Best of the Week
Most Popular
1.North Korean Chinese Proxy vs US Military Empire Trending Towards Nuclear War! - Nadeem_Walayat
2.Researchers Find $10 Billion Hidden Treasure In A Dead Volcano - OilPrice_Com
3.Gold and Silver : The Battle for Control - Rambus_Chartology
4.Asda Sales Collapse and Profits Crash! UK Retailer Sector Crisis 2017 - Nadeem_Walayat
5.Deep State Conspiracy or Chaos - James_Quinn
6.The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - Plunger
7.Gold Stocks Coiled Spring - Zeal_LLC
8.Neil Howe: The Amazon-Walmart Rivalry Will Determine the Future of Retail - John_Mauldin
9.Crude Oil Price Precious Metals Link in August - Nadia_Simmons
10.Gold and Silver Precious Metals Nearing Breakout - Jordan_Roy_Byrne
Last 7 days
The Stock Market No Longer Cares About Trump - 21st Aug 17
The Coming Boom Of Productivity Will Get Our Economy Back On Track - 21st Aug 17
Buffett Sees Stock Market Crash Coming? His Cash Speaks Louder Than Words - 21st Aug 17
This Could Be The Biggest Gold Discovery In History - 21st Aug 17
Stock Market Correction in Full Swing - 21st Aug 17
Seeking Confirmations – US Stock Market - 21st Aug 17
The changing demographic of online gamblers - 21st Aug 17
Gold is a coiled spring… the breakout is here, fundamentals are in place, technicals are compelling - 20th Aug 17
A Midsummer Night's Dream: Buy Gold and Silver - 20th Aug 17
Gold Mining Stocks 2017 Fundamentals - 20th Aug 17
EIA Weekly Report and Crude Oil - 19th Aug 17
4 Insights for Adjusting Your Portfolio in a Rate-hike Environment - 19th Aug 17
Gold Direction Indicator - 19th Aug 17
Historical Inevitability and Gold and Silver Ownership - 19th Aug 17
You Are Being Lied To About “Low” Gold Demand - 19th Aug 17
This is Why Cocoa's Crash Was a Perfect Setup - 19th Aug 17
Gold, Silver Consolidate On Last Weeks Gains, Palladium Surges 36% YTD To 16 Year High - 19th Aug 17
North Korea Is Far From Being Irrational… It Has A Plan - 18th Aug 17
US Civil War - FUNCTIONAL ILLITERATES TRYING TO ERASE HISTORY - 18th Aug 17
Bitcoin Hits New All-Time High Over $4,400 As It Catches Paypal In Total Market Cap - 17th Aug 17
3 Psychological Ingredients behind Great Web Content - 17th Aug 17
The War on Cash - Rogoff, Orwell and Kafka - 17th Aug 17
The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - 16th Aug 17
Stocks, Bonds, Interest Rates, and Serbia, Camp Kotok 2017 - 16th Aug 17
U.S. Stock Market: Sunrise ... Sunset - 16th Aug 17
The Next Tech Crash Could Delay Your Retirement by a Decade - 15th Aug 17
Gold and Silver Precious Metals Nearing Breakout - 15th Aug 17
North Korea Showdown: Pivotal Market Turning Point - 15th Aug 17
Tech Stocks DOT COM Bubble Do-Over? - 14th Aug 17
Deep State Conspiracy or Chaos - 14th Aug 17
From the Trans-Atlantic Axis and the Trans-Asian Axis - 14th Aug 17
Stock Market Intermediate Correction Underway - 14th Aug 17
The Islamic State Jihadi Pivot to Asia - 13th Aug 17
Potential Pivots Upcoming for Stocks and Gold - 13th Aug 17
North Korean Chinese Proxy vs US Military Empire Trending Towards Nuclear War! - 12th Aug 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

How Deflation Creates Hyper-inflation

Economics / HyperInflation Dec 15, 2008 - 09:57 AM GMT

By: Eric_deCarbonnel

Economics Best Financial Markets Analysis ArticleI keep reading about the dollar being a "new multi-year bull market" and that the US is headed for "Japan style deflation". Frankly, it is a little tiring. The people making these arguments should know better.


Deflation Vs Hyperinflation

Yes, there is debt deflation, and the overall money supply is shrinking as a result. However, those calling for "multi-year bull market" for the US dollar are insane. These individuals need to review basic monetary theory . The money supply is only one of three factors that determine whether prices rise or fall. The other two are the changes in the velocity of money and the real output of the economy. The danger of hyperinflation lies in a dramatic increase in the velocity of money due to a loss of confidence, not in changes in the money supply.

Confidence and the velocity of money

When confidence in an issuing authority crumbles, money starts flowing through the economy at a feverish pace. For example, in normal, noninflationary times the money supply might be equivalent to three months of output, but in a period of hyperinflation it might drop to two weeks worth of output. Since increases in the velocity of money have the same impact on prices as increases in the money supply, a 1000% increase in the velocity of money (typical in any period of hyperinflation) is equivalent to a 1000% increase in the money supply. Due to its effects on the velocity of money, the ebb and flow of confidence have a much greater impact on the short-term trend of prices then changes in the money supply.

Deflation can create Hyperinflation

It is no accident that many of the worst periods of hyperinflation are preceded by deflation. In fiat currencies with high levels of government debt, severe cases of deflation cause a loss of confidence in the nation's currency by shrinking the economy and making the government's debt appear increasingly unsustainable. The loss of confidence then causes the flow of money to speed up as individuals become desperate to exchange cash for real goods as fast as possible, producing hyperinflation.

As an example of deflation leading to hyperinflation, consider the case of the Weimar Republic . In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government's money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%.

Eventually, as a result of the money supply's rapid expansion, the nation's massive foreign debt, and the shrinking economy, German citizens lost all confidence in their currency, and the Weimar Republic experience one of the worst cases of hyperinflation in modern economic history. Billions of hoarded marks came out of hiding and entered the marketplace. The chart below tells the rest of the story.




How deflation creates hyperinflation

1) Deflation slows the speed of money to crawl due to fears about the deteriorating economy. The public hoards cash, or, in the case of the US, short term treasuries.

2) The slowing speed of money and debt destruction force the government to create huge quantities of cash to prevent prices and the economy from collapsing. However, because the public is hoarding cash (or short term treasuries), most of the money doesn't reach the real economy, which leads the central bank to print even more money. In essence, cash hoarding acts as a dam, preventing the enormous quantities of printed money from affecting prices.

3) Deflation weakens economy until it leads to a loss of confidence. With doubts about the government's solvency growing, the velocity of money quickly picks up speed, and a flood of hoarded cash comes out of hiding, entering the marketplace all at once and creating hyperinflation.

US stands on the verge of hyperinflation

Gold Backwardation signals that the next phase of the economic crisis, a rapid acceleration in the velocity of money, is about to begin. Right now, the flow of money through the economy is basically frozen: everyone is panicking into treasuries due to deflation fears. Negative yields on the 3 month treasuries are a sign of this.

Despite the glacial rate money is moving through the economy, the dollar has started to fall again, and gold has begun to rally. As this continues, investors will begin to questions the safety of treasuries, and sell them off. The money coming out of treasuries will add fuel to gold's rise and the dollar's fall. Once the dollar hits new lows and gold breaks convincingly over $1000, Investors expecting deflation will begin to panic, and a flood of money will come out of treasuries. It is then that hyperinflation will begin in earnest.

By Eric deCarbonnel
http://www.marketskeptics.com

Eric is the Editor of Market Skeptics

© 2008 Copyright Eric deCarbonnel - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Eric deCarbonnel Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

A.B.
15 Dec 08, 16:57
Loss of confidence ?

I don't think this makes sense. To you, the money supply has nothing to do with hyperinflation which is driven by "loss of confidence". Then you claim that Weimar inflation was started by the printing press (expansion of the money supply), but not because there were a lot of money chasing few goods, but because people "lost confidence". After a deflationary crisis, when lending resumes, the inflated monetary base expends fast, which drives up prices and encourages people to get rid of their currency, creating an hyperinflation.

The value of money is based on its acceptance and its quantity, not faith in the government. Kurds keep using Sadam Hussein's regime fiat note although the regime was overthrown.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife