Copyright 2012 by John T. Reed

You would think that hyperinflation just means prices going up really fast. That’s the definition, right?

Well, it’s the definition of inflation and hyper just means extraordinarily high. I wrote a whole book on it and it took me 320 pages. (How to Protect Your Life Savings from Hyperinflation & Depression, 2nd Edition)

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Look at the history, not just the theory

But study of actual hyperinflation in Zimbabwe; Argentina, Israel; 1920s Austria, Germany, and Hungary reveals there is a lot more to it than just a simple higher inflation rate.

First off, hyperinflation is caused by the federal government “printing” too much money. Nowadays, they do that by the Federal Reserve buying U.S. government bonds with money that the Federal Reserve conjured out of thin air. In 2011, the Federal Reserve bought 61% of the new U.S. government bonds sold. I do not understand why we do not already have hyperinflation with that level of money “printing.” Actually, I assume it is the result of low velocity, that is, people get the money that was “printed” and just save it so it is, momentarily, as if it does not exist. But velocity can change overnight.

Hyperinflation requires a whole lot of bad new laws to make it work for the government

However, hyperinflation is not just too much money. Hyperinflation causes certain behavior and the government that caused the hyperinflation must then pass additional laws to prevent its citizens from making a run on the dollar.

When hyperinflation starts, everybody on earth suddenly sees that the price in U.S. dollars of, say, gasoline, starts skyrocketing up. $5 a gallon. $10 a gallon. $30 a gallon. $50 a gallon. And higher. Same applies to groceries, cars, houses, toilet paper, and so on.

A run on the banks to end all runs on the banks

So people—logically—pull their dollars out of the bank and use them to buy everything before it goes up in price any more—before the purchasing power of their dollars falls even more. When everyone in the world who owns dollars does that, which they absolutely will, you have the run on the bank to end all runs on the bank. Actually, it’s a run on the dollar, not the bank, but if the bank is in the U.S., and all its deposits are U.S. dollar-denominated, it’s a run on the bank.

U.S. bank deposits are FDIC-insured roughly speaking up to $250,000 per account. But the FDIC is currently underfunded compared to its regulations. And its $500 billion line of credit from the Treasury is a joke because they Treasury is broke, if I may quote Barack Obama. Even if FDIC had the amount of reserves they are supposed to, and the Treasury actually had $500 billion, it would not matter.

In the Great Depression, runs on the bank were caused by lack of confidence in some banks. 9,000 of tem failed. The run on the dollar of which I am speaking is a run on every single bank in the U.S. by every depositor that is sentient plus on every single dollar-denominated bank account worldwide and on every single dollar-denominated asset—namely U.S. government bonds—worldwide. There is more or less not enough money in the world to make depositors whole in a timely manner when that happens.

Hyperinflation is a deliberate government policy to enable it to continue to pay its bills when they can no longer borrow the money to cover deficit spending. A run on the dollar nullifies the policy. Hyperinflation is a hidden way for government to steal from the people who were dumb enough to trust the U.S. dollar.

Nail the exit doors shut

When people suddenly realize that is happening, they try to rush out of the theater, so to speak. So the government must pass a bunch of additional laws to prevent U.S. citizens, at least, from “leaving the theater.” They nail the exit doors of the theater shut. I say U.S. citizens because the U.S. government cannot pass laws that prevent citizens of other countries from “leaving the theater.”

What are these laws?

• wage, price, and rent controls
• capital controls (prohibitions on possessing, using, importing, exporting foreign currency or gold; confiscation by the government at below-market rates of whatever foreign currency and gold that are already here)
• financial repression (forcing all Americans to buy U.S. government bonds for more than they could get in the free market by forcing banks to put a very large percentage of their reserves into U.S. bonds and forcing Americans to put their money in bank accounts) On 5/1/12, the day after I wrote this article, a Harvard MBA friend sent me an item from the Financial Times of London saying U.S. economist Martin Feldstein urged Spain to pass a law forcing Spanish citizens to buy Spanish federal government bonds. Told ya. How about a law requiring Feldstein to buy Spanish bond?. Here is the U.S. we could pass a law requiring Warren Buffett to buy U.S. bonds.
• rationing and limits on amount of food, fuel, etc. that you are allowed to have on hand (hardly any)

Tariffs against U.S. exports

Plus there are generally laws passed by other countries outside the hyperinflated country, mainly tariffs on the exports of the hyperinflated country and maybe restrictions on tourism into the hyperinflated country. That happens because the goods and services of the hyperinflated country suddenly become extremely cheap compared to those of countries who are not hyperinflated.

Each of these causes their own extreme problems like the gas station lines we had in 1973 and 1979 (caused by price controls and the federal government deciding how much gas each station received). Rent control in NYC made it extremely difficult to find an apartment there in the not-too-distant past and, at the worst, caused 30,000 units a year to be abandoned by landlords who could not make a profit from them.

Price controls cause extreme shortages including total disappearance of the item in question as well as diminution of quality as a back-door way of raising prices in spite of controls. Capital controls cause foreigners not to invest in the U.S. and to want to remove whatever investment they made in the past ASAP. Financial repression discourages savings and investment.

In short, list all the bad things that would stop or reverse economic growth and that’s what you get with hyperinflation.

Multi tiers of prices

But my main point here is you end up with a many-tiered price situation, not just one tier with much higher prices. The tiers are:

A. What the prices were before the ’flation hit the fan. Everyone tries to relate the hyperinflated prices to the pre-hyperinflation ones to ascertain what price is too high and what is too low.

B. What official, controlled prices are now.

C. What local black market prices are now. They represent not pre-insanity reality but current reality within the hyperinflated country.

D. What prices are now in other countries that are not hyperinflated.

E. What prices you are paying when you buy and what you are getting when you sell which are often none of the above at least on average. For example, you may have some special privilege or situation that exempts you from government controls at least in part. You may have a connection or relationship that enables you to get some supplies in your own private black market and vice versa. You may have money or business operations or relatives overseas such that you are partially not under the thumb of the hyperinflating U.S. government.

F. Barter which is simply insane and unquantifiable. Generally buyers using barter seemed to grotesquely overpay with expensive luxuries like a grand piano for cheap mundane items like a bag of flour (page 149 of Anna’s diary). Other mundane necessities for which people must trade expensive luxuries include milk, eggs, soap, bandages, etc.

On page 19 of Anna Eisenmenger’s hyperinflation diary she has a table showing the A (above) type of prices and the B type prices in Vienna in 1918. Here are some of them.

prior normal
govt controlled
black market
peas 28.7 120 660
potatoes 6.9 20 110
sugar 34.7 186 1,023
beef 1.8 20 110
eggs .09 .50 2.75
butter 2.5 27 148.5

They happen to be in the Austrian currency of the time. Ignore that. Just look at the relative numbers.

Black market

The black market (type C) column is simply the controlled prices multiplied by 5.5 times. Anna said black market, or as she called them, “smuggler” prices, were “5 to 6 times” the government-controlled prices.

Obviously, black market prices, which are free market complicated by illegality, are higher than government-controlled prices because the government is trying to be popular with voters by making sellers sell at below cost. Typically, you cannot get much at the government-controlled prices because they are unprofitable and sellers predictably find a million excuses to be “out of” the controlled items.

On page 23 Anna said the smugglers were becoming millionaires. Same as the Mafia during prohibition, for the same reason.

Foreign currency the most sought-after thing

The most-valued things in the hyperinflated country were foreign currency from non-hyperinflated countries and the necessities that were taken for granted back in the good times: meat, eggs, milk, butter, sugar, cigarettes, cigars, medicine, bread.

You might think that if a gallon of milk cost $4 US in 2012 in the U.S. and $4 Canadian in 2012 in Canada would still be the same at least for the Canadian after the U.S. became hyperinflated. Apparently not. Based on my reading of the history, it sounds like for a U.S. resident, the cost of the gallon of milk might rise to $100 a gallon in U.S. dollars but drop to $1 if the buyer had Canadian dollars. Why would the price of milk go down within the U.S. for a Canadian using Canadian dollars? I guess because Canadian dollars were usable money and in a land that has no money, foreign money that is not hyperinflated is extremely rare and valuable.

In the land of the blind, the one-eyed man is king. In the land without a stable currency, the stable currency of another country is extremely valuable, far beyond what it would buy in its own non-hyperinflated country. Anna’s family referred to foreign currency as “gold” not intending any precise meaning, only that it was the supreme thing of value to get hold of. It would hardly be an exaggeation to say that in hyperinflated Vienna, a middle- or even lower-class foreigner with currency from his own country practically had rose petals and red carpets rolled out in front of them as they walked. (See page 243 of Anna’s diary.)

That is why I am moving so much money into foreign currencies. I am not planning on taking advantage of extremely low prices in the U.S. More likely, when we get hyperinflation, we will just leave and spend our foreign currency in the foreign country that printed it where it gives us no advantage, just the normal ability to eat fresh food and stay warm.

And who were the poorest of the poor, the most miserable people in Austria? Pensioners, especially former civil servants whose only “skill” was to push paper. And which locals were best off? Farmers and others in the food and other necessities businesses.

John T. Reed