HOW INFLATION BEGINS
As societies become wealthier as technology advances, the desire to advance to the upper echelon of the social ladder increases.
This can be called Conspicuous Consumption. Thorstein Veblen in 1934 said that SOME forms of consumption serve no purpose other than enhancing status. The hedonic mentality of society becomes very dangerous. The appetite for conspicuous consumption, often referred to as “keeping up with the Joneses,” becomes a problem when the appetite can no longer be fed with current income. When borrowing becomes the norm to maintain an elevated lifestyle and to accelerate the normal evolutionary growth of the borrower, the competitive position of the borrower experiences a relative decline.
This relative decline is the result of cheap credit and mountains of cash being infused into the economic structure, and can also be called INFLATION.
IMPLICATIONS OF INFLATION
As inflation persists and becomes excessive, the economy will eventually stagnate. The stagnating economy produces increased unemployment, shortages in all types of products (essential and nonessential), a collapsing standard of living, increasing bankruptcies and increasing interest rates.
Increasing interest rates put downward pressure on many assets, including real estate, stocks and bonds, and investors will eventually begin to pull the plug on their currency holdings in exchange for anything more tangible and liquid.
Once the inflation rate begins its rapid ascent into a potentially hyperinflationary state where savings accounts are eliminated and anyone living on a fixed income, such as Social Security, could be impoverished almost overnight.
This scenario is presently occurring all over the world at varying rates. Could it happen in America?
OF COURSE IT CAN! What I explained is simple economics and America is NOT IMMUNE to universal laws of economics! But it is happening in such slow motion that the populace is unaware of the erosion of their purchasing power. Since the Federal Reserve was created in 1913, the dollar has lost 98% of its purchasing power via inflation.
INFLATION’S IMPLICATIONS TO DEMOCRACY
Imagine what it would be like to realize a decline of 98% of retirement assets or life savings in a month, week, or even day.
The hyper-inflationary scenario has been played out to that tune many times, from the Weimer republic Germany in the 1920s to Yugoslavia in the 1990s, and countless others. Social chaos and economic upheaval always show up at the party to dance with hyperinflation, and this is a party to which nobody wants to be invited.
How does the party end? As in the case of Germany, there is gravitas towards anyone who offers a reasonable solution to fix the problem, and there tends to be gravitas towards a regime change, that is, from a democracy to a dictatorship, or vise-versa. World history has many examples of regime changes birthed by economic shocks.
- In the case of Germany in the 1920s, Adolf Hitler arrived at the party and absolutely took over the dance floor.
- During the French Revolution it was Napoleon who crashed the party.
Let’s take a moment and look at how Adolf Hitler came to power. During World War I, Germany did a ton of damage on its enemies. In 1919, the Treaty of Versailles was signed. That treaty required Germany to basically rebuild and pay back many of the territories it destroyed. They didn’t have the money, they just suddenly had too much debt, and it was nearly impossible to pay it back. So, they abandoned the gold standard in order to print without discretion. They printed so much money and devalued their currency so much that the rest of the world no longer wanted it. They just kept printing, and a snowball effect of inflation ensued.
When the German hyperinflation started, the German currency was relatively stable at about 60 Marks per Dollar during the first half of 1921. It’s interesting to see how quickly a currency can deteriorate once the ball starts rolling. The following chart shows the number of German Marks it took to buy one ounce of Gold.
It’s hard to read stories of how quickly things eroded. People literally had to be paid in WHEELBARROWS or SUITCASES full of cash. If they didn’t go purchase their loaf of bread with that wheelbarrow of cash, the bread may have DOUBLED IN PRICE the next day! Mommies and Daddies couldn’t afford to feed their babies. Life was chaos. People were starving. Faced with this, people lost all hope.
This is when Hitler entered the scene. He campaigned with promises of hope and change and people WILLINGLY voted for him.One of the most RUTHLESS DICTATORS the world has ever seen didn’t hold a gun to peoples’ heads and say, “vote for me or die.” People willingly voted for him! They were willing to give up their POLITICAL freedoms, RELIGIOUS freedoms, PERSONAL freedoms, and ECONOMIC freedoms in exchange for PERCEIVED SECURITY. This is exactly how a society can change from a democracy to a dictatorship ALMOST overnight due to a inflation that went unchecked and spun out of control!
LOSS OF FREEDOM
Throughout history, when a country experiences hyperinflation, it changes its government and loses its freedom.
Every hyperinflationary period throughout history has occurred after 1914. It is no surprise that all hyperinflations, with the exception of France after the French revolution in 1789-1796, occurred under discretionary monetary standards (fiat currency). Prior to 1914, most economic systems were based on a metallic money standard that was linked directly to a supply of gold or silver.
When a currency is backed by gold, the tendency for inflation to occur is minimal as the physical supply of the monetary metal needs to increase in order for inflation to occur.
Inflation is a direct threat to wealth and thus a threat to democracy that is so cherished in America.
DEFINING INFLATION AND DEFLATION
A decrease in the money supply (i.e. fewer dollars chasing goods and services means the price level will decrease).
An increase in the money supply. General price levels will rise as the relative value of currency decreases (i.e. it takes more of the worthless currency to buy goods and services).
A rate of inflation generally considered to be more than 100% per year.
A condition in which prices increase rapidly as a currency loses its value. Definitions used by the media vary from a rate exceeding 100% per year to inflation exceeding 50% a month, or anything greater.
Here are some countries where a HYPERINFLATION has occurred. This is just a small sampling, as there are well over 30 nations that have experienced a HYPERINFLATION throughout history.
WHAT CAUSES HYPERINFLATION?
The main cause of hyperinflation is a massive and rapid increase in the amount of money that is not supported by a corresponding growth in the output of goods and services. This results in an imbalance between the supply and demand for the money. Hyperinflation effectively wipes out the purchasing power of a currency. The growth of the money supply unchecked will ultimately lead to hyperinflation as the aggregate demand for the currency approaches zero. Sadly, when a government decides to abandon any kind of tangible backing for their currency, THE ONLY THING THAT GIVES A CURRENCY VALUE is people’s perception and what they will actually pay for it. When inflation persists, the currency is devalued. When the currency is devalued, investors need to be ENTICED to invest into that currency. How is that done? By RAISING INTEREST RATES!
Let’s say China sees that the United States is treating the US Dollar like monopoly money. Why would CHINA invest in U.S. Treasuries if the yield is only 2%? THEY WOULDN’T. To attract foreign investment, a country with a stinky currency needs to raise rates. Then, even a stinky currency could attract investors if it is paying 10-20% interest. There needs to be an appropriate REWARD for the RISK taken. Consider this chart of the US Monetary Base. It has now gone PARABOLIC! HYPERINFLATION IS COMING!
Asset prices will go through the roof and wages will not keep up with them. Thus, IT WILL WIPE OUT anyone who is not hedged with tangible assets that are not linked to the paper currency, like GOLD AND SILVER. This kind of economic catastrophe will lead to a POLITICAL REVOLUTION. The Freedoms that are generally lost with this are:
- PERSONAL FREEDOMS
- RELIGIOUS FREEDOMS
- ECONOMIC FREEDOMS
- POLITICAL FREEDOMS
Do you see any of these eroding already? Things are already happening! The time to prepare is NOW! The currency will be wiped out, which will lead to major trade imbalances. If the country is a DEBTOR nation (like the United States), creditors will become EXTREMELY upset as we begin to default on our obligations. Thus the Cycle of Financial Problems completes.
THE CYCLE OF FINANCIAL PROBLEMS
- FINANCIAL PROBLEMS lead to
- ECONOMICS PROBLEMS, which lead to
- POLITICAL PROBLEMS, which lead to
- GEO-POLITICAL problems
THIS GENERALLY MEANS WAR.
THE GOVERNMENT FIX
The initial government “fix” will make things worse. Printing money like there is no tomorrow to stimulate the economy by providing liquidity is inflation! Deficit Spending (which is spending more than we make), has led to the government running out of money, and creating a debt level that is unsustainable. Therefore, the only ways out of this situation from a public policy perspective is to create more liquidity (print more money). . . or try to increase revenue by raising taxes; or both.Printing more money causes inflation, and raising taxes when people are already living at the margin means people will just spend less. This will lower government revenues.
HIGHER PRICES + REDUCING PEOPLES INCOME = A RECIPE FOR DISASTER!
FOREIGN RELATIONS AND INTERNATIONAL TRADE
Hyperinflation will impact a country’s foreign relations and trade. International trade will become a major issue as nations refuse to accept the worthless hyper-inflated currency in exchange for valuable goods and services. This poses a problem for the United States, and any country that relies on imports. The U.S. is a net-importer of most things. When other countries stop accepting their currency, people could starve.
What happens next is the same thing that happened in during the Weimer Republic regime in Germany. There will be civil unrest, blood in the streets and political upheavals.
Start acquiring products that would be useful for barter. Barter is simply exchanging goods or services for other goods and services when money becomes worthless.Gold and silver can be great barter items (because they are portable and valuable), as well as phenomenal investments that act as a hedge against inflation.
Gold and Silver actually become invaluable during a hyperinflation. Their prices will go through the roof and their purchasing power will not just remain, but actually increase as the value and purchasing power of the U.S. Dollar decreases. Here’s an example of how gold has maintained its purchasing power.
Back in the 1920s gold and the U.S. Dollar were inter-changeable. One ounce of gold could be switched back and forth with a $20 Bill. (This is because the U.S. Dollar used to be backed by gold). What did one ounce of gold or a $20 Bill purchase back then? It would buy a finely tailored men’s suit, a shirt, a tie, a belt and shoes.
What does that $20 Bill buy you today, in 2017? It barely gets you a meal for you and your spouse at McDonald’s! But, the one ounce of gold at well over $1000 per ounce today still buys you a finely tailored men’s suit, a shirt, a tie, a belt and shoes.
GOLD AND SILVER AS INSURANCE
Gold and silver are your insurance policy against a collapsing currency, in addition to being fantastic investments.
Right now, because of the global, political, geo-political and economic conditions we are faced with, all arrows are pointing towards gold and silver for preservation and protection.
THE PROPER ALLOCATION MIX
A 50% allocation of your investable assets into precious metals will give you a perfect 1:1 hedge against your paper assets. However, the more extreme the inflationary scenario becomes it may be wise to allocate an even higher percentage into tangible assets.
A properly designed portfolio will also consist of high quality income generating assets and an emergency fund of cash.
As stocks, bonds, mutual funds and real estate get hit hard when interest rates go up in response to a devaluing currency, gold and silver will go up over time, thus minimizing your total portfolio risk and giving you peace of mind in the midst of the storm.
TAKE ADVANTAGE OF THE TRENDS SO THE TRENDS DON’T TAKE ADVANTAGE OF YOU
Never put all your eggs in one basket. (This includes having all your eggs in “paper” like stocks and bonds.
I said it earlier, but it bears repeating. Over-allocating into precious metals (over 50% of your portfolio) may be prudent given economic conditions and where we are in the inflationary cycle because you are not just participating in the insurance mandate that precious metals offer, but also the growth mandate.
The goal of any investment portfolio is to be in the right place at the right time and follow the positive trending asset classes.
This will MINIMIZE YOUR RISK while MAXIMIZING YOUR RETURN.
The wrong thing to do is to do nothing. The other wrong thing to do is to take advice from those you no longer trust. A definition of insanity is doing the same thing over and over again expecting different results.
- LEARN FROM HISTORY
- OBSERVE THE OBVIOUS
The majority of people are moving in the wrong direction the majority of the time. What direction are you heading in?You were created to THRIVE, not just SURVIVE.Take ACTION Now. It’s up to YOU!
Veblen, T. (1934). The theory of the leisure class: an economic study of institutions with a foreword by Stuart Chase. New York: The Modern Library.
Bernholz, P. (2003). Monetary regimes and inflation. Northampton, MA: Edward Elgar Publishing.
Bresciani-Turroni, C. (1937/2003). The economics of inflation. (Sayers, Trans.). London: Routledge.
Kershaw, P. (1997). Economic Solutions. Boulder, CO: Heal our Land
Parsson, J. O. (1974). Dying of money. Boston: Wellspring Press.
Ringer, F. K. (Ed.). (1969). The German inflation of 1923. New York: Oxford University Press.
Smith, A. (1963). An inquiry in to the nature and causes of the wealth of nations. With and introduction by M. Blaug (Vol. II). Homewood, IL: Richard D. Irwin, Inc.
Federal Reserve bank of Saint Louis