Augustine guest post, part 2

This is part 2 of the first guest post I have ever had on the blog.  Part 1 gave a brief introduction of the author and in part 2 he attempts to give more perspective on the process of hyperinflation. as he experienced it over the course of decades in Brazil.
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PART II

Life in Brazil from the 1980s through the mid 1990s was like that of paramecium on an economist’s Petri dish.  Instead of describing the numerous economic experiments inflicted on the people, I’ll draw a parallel between what some people are beginning to consider plausible to happen in America and my experience living in Brazil during its chronic economic crisis.

The following excerpts from a newsletter by Jeff Clark of goldsilver.com may be helpful to illustrate how much and how little grasp many analysts have of extreme economic crises. The facts alluded to by the author correspond pretty much to the body of knowledge, theoretical and historical, accumulated about economic crises.  I cannot fault the author about getting the overall picture right.  Where I think he fails is in the degree and timing of it all.  Virtually all the online commentary about a probable deep economic crisis fall into this same trap.  So this is not so much picking on this author, but on the trend that he represents.

What the Upcoming Wealth Transfer Will Look Like

By: Jeff Clark, Senior Precious Metals Analyst

...

The world is in a panic—the US dollar has crashed and the resulting inflation has gotten out of control. Everyone around you is desperate to get their hands on any gold or silver they can. It’s morphed from greed to fear to survival. Investors scramble to buy bullion while it’s available, premiums be damned.

…

In the paragraph above, the author refers to the crash of the US dollar.  While the USD holds the exorbitant privilege of being the official currency of international trade and reserve, it is not the first one to enjoy this privilege.  Other currencies enjoyed it at least as a matter of fact, if not officially, be it the Medieval ducat, first from Venice and later from the Austro Hungarian empire, be it the British Pound Sterling before the USD.  Of these, only the GBP eventually was also a fiat currency as the USD.  And the fact that the GBP ceded the privilege to the USD means that this privilege does not isolate a currency from debasement or destruction.

However, I find it remarkable that the author chose to describe this event as panicky, as if it had happened overnight.  It is not easy to destroy a currency.  When it happens, it is not the intended result of policies, but their side effect.  Yet, it is important to understand that a currency is not exactly destroyed, but it loses the confidence of its users as a consistent store of value in the short term.  While fiat currencies invariably lose value over long periods, it is an accepted, rightly or wrongly, fact that that happens slowly enough to not disrupt economic calculation from day to day or even year to year.

Excepting the current Indian prime minister, Narendra Modi, who is probably the first one to actually decree the destruction of a currency in practice, by decreeing the value of over 80% of the circulating money back where it came from: thin air.  And that in a country whose consumers carry out over 90% of their transactions in cash.  Evidently, it caused panic overnight and the impact on the Indian society, let alone its economy, is still unfolding.

However, difficultly would a reserve currency fail overnight.  The GBP took some decades to fall out of this privilege that lasted about a couple of centuries.  Even considering that financial transactions took place much more slowly a century ago than nowadays, the main stock markets in the world were already connect by telegraph, matter of factly in the telecommunications age.  The reason is probably because too much is literally invested in a reserve currency to admit that it is failing.  This dampens sudden moves to zero with an awesome inertia, perhaps even able to resist a deliberate attempt to crash the USD by the US Treasury.

And it's all happening because central bankers, in a desperate reaction to deflation, overshot and printed too much currency. Inflation is now officially out of control and has scourged every part of life. You mock government officials that insisted this couldn't happen and curse those economists and TV pundits that claimed there was nothing to worry about. Their lies have been exposed for what they are: empty promises that had no basis in reality.

Cash has become a hot potato, and everyone rushes to spend it before it loses more purchasing power. It seems everyone is clamoring to get something tangible, but mostly gold and silver. Hyperinflation is knocking on the door and feels inevitable.

It’s got to the point where prices change every day, sometimes several times a day. The $100 you left your spouse that morning to buy dinner isn’t enough. Stores and restaurants post prices on a chalkboard and update them throughout the day, always higher. You suddenly remember you forgot to fill up your gas tank on the way to work, and realize you’ll now pay more and be stuck in a long line. Your salary this month will be woefully inadequate to pay for basic necessities. The government is trying to work out an official “inflation adjustment.” Good luck with that, you mutter.  

In the next paragraphs, the author commits the mistake of conflating many years into a few hours.  It just takes too long a time to inflate the value of a currency to near zero, even digitally, as there are legal and practical limits to it.  To put it simply, to half the value of the currency (100% inflation), twice as much as existing before would have to be in circulation.  To decimate its value (1000% inflation), it’d be necessary to have as much as ten times more in circulation.  The actors inflating the currency actually count on the inherently slow speed of inflation to reap its benefits, as its first recipients.  

As I mentioned in part I, price inflation in Brazil climbed the rungs of double digits before reaching those of triple digits and finally four digits over a span of about two decades, including devaluing and renaming the currency six times along the way (v. this).  Two decades is too long a time for a change to lead anyone to panic.  On the contrary, it’s a time long enough for the population to adapt to the new daily reality of price inflation.  Firstly, moderate, then high inflation and finally hyper inflation.  Indeed, once price inflation reached four digits, shoppers, especially the poor, would go the stores early in the morning, for in the afternoon the prices would be higher.  Or even rushing to an aisle in the grocery store - before bar codes existed - as soon as the price labeling machine was overheard to grab the merchandise before the store worker would attach a new price on it.

A local radio station interrupts to report that an emergency summit of all heads of state is being held. They're “working urgently” on the problem, but you and everyone else instinctively knows their solutions will fall short. Your gut tells you they don’t have the ability to solve the problems they themselves created.

It is actually the situation in this paragraph when panic would be a legitimate reaction.  It’s not that heads of state would convene to work on the crisis, but economists would rush to the opportunity of experimenting on a whole population their wildest ideas on how an economy should really work.  Since the elite economists are actually trained in just a handful of schools around the world, nothing but regurgitations of the same demiurgic ideas can be expected from them.  It was so with the Brazilian finance ministers who shocked the economy repeatedly, all holding PhDs from universities like Berkeley, Harvard, Cambridge, NYU, etc.  Now such ivory tower luminaries are inflicting nominally negative interest rates for the first time in modern history in the largest developed economies.

Violence has quickly escalated, and rioting has become a near daily occurrence. The President ordered increased police presence, but you hear reports that politicians and other government officials are given first priority, above regular citizens. A major TV network runs a special report about the spike in arrests at the Canadian border… scores of US citizens have been caught trying to sneak bullion and stock certificates out of the country.

Everyone is infuriated at politicians. A local government office was overrun by angry taxpayers and frantic benefit recipients whose checks can’t keep up with inflation. You hear another government office was set on fire. A riot erupted in the nation’s capital last week and martial law was temporarily declared. It's becoming increasingly dangerous to travel. You worry about the safety of your kids.
... 

In the last paragraphs above, the author paints an extreme situation that would likely happen if the currency suddenly lost its value, but, in a more typical situation, it would likely never turn violent immediately.  The people would actually be demoralized by years of economic instability, with their savings vaporized and their careers derailed by frequent layoffs.  In Brazil, massive protests eventually erupted all over the country in 1984 demanding the end of the military junta’s 20 year old stronghold on power.  However, the people was actually looking for a messianic political figure to save them from the injustices inflicted on them.  What ensued was a mix of politicians who had made a career serving the junta, opportunists and extremists.  No matter the color of their ideas, the politicians who made the wildest eyed promises were catapulted onto power by the gullible people, too weak and desperate to take a step back and consider the long term effects of their choices.

The caliber of politicians who came along continued their economic experiments that continued rocking the Brazilian economy.  Economists in ministerial posts got their hand trying out their dissertation thesis in a population of almost 200 million people, even if their tenure were of just one or two years (v. this and this).  Instead of falling in disgrace, these economists followed on to prestigious positions in academia, in Brazil or abroad, or in international financial institutions, like the World Bank and the IMF.  In his latest book, “The Road to Ruin”, Jim Rickards describes how capital controls would come about and the role of the IMF in papering over the upcoming global economic crisis.  You can check out some of his points in an interview here.  He talks about capital controls in bank deposits and taxation of withdrawals, price control and monetization of debt.  

All measures that I suffered in Brazil: capital control on deposits and taxation on withdrawals in 1990 (v. this), price control in 1986 (v. this), monetization of debt in 1995 (v. this).  If Rickards is right, then Brazil was the alpha version of the package that will be released, rather, unleashed in the world.  Only it is not a new and improved package, but the same stale one that will inflict at a global scale the same economic, political and cultural devastation that they did in Brazil.  As a matter of fact, it’s already started.  Pay attention to Cyprus, Greece, India, where the beta version of such ideas have recently been unleashed, and a country near you, America, and prepare accordingly.

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In these matters, Augustine has the benefit of personal experience which cannot be discounted and I thank him for providing these insights.  

At the same time and without forgetting or discounting the general South American hyperinflation model, I do not think that hyperinflation must take decades in order to play out.  Each situation will be different.  As you can see from below, the hyperinflation of the Wiemar republic took place over 5-6 years.  Additionally, much of it was back end loaded into the last 2 years as wave 3 of 3 took hold.

I also want to mention that while money printing can be contributory and usually is, the real root cause of hyperinflation is loss of confidence in the issuing authority.  Because of this, the way that hyperinflation plays out is VERY related to the demeanor of the population experiencing it.  

We might find, at the end of the day, that 3rd world countries have such a long history of crappy paper money that the people have grown accustomed to it.  They are thus long suffering and more tolerant.  Additionally, they might not think of themselves as exceptional.  They might think that they almost deserve the kind of mistreatment they are getting.  Finally, they might simply not have any guns in hand with which to mount a protest.  I have noted that a person with no perceived ability to change his own fate will generally buckle under while someone who does have such ability will be quicker to stand up and fight.

In contrast to 3rd world nations, Americans are probably more like Wiemarians.  Americans have not had a long history of dramatic inflation.  We as a people are NOT used it in the slightest and many of us are vary wary about its arrival.  Additionally, Americans do think they are exceptional regardless of whether there is any relative merit in this view.  People of this mindset are much less likely to take it up the @$$ than people who do not have such view of their self importance.  When they see something is wrong, they act.  The Wiemar hyperinflation is nothing more than the people acting to move away from a currency which they had sudden and growing reasons to be distrustful of.

Additionally, Americans are armed to the teeth.  I myself have more than 10000 rounds of ammo in my possession at any time.  It's not crazy folks.  I like to practice and that burns up rounds.  Additionally, when I see ammo on sale I tend to load up big time.  But more importantly, the ammo never goes bad and it will always have value.  Economically speaking, it is a form of commodity currency.  I am buying it when there is no conflict and so the price reflects the cost of production and distribution.  But if a conflict were to arise then you can bet that the price would go way up and I would be able to sell what I don't immediately need for a handsome profit.  Needless to say, I am not the only American who thinks like this.  

As a result of our gun-friendly laws and of this kind of mindset, many, many Americans are armed and dangerous to anyone who might show us treachery.  So we will not be of the mindset to take it up the @$$.  We could well react to certain circumstances just like the people of Wiemar Republic did.  For example, if we sensed that the rest of the world has decided not to use our money anymore and thus they sent it all back to us, we might decide to default on everything before they could do this.  DO NOT discount this as a possibility.  We already did it with gold backing of the dollar.  We saw that people wanted their gold back  and when a trigger was tripped we just said Hell no, you keep the fake paper.  And now we have a president elect with a long history of screwing his bankers and a stated intention to do so if needs be once he gets into office.