business lending rates very high and pocketing the spread. If the banks didn’t act like a cartel, market forces might prevent this, but of course they *do* act like a cartel. This causes me to question whether under such circumstances the Federal Reserve can actually control rates, even to push them down, at the consumer end, absent a direct-lending policy from Congress.

    I believe you may have already discussed this, however. This would be akin to an exogenous event — massive banking corruption with government connivance.

  • Nathanael

    I actually suspect that hyperinflation can happen in, for instance, a gold-backed system.

    First the classic scenario:
    (1) People stop trusting that the paper is backed by gold, and they stop trusting that the coin isn’t debased. Ping! Currency collapse.

    Second the alternative scenario:
    In the 1600s Spain discovered a massive, massive amount of gold in the New World and promptly set to mining it all and turning it into coins. The only result of their currency mismanagement was worldwide inflation — but the inflation was worst in Spain, and ended up driving business out of Spain. It didn’t cause hyperinflation, but it demonstrates a key point: gold mining can be used to flood the country with money and cause severe inflation. If the Spanish government had been distrusted and considered corrupt by the locals, if it had just lost a war, hyperinflation might have been a serious possibility. (It did lose a number of wars but by then the mines were no longer dumping gold on the market at massive speed, IIRC.)

  • ernst

    There is a new website, theendofamerica10.com, that plays on the fear of a US dollar crash. What are your thoughts?