Our Money is Dying

2012-JUL-19

A question on the minds of many people today (increasingly those who manage or invest money professionally) is this: How do I preserve wealth during a period of intense official intervention in and manipulation of money supply, price, and asset markets?


As every effort to re-inflate and perpetuate the credit bubble is made, the words of Austrian economist Ludwig von Mises lurk ominously nearby:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner, as the result of a voluntary abandonment of further credit expansion, or later, as a final and total catastrophe of the currency system involved."
(Source)

Because every effort is being made to avoid abandoning the credit expansion process – with central banks and governments lending and borrowing furiously to make up for private shortfalls – we are left with the growing prospect that the outcome will involve some form of "final catastrophe of the currency system"(s).

This report explores what the dimensions of that risk are. It draws upon both historical and modern examples to try to shed some light on how the currency collapse process will likely unfold this time around. Plus, we'll address how best to avoid its pernicious wealth destroying effects.

When Money Dies

In the book When Money Dies by Adam Fergusson, which details Weimar Germany's inflation over the period from 1918 to 1923, the most riveting parts for me were the first-hand accounts from the people caught in the storm.

So many people left their wealth in the system only to watch it get eroded and utterly destroyed over time. The reasons were many: patriotism, inertia, disbelief, and denial cruelly fed by hope every time prices moderated or even retreated momentarily.

The simple observation is that many people had a blind belief in the money system. They lost their wealth because they were unable or unwilling to allow reality to challenge their beliefs.

It's not that there were numerous warning signs to heed -- in fact, they could be seen everywhere -- but most willfuly ignored them.

Most mysterious is the fact that in Austria and Germany, where the inflation struck most severely, there were numerous borders and currencies into which people could have dodged to protect their wealth. That is, protecting one's wealth was a relatively straightforward and simple manner.  And yet… it did not happen.

The many types of inflation

As always, the landscape of inflation needs to be carefully mapped before we can begin to hope to have a conversation with a destination. Where the symptom of inflation is rising prices – in fact, rising prices are the only things tracked by the Consumer Price Index, or CPI – the causes of rising prices are many, but they always boil down to the overexpansion of money and/or credit. Knowing the cause is essential to knowing what to do next.

Here are the main flavors of rising prices that we need to keep in mind:

Non-inflationary price increases – These are caused by demand exceeding supply. It happens all the time. A poor harvest driving up the price of corn is not inflationary, but it will show up in the CPI. These sorts of price movements reverse themselves as markets respond by chasing the price and delivering more of whatever was in short supply. The only exception is when there is some essential, non-renewable natural resource in sustained depletion – which means that demand will always exceed supply and prices will rise and then rise some more. Excessive speculation can also lead to price rises and, as long as the speculation centers on the item(s) involved and not on excessive money/credit expansion, it, too, can be (and eventually will be) reversed.

Simple inflation – This is the 'textbook' case of inflation where too much money and/or credit is created relative to goods and services. Print too much money or make credit too cheap/easy and prices will rise roughly in proportion to the excess. Simple inflation operates in the low single digit percentages. Central banks openly target simple inflation in the 2%-3% range as that level of expansion allows banks to have healthy profits, prevents past loan errors from swamping the system, and generally keeps the exponential money system operating well.

Loss of confidence in money – A more severe stage of simple inflation takes over when enough people lose faith in the money and seek to actively spend their money on something, anything, before that money loses value. This type of inflation operates in the high single digits to low double digits, somewhere between 8% and 15%. This is just simple inflation on steroids. Not everybody participates in this game yet, as the loss of confidence has not yet reached criticality, but enough people do to keep this process locked in a self-reinforcing spiral that requires aggressive money tightening to halt. Think "Volcker" and "21% interest rates" and you get the picture.

Hyperinflation – Further along the inflationary spectrum is what happens when a critical mass of people within a society lose faith in their money and the monetary authorities are incapable of reducing the money/credit supply, either because there’s already too much of it out there to ‘call in,’ or because they lack the political will to do anything but print more money in response (i.e., there are no Volckers around).  Once this critical mass is reached, every corner of society is participating, and it is no longer socially taboo to talk about the hyperinflation or how to escape its effects. Everyone is wheeling and dealing, speculation runs rampant in everything from stocks to pineapples, and you cannot possibly spend your money fast enough to avoid the ravages of inflation. The annual percentage rates for hyperinflation range from medium double-digits into the hundreds of millions.

Currency destruction – There is another type of inflation that happens when your state currency is shunned by the rest of the world. While there may be no additional money creation and credit may even be dropping, inflation is still a very serious problem as everything imported goes up in price. There are many reasons that a currency may be shunned. It could be that other countries lose faith in the currency due to mismanagement and overprinting. It could be due to acts of war. Or it could happen at the end of a very long period of excessive credit and money expansion, when that bubble finally bursts and confidence in the associated currency unit(s) is lost. There is really very little that local authorities can do to fix things unless the country imports nothing, a condition that applies to exactly nobody. Prime candidates to experience this form of inflation are the US and Japan; the former because of massive imbalances fostered by its several decades of reserve currency status, and the latter because of persistent and massive over-printing enabled by domestic savings and a once-robust export surplus. The dynamic of currency destruction is for imported items to rise sharply in price first, with everything else soon following in upward price spirals. Policy responses are quite limited and are usually ineffectual at preventing a massive amount of economic destruction and wealth loss for the holders of the stricken currency.

It is this last type of inflation – currency destruction – that we’ll explore here, because it represents a severe risk and is very rarely talked about or analyzed.

Spinning in the water

A modern case study of a shunned currency is Iran.

For a variety of reasons Iran finds itself the subject of a very sustained effort by the US to subjugate its nuclear programme to international inspection and curtailment. Already the target of many overt and covert efforts to bring it to heel – ranging from two highly destructive and invasive computer worms (Stuxnet and Flame), to stealth drone overflights, to an international ban on oil exports – Iran now finds that its currency, too, is being internationally shunned... Read more:  Our money is dying | Gold Price News