Thursday, March 11, 2010

Is hyper Inflation in Americas future?

I had an uncle (who married my father's sister) who lived in Germany prior to the outbreak of World War 2. He once told me that, when he was a boy, in the 1920's, when Germany was held accountable for the debt of the first world war, he saw people actually take wheel barrows full of cash (Deutche marks) to the grocery store to get food. It was not unlike the boy pictured here, in modern day Zimbabwe. That was the effect of hyper inflation. The rise of Adolph Hitler was one of the results.

I just read a great article by Ron Hera at In that article Hera lays out, in much detail, why, he believes, hyper Inflation is coming to America. It is an article that deserves to be read by every investor, American or not, who has money in today's markets. It should especially be read by those who are hoarding their cash, as they are the most likely to face huge losses in the coming years.

I touched on this subject in previous articles including:

Dilly Dollar Daze in the USA
IMF selling more gold
America on the road to ruin
Hold on to your Loonies
Capitalism, Greed and the Faustian bargain of more liquidity
and finally:
The Argument for Gold

However Ron Hera, founder of Hera Research, LLC, and the principal author of the Hera Research Monthly newsletter holds a master's degree from Stanford University and is a member of Mensa and of the Ludwig von Mises Institute. A much smarter guy than this writer, he lays out in a very methodical, and convincing way, why hyper inflation is in America's future, and it is not very far away. Some excerpts:

"Deflation causes debt default and that harms lenders. Governments have no mechanism to tax gains in the value of currency so monetary policy always errs on the side of inflation.
The result is a long term devaluation of the currency" (in this case the usd).

A case in point, Hera points out that "Since the inception of the Central Bank in 1913, the U.S. dollar has lost 95% of it's value"

Some more excerpts from Mr. Hera's article:

Patterns of Hyperinflation

"From the perspective of sovereign debt, the commonly understood process of hyperinflation is that if a government responds to declining foreign appetite for its debt with monetization (or in a historical context direct currency debasement) rather than immediate budget cuts, its currency loses value, at first in proportion to the dilution of the money supply and then more quickly as foreign bond holders and the nation’s own citizens seek shelter from inflation in other asset classes.

The cost of the government’s future obligations then tends to rise in nominal terms, creating an apparent need for larger bond issues while bond yields rise, i.e., the cost of borrowing increases since monetization signals greater risk to investors. Exacerbating the problem, tax receipts tend to lag behind as domestic price inflation sets in.

Further monetization is the path of least resistance. Although officials certainly believe that monetization is only a temporary measure both confidence in and the credibility of the government fail. Insolvency is eventually recognized as a reality and the nation’s currency then collapses entirely."

Crisis of Credibility

"A gradual decline in the value of a currency is generally accepted by consumers and businesses because it has little immediate impact and can have short-term benefits, such as making money more accessible and stimulating economic activity and growth.

However, when debt increases disproportionately, a deflationary bust is inevitable and if it is postponed by further credit expansion systemic instability results."

In 1949 Ludwig von Mises pointed out in Human Action (Chapter XX, section 8) that “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.”

Among other things, excessive monetary inflation means that the US dollar cannot function as a store of value. Mounting evidence points to systemic instability, a lower US dollar and ultimately to a hyper inflationary outcome"

"Seven US states are worse off than the financially troubled European nations of Greece, Ireland, Portugal and Spain resulting in warnings of a US credit rating downgrade possibly indicating an eventual sovereign default."

In an article last year, I pointed out that U.S. Banks were holding financial Derivatives such as CDSs in the Trillions of dollars, and that they were not counted on their books. In that article I speculated that the amount of Financial Derivatives might add up to more tha 3 times the world GDP. I was obviously wrong. Here is a real eye popping statistic that Hera lays out:

"The largest US Banks remain the largest holders of financial derivatives, e.g., credit default swaps (CDSs), which suggests that they may hold liabilities far in excess of amounts that can be paid or that can be bailed out if significant losses occur. The CDS market, which is the single largest class of financial derivatives, represents over $600 trillion dollars, a roughly 10x multiple of world GDP."

Now that, my friends, is a truly scary number! No wonder Warren Buffet called these "Financial instruments of mass destruction". He wasn't kidding or even exaggerating.

Finally, Mr. Hera points out obvious warning signs for his hypothesis:

"Perhaps the most important indicator of impending hyperinflation is whether the statements of a government or of its central bank, e.g., with respect to the government’s budget or the central bank’s balance sheet, are evidence based or ideological. If they are not evidence based, the credibility of the government or central bank, and its currency, will weaken and eventually fail.

Currently, the largest buyer of U.S. government debt is it's own Central Bank. If a government so lacks credibility that it cannot issue bonds because there are no buyers other than its own central bank, the value of its currency declines faster than money is printed to cover its obligations.

When the balance sheets of US banks are maintained by suspending accounting rules and when banks hold financial derivatives liabilities greater than world GDP, both the stability and credibility of the banks is questionable.

When private financial losses and toxic financial assets are transferred to taxpayers while profits and bonuses abound on Wall Street thanks to accounting rule changes in the midst of the worst economic contraction since the Great Depression, the credibility and competency of the US Treasury and Congress, with respect to the finances of the nation, is questionable.

When the US Federal Reserve defies the US Congress, resists independent auditing, engages in ongoing QE and is the lender of last resort for banks that under normal conditions would be insolvent, its credibility is questionable. When the Chairman of the Federal Reserve, who failed to detect the largest asset price bubble in the history of the world and who has been consistently wrong in his assessment of the US economy is reappointed following the worst financial and economic disaster in generations, both his credibility and that of the Obama administration are questionable.

The plethora of red flags spewing from Wall Street, from the Federal Reserve and from the federal government point to a breakdown of de jure value that is already in progress, thus to a hyperinflationary outcome for the US dollar."

I encourage you to read the entire article at: Seeking Alpha.

Here's another, in depth view.

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