Tuesday, July 15, 2014

Spontaneous Combustion Theory of Inflation

There have been many posts trying to ridicule the Spontaneous Combustion Theory of Inflation.  The name is to make it seem ridiculous that inflation could just suddenly take off.  However, in the real world hyperinflation does just suddenly take off.   There is good theory as to how inflation suddenly takes off.  Making a silly name for something is a debating technique but it is not a sound logical argument.  Hyperinflation is a real thing.

Friday, April 11, 2014

Problem with central banks making it up as they go along

I highly recommend this speech that Dallas Fed President and FOMC voting member Richard Fisher gave in Hong Kong.  I think he does a good job of explaining the reality of central banking.  It really boils down to making it up as they go along.

The problem with this is the risk of getting sucked into a hyperinflation feedback loop.   If you are wondering around and making things up as you go along, and happen to step into the hyperinflation death spiral, you will not be able to just step back out.

The politicians, with their large debt and deficit spending, are really a key part of the setup for hyperinflation.   I think the politicians and central bankers do not yet understand hyperinflation well enough to take the difficult choices needed to avoid stepping into the hyperinflation trap.  

Wednesday, March 19, 2014

Living Like Parasites

Putin said of America, "They are living like parasites off the global economy and their monopoly of the dollar."

Putin understands something that few do.

Imagine half the dollars are outside the USA and half are in.  Then imagine $1 trillion new dollars are made and owned by the USA.  No real new value is made when this new $1 trillion in money is created.  Eventually all the existing money will be reduced in value because of this new money.  Half of this stolen value comes from reducing the value of the money outside the USA.  So in effect the USA has sucked $500 billion out of the rest of the world.  Living like parasites is a good description.

Sunday, March 9, 2014

The Threat of Dumping Bonds

When the British, French, and Israelis attacked in the 1957 Suez Crisis, America was able to put financial pressure on Britain. It held many British bonds and threatened to start selling them if the British did not stop the attack. From the Wikipedia article:

"Britain's then Chancellor of the Exchequer, Harold Macmillan, advised his Prime Minister Anthony Eden that the United States was fully prepared to carry out this threat. He also warned his Prime Minister that Britain's foreign exchange reserves simply could not sustain a devaluation of the pound that would come after the United States' actions; and that within weeks of such a move, the country would be unable to import the food and energy supplies needed simply to sustain the population on the islands."

Some say this marked the end of the British imperial power and the start of America as a "superpower".

Now Russia is threatening to dump US bonds if the US imposes sanctions on Russia for Crimea.  


Friday, March 7, 2014

Scientific Theories Make Testable Predictions

A common criticism of "people who believe in hyperinflation" (as if it was like the Tooth Fairy) is that we can not reliably say when it will start.   You can see this at Cullen Roche,  Scott Sumner, Mike (Mish) Shedlock, and Paul Krugman.   Several of these have had many posts of the form, "ha, ha, I have been right so far".  However, I have not been able to any real debate from these people over the theory of hyperinflation as in  Hyperinflation FAQ and also Hyperinflation Explained in Many Different Ways.

The average paper money seems to last about 25 years. Big developed countries pull this average up, but even America has had hyperinflation a couple of times.   But for discussion, lets assume hyperinflation happens 1 out of every 25 years in the average country.  This means that 24 out of 25 years there is no hyperinflation.   Someone who just says, "no hyperinflation this year" is like a stopped clock that is right 96% of the time.  And still they are so proud.  :-)

Just to be very clear, if these people don't switch to "there will be hyperinflation this year" right before the hyperinflation starts, then I claim that in all their previous predictions of "no hyperinflation this year", they were just being stopped clocks.

I also like to point out that when you go from 2% inflation to 26% inflation, 30 year bonds will lose 99%  of their real value.  So it is better to be many years early than one year late in getting out of bonds if hyperinflation is coming.

Still, there is some truth to this criticism.     A scientific theory makes testable predictions.  A good theory should make predictions that turn out right.  Not looking to debate if The Dismal Science is a real science.

With my many explanations of hyperinflation we have many good theories of how hyperinflation works.  In general there is a feedback loop.  But most of these theories don't give us much clue about  when the feedback loop will start.   The timing is not really part of these theories.

However, one of these does have timing information.   The backing theory of hyperinflation.   This says that the central bank has to have reserves to support the value of the currency.   If the central bank is burning through these reserves at a rate where they run out after a certain time, we have some handle on the timing.  They may prop up the value of their currency till they are almost out of reserves, but that  is it.  There will be a  day of reckoning.   We can estimate when by how long till they run out of reserves.

When the Argentine government took much of their central bank's reserves, I said to myself that they were headed for hyperinflation.   A reader of this blog pointed out that the Ukraine's central bank did not have enough backing and so seemed headed for hyperinflation.   Both of these were based on the backing theory of hyperinflation.   So to me the backing theory of hyperinflation seems a very good way to predict timing for hyperinflation.   So I would like to try to do this in a public way.  Clearly predictions made in public are far more impressive.

For me the interesting prediction is when a currency will go from something normal like 2% inflation to 26% or higher yearly inflation.  There are also many more making this transition than those that go all the way to 50% per month.

Do any readers have an ideas for countries that now have moderate inflation but where the central bank reserves per note issued are far below the current value of the note?   A government running a big deficit has a harder time bailing out the central bank, so that is an important factor as well. In fact, it is prbably reasonable to just look at foreign reserves if the government has a large deficit, ignoring government bonds.

 I will update this post trying to make an ordered list of hyperinflation candidates.

The central banks in the big reserve currency countries seem to have lots of long term bonds in their own currency.  It would be nice to  know how much these  would drop in value as interest rates went up.   Like if Japan's interest rates go up 2% what does that do to the value of the central bank's reserves?

I have an earlier post on ideas for predicting the timing of hyperinflation.

Thursday, February 13, 2014

Preventing Crises

If since the USA was founded they had required banks to sell 10 year bonds to get the cash to use for 10 year loans (banks can't use demand deposits, must have matched duration bonds and loans, so no fractional reserve banking or "bank made money") and never went off a gold/silver coin money (no paper money or central bank) then I think that there would not have been anywhere near the number of inflations/booms/busts/deflations/financial-crises between then and now. If regular banks and central banks can increase or decrease the money supply, then the money supply is not stable, and you get booms and busts and crisis after crisis.

This is sort of my version of the Austrian Business Cycle Theory.   I think it is easier to think about in terms of central bank made money and private bank made money not being stable, so nothing is.   Fractional reserve banking is the core cause of financial crises and the reason people think they need a central bank to act as a lender of last resort.   If you did not have fractional reserve banking, then you would not need a central bank and could have a much more stable money supply and financial system.

For more than 2,000 years an ounce of gold has been about the value of a nice suit, shoes, and belt.   This is amazing stability.  The median life expectancy for defunct paper currencies is only 15 years.   Even in the big stable countries paper money loses more than 90% of its value in under 100 years.  In the 1950s a silver dime was about the value of a gallon of gas and 1/10th of an ounce of silver is still around the value of a gallon of gas but the US dollar does not buy anywhere near as much gas it could 60 years ago.  Paper money does not come close to the stability of gold and silver.  Paper money and fractional reserve banking together is a recipe for financial disaster.

Keynesians think that if we just make more money we could avoid the pain of the bust.  However, this can lead to hyperinflation and far more pain.   I think it is much better to understand the cause for the boom and bust and how to avoid these.   

This post comes from a conversation with Tom that deserves its own post and thread.

Monday, February 3, 2014

Phillips Curve Fallacy

There is a good article in Forbes about the Phillips curve fallacy that most economists seem to operate under.

Phillips studied wages under a gold standard and found that when labor was in tight supply that wages went up.  This is just saying that when supply is tight the price goes up.  This is basic economics and common sense.  

But most modern economists take this study and think that if they print money that employment will go up.   This study does not show that at all.

Monday, January 20, 2014

Three points for Cullen

Cullen has agreed to respond to 3 of my points of my choosing.  So here they are.

1)  In Hyperinflation Explained in Many Different Ways I would like him to respond to the section,  Modern Monetary Theory and Monetary Realism.

2) In my Hyperinflation FAQ, the comment, "Can't we wait till there are signs of inflation before doing anything?".

3) In my Hyperinflation FAQ, the comment, "How is hyperinflation stopped?".


Cullen replied here.  Thanks Cullen!


Cullen, if you are rejecting the MMT view that government bonds are part of the money supply then how can you logically keep their claim that when the central bank makes new money and buys up bonds that it is “just an asset swap”. Their logic was that if bonds are already money then swapping for money does not change the quantity of money. If bonds are not money then making new money and buying bonds is “monetization”, replacing government debt with money. So if you reject their view on bonds, how can you keep saying it is “just an asset swap”?

Cullen, I really meant for you to respond to my answers for the FAQ questions, not just the questions themselves.


It is just an asset swap. If you want to call it monetization then fine. Just be sure to also call it unassetization or something like that. Call it unprinting if you insist on calling it money printing. Talk about both sides of the ledger. An asset gets printed and another asset gets unprinted. If you want to claim that will cause hyperinflation then so be it.

I’d love to go back and forth on this stuff, but I am pretty busy today so maybe another time. Take care.


In my FAQ the parts that I wrote are the answers.   So to respond to me should have been responding to my answers.  Instead Cullen just looked at the questions.   I called him on it and he ignored me.

He answered part 1 but when I point out a logical flaw in his position he does not address it and says, "I am pretty busy today so maybe another time".   Cullen then responds to 7 other comments in that thread.  I call BS.  Cullen is not really debating with me.  

Tuesday, January 14, 2014

The Peg Route to Hyperinflation

I got an email from Alexey Eromenko pointing out that I really sort of ignore another common way to hyperinflation.

If a central bank is trying to peg the local currency to a foreign currency even while printing new money they can lose too much of their reserves and not be able to hold the peg.  At this point the currency can suddenly crash and they can get hyperinflation.

In general I am focused on Japan, the UK, and the USA.  These countries are big and seem headed for hyperinflation.   These guys don't peg to anyone else, so I have not thought about it much.

However, Alexey is correct that a currency peg has been an issue in some case. In Argentina's case the government basically stole the reserves of the central bank.   Using the Real Bills view of hyperinflation, we can see that this, or even losing all your reserves trying to defend a peg,  should lead to hyperinflation. 

I suspect that it is going to turn out to be true that much of the time this happens the government was running a large debt and deficit.   So the central bank was trying to help out the government with new money, but then ran into trouble defending the peg.   So in some sense it is very similar in origin to others.   If a central bank is running a proper currency board they would always be able to defend a peg to the other currency.  

But my idea of the typical start to hyperinflation is the central bank monetizing bonds and people fleeing bonds.   The central bank has to keep buying bonds because the government has a huge deficit and needs cash to operate, so there is a huge flood of new money.    The peg route to hyperinflation is different from this.   Something worth keeping in mind.

Thanks Alexey!