Good old Wikipedia:
Hyperinflation is often associated with some stress to the government budget, such as wars or their aftermath, sociopolitical upheavals, a collapse in aggregate supply or one in export prices, or other crises that make it difficult for the government to collect tax revenue. A sharp decrease in real tax revenue coupled with a strong need to maintain government spending, together with an inability or unwillingness to borrow, can lead a country into hyperinflation.
If that doesn’t get the hairs on the back of your neck standing up nothing will. There are certainly many that believe we are in for big inflation and the consensus on the pathway of this future development is first deflation then rocketing inflation.
The first instinct for anyone who is scared of inflation is to buy precious metals and if you look around the internet right now you will see you are too late. Its gone or at least gone at a price remotely near the commodity exchanges price for it. This feels like a prediction of a future rally in the commodity futures markets but the value of precious metals are not well reflected at retail because to get to you they go through multiple middlemen astute at profiting from unsophisticated demand that comes and goes with the news.
But it is a signal to note.
In this new economic world of ‘whatever it takes’ bailouts, it has to be remembered sometimes there is not enough of whatever there is to give to recover. The goal of government is to try and smooth a process that would otherwise be very rough and to minimize the damage. The result can still be rough and ruinous, just not as bad as otherwise. Can all these trillions be printed and not create an imbalance?
The answer in the modern model of economics, (NMT,) which has been sling-shot-ed into the position as the new orthodoxy, is that inflation can be controlled by taxes. So if these trillions escape and start to create inflation, taxes can be banged on to pull the money back out of the economy.
Great in theory but painful in practice and there is one flaw. Government wont shred that tax money, it will simply spend it back into the economy. That is the DNA of government. Government does not tax to fund its budgets, it budgets to the highest amount it can tax. That is to say government doesn’t say ‘how much tax do I need to do our things,” it says “how much tax can we grab so we can do as much as possible” and of course it then borrows more and spends that too. So the ‘new monetary theory’ of the way it can control inflation caused by monitisation and straight money printing, falls down at the first hurdle because the control method is not politically possible.
Central banks used to use the economy to regulate money supply. Banks created monetary demand which drew down money from the central bank, in theory that was a fine constantly adjustable method of balancing money supply. Then the banks went off the rails and trashed the system creating the circumstances for the GFC (Global financial crisis, credit crunch, great recession… whatever you want to call it.) The central banks took this process back in house and used QE rather than the fractional reserve banking system as a way to keep the economy on track. Now the Covid-19 crisis situation isn’t their fault and they are trying their hardest to keep the system from complete collapse. They have their tool kit but it is not design for this purpose.
Historically in a situation of collapse a government prints money and spends it. This creates inflation because the new money does not come with a real liability so is free to be used willy-nilly. It is easy come, easy go money. QE didn’t have this effect because the money came with a liability attached, which meant you couldn’t just blow it on a whim or on exaggerated prices, unless of course you bought an asset like an overpriced stock or property. Back in the old days, after war, for example, you buy time for the economy to reset by printing money in a way that in effect cancels the value of old unrepayable debts, the value of pools of earned but inconveniently placed existing money while keeping things busy until the moment the situation is sufficiently reset you can cancel the old money entirely and introduce a new currency which is then, hopefully, not put back through the inflation process. Don’t imagine for a minute inflation or deflation is not policy. If you think that Zimbabwe can organize inflation but the denizens of the Bank of Japan can’t, then think again.
So the world economy has been frozen and the thaw will take too long to save the old system. Deflation will make the recovery situation worse and in the end how are we going to have deflation for long after oceans of money have been injected into the system to avoid complete meltdown.
Once the system is shocked back into life, then what?
There will be a gap in output. Massive unemployment. A huge budget deficit….. straight out of the text book for the conditions for hyperinflation.
Crash 2020: How to ride out the deflation, inflation puzzle.
So the world economy has been frozen and the thaw will take too long to save the old system. Deflation will make the recovery situation worse and in the end how are we going to have deflation for long, after oceans of money have been injected into the system to avoid complete meltdown.
Once the system is shocked back into life, then what?
There will be a gap in output. Massive unemployment. A huge budget deficit….. straight out of the text book for the conditions for hyperinflation.
Is the government going to slash its budget? If it does that will hurt on many levels. Will it tax? That’s not exactly going to have people dancing in the streets or for that matter help recovery. More importantly with a giant budget deficit, is the government going to be able to keep issuing bonds to fund itself? Who is going to buy them? who will have the spare money? Will an angry China buy? Will a broke Middle East? Will Russia (ok that’s a joke)?
Well actually the US government will buy them, like it has done for a long time now and that is how monetization happens, which works if you do not have enough money supply, but when you don’t have enough output, the outcome must inflation. So probably global governments will buy each other’s bonds to make it look less obviously what they are doing and it will help them keep their currencies within the sorts of bands they will feel comfortable with, but monitisation will not be avoided.
Monitisation = inflation if it runs ahead of economic activity and as this monitisation by definition will be to fill budget deficits it will be inflationary.
So what is An investor to do. As I wrote a few weeks ago, my plan is to be invested and diversified across Cash, Stocks, Gold/Bitcoin, with the weighting depending on the developing situation
Move your allocation towards cash if you feel deflation is coming and push your allocations from cash, through Stocks towards Gold and Bitcoin as inflation begins to bite. These asset buckets are cheap to buy and hold and they are liquid. Physical Gold is a bit of an exception to this but that is why I prefer Crypto and there are other proxies for physical Gold.
Proxies should be considered. Cash and near cash come in all shapes and sizes, as do stocks and exposure to Crypto and Gold. You can play around with those ideas but the central one is to adjust your inflation/deflation exposure as your horizon of certainty shifts with events, across cash-like assets, stocks and Gold/Bitcoin. You can ramp up the complexity as much as you like, go on, buy a Swiss franc denominate gold mine stock, if you can find one, but I personally believe in keeping things simple if you can.
I have bought gold and silver stocks, even though I abhor the sector as full of risky fellows and situations, but I remain heavily in cash. I hate that but if I traded what I see in my own behavior it suggests my positioning points at deflation. Strangely we could get both because some assets are in a bubble and they could fall heavily while everyone gets to drink $10 inflation sodas.
Property and certain stocks remain in a bubble. The story stocks like Facebook, which reminded me recently why I don’t short, will come crashing down (how is that for a spicy prediction) but it seems unlikely that this will hit precious metal stocks, which will quite likely rally off the back of a spike in fear.
One thing seems certain, what happens next will be a cascade of outcomes, with one emergent situation creating the next. If you can navigate these unfolding scenarios correctly there is a lot of money to be made but get it wrong, even by doing nothing and you could end up wearing a barrel.
What I am looking out for, and its not a high probability, is immediate inflation. This would happen like this. When the economy unlocks, there is not a full supply chain of stuff, companies are on their knees and need to make money fast or go out of business. They jack their prices as there is nothing else to do or to lose. Take a restaurant which can now only host half the customers. They either go bust or jack up their prices and pray. They can’t drop their wages much, they can cut their headcount but their overhead is pretty much unchanged. Their supply chain has also jacked up its prices, because lower volume needs higher prices to cover their overhead too and their supply chain is cranky as well. So everyone raises their prices. People can’t afford this, so as well as the many that don’t reopen, many of the ones that do, close. Now there is less supply and less demand and higher prices. Off we go on the inflationary loop of those that can demanding more money as prices rise as money is printed to keep things from utter meltdown..
If this happens it will happen fast and if it happens we go straight to high inflation and Gold and Bitcoin will go ballistic. Beyond watching prices, market action will indicate strongly if this process is underway. It will be binary. It will either explode or not happen at all.
If high inflation gets going fast, that would be awkward for me with my cash pile, but the first principles of investing and trading are, the market doesn’t care one iota about me, if I’m right it will pay me, if I’m wrong it will take my money, if I don’t play, the world will move on without me. The market is uncaring, it has no remorse, it does not stop.
Big government have mortally wounded themselves and only individuals that take their whole futures in hand will escape the worst of the changes to come. The near future is not a world of nuance so it will be the big call that set our trajectory.