Hyperdeflation, Hyperinflation, or Choice C?

Column by David Calderwood, posted on March 27, 2012

Column by David Calderwood.

Exclusive to STR

When it comes to liberty, I am both idealist and pragmatist.

Ideally, I favor the notion that the cooperative, mutually voluntary way we all usually interact with each other in our daily lives is the same system that can and should govern all human social interactions.

This makes me a Voluntaryist, or individualist-anarchist, or whatever label one chooses for the same thing.

Pragmatically, however, people are people. Ancient Roman Historian Sallust said, “Most men do not desire liberty; most only wish for a just master.” [I can’t guarantee the translation from Latin, but I think the sentiment is probably an accurate statement of reality.]

So, for the foreseeable future, I figure I’m stuck with this statist crap.

That said, I love life and all the wonders it offers, so my hobby is trying to figure out what I should be doing today to best extend and enrich (in every respect) my life.

An important aspect of this is finance. In a broad sense, if I’m financially poor, my choices are limited. I’d like to acquire and maintain as much wealth as I can, in a pro-life sense. I don’t want to rob others, but I don’t wish to be robbed, either.

“Avoiding robbery” occupies a lot of my thoughts, especially given the near-continuous robbery-by-inflation of the last 90-plus years in the USA. There are several posited paths ahead, and they are as different, preparation-wise, as a Great Drought vs. a Great Flood. Figuratively, do I build a cistern or an ark?

I've read widely on the subject and applied as much reason as I can muster, and at the moment I concur with the analysis I first encountered in books by Robert Prechter, Jr. of Elliott Wave fame.

Briefly (and inadequately), his view appears to have much in common with Hyman Minsky's and Irving Fisher's concept of what has to follow a credit-induced boom. Prechter's work is not "economics," as it centers on the concept of shared social mood, which naturally and endogenously varies from positive (optimism, trust, etc.) to negative (pessimism, anger, distrust, etc.). The relative position and direction of change of this social mood dictates social actions in every sphere of social endeavor (economics, politics, pop culture, etc.).

Prechter's position is that we recently endured a mania in positive social mood and the euphoric conditions allowed an unprecedented level of debt to build. Today's money supply is made up of both paper currency and what amount to electronic IOUs to deliver (ultimately) what could be turned into paper currency. For example, when we hear that U.S. corporations are sitting on huge piles of cash, this is of course a metaphor; they actually just hold title to debt securities, they don't have a room in the basement with piles of hundred dollar bills.

In fact, the vast majority of monetary wealth today is not currency; it is IOU-currency, naught but promises to pay in the future. Corporations float debt collateralized by future profits. Governments float debt collateralized by the future income streams of tax-paying citizens. In sum, however, the value of all that debt is nothing more than a consensus that those future cash flows are adequate to actually service the repayments as they come due.

The ocean of debt now extant is far too large to service. It was able to grow to the sky because in a mass social mania, people convinced themselves of the patently impossible. Social mood has, astonishingly, pinned the needle for so long that we forget that these conditions are, historically, all but unknown (the last mania close to this large was probably the twins of John Law's Mississippi Scheme in France that jumped the Channel and fomented England's South Sea Bubble). The only two temporary periods of waning optimism in our mania were 2000-2002 and late 2007 to March of 2009, periods characterized by 50% cuts in major stock averages. I think they were but the warm-up.

When money is largely (or exclusively) paper currency, the issuer can simply print more, endlessly, often raising denominations of bills along the way. This is the prototypical hyperinflation.

When money is mostly IOUs, and IOUs rest on the collective belief that they will be honored, and that belief erodes, simply creating more IOUs does not cause the money supply to rise. On the contrary, such actions (if perceived) undermine confidence in repayment all the faster. This is why, though the US government has borrowed and spent like a drunken sailor on shore leave visiting a brothel and waving a credit card, prices in the aggregate are just barely holding up, not skyrocketing.

Today people have almost NO currency. Almost all money is "deposited" (where it becomes an "IOU-currency" and nothing more). Moral hazard has drained almost all the healthy distrust from depositors (FDIC, bank regulations, etc. will protect me so I need not worry about such arcana), creating the perfect environment for the ultimate Black Swan event in the money supply.

In practice, what this means is that under the current paradigm, holders of currency-cash are robbed each day by engineered inflation, harassed by FinCEN (Financial Crimes Enforcement Network) when removing cash from the system, and court both official (via "Civil Asset Forfeiture") and unofficial robbers tempted to target concentrations of little green-ink pieces of paper. Holding banknotes is thus not cost-free, and it is potentially dangerous. Homes are not equipped to safely store cash.

Cash is a problem. (So, too, is holding a bunch of gold, but that’s another discussion.)

Paradoxically, in the event of the aforementioned Black Swan, only those holding actual currency-cash are protected from a collapse in the collective belief that IOUs will be honored. This is exactly what occurred in Argentina in 2001 when those who withdrew their US-dollar denominated deposits as currency-cash avoided the engineered confiscatory deflation of the Argentine government. Such people experienced an immediate more than doubling of their peso-based purchasing power when the government effectively seized dollar-denominated accounts and devalued the peso multiple times in the aftermath.

The USA is very different from Argentina in many ways, but I think there are parallels here. My cursory overview of Minsky's and Fisher's analysis also suggest that even in a pure fiat environment, debt-money cannot be created at will and in fact the only path ahead involves a collapse in the aggregate amount of that debt-money down to what people sharing a negative social mood believe is adequately collateralized. Such a shrinking total of money leaves remaining money units with growing purchasing power, and prices for things in general should fall, possibly precipitously.

I think the money supply can and will probably collapse, and for a short time physical Monopoly Money ($USD) will be the most valuable way to hold asset value. Such a condition might only last for a couple years as the IOU ocean is drained by hyperdeflation, and I've little doubt politicians would respond to this eventually, trying to reflate the money supply by literally printing more currency-cash.

If this is the path the future takes (and no one knows the future, in my opinion, all this is just a thought-experiment), we will know it's time to trade currency-cash for some kind of commodity-value when we see the reappearance of $1,000, $10,000 and perhaps even $1,000,000 banknotes (I vote to put Reagan's face on this last note, although one could also make a better case for Nixon's).

I could be wrong, and I remain open-minded on this subject. At the moment, however, there is a slight majority of the always-mixed signals (in my opinion) favoring this perspective. In the end, however, we all pay our money and take our chances.

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For more on this tiny minority viewpoint, Prechter’s Elliottwave.com website offers their “Club EWI” which offers painless and free access to much of Precter’s writings on the inevitability of deflation. Yes, it’s a way to attract paying subscribers but his is probably the best, if not only full exposition of this contrarian view and is an important consideration given the near-total consensus (of hyperinflation’s inevitability) it opposes. As full disclosure, I do not usually subscribe to the paid services but have done so in the past, and have published a review of one of Prechter’s books.

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