Thursday, September 16, 2010

Was Stagflation in ‘79 Really Hyperinflation?

If my best friend is the truth, then my next best friend is history. 

I’ve been writing about the possibility of hyperinflation, if there is ever a run on Treasury bonds. My argument has been, Treasuries are the New & Improved Toxic Assets, a termite-riddled house waiting to collapse. If and when there is a run on them, money will flow to a safe haven, which I am predicting will be commodities. As a byproduct of this sell off in Treasuries and buy up of commodities, consumer prices will rise catastrophically in a hyperinflationary event—and the dollar will be left dead on the highway like roadkill. 
This scenario got me thinking about the last time there was a panicked run-up in commodities: The stagflation of the 1970’s in the United States, specifically the period 1979–1983. Oil nearly doubled in price, gold and silver went hyperbolic. Gas shortages were rampant—the situation almost got to the point where the government considered rationing gasoline. In fact, ration cards were printed—that’s how bad things got. 
Because of the Oil Shock, the inflation index rose to a peak of 15%—yet unemployment also exploded, reaching almost 11%. This combination of unemployment and inflation was what gave the period its name—stagflation: “Stagnant inflation”. 
Thinking about this period, I asked myself a simple question: Could the ‘79 Oil Shock, and subsequent bout of stagflation, be better understood as a period of incipient hyperinflation? And if so, what lessons could it teach us about today? 
First, a bit of history:   

Starting in late 1977, protests against the regime of the Shah of Iran culminated in his overthrow in January, 1979, and the subsequent disruption of Iranian oil production. From an average of 5.75 million barrels of oil a day, Iranian production dropped catastrophically—at one point to zero—to a new average of about 2.25 million barrels per day. 
This event naturally led to oil prices ballooning, from a nominal average of $15 per barrel in 1978, to $25 per barrel in 1979 (data is here). This had a profound impact on inflation throughout the American and world economies. 
Chart by GL, from cited data. 
Up to the overthrow of the Shah, the U.S. inflation index had been at a moderate-to-high plateau. The Consumer Price Index (CPI) averaged 6.5% during all of 1977 and for the first third of 1978. 
But in the lead-up to the Revolution and the subsequent overthrow of the Shah, inflation got in high gear: For the rest of 1978, inflation averaged 8.13%, and by March of ‘79—two months after the Iranian oil supply was disrupted—inflation was tracking at over 10% annually. By the end of 1979, average inflation for the year was 11.22%, and by March of 1980, inflation was peaking just shy of 15% (data is here.) 
That was also the winter when gold and silver took off in parallel speculative jags that reached all-time highs—that winter was retrospectively the peak of inflation in the United States. 
Keep that date in mind: March of 1980. Annualized inflation: 15%. 
Though the inflation index was rising, unemployment hardly budged for a full year after the Oil Shock. Unemployment was at 5.9% when the Shah was overthrown in January of ‘79. And during the rest of ‘79—even though oil prices skyrocketed and the attendant inflation swept the economy—U.S. unemployment was more or less steady at or below 6%— 
—until 1980: Starting that winter, unemployment bumped up to 6.9%, and it didn't look back. Unemployment would eventually reach a plateau of 10%, and stay at that plateau for a whole year (July 1982 to June 1983), peaking at 10.8% in November of ‘82. 
Though unemployment would slowly fall, it wouldn’t be until September of 1987—almost nine years after the start of the crisis—before it reached its pre-Oil Shock level of 5.9% (unemployment data is here). 
But during those years—nearly a decade, really—of staggering unemployment, what happened to inflation? 
Well, in a word, it got a stake driven through its black heart—but like all scary movies, it was a close call. 
Inflation got killed as dead as Dillinger because of the measures taken by Paul Volcker, the Chairman of the Federal Reserve. 
As can be seen by the chart, up until Volcker was named Fed Chairman in August of ‘79, Federal Reserve interest rate policy was playing a game of catch-up with inflation—and inflation was winning. 
But in October of ‘79, Volcker raised the Fed funds rate to 12% in the so-called “Saturday Night Special”—and then kept on raising them. Volcker kept the Fed funds rate up above 15% for most of 1980 and ‘81, peaking at 19.1%. 
That’s right: 19.1%. It shocks the senses to look at that number, and then compare it to the current Fed funds rate of 0.25%. 
From the graphic, it’s crystal clear that unemployment jumped up as a result of the first harsh taste of Volcker rates—in January, three months after the first interest rate hit, unemployment jumped to 6.3%, held steady there through the winter, then jumped to 6.9% in April and 7.5% in May. Then it just kept on climbing after that. 
Essentially, Volcker induced a severe recession, in order to beat back inflation. There’s really no other way to look at it. Like a doctor administering chemotherapy, Volcker hiked interest rates high enough to kill the cancerous inflation—but he also killed business investment as well, during his reign of double-digit interest rates. 
But all’s well that ends well—eventually, when inflation was safely taken care of, the Fed lowered its funds rate: Investment returned, the economy picked up, unemployment went down. 
And inflation? It went into remission, after Dr. Paul’s tough medicine. Since the stagflation period and its successful treatment, inflation as measured by the CPI numbers has been basically a non-issue. 
Now, let’s double-back to take a closer look at what happened back in 1979, and how it might compare to our situation today in 2010: 
(A quick note on terms—by the word “inflation”, I mean two distinct things: One is the macro-economic event whereby prices rise, due to the expansion of both the economy and the credit environment, which bids up the prices of consumables. This sense is used in opposition to the other three macro-economic events, deflation, disinflation, and hyperinflation. The other meaning of the word “inflation”—or what I sometimes call the inflation index or sometimes the CPI number—is simply the actual percentage rise in prices in an economy, regardless of whether the cause is inflationary or hyperinflationary.) 
The cause of the rampant inflation of ‘79–‘81 was an oil shock. It wasn’t that the economy was overheating, and consumables (labor and commodities) were being bid up in a growing economy coupled with an expansionary credit environment. Rather, commodities were rising against the dollar—the market was turning on the dollar, and determining that every day, it was worth less vis-à-vis commodities. 
What was happening was that, in a very real sense, the dollar was going into a death spiral, when Paul Volcker implemented his psychotically aggressive interest rates. 
Note how money supply played no role whatsoever in the inflationary period 1978–1983. Consider the following table: 
Not seasonally adjusted figures, in $billions.
Source: Federal Reserve, data is here
Increase in the money supply was both inverse to high inflation levels some years (like Jan. ‘75) and inverse to relatively low inflation levels in other years (like Jan. ‘77). But it also tracked high inflation levels other years (Jan. ‘82) as well as low inflation levels in still other years (Jan. ‘86). 
Therefore, one cannot make any type of meaningful correlation between money supply and inflation levels, at least not insofar as the period 1974 to 1986. 
I would further argue that, if money supply is expanding within mundane historical bounds, then to claim it is either a necessary or (much less) a sufficient condition to affect the inflation index at some indeterminate point in the future is just not accurate. 
When inflation was indisputably on the rampage—1980—money supply had increased by a mere 8.34%: The low end of the curve. Yet inflation that year was over 13%—even in the teeth of Volcker’s medicine.

This is significant: Even with those psycho interest rate levels, inflation didn’t instantly roll over and die: Inflation took a long time to draw down—over three years, from peak to trough.

From the March 1980 peak of 14.78% annualized, inflation remained over 14% during that spring of ‘80, before beginning its slow decline. It averaged 13.58% for 1980, and 10.35% in 1981—but in 1982 it was just 6.16%, and by 1983 a mere 3.22% (data as per above).

This decline in the inflation index happened over a 39 month period, even as Volcker kept the Fed funds rate, on average, 464 basis points higher than CPI levels. To repeat: Volcker kept the Fed funds rate 4.64% higher than inflation, and it still took over three years to kill the disease.

During all that time, Volcker was under enormous pressure to ease off on interest rates—the cover of Time magazine pretty much says it all, about the mainstream’s perception of Paul Volcker: An evil Darth Vader-like figure, smoking a glowing red cigar.
Yet Paul Volcker did what had to be done.

Let’s consider a counterfactual: Suppose Volcker had not been the psycho-killer inflation warrior that he was. Suppose he had been timid or slow to act. What would have happened to the dollar?

Easy: The markets in 1980 would have bid up commodities higher even than they did. The Federal Reserve would have continued its ineffective game of catch-up to inflation, as it had done in ‘78 and most of ‘79. Gold and silver would not have shot up in price and then come back down—they would have shot up and stayed up at those exorbitant levels, probably to $1,000 and $100 per ounce, respectively. Oil probably would have crossed the $100 a barrel mark as well. Other commodities and foodstuffs would have followed suit.
All this would have meant that inflation would have continued up, unabated. This is because the only thing that stopped inflation’s moonshot in the spring of 1980 was Paul Volcker’s psycho Fed funds rate.  
Had Volcker not applied his medicine, ever-spiraling commodity prices would have sent inflationary tsunamis throughout the U.S. economy—until eventually, there would have been a run on the dollar. If CPI numbers had ever crossed 20% or 25% or some other psychologically important (and so far unknown) number, then it would have been Game Over for the dollar—Zimbabwe/Weimar absurdities would not have been far behind, because there would have been a complete loss of faith in the dollar: After all, a fiat currency is only as strong as the belief it inspires in its holders. 
The conclusion is therefore obvious: Paul Volcker prevented hyperinflation from happening in the United States. Had inflation continued rising unabated, the dollar would have collapsed—which would have meant the collapse of the U.S. economy, much as the Soviet Union collapsed in 1991. 
If Paul Volcker were a rock star, then I'd be a screaming 15 year-old girl—Tall Paul is my hero. One cannot overstate the political will and strength of character it must have taken for Paul Volcker to resist all the calls to cut interest rates—which were a hysterical clamor, at the time. Had he caved, the Cold War would not have been won, and so our world would be much, much different—for the worse. Those like myself who know this, know how much we owe him—which is why we respect him. As far as I am concerned, he ought to have a white marble statue thirty feet high, placed prominently on the Mall in Washington, D.C., eye to eye with the other great heroes of the Republic. He earned it. 
Now, let’s ask ourselves: Was this near-catastrophe Paul Volcker saved us from back in 1979 really a case of incipient hyperinflation? 
Many people have been using a throwaway line I wrote as a definition of hyperinflation: “Hyperinflation is the loss of faith in the currency.” If I do say so myself, it’s a nice line—but it’s inaccurate. 
Hyperinflation is a severe price distortion, that eventually leads to a loss of faith in the currency. In every hyperinflationary event, CPI numbers rise as the prices of consumer necessities rise. Their prices rise for different reasons—which for this discussion are myriad and irrelevant. But what is relevant is, eventually, such price rises skewer the overall economy. 
One of the key distortions that hyperinflation inflicts is price distortions on assets, be they equities, bonds or real-estate. By creating a run-up in consumer prices, hyperinflation imbalances the whole of the economy, making bonds, equities and real assets less valuable. This effect has been observed in every undisputed hyperinflationary episode. 
So apart from the severe rise in CPI numbers between ‘79 and ‘82, was there such a hyperinflationary fall in asset prices in the United States?
Yes—without question. 
In nominal terms, the New York Stock Exchange was essentially flat—the index was 839 on Jan. 1, 1979, and 875 on Jan. 1, 1982—which means that in inflation adjusted terms, equities fell (nominal data is here). Recall that CPI rose 11.22% in 1979, 13.58% in 1980, and 10.35% in 1981—in other words, 39.39% in those three years. 
Average real estate prices, on the other hand, rose nominally though fell in inflation adjusted terms. Average and median home prices in January ‘79 were $67,700 and $60,300 respectively, whereas those same numbers in January of ‘82 were $78,000 and $66,200 (raw data for nominal average price here, and nominal median price here). That represents a 15.2% rise and a 9.8% rise in the average and the median home price. Again, contrasted with a 39.39% rise in CPI during that period, home prices fell during the period of stagflation. 
So any way you look at the situation of ‘79 through ’82, it is reasonable to describe it as an incipient hyperinflationary environment. Therefore, the title of our movie ought to be “Stagflation ‘79: Almost Hyperinflation”. 
(By the way, this gives lie to the notion common among money supply fetishists that “there aren’t enough dollars in the economy to ever start hyperinflation”—of course there are enough dollars: We saw it in ‘79. Money supply has got nothing to do with hyperinflation. Where there is a shortage or need for a good or commodity, the economy will rebalance itself to meet this new demand. In simple terms, people will somehow always find the cash to purchase their necessities, whatsoever price those necessities might reach. And if the market—for whatever reason—determines that a currency is worth consistently less against the same amount of commodities, then that currency is circling the hyperinflationary drain. The central bank need not inject more money to bring about this end—it can happen without recourse to money printing, or any other central bank or governmental measure.) 
Now all of this history is well and good—but how does it apply to the situation we find ourselves in today, in 2010? 
Very simple: I have been arguing that Treasury bonds are in a bubble, as they have become the New & Improved Toxic Assets. I have further argued that, at some point in the future, the markets will realize that Treasuries will never be repayed, and if they are, they will be repaid in debased dollars. Therefore, I have argued that when such a realization occurred, the markets would begin exiting Treasuries, and go to commodities as a safe haven. 
Contrast this with 1979: At the start of the ’79 Oil Shock, commodity prices rose because dollars were chasing commodities. These dollars weren’t fleeing from Treasury bonds—if they left Treasuries, it was simply as a byproduct of going towards commodities. As more and more dollars went towards commodities, those commodities bid themselves up, creating inflation. 
So in a practical sense, the period we are living in now and the period just before the Oil Shock are identical: In both cases, dollars were poised to chase after commodities, following a triggering event. In ‘79, it was the fall of the Shah. In 2010, we are waiting for our moment to exit Treasuries. 
Therefore, one can look at the events of ’79–’82 as a dress rehearsal for what I think will happen today, and in the immediate future, if and when the Treasury bond bubble pops: 
Like in ‘79, there will be a crisis that will trigger a run on commodities. Like ’79, the inflation index will start to pick up. Like ‘79, this will create hyperinflationary distortions in the American economy, which will be seen at least initially as “stagflation”. 
In my previous writings, I had originally thought that, when the moment arrived when markets lost faith in Treasury bonds, commodities would go hyperbolic immediately, or within a very short time frame. 
However, studying the events of ‘79 more closely, I realize I was wrong: I now no longer think commodity prices will spike hyperbolically and in a reduced time frame. I now think commodity prices—and CPI numbers—will rise initially at an accelerated clip, say at an annualized rate of 5–6% in the first month. 
But here is the tragedy: Increased inflation will not be perceived—at least not at first—as anything to get into a twist over. Each subsequent month will see an inflationary rise at a slightly faster pace, adding a percent or two a month to the annualized rate—but at least at first, not only will this not be perceived as anything worrisome, it will be considered a good thing: Because of the current deflationary recession we are in, any pick up in the inflation index will be interpreted as a pick up in the overall economy. 
Eventually, however, as inflation continues to rise but the jobs market doesn’t really improve, the current American economy will wake up and find it has reached the exact same point that was reached back in March of 1980—a 15% annual inflation rate. 
But here is the key difference: Ben Bernanke and the Federal Reserve cannot raise rates to reign in incipient hyperinflation, like Volcker did in ‘79
Apart from the obvious fact that Bernanke is not half the man Paul Volcker is (both literally and figuratively), and therefore lacks the balls and the backbone to do what needs to be done, Bernanke simply does not have the room to maneuver, insofar as the Fed funds rate is concerned. 
If there was a run on Treasuries, Bernanke today cannot raise interest rates to retain Treasury holders—if he did, he would wipe out all the Too Big To Fail banks, and break the Treasury of the U.S. Federal government, both of which depend on the Fed’s cheap money as completely as if it were oxygen. 
Back in 1979, Volcker didn’t have this constraint. He could raise rates—but even so, he paid for it with 400 basis points of unemployment. 
However, unemployment today is already at 10%, in a soft credit environment. So even if he didn’t have the TBTF banks and the Federal government on the cheap money life support, Bernanke cannot raise rates in order to stop a run on Treasuries, stop a run up on commodities, and stop incipient hyperinflation: The economy is too weak. Adding 400 basis points to the current employment situation—that is, driving U-3 unemployment to 14% or more—would cause political pandemonium, not to mention riots. 
Finally, Bernanke won’t raise rates—can’t raise rates—because of a disease of the mind that he has: Due to Alan Greenspan’s pernicious, destructive influence, which I have discussed at some length, Bernanke thoroughly believes that only liquidity injections and cheap money can save the economy—he is looking for inflation. He is so terrified of the American economy circling the deflationary drain, that he is deliberately going in the other direction: He is trying to cause inflation. 
Bernanke doesn’t realize that inflation is a symptom that can augur many things. He is convinced that inflation means growth—the opposite of deflation. So all his liquidity windows, all his cash infusions to prop up the Too Big To Fail banks and their bankster operators, QE, QE-lite, the forthcoming QE2—all of it is being carried out by Bernanke so as to cause inflation. He is convinced that inflation will signal that the economy is recovering, and that the Federal Debt will be inflated away, and therefore not break the Federal government finances. 
He believes that rising prices will mean that the U.S. economy is about to be saved
This is why Bernanke is set up to take a hit from hyperinflation: If and when there is a run on Treasuries, and a subsequent run up of commodities, at least initially, the Federal Reserve under Ben Bernanke will not only do nothing, they will encourage this situation. The Fed and its current leadership will interpret this rise in the CPI number as an indication that “We are on the road to recovery!”
We are not: The first hint of commodity prices rising as the Treasury markets begin to fade will be an indication that hyperinflation is on its way. And by the time we get to our March 1980 moment—by the time we get to 15% annualized inflation index—it will be over. 
The next stop will be Zimbabwe. 


  1. Well, this is a very BLEAK picture.
    But - if possible - the situation of Mr Bernanke is even WORSE than that described above.
    This is because the measures of unemployment of the present ARE NOT the same of the measures of thirty years ago ... today the unemployment is ALREADY FAR ABOVE 10% IF MEASURED WITH THE STANDARDS OF THIRTY YEARS AGO ...

  2. Gonzalo, I've really enjoyed reading your series on hyperinflation but you've lost me here on the comparison to '79.

    Volker is certainly hero as far as recent U.S. history is concerned (and it's a shame that he doesn't have a stronger voice in the current administration) but let's not lionize him as the savior of the free world. You haven't made a convincing case that we were on the edge of the abyss in 79-80. Why would 20% + inflation in the early 80's been the end of the world? What were the alternatives to the U.S. $ at the time? Remember winning the Cold War was an enormous objective. This objective had far more clarity than say winning the "war on terrorism" of today.

    My guess is prolonging inflation in the 80's would have been bad but not disasterous. We would have muddled through. Our economy at the time - even with sharply accelerating inflation - was still far more productive than the economy in the USSR. The baby boomer generation was starting to move into their working prime. Perhaps stubbornly high oil prices would have pushed us more quickly to energy alternatives. Perhaps Reagan would have been a one-termer. I don't see how basic history would have changed. Capital would have found productive inputs.

    That last point segways to our current problem - accumulated years (or even decades perhaps) of applying our excess capital (essentially the boomer generation savings) into unproductive inputs. The first bubble - the tech craze - was the least damaging. Author Michael Lewis has writen a pretty good case that the bubble actually boosted productivity in a number of ways - remember Global Crossing wrapping the world in fiber optic cables? Anyway, we decided to move our capital into housing. Unless you open a farm, a house provides little net value-added to the economy, no matter how many garages you have. Instead of writing that off, we passed that hot potato to the U.S. Treasury. Meanwhile, the U.S. Treasury was busy collecting its own inventory of useless junk - counterproductive wars, counterproductive health plans, etc. We've "consolidated" all are credit card loans to one place. Given that capital now moves at the speed of light - literally - this is unprecedented in world history. It's certainly much different that 1979.

  3. As Spengler predicted, politics eventually destroys the money system.

  4. Well written. One thing I would add to Bernanke's psyche is that he is not only trying to cause inflation, but he is trying to induce a wealth effect by driving up equity and asset prices.

    Clearly this has thus far not worked, as outflows from equity mutual funds have been non-stop and housing overhang is resulting in a resumed price decline.

    Thanks for your clear thoughts.

  5. Great article. I have to agree with you 100%. I wrote something just the other day saying pretty much the same thing, just not as eloquently as you did.

    It is going to be very ugly when everything starts pouring into commodities. God help us all.

  6. Gonzalo,

    This scenario is extremely plausible. I think you hit the nail on the head when you said "Bernanke thoroughly believes that only liquidity injections and cheap money can save the economy—he is looking for inflation".

    As Bill Gross told us in August 2009:
    "Reflating nominal GDP by inflating asset prices is the fundamental, yet infrequently acknowledged, goal of policymakers. If they can do that, then employment and economic stability may ultimately follow."

    I emphasize that Gross used the words IF and MAY, not when and will!

  7. John Hussman's Aug. 23, 2010 commentary "Why Quantitative Easing is Likely to Trigger a Collapse of the U.S. Dollar" on this topic was excellent.

    "My impression is that Ben Bernanke has little sense of the damage he is about to provoke. A central banker who talks about throwing money from helicopters is not only arrogant but foolish."

    Later in the commentary, Hussman:
    "Good policy is not rocket science. IT BEGINS WITH THE REFUSAL TO MAKE PEOPLE PAY FOR MISTAKES THAT ARE NOT THEIR OWN. This economy continues to struggle with a fundamental problem, which is that debt obligations exceed the ability to service them. While policy makers have done everything to preserve the patterns of spending and consumption that created the problem in the first place, we have done nothing to restructure those obligations."

    The emphasis in capitals is mine.

  8. Right on Gonzalo. That was a bomb of an article.

  9. Gonzalo:

    It's great to hear you reference this period in our history..... I was a floor broker at the CEC and a partner at a small boutique IB/TH.... I lived that period at my trading desk in lower Manhattan and in the silver, gold and sugar rings at the CEC in the WTC at the COMEX and the NYCS&C Exch.

    Those were truly memorable times and I reference them regularly as a parallel to this state of affairs we're in today....

    In this latest post, I believe that you have articulated some adjustments in the synthesis of your theoretical forecasts, that fall much more in line with my own.

    Correct me if I'm wrong.... However, I see you moving more towards the hyper-inflationary scenario in the deflationary context school of thought. That is precisely what I have positioned myself for in the markets. I wholeheartedly agree with you that treasuries are bubblelicious. Gold, silver and sugar (I consider sugar to be the agricultural currency) are undervalued. And equities as a matter of fact and not perception, are well overvalued. I'm not going to touch oil for reasons that I can't go into at the moment, however, I do anticipate that the price of oil will move much higher later in the cycle.

    To those who have a blind spot to your measured and well thought out theories, all I can say is GOOD LUCK....

    Best regards,


  10. Well said. Even now we can watch the price of silver as reflecting exactly what you are arguing.

  11. _____________________________

    Greenspan Hint: The Federal Reserve System Fraud is in fact much worse than what Ron Paul envisioned:

    "Most Effective Stimulus Now Would Be Rising Stocks"

    Is the FOMC Playing the Stock Market?


  12. Gonzalo,

    In my opinion the oil supply played a key role in helping Paul Volcker fight back inflation. I'm going out on a limb here, I don't have the numbers to back this up, but at the beginning of the 80s the world still had plenty of untapped supplies, starting with Saudi Arabia. The USA used their political pull to nudge Saudi Arabia, as well as other befriended Middle East states, to produce more, which was instrumental in diminishing the pressure on commodities and reinforcing the faith in the dollar. Later on, the North Sea discoveries were also a huge factor in helping the western world, especially the UK, fuel a new economic boom.

    In other words, Paul Volcker could count on the fact that the oil supply disruption were temporary and politically induced. There was no "peak" situation in any commodity like today, no peak oil, no peak gold, no peak copper or iridium...

    It's absolutely not the same for Bernanke now. On the contrary, the constraints on the oil supply are now almost entirely geological, and we know that in the coming years world oil production will gradually decline. It is very unlikely that new discoveries will save the Western economies at the 11th hour.

  13. Gonzalo,

    disappointed you didn't mention that Volcker was one of the 'advisers' that took the US off the gold standard and started the mess in the first place !

  14. Vincent said:
    " the coming years world oil production will gradually decline. It is very unlikely that new discoveries will save the Western economies at the 11th hour."

    I think you're right Vincent that oil will no longer be available "cheap" - not necessarily because there couldn't be new discoveries but because $150 oil was an ominous warning that world demand is increasing faster than supply.

    We could avoid the disaster at that 11th hour by recognizing NOW that the price of oil will surely go up; and setting federal policy to encourage us toward alternatives (rather than waiting for the regular demand/supply forces to bring about that change).

    The good news is that when oil-based energy triples in price, from where it is now (ie, $10 gasoline), then virtually all alternatives will become viable. [Based on this I see a $300-$400 ceiling on oil.]

    The bad news is that the US is at the very bottom in creating a *stable-energy-policy* (one that isn't blocked by politics or changed every 2-4 years).

    I view a well-thought-out AND *stable-energy-policy* to be MORE IMPORTANT than almost all other issues facing our economy.

    If all US consumers of oil-based-energy knew that oil would gradually become less viable as an energy choice (perhaps every 3 months there could be a small tax-increase on each barrel of oil extracted/imported, over a 10-year period), then individuals and businesses would develop their plans accordingly. There would be no need for CAFE standards, or other heavy-handed methods. With a known energy policy, consumers would know how choose, and capitalists could do what they do best: be capitalists!

    [Note: I prefer government "encouragement" in the form of gradually-implemented taxes, rather than passing out subsidies chosen by bureaucrats that have no capitalist incentive (and possibly corrupt motives).]

    Alas, it will probably not happen that way, I expect to see a disaster (either/both of dollar-destruction and war) long before the US adopts a "stable-energy-policy".

    PS - my apologies for getting a bit off-subject.

  15. Two comments on currency:

    Consumers tend to have little plastic printing presses in their back pockets. An expectation of price hikes on commodities will probably send a lot of us to Costco, to stock up using our credit cards. The collective balance on those cards will then be an asset which the card issuers can leverage for further cash flow. This might result in some sudden inflationary events; the first crowd-sourced devaluation, if you will.

    It's also interesting to consider USPS "forever" stamps as portable, exchangeable, commodity-backed currency. Their nominal price hasn't gone up much, recently, but I could imagine people using them to store some small amount of value. It's probably of academic interest that postage stamps are backed by a commodity service rather than a commodity good, and a service tied so closely to transportation fuel prices. It's very interesting that the USPS chose to de-couple from the US dollar when they did.

  16. Where's Mish...? :-)

    I like the poster above who suggested the imperative and 'clarity' we had in 'winning' the Cold War...

    We spent a lot of money, that's for certain. But in the context of of the old Soviet Union, vs. the New & improved FSB, what did we win? In terms of their still-existing partnerships with 'terrorists' (like Iran & Syria), and fellow travelers (like Red China), what have we 'won'?

    The Russians still have nuclear weapons - and other armaments that are equal or superior to ours. And they're building...

    We didn't 'win' anything. And the Russians are still 'Soviets' in many aspects. And Putin still runs the country.

    Another piece of re-written history that needs to be un-re-written and put back in its proper context...

  17. I disagree with you not one iota. "Tall Paul" deserved a tremendous amount of credit. However, you failed to mention the name of Ronald Reagan once much less B. H. Obama. President Reagan backed Volker throughout this entire period and took the political heat. On t
    he other hand you have the "annointed one".
    St. Louis

  18. Comparing the remains of the US today to the 1970s may be optimistic.

  19. Problem with this analysis is that there was no oil supply shock. The dollar price of oil increased but the gold/oil ratio (the real price of oil) was fairly steady at between 1/13 and 1/15. So the reason the oil price doubled is because the gold price doubled. The price of gold pulled the price of oil up with it. The exact same thing is going on today.

  20. Gonzalo, your thesis that a selloff of US Treasuries will lead to a commodity bubble should be tested against the more recent history in 2007 and 2008. At that time, we had a commodity bubble with oil prices approaching $150 per barrel. There are people who believe that the following collapse of commodity prices (oil prices fell all the way down to $40 per barrel) was initiated by Paulson and Bernanke in order to prevent a Dollar hyperinflation. Regardless whether true or not, the fact is, that oil prices did collapse (even gold fell 20%) and money started to flow into US Treasuries. The Treasury bubble is still going on with no end in sight.

    The question therefore is: If Treasuries sellout and money flows again into commodities, why can the trick of 2008 not be repeated and a huge sellout of commodities be forced upon the market? It would be enough to convince a few large hedge funds to sell out their commodity positions. That is was happened in 2008.

  21. I don't think that commodities would have gone any further than they did and it is not clear to me that Volcker's actions were completely necessary.

    Gold price rose, reflecting a loss of faith in the dollar--this much is true. However, the gold price hit its (up to that time) all-time intraday high of $875/oz at which point the US treasury obligations were fully backed by the bullion that the US held. At that point, the US was solvent again, and with short rates at 19% it was extremely tempting to leave gold and move back into treasuries, which is what happened.

    If interest rates had been somewhat lower, the situation would have been the same. The key event was the pricing of gold at a level sufficient to back US obligations.

    Of course, now those obligations are so large compared to the gold held by the US (which is unknown without an audit) so the same fix will occur at a presently unknown gold price.

  22. While I think you've made an admirable attempt here, it seems to me that you're taking the relevant context too narrowly to get a full picture. It seems to me that, while the oil may have been a catalyst, there were far more basic reasons for the occurrence of stagflation in the '70s and '80s, namely the fact that this was the start of the period in which American manufacturing could no longer compete with Asian companies, where the US capitalist class was taking its investment capital. This could not be fixed, however, because of the - at the time - counterproductive labor unions, which prevented wage adjustments and other changes that might've made american businesses more competitive, and because of US subsidization of the car industry through gas price subsidies etc., which allowed US auto makers to ignore the fact that their cars were obsolete. In this and similar ways, protectionism and unions caused the stagflation.. But while the problem today is still the fact that US manufacturing cannot compete, this is no longer because of labor, as we know that the US worker has not had an inflation-adjusted wage increase since the mid-70s.. The problem lies entirely with the capitalists who are no longer interested in making sure their consumers earn wages which they can then use to buy goods with, and in stead asked Greenspan to make it happen that US consumers could borrow and fund their consumption that way, which he promptly did.
    Anyway, parts (higher-educated workers) of the US workforce are still competitive, and other parts have become more or less competitive by now, so I don't think hyperinflation would've been a very likely outcome, but it seems to me that the stagflation From The Perspective of the (lower) Middle Class has never really abated, but it is only in the last few years or so that people have started noticing this - a fact that is absolutely pathetic. As for now, I doubt that inflation will really happen, as all the QE has not led to a marked increase in M1/M2, and it is disadvantageous in the extreme for the rich to own a devaluating currency.

  23. Huh? what gold, backing what dollar?

    have you not learned that Nixon got mad at France in 71 and abandoned the gold standard, refusing to honor the pledge to exchange gold for dollars at the rate of $35 per once.

    Best I know, that policy is still in effect.

  24. if the truth is your best friend, why did'nt you post my comments on the federal reserve? are you in denial? its ok, you figure you will be squashed if you naysay the fed. but just for youself - try to identify the shareholders of the fed. It's the best kept secret since dealy plaza.

  25. Don't forget that some of the PM leaps up were connected to the Hunt's efforts at cornering the silver market. They might have made it and the price of silver hit the moon but the exchange rules were changed which shot down both silver and gold. If that large-economy cheating didn't happen, it's interesting to speculate what might have happened.

  26. "In simple terms, people will somehow always find the cash to purchase their necessities, whatsoever price those necessities might reach."

    Can you please explain your rationale for this statement? Exactly what is the "somehow" people use to find cash to buy necessities when they are unemployed and their bennies have run out.

    Inflation can only persist if the consumer has money to spend. Reality check Gonzalo, the consumer is ALREADY BK. Prices go up any more, people will not buy at those prices, necessity or not. They will steal it, they won;t be ABLE to buy it.

    Deflation all the way my friend.


  27. Deflation all the way to where?

    The problem with the deflationists' argument for me is that I have never heard a convincing outcome to the deflationary period.

    Please, could a deflationista describe what they see is the endgame to the deflationary period, if it isn't hyper-intflation/currency death?

    Thankyou in advance

  28. In the late 1970's Gold nearly doubled from around $400.00 after the Soviet Union invasion of Afghanistan. Also, one of the largest mines and source for Gold in the late 1970s went on strike in South Africa. Important to note that gold ownership by citizens had been restricted or outlawed by the government until the mid 1970s. This means the rise in gold was in part due to the US government leagalization of gold ownership in the 1970s. Mr. Volker was indeed lucky to be in the right place at the right time to receive credit for the Gold and Silver commodity bubble burst. The true market value of Gold at the 1980 peak was about $80-125.00 based on the government deficit figures. The government deficit caught up and surpassed gold in the late 1990s. Except for extreme events or supply disruption that occurred during the late 1970s, add about $100 to the price of Gold for every 1 trillion dollars added to the government deficit based on the governments current high credit rating. As stated in another post above, the Hunt Brothers helped Silver rise to about $50.00 before it collapsed.

  29. Anonymous said:
    "Please, could a deflationista describe what they see is the endgame to the deflationary period..."

    I don't consider myself a "deflationist", nor am I sure what it means, but I'll try answering the question "How can a nation escape a deflationary spiral?"

    If a nation has little or no debt, then it is much easier to end deflation, but in that case it is unlikely that such a nation would ever fall into the deflationary pit. The nation could borrow and use that to pay down private debt.

    If a nation owns some particular natural resource (gold, oil, timber, etc), then that wealth could be used to pay down private debt.

    War may be the most common endgame for those nations that can actually pull off a "win" of such war. War works because the government can successfully pull-off things like wage-price freezes, rationing, ceasing private wealth/property, restricting flow of money, and dozens of other things that seem anathema to today's citizenry.

  30. My take away; get out of I bonds. Thanks!

  31. You can't think of any other outcome to credit collapse than hyper-inflation? Was the outcome of the Great Depression a hyperinflation in Amerika?

    Hyperinflation is the anomaly rather than the norm. Generally in deflationary depressions goods simply disappear from the marketplace as the money supply disappears.

    Anyhow, hyperinflation may occur once Da Goobermint starts passing out free money to J6P as they do for the banksters, but until then if prices go up to the moon, people will simply stop buying, necessity or not. They don't have the MONEY. That is the simple truth.


  32. Hyperinflation is economically defined as a minimum monthly inflation rate of 50%. In the world's greatest hyperinflationary event - post-WWII Hungary - prices doubled every 13 1/2 hours. Even the recent Zimbabwean hyperinflation 'only' experienced price doubling every five days. Hyperinflation is not a relative thing. It either is, or it isn't. Using the strictest of definitions, 1979 was no more hyperinflationary than was 1937. That said, there's no reason to believe that hyperinflation will by-pass the U.S. under current monetary and socio-political conditions.

  33. Thank you so much for these recent articles, they have given me great insight into things I have come to only recently.

  34. In response to RE, during the Great Depression the U.S. dollar was a gold backed currency. Today, it is a pure fiat currency, meaning that it requires the public's faith in order to have any value. That's why we didn't have hyperinflation then.

    Hyperinflation will happen here because it's impossible for the government to pay off its debts. This is not widely recognized yet. Once it is recognized, the flight out of bonds will begin, and that money will go straight into commodities. Deflationists believe this money will go straight into the U.S. dollar, which makes absolutely no sense to me. And quite frankly, I don't see how anyone who follows the economy, and the philosophy of the Federal Reserve Bank, could possibly believe such a thing. After all, bonds are just promises to pay dollars. The Fed is not going to default on its debt. No way in hell. They will print.

  35. You explain hyperinflation better than anyone else I've read, and I've read a lot of people's work on the subject. Excellent!

  36. The US dollar may be the beneficiary of large capital flow. Most debt in the US and on other balance sheets is denominated in US dollars. This moutain of debt could act as a huge synthetic short against certain tangible items leading to a rush to dollars to service public and private debt. The massive wave of US dollar creation may be partly a final step to dollarize the world or leave the world few alternatives due to US dollar related debt.

  37. Gonzalo, I hope you read the comments on your blog. I'm posting this comment instead of sending you an email.

    I've read your posts the past few weeks about hyperinflation, the treasury bubble, and now stagflation, and I think you are dead on target. I agree with everything you have said -- except your assessment of Glenn Beck. :) Ironically, I think you and he would agree with each other on many, if not most, things.

    Having lived also in S America during highly inflationary times, having seen the consequences of both military and socialist governments, and knowing the resulting civil unrest, I share many of your perspectives.

    I am beginning to wonder if we are now seeing the early stages of commodity hyperinflation.

    I am a commodities trader, and despite that with every tick higher I make money, I am genuinely alarmed that commodities are back in bubble territory very much like 2008 again. Just look at the weekly charts for corn, soybeans, sugar, coffee, and cotton. They are going parabolic!

    I expect each day to see these commodity bubbles collapse and prices crash back to earth, but each day, they move higher and higher. Instead of prices reaching a zenith and tumbling back to earth, they are ACCELERATING higher, not lower! Other commodities, especially agricultural commodities, are rocketing higher almost every day. So are commodities not traded in the futures exchanges. Even commodities that were trending downward (lumber, cocoa, natural gas) have now reversed and are trending higher again.

    I don't know of any commodity futures that are trending lower except for crude oil, which is only down 3 days. Corn, sugar, cotton, coffee, orange juice, soybeans, soybean oil, soybean meal, live cattle, milk, lean hog, oats, gold, silver, palladium, platinum, copper, and rice are all trending higher. Many are rising at parabolic rates. Just look at the charts! Why not post those weekly charts here? They would help to make your case!

    I find it hard to believe that ALL these commodities are all facing strong demand with limited supplies simultaneously. I can't help but wonder if some of the QE money being funneled through the primary dealers is also finding its way into commodities. This is likely to accelerate even faster when the bond/treasury bubble(s) pops. It makes me very nervous to see where this is headed.

    When I read your articles a few weeks ago on ZH and here, something clicked in my head and I had an "aha" moment. I think you are absolutely correct and with the very rapid rise in commodity prices over these past few months, I am beginning to wonder if we're seeing it in its early stages right now.

    I also remember reading some months back an article suggesting that we could see hyperinflation in some assets while we are simultaneously seeing debt-based deflation of other assets (eg., real estate) and paper assets (bonds, stocks). Sound familiar? Commodity inflation (bad enough) or hyperinflation (much worse), the author suggested, would kill pricing power of businesses, thus plunging many into insolvency, while consequently leading to even higher unemployment. (By the way, the effect on employment would be a subject that I would like to know more about in the Allende government. What was the impact of hyperinflation on unemployment?)

    Keep up the insightful writing! Thanks for having the courage to share it with the rest of us!

    Hasta entonces, amigo!

  38. To RE.... Why the hell does the price of gold keep going up if people have no money? Food aint gotten any cheaper either... Lol
    who the hell is this Anon who states the price of gold went up in 1971 because the Feds allowed gold ownership again... That has to be the single stupidest thing I ever read. Hello! The price of gold went up because we went to a fiat currency and Nixon turned down France's request to turn in their dollars for gold. We renigged on the Bretton Woods agreement! Ya think... Maybe... Just maybe that had a bit to do with it? Wow!

  39. S Benard said it...commodities are already going up and have been since May or June of this year. Meanwhile the long end of the curve is beginning to steepen with the /ZB futures down 3 of the last 4 weeks.

    food for thought.

  40. @Neil

    That the Fed will continue to print, of this I have no doubt. They have been doing it for well onto 2 years now, with no hyperinflation. What the Fed will NOT do is distribute free money to anyone but the PDs, who will not hand out the money to anybody else. So unless and until Da Goobermint pulls a China and FORCES the banks to lend and FORCES biznesses to take the loans, the notional currency simply never goes into circulation. When one of these factors changes you can get your hyperinflation, but at the moment its not politically possible to do that here inthe FSofA.

    Anyhow, I wrote a longer explanation of this over on Reverse Engineering. The article is too long to fit in this response field.


  41. Very good article, Thanks. My comment is that faith in the dollar and thus price of commodity could rise very quickly instead of gradually
    1. at that time the Feb kept rasing interest rate to chase after inflation rate. Today it's likely the Feb will keep it low even if CPI starts to go up
    2. at that time dollar = oil. Today countires starts to sell their oil in other currencies.
    3. Today we have China

  42. Having lived through that period running a family petroleum distributor biz (and saddled with an MBA), there is a need for clarification on what was what back then. Note the following differences:

    1. When people saw that they could get a 2 year CD at 18%, they believed like he** in the $. This is the MOST important point. Wouldn't you like that now from a stable bank?
    2. The US had a manufacturing base. In NC/SC, most county seats had their traffic jams at 3:30 when the 1st shift got off.
    3. Moral Malaise Carter got run out of town by Reagan.
    4. Remember that price controls existed on oil and gasoline. Reagan dumped them and gasoline/ heating oil doubled in price in a year, going from 60 cents to $1.20.
    4. Derivatives? We don't need no stinking derivatives. Yes, there was some CBOE hedging. How gauche and unsophisticated.
    5. The mainstream press was nothing like what it is now. They WANT us to suffer now.
    6. FICA was 1% when JC got elected - Democrat legislation in the late 70s ramped it to the 15.3% level.
    7. There were local businesses and full service gas stations. Now we have WalMart and pump your own, bitchez.
    8. Prez Ford actually had red/white buttons printed saying "WIN" - Whip Inflation Now". It was around 5% then. The Man From Plains got it to 15% or so.

    Ho hum. The bottom line was that no one felt that the US was going down the tubes.

  43. Well, just my thoughts, I don't think the commodity prices have been rising during the last several months from people slowly and surely running from dollar, but mostly from equity linked trades(stocks are to go up, they also trade to bet commodity go up) or actual belivers of V shaped economy.

    I believe the event in Iran back in 1979 was a surprise to everyone, it was really a shock. On the other hand, US treasury, Fed, and banks throwing around US debt is not a secret and it has been going around for many months. Even governments around the world are worried about defending dollar. I am afraid that once we see the possibility of an auction failure, the run will be a sudden and large one. And I wonder whether everyone will run to commodities. There are good currencies out there with a lot of trade vol, these just have to be "safer" than the previously so called safest US assets. NZ, AU, NOK, and a few others might qualify, even Yen.

  44. Ag commodities continue to go parabolic Sunday evening.

    I remembered whose article I read about some assets were inflating while others were deflating. It was Gordon Long, who also has posted to ZH. You guys on on the same page!

    ...and from what I'm seeing of real estate and ag commodities, the markets are too!

  45. CFTC COT report from Friday indicates that USD shorts are increasing their bets. No small wonder!

  46. Hey S Benard—

    Busy arguing abortion. As I've said, e-mail me any time.


  47. I have a question: is there a measure people can look at to see how many dollars have been created by the Federal Reserve? Would that be MB, as explained on Wikipedia?

    It seems to me that the effects of fractional-reserve banking should not affect our faith in the value of a dollar, so measures of the money supply that include those effects (M2 among others) don't tell us whether the dollar is being debased or not.

    I understand that a panic can occur based on a widely-held belief that the Fed will debase the currency in the future, even if the Fed hasn't actually done so at all yet, but I'd like to be able to watch what the Fed actually does, if that's possible.

  48. Karen,

    The Fed has been sneaky about debasing the dollar—I'll have a post in a couple of days. Meanwhile, the best way to figure out how the Fed is debasing the dollar is to look at its balance sheet.

    In the "Termite-Riddled House" post, I linked to a very good interactive graph the shows the composition of the Fed's balance sheet through time.

    Hope this helps. Specific questions, do feel free to e-mail me.


  49. It should be noted that inflation was a windfall to homeowners in the 1970's as the value of their homes soared and the dollar value of their mortgages remained unchanged. Business who invested in capital goods to grow businesses in this period also benefited. We have been brainwashed to believe that inflation is a wholly negative phenomenon,rather than a phenomenon that has winners and losers. Volker's fight against inflation help set the stage for the debt laden strait jacket the US and the rest of the world is now facing. The fight against inflation was won at the cost of high unemployment which undermined the bargaining power of labour to demand fair wages. The nail in the coffin of inflation was augmented by the outsourcing of american jobs and the importation of cheap foreign goods.
    The engine of growth for the American and world economies for the past several years has been debt, both private and public. This debt will only be repaid if economies create jobs to repay this debt. Inflation ensures that those holding cash put the money to work either by buying assets or investing in businesses.

  50. trishflanagan -

    I think it is impossible to say that true hyperinflation is anything but awful. It leads very quickly to a barter economy, and one in which some people (farmers) can do OK but others (government employees) have to come to the black market with nothing but their (nearly worthless) stuff to trade.

    I read a book about inflation (The Economics of High Inflation, by Paul Beckerman, 1992) that did a bad job of explaining its causes but a good job explaining why it is bad. Mr. Beckerman certainly convinced me. His points:

    (1) People avoid holding money. Many buy hard assets like gold, silver, foreign currencies, and artworks. That money is totally nonproductive. Others buy stocks, which is not as bad, but when people do this they spend a lot more time juggling their accounts and investments, because they have to buy and sell stocks all the time to pay the bills. They also experience a lot more anxiety, especially if stock prices are volatile.

    (2) High inflation tends to be unpredictable. The higher the average value, the higher is the variability. That leads to difficulty in planning, which leads to avoidance of long-term loans, which makes financing big projects very difficult. Big projects are therefore postponed or abandoned, which shrinks economic activity.

    (3) High inflation affects different goods and services differently, distorting relative prices and leading to the misallocation of resources. So lenders and borrowers cannot escape uncertainty by agreeing to "real value" inflation-adjusted repayment terms, because if the borrowing business doesn't have enough pricing power it won't be able to repay the loan.

    (4) High inflation increases conflict and reduces trust, damaging social cohesion. Loans tend to end up being unfair in one direction or the other, causing resentment in the loser. Different interest groups (business, labor) also try to protect themselves by lobbying government for special treatment, which when granted always hurts the other parties.

    Sorry for the long post!

  51. GL - Thanks, I'll look forward to that post!

    I hope you will clarify whether everything is reflected in that balance sheet, including currency. If so, that seems kind of scary.

  52. Reverse Engineer's Deflation all the way is nonsense.
    If Americans won't have the cash to buy things which are dirt cheap in the stores you think the Chinese will not either?

  53. Neil:"In response to RE, during the Great Depression the U.S. dollar was a gold backed currency.":

    Uhh, no it wasn't, after 1933, when FDR took the US off the gold standard.

  54. It's the end of 2012, and it isn't happening. I don't doubt the fact that hyperinflation is likely, but it seems like the status quo can be maintained for a long time.

    Kicking the can down the road seems to be the policy of the government for now..


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