Getting with the Program

Two years ago, Financial Armageddon raised eyebrows and caused lots of sniggers with an in-your-face title and a table of contents that included the following section:

PART TWO: RISKS

5. Economic Malaise
6. Systemic Crisis
7. Depression
8. Hyperinflation

Since then, of course, we've gone through the first two phases, and all signs indicate that the third is currently unfolding.

For the most part, the mainstream analytical crowd has been unwilling to allow for or even acknowledge these outcomes until the facts made it virtually impossible to do so.

Now, however, some of the establishment types are beginning to get with the program a little faster than they did before.

In "Hyperinflation Is a Possibility, Say Morgan Stanley," the Financial Times' FT Alphaville blog details one recent example.

That’s not in Zimbabwe by the way.

Morgan Stanley’s Jocahcim Fels and Spyros Andreopoulos look at the possibility of hyperinflation hitting the western shores of the UK, Europe and the US in their latest note. Their conclusion is a little scary (our emphasis).

One stark lesson from the ongoing financial and economic crisis is that so-called black swans — large-impact, hard-to-predict and seemingly rare events — can occur more frequently than generally believed.With policymakers around the world throwing massive conventional and unconventional monetary and fiscal stimuli at their economies, we think that it is worth exploring the black swan event of very high inflation or even hyperinflation.

While such an outcome is clearly not our main case, the risk of hyperinflation cannot be dismissed very easily any longer, in our view. We discuss the historical evidence, the conditions that can lead to very high or hyperinflation, and whether and how it might happen again.

So hypinflation is a black-swan event that, given all the other black-swan events of late, should not be dismissed.

As they remind, the classification of hyperinflation is: an episode where the inflation rate exceeds 50 per cent per month. In history this has occurred in the 1920s in Austria, Germany, Hungary, Poland and Russia. Germany in 1923, for example, experienced a 3.25m per cent inflation rate in a single month (see picture left). Since the 1950s hyperinflations have been experienced in Argentina, Bolivia, Brazil, Peru, Ukraine and Zimbabwe - so confined largely to developing and transitioning economies.

The root cause of hyperinflation is: ‘excessive money supply growth, usually caused by governments instructing their central banks to help finance expenditures through rapid money creation.’

Back to whether it could happen to Europe or the US? Morgan Stanley says possibly yes, under certain conditions.

Firstly, the rapid expansion of the monetary base by the Fed, ECB and BoE would have to continue and feed into a more rapid and sustained expansion of money in the hands of the general public.

Secondly, Morgan Stanley says  governments would have to face difficulties financing their bailout packages and funding their debt.

Lastly, public confidence in the government’s ability to service debt without resorting to the printing press would have to disappear, as well as the government’s actual ability to withstand the pressure to do so in the first place.

And while all of the above is an extreme scenario, the Morgan Stanley analysts say:

…given the size of the current and prospective economic and financial problems, and given the size of the monetary and fiscal stimulus that central banks and governments are throwing at these problems, investors would be well advised not to ignore this tail risk, especially as markets are priced for the opposite outcome of lasting deflation in the next several years. Put differently, we believe that buying some insurance against the black swan event of high inflation or even hyperinflation makes sense and is relatively cheap currently.

Of course, when hyperinflation occurred in the eastern block countries towards the end of the communist era, most citizens hedged via significant purchases of black-market US dollars, the US dollar becoming the effective proxy store of value. This time round, that would not be an option.

Comments

[Independent Accountant]

I have long predicted a decade of measured CPI inflation in the 10-12% range, with "Shadowstats" measured inflation higher. Do I see hyperinflation as a possibility? You bet. With the monetary base increasing 106% in 18 weeks, anything is possible. I don't call Him (capitalized by design) "Zimbabwe Ben" for nothing.

[Marion Shaw]

NOT ONE PERSON has suggested that we tackle our crisis
by interest rate reform. Make adjustable rate mortgages illegall, retroactively, restore the six percent rule, that was left to die on the road in 1929, and apply the same to all credit card holders. When this happens, there might be a chance to save the
system.

[Bank Spiral]

Wondering if anyone else noticed that 6 banks failed in January of this year. 25 banks failed in 2008...total.

I updated Bank Spiral to show the latest set of bank failures (this is automated, so that every time the FDIC updates its site, it is reflect on the site, along with relevant news).

Still too early to tell, but extrapolating 5-6 bank failures a month in 2009 reeks of depression to me...