Sunday, February 12, 2012

Q&A With the Doc: The Causes & Results of Hyperinflation

Sitting Bull writes:

I am a physician and have converted my entire portfolio to 50% gold and silver bullion and 50% quality mining stocks. So I am with you. What I am trying to understand is exactly how a 40% devaluation of the dollar will immediately affect American's day to day lives. Can you help me with this? I have studied and studied, but I am trying to understand how prices will be affected for the average person initially. What happened in Mexico? What happens here? Does gasoline go up 80% overnight? Does food go up 80% overnight? I was a Peace Corps volunteer, so I can explain the inner workings of certain pacific island cultures in ways no text book can seem to get right. I was hoping you could do the same thing for me involving this. Thanks.

Sitting Bull,

For an understanding of hyperinflation and where we are headed, a proper understanding of Jim Sinclair's formula, released nearly 8 years ago, is crucial:

1. First interest rates rise affecting the drivers of the economy, housing, but before that auto production goes from bull to a bear markets.  -Check

2. This impacts many other industries and the jobs report. An economy is either rising at a rising rate or business activity is falling at an increasing rate. That is economic law 101. There is no such thing in any market as a Plateau of Prosperity or Cinderella - Goldilocks situations.

3. We have witnessed the Stock Markets rise on economic news indicating deceleration of activity. This continues until major corporations announced poor earnings, making the markets fall faster than it rose, moving it deeply into the red.
4. The formula economically is inherent in #2, which is lower economic activity equals lower profits.

5. Lower profits leads to lower National/Federal Tax revenues. -Check ($1.5 Trillion annual deficits)

6. Lower Federal tax revenues in the face of increased National/Federal spending causes geometric, not arithmetic, rises in the National/ Federal Budget deficit. This is also true for cities. -Check

7. The increased Budget deficits in the face of the Trade Deficit increases the Current Account Deficit. Dramatic for the USA and Europe. (see what happens in Greece)

8. The Current Account Balance is the speedometer of the money exiting a country into world markets (deficit).

9. It is this deficit that must be met by incoming investment in any form. It could be anything from businesses, equities to Treasury instruments. We are already seeing a fall off in the situation of developing nations carrying the spending habits of industrial nations; a contradiction in terms.

10. If the investment by non domestic entities fails to meet the exiting dollars, euros, british pounds… by all means, then this specific country must turn within to finance the shortfall.
-And CHECK- This is QE to Infinity defined.
11. As the action under #10 starts to become reality, and a country turns inside to finance all maturities, interest rates will rise with the long term rates moving fastest regardless of prevailing business conditions. (ex. Greece, Portugal)  (Doc's note: Operation Twist's whole purpose is to prevent/ delay this inevitable outcome)

12. This will further contract business activity and start a downward spiral of unparalleled dimension because the size of for example the US debt already issued is of unparalleled dimension.

Therefore as you get to #12 you are automatically right back at #1. This is an economic downward spiral.

Currently, only a small minority of educated individuals understand this formula and the fact that point 10 is already well underway, and that point 11 is inevitable.  Point 10 by itself is massively inflationary (an increase in the supply of money) but it requires widespread RECOGNITION to become hyperinflationary.  This is the whole purpose of what Sinclair calls MOPE (Management of the Perception of Economics).  Preventing the widespread RECOGNITION of point 10 and the inevitability of point 11 is key.   Once the public as a whole loses CONFIDENCE in the purchasing power of their currency (the US dollar in this case), this is the trigger for hyperinflation. 
It is critical to understand that hyperinflation is NOT inflation on steroids, it is a CURRENCY EVENT- a sudden and rapid complete loss of confidence in the currency.  Mathematically, this is described as the Velocity of a currency- the rate at which it is turned over.  For example, during the hyperinflation of the Weimar Republic in Germany, workers were paid hourly, and their spouses stood outside the factory and immediately rushed to the market to purchase physical goods with the rapidly depreciating currency.  When the velocity of a currency approaches infinity, the value of it by definition approaches zero.
Most also fail to understand that in nearly all cases, a period of significant economic decline or depression precedes hyperinflation.  This is understood after studying Jim Sinclair's formula above. 
The resulting response of massive money printing to alleviate the shortage of goods and services as well as purchasers of debt can be seen in Peter's hyperinflationary formula:

A prerequisite of hyperinflation and monetary collapse is that a disruption in the availability of essential goods occurs, today this could happen as a result of past reliance on expanding credit and fiat money temporally facilitating dependency on low cost imported goods many of which now feed primary needs leading to a commensurate loss of home production capacity with an inherent delay to the medium-term should such reengagement with manufacture become necessary as it would in the event of off shore suppliers losing confidence in reciprocal worth of monetary instruments offered in exchange for goods, and or shortage of essential goods may arise as a result of natural correction occurring, by way of example from the collapse of speculation driven credit markets and or as a result of collateral damage to the production cycle caused by inappropriate governmental action in further increasing money and credit supplies in attempt to drive a spontaneously occurring and necessary correction back in the direction of instability and in so doing distorting essential work ethics and disincentivising investment in the production cycle,
In my view the most probable sequence of events resulting in hyperinflation and monetary collapse is as follows:
1. A broad based shortage of goods that are thought essential develops and this is not relieved in time to satisfy demand.
2. Consumers trying to acquire essential goods that they believe are in short supply become fearful and are prepared to pay increasingly higher prices and stockpile these goods further increasing shortages and accelerating prices as a sellers market develops.
3. Prices rise for essential goods in short supply as an increasing proportion of the money supply circulates in these goods, also with increasing velocity and as most of these goods are consumables with high turnover upward re pricing quickly occurs.
4. The proportion of available money circulating in goods that are perceived as essential increases and the demand for less essential goods diminishes I.e essentials become disproportionately more expensive than the norm against non essential goods displacing money towards the goods most in demand further fuelling inflation,
5. The shortage of essential goods accelerates as manufactures increasingly focus on short term survival, longer term risk is avoided and investment in the production cycle is reduced accelerating 1.
6. The normal balance of demand for all goods increasingly prefers those goods required to satisfy primary needs and people engaged in making and supplying less immediately essential or non essential goods become unemployed who then pressures governments accelerating condition 9.
7. Eventually goods not immediately required but non the less essential are needed and rapidly increase in price as they also become in short supply.
8. Consumers with least money first find it increasingly difficult to secure essential goods, become frightened and are forced to allocate greater proportions of their money on essential goods and demand greater income,
9. The demand for money forced by need and fear becomes irresistible so governments feel insecure and provide increasing amounts of fiat new money,
10. Consumers first to spend the new money see some value but soon as this new money is distributed and its value is lost, the velocity of money also accelerates as people rapidly exchange money for goods, wealth is seen as best protected when stored as goods rather than cash further increasing price and reinforcing condition 9.

So from first Sinclair and next Peter's formulas, we can understand that massive money printing by the government is not the trigger that causes hyperinflation, rather it is the loss of confidence in the currency by the people, WHICH THEN RESULTS IN A MASSIVE PRINTING OF MONEY BY THE GOVERNMENT IN A VAIN ATTEMPT TO ALLEVIATE the problem- which throws gasoline on the fire, and exacerbates the problem.

As to what this looks like in practice, we suggest you read LoneRangerSilver's account of living through the Mexican Peso Devaluation, and Gonzalo Lira's first hand account of the Chilean hyperinflation. Lira's description of trading necessities such as a car for a valuable apartment demonstrate point 4 in Peter's above formula.

The fact that Jim Sinclair's formula is nearly complete demonstrates the eventual inevitability of Peter's formula, and resulting hyperinflation as a result.  The best way to protect one's self from this is by storing your wealth in physical tangible assets such as gold and silver.

Hope this helps Sitting Bull.