The day the hyperinflation dies

Periods in hyperinflation throughout history have been excruciatingly painful for those who lived through them and seemed to go on forever. But they, too, are governed by the rule the old farmer offered when a young city slicker asked after days of rain,

Think it’ll ever stop?

It always has.

Do we need to discuss this? I mean is there anything to know other than we go out and celebrate in the streets?

We need to discuss it.

Yin-yang

My book How to Protect your Life Savings from Hyperinflation & Depression

$34.95

covers both inflation and deflation (depression) because I did not know which we were more likely to have. And you need to protect yourself from each, just as a homeowner on a flood plain would have both fire insurance and flood insurance. (I now believe we are more likely to get hyperinflation.)

So that book has a bit of a yin and yang format to it. Wikipedia says,

In Chinese philosophy, the concept of yin - yang, which is often referred to in the West as "yin and yang", literally meaning "shadow and light", is used to describe how polar opposites or seemingly contrary forces are interconnected and interdependent in the natural world, and how they give rise to each other in turn in relation to each other.

Just so. And now I have another yin-yang for you: the day the hyperinflation dies.

I already wrote about The Day the Dollar Dies, a.k.a. the first day of hyperinflation. This article is about the day after the last day of hyperinflation.

Humans can adjust to almost everything. Combat veterans, both military and civilian, often marvel at how quickly everyone just made combat a normal part of their lives. I remember the enemy rocket attacking us around 6:00 AM every pay day in VIetnam. We made the age-old GI jokes about setting your watch by the attacks.

And so it is, ultimately, after hyperinflation hits. Belatedly, and after they have lost almost all of their life savings, people will adjust to the plummeting purchasing power of the U.S. dollar.

Be careful

The message of this article is be careful how you adjust.

Because eventually, probably in one to three years, it will end. And as I have often written, it ends overnight. Inflation is a creature of government requiring legal tender laws, a monopoly on “printing” money, and capital controls. All the government need do to end it, is end the legal tender laws (which require that all creditors accept the U.S. dollar at face value for all debts), stop “printing” too much money, or end capital controls (which prohibit converting U.S. dollars to foreign currency or possessing or using foreign currency). Zimbabwe ended its recent hyperinflation overnight in 2005 by simply ending all those laws.

Government will continue hyperinflation for as long as it thinks it can get away with it. When they finally realize they no longer get any benefit from it—because the U.S. dollar is totally worthless and accepted by no one—they will end those laws and the “printing.” The hyperinflation will instantly stop as a result.

Celebrate?

Should you run out and celebrate?

Before you do that, you’d better do some other things:

Sell all your gold and other commodities that you overpaid for during the hyperinflation. The historical long-term average price of gold has been $642 in 2011 dollars since 1968. That means the future long-term average price of gold will be $642 2011 dollars, too. But you get to that average by it dropping well below that after having been up in the $1,600-per-ounce range in the early 2010s. In other words, gold will drop to something like $500 an ounce the day the hyperinflation dies.

Gold bugs reading that scoff.

The highest ever gold price was $850 on January 21, 1980. In 2012 dollars, that would be $2,367.

Why?

We had double-digit inflation in 1979-1981.

What was gold selling for in 1982? $376 or $894 in 2012 dollars.

In 2001, gold was selling for $272 or $352 in 2012 dollars. In 1970, gold sold for $36; $213 in 2012 dollars.

After you sell your gold on the day the hyperinflation dies (before then would be a far better idea), you can go out and laugh at the gold bugs who refused to believe it would ever drop back to those levels and therefore still own the stuff.

The reason gold has late been selling for four-digit numbers is fear of U.S. dollar hyperinflation. The day the hyperinflation dies is the day the fear dies. The day the fear dies is the day gold dies. That is the day it becomes a useless pile of coins or bars. It pays no interest. It only is sought-after during hyperinflation fears. It sucks in terms of convenient denomination and the need to have it assayed and for other reasons.

Basically, when there is no hyperinflation, gold cannot compete with stable currency which can be held in accounts and shot round the world at light speed or spent in whatever denomination you need and which requires no assayer to confirm its value.

Is the day the hyperinflation dies deflation?

No. It is stable. The purchasing power of the dollar stops falling. That does not mean it goes up. In deflation, the purchasing power of the dollar actually rises. You can buy more stuff with it after you take it out of your safe deposit box than you could before you put it in.

Switzerland had deflation in 2009 and has had it since the end of 2011. Accordingly, I have Swiss franc cash in a safe deposit box. You should, too. If Switzerland goes back to inflation of any significance, I will have to reconsider that.

So does the fact that hyperinflation ending is not deflation mean that the stuff I said about deflation protection in my book does not apply to the end of hyperinflation?

Well, let’s be careful here.

Real interest rates

What I said in the book about fixed-rate debt is that it will crush you financially during deflation. But the key thing that I said about debt in the liabilities chapter is you must not pay a high real rate of interest. That is the rate of interest you actually pay after you subtract inflation from the nominal rate that is printed on the loan documents.

In the early 1980s, home mortgage interest rates in the U.S. reached 16.55% in 1981. Was that high? No, not after you deducted the inflation rate that year—10.3%—to get the real interest rate: 16.55% - 10.3% = 6.25%.

But during hyperinflation such loans as are available would no doubt have extremely high interest rates, like 50%. If inflation is at 80%, the real interest rate is 50% - 80% = -30%—a gift to the borrower.

But if your interest rate is 50% and the inflation rate suddenly drops to zero, your real interest rate becomes 50% - 0% = 50%. Where are you going to get the income to pay such a high real rate? Nowhere. You’re toast.

Solution: you’d better have the money available to pay the loan off and the right to do so—no prepayment penalty in the loan agreement. Or it had better be a nonrecourse mortgage meaning you can legally and ethically walk away from it. I discuss how you get nonrecourse mortgages in my How to Protect your Life Savings from Hyperinflation & Depression book. Also, the H.E.C.M. mortgage is a nonrecourse mortgage.

Or you could have no mortgage at all. That would prevent you from the big profit in hyperinflation, but it would also save you from paying intolerably high real interest rates.

What else happens the day the hyperinflation dies?

Stock market crash

The stock market crashes. Why? It becomes an alternative to the U.S. dollar after hyperinflation starts. As I described in my The Day the Dollar Dies article, on that day, everyone tries to spend their dollars or move them into hard assets—right now—a worldwide run on the dollar. One of the places they try to move their dollars is to the stock market, which goes up as a result. It is somewhat like gold—inflated by fear with regard to the purchasing power of the dollar—then the resulting balloon is popped when that fear ends, as with gold.

So what should you do? Same as with gold. Get the hell out of the stock market before it happens.

Foreign currency?

What about foreign currency? Does its value fall because of the end of hyperinflation?

Well, first, foreign currency is foreign. That means it was not the hyperinflating currency. All this stuff I am writing about in this article is what happens within the hyperinflated country when the hyperinflation stops.

People in the hyperinflating currency country were trying to get foreign currency because it was stable. Asking if foreign currency goes down in value like the currency of country A when the currency of country B stops hyperinflating is like asking if putting out the fire in your house also puts out the fire in your mom’s house on the other side of town, even though her house was never on fire.

Freeze not melt

The German mark to U.S. dollar conversion rate in 1913—normal times—was 4 marks = $1. In 1923, it was 4 billion marks = $1. The mark was replaced then by the rentenmark, which had a conversion rate of 1 billion marks = 1 rentenmark which meant the day after the hyperinflation died in Germany 4 rentenmarks = $1. The rentenmark was stable, like the U.S. dollar was then.

So the end of hyperinflation does not make the value of foreign currency fall. It would lessen demand for the currency because of the Americans no longer needing foreign currency, but the foreign country in question would simply “print“ fewer of them in the future to offset that.

Hard assets

Gold is a hard asset. If the end of hyperinflation means gold falls won’t it mean the same for all other hard assets like real estate, cars, farms, factories?

No. Gold does not fall in value the day the hyperinflation dies because it is a hard asset. It falls because it was overpriced in relation to its historical value.

In a recent article, I said when hyperinflation arrives, you must think and analyze only in terms of some stable foreign currency like the Canadian dollar. So think like this. In 2012, your home was worth $400,000 in both U.S. and Canadian dollars. (In recent years, the Canadian and U.S. dollars have coincidentally been around parity, meaning $1 U.S. = $1 Canadian.)

During hyperinflation, your home remains worth $400,000 Canadian, but rises in U.S. dollar value to $20 million U.S.

Hyperinflation ends. What is your house worth?

$400,000 Canadian and $20 million U.S.

Even the day after hyperinflation ends? Yes. It ends. It does not reverse course. It is a freeze, not the reaching of an apogee of a trajectory.

At that time, the U.S. dollar will almost certainly have been replaced by a new stable U.S. currency like the German rentenmark. I cannot predict what the conversion rate will be from the old U.S. dollar to the new U.S. currency but they may try to restore the old purchasing-power denomination as the Germans did in 1923 and make the New Dollar worth, say, $50 old U.S. dollars. That would mean your house would be worth $20 million ÷ $50 old dollars per New Dollar = $400,000 New Dollars.

The same would generally be true of all hard assets inside the hyperinflated country.

Only the hard assets for which you overpaid will fall in value

The issue is not that the end of hyperinflation decreases the value of hard assets. It does not. The issue is whether you lost track of values during hyperinflation or the lead up to it and overpaid for the hard asset in question as gold bugs have unquestionably done since around 2005.

Think foreign

How do you avoid losing track of values? Always think in terms of a stable foreign currency as I recommended in my recent article “Surprising lessons learned about hyperinflation from the Economics of Inflation: A Study of Currency Depreciation in Postwar Germany by Turroni.”

Think long-term historical average with regard to assets whose dollar values are affected by inflation fears

Also, always think about hard assets that are affected by inflation fears, like gold, in terms of their historic average long-term price. You can see that analysis in a spreadsheet in the “Gold and other commodities” chapter of my book How to Protect your Life Savings from Hyperinflation & Depression. The logical basis for it is regression toward the mean. That is a mathematical phenomenon that says things that go away from their long term average tend to go back to the average (mean), like a swinging pendulum for which the straight down position is the mean.

Put another way, there is no reason for the relative intrinsic value of gold or homes to change compared to other assets like corn or an iPod or a pound of chicken breast. The temporary high dollar price of gold caused by fear that the U.S. government will print too many dollars does not change the fact that gold only has a few limited industrial uses like dental crowns and jewelry and that its heightened value increment as a fear calmer during hyperinflation or threatened hyperinflation disappears when the threat of hyperinflation disappears.

The long-term mean measures its intrinsic value in both fear and non-fear times. Indeed, after hyperinflation, it is likely the public and government will be so terrified of hyperinflation, as Germans have been since 1923, that it will probably be a century before gold reacquires its fear value increment. So we are on the eve of a one- to three-year hyperinflation that will temporarily boost gold’s dollar value, but we are also on the eve of a century of being profoundly chastened by having “printed” too many dollars, causing the horror of hyperinflation, and a century of gold being banished to the wilderness—values maybe averaging less than $642 2011 dollars.

Bought too many hard assets they did not need

In Germany after hyperinflation died, there were too many new factories and mines and machines and all sorts of hard assets that people and companies acquired in a panic when the purchasing power of the mark was plummeting..

Did they drop in value when the hyperinflation ended?

No. They sucked from the day they were acquired, but the people who acquired them could not see through the fog of hyperinflation. They failed to think in terms only of a stable foreign currency when acquiring them. If they had, and done the same with their business’s costs and sales, they would have seen that the return on the hard asset purchases would not adequate. When the fog of hyperinflation lifts, that is immediately evident. “We don’t need all these factories and machines. Our market is not big enough to sell that much product.” During the hyperinflation, they stopped doing that analysis and just said, “Get rid of all marks. Buy anything else we might need: factories, equipment, farm land, mines, whatever.”

The end of hyperinflation will punish you for overypaying for hard assets—like gold—during the hyperinflation and for buying more of any hard assets than you needed—like a bigger building for your business when there was no fundamental corresponding increase in your real unit sales.

When the hyperinflation ended in Germany, they were closing mines, demolishing factories, selling unused new equipment for salvage value, and so on. See “Surprising lessons learned about hyperinflation from the Economics of Inflation: A Study of Currency Depreciation in Postwar Germany by Turroni” for more details.

Government will be the last to figure it out

The government will be overtaxing and such when hyperinflation ends. They are the last to figure out how to deal with it and the last to figure out how to deal with its end. Dopey, inadequately-motivated, government bureaucrats.

Noncallable bonds issued by reliable counterparties

Any noncallable bonds that still exist when hyperinflation ends, and which are likely to be paid as agreed by their borrowers, should rise in value when hyperinflation ends because the decline in market interest rates will make the higher interest rates on the bonds more attractive. Again, that means nothing if the borrower who issued the bonds cannot or will not pay them as agreed. This happened in the disinflation of 1982 with U.S. government bonds which are not callable. Corporate bonds are typically callable. Callable means the borrower can refinance at the new lower market interest rates and pay the old high interest rate bonds off. After hyperinflation, do not be surprised if the U.S. government defaults on its high-interest rate noncallable bonds that were issued during the hyperinflation.

Note, disinflation happens after mere inflation, not after hyperinflation. There is no dis-hyperinflation. After hyperinflation, the old currency is simply replaced with a new one. The old one never comes back as it did in the U.S. during 1982 disinflation.

It could be worse. At least you know.

Am I depressing my readers with articles like this? Cheer up. It could be worse. You could be one of the 99.9% who do not read these articles and when the shit storm hits, you would not have a freaking clue what’s happening. You guys—my readers—will be rather squared away for not only its start, but also its end, and if somehow it goes that way, its never happening.

You, my readers, understand what it coming and what to do about it and, luckily, you apparently still have time to take the necessary actions.

About the only thing worse that being one of the 99.9% who do not read these articles would be to be one of the .1% who do and not take the indicated action. The “mating call” of those after reading my hyperinflation articles is “This can‘t be right.” My response to them is “Vaya con dios.”

After hyperinflation hits, as your friends, relatives, and colleagues wail that no one warned them about all this, you can say, “No, there was this one guy…” Harry Markopolos warned people including the SEC about Bernie Madoff. No one would listen. After the Madoff scandal broke, Markopolos wrote a book titled “No one would listen.” I can’t use that title. Many of you are listening. My foreign bankers tell me you are coming to see them. I am not the only one warning, but most of the rest seem to be gold pushers or the good men whose social filters—inability to call a spade a spade because they do not want to be seen as too radical—enable bad men to prevail.

But generally, I know how Harry Markopolos felt.

John T. Reed