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!


  1. Well well...- check this out - http://armstrongeconomics.com/2014/01/ - Martin Armstrong has 2 posts on hyperinflation and how there is ZERO chance of it happening in the US. The two posts may be a post or 2 down from the top of the page.

    1. He expects the US central government to default on its debt. I can find no case in history where a government that could print money defaulted on debts in its own currency. There are hundreds of cases where it printed to pay off debts. I really think I will be right and he will be wrong.

    2. I agree. It seems like the path they have already chosen. Unless they stop QE totally and really start raising taxes, a lot, it appears printing it is the game plan.

    3. The stock analogy he uses is wrong. Here is the right one from my 38 year cycle page:

      Think of governments that issue currencies like corporations issuing shares. A government tax creates a demand for currency. Imagine the company never pays a dividend and only does share buybacks to create demand for their shares (common these days). In this case the goverment currency and corporate shares are really very similar. A company or a government has 3 choices to raise capital:

      Make-profits or collect taxes
      sell bonds
      issue more shares or currency

      As they make more shares/currency they dilute the ownership of all previous share/currency holders. If they dilute too much or too fast, then shareholders or currency holders will run away. They can extinguish shares or currency by buying shares or forcing people to turn over currency to pay a tax. If the are spending far more than they take in and have huge debts then it is not good to own those shares/currency, because they are not able to provide enough demand.

  2. "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 deficit has been pretty flat at around 1.3 trillion and there has been no issues selling the debt. At this rate, there doesn't seem to be any major issues selling the bonds, if there was some weakness - rates can and will be increased to drive up demand. Additionally, it's all relative - would you rather buy Chinese bonds or perhaps Brazilian bonds, or maybe ECB bonds? I don't see where this hyperinflation is going to come from.

    1. Right now the Fed is buying more bonds than the Treasury is selling. Right now there is no issue. But rates have been going up and I think they will continue to do so. There were several months when foreigners were reducing their bond holdings. And since the Fed is buying more than the Treasury is making the net for everyone else is already selling.

      The hyperinflation would come after the selling turns into really heavy selling or panic selling. I think Japan is closer to this than the USA. The central bank there is buying bonds at an amazing rate. They are increasing the money supply around 1.6% every 10 days.

    2. Why would anyone sell US bonds? Who or which country would that be?

    3. Over an 8 month period the overall foreign holdings of US Treasuries went down.


    4. Isn't that just a sign of a weakening global economy? I mean, do other countries really want their currencies to appreciate against the dollar?

      I don't think so.

  3. Vincent, can you help me translate this one?



    1. That's Austrian-speak isn't it? What does it mean?

    2. Maybe that comment is saying the post is ignoring Austrian business cycle theory.


    3. I think this is a good comment:

    4. Vince, you may like the comment, but if you ever want anybody to interact with you, don't write like "Geoff" (AKA Major_Freedom). "Geoff" changed his name to Geoff in the hopes of duping people into interacting with him on Sumner's site more than a year ago, but I don't think I've ever seen Sumner EVER interact with Geoff/Major_Freedom... Sumner has a policy of not erasing any comments, but sometimes the thread is polluted with Geoff speeches and it gets rather annoying. Being ignored never seems to deter MF though... he just keeps plugging away.

      Even on sites more sympathetic to his views (e.g. Robert Murphy's site), Murphy had to tell him once (paraphrasing), "Major_Freedom, I have a regular job. I can't take the time to read your comments. If you have 57 reasons why I'm wrong about something, perhaps you can just pick the best three and leave it at that."

      Haha. :D

      Why don't you let Geoff know you like his comment! He's completely ignored by most people, and the little interaction he does get is 99% negative. He probably wouldn't know what to do if somebody actually complimented him! ... he'd probably suspect you were being sarcastic! Ha!

    5. ... offhand, it seemed to me that Greg_Ransom may actually be a little WORSE than Geoff. At least Geoff doesn't sound like he's on drugs when he writes. But then again... who is more interesting to read? Hmmm.

      Of course it could be that Greg_Ransom is just the name Geoff/MF uses when he's drunk... what do you think? I don't think so, but I'm not 100%.

      Thanks for taking the time to decipher that Greg speech... I had to laugh because I really couldn't understand it at all, but I think you may actually have the right idea (ABC).

    6. Here's a classic one from Geoff/MF:


      ... so I guess this humor page contains some truth:


  4. ... and regarding the MF comment... it's funny that you picked that one, because I generally never read his comments, but once a year I pick one at random to see what he's on about (it's usually always the same thing), and that was the one I picked for 2014!... so I'd actually already read that one. Funny.

    I didn't see anything new there though... it's his usual speech as far as I can tell.

  5. BTW, I probably already showed you this, but I had an idea that Noah had selected Geoff/MF as an example of an "Austrian" econotroll, but he hadn't:


    He did select somebody in particular for his "Uncategorizable" troll though (at the bottom). Do you know who it is? Take a guess.

  6. ... and regarding Bob Murphy's comments to MF that I paraphrased above... I believe you had to tell me something similar once too, right? Hahahaha... so I guess I'm the pot calling the kettle here, right?. :D

  7. Hey Vincent, another topic here: how would you feel if the central bank decision makers were replaced with an open source algorithm to do NGDPLT for example?

    Sadowski says such an algorithm (rule) already exists, and in fact it's the well knownTaylor Rule. Using the Taylor rule to do what it's most famous for: inflation targeting (instead of NGDPLT) is really just a special case:


    1. BTW, I asked David Glasner some very general questions about MM (to be an MMist essentially means you want to do NGDPLT). Here's a bit of that convo:

      Tom Brown:
      "3. MMists see a 5% NGDPLT scheme for the CB as a practical means of “eliminating the money illusion” … i.e. the problems associated with money (such as sticky wages and prices) that prevent a society using money from approaching the perfect Say’s Law barter economy. The purpose of NGDPLT is to smooth out the effects of supply or demand “shocks” and prevent them from doing unnecessary things to the economy such as creating an excess demand for money which in turn can lead to an unnecessary recession or even depression. NGDPLT won’t cure booms or busts or “structural problems” but it will tend to eliminate “unnecessary” problems which arise due to the weirdness of money."

      David Glasner:
      "On point 3, I think you are generally on the mark."

      He wasn't happy w/ my Say's Law reference, but I was glad to hear I was generally on with the rest. My point 1. was that MMists were generally (but not necessarily) libertarian, neo-liberal types who were fans of Milton Friedman. He agreed, but isn't a Milton Friedman fan himself. My point 2 just demonstrated my misunderstanding of Say's Law.

      Why bring this up? Well some Austrian types (Geoff/Greg) always talk about how the central bank is tyrannical and that you have to be a sociopath to want to be a decision maker there. Here's an example:



      So what if we decided (say put it to a vote) to put the matter into the hands of an open source rule or algorithm which implemented NGDPLT (NGDP level targeting)?

      That's one way to remove the tyrant element, no? Or would that just be the tyranny of the majority?

      I kind of like the MM/NK story about how an excess demand for money (as the MOA) can cause unnecessary recessions and depressions if the central bank reacts badly to it. I'm not 100% on board with it, but it does seem logical to me. So if 5% NGDPLT is supposed to fix that I could see giving it a try, especially since it doesn't require any human intervention beyond setting it up.

      Rowe once asked his readers if they could find a case in which 5% NGDPLT would not have helped avoid these unnecessary problems. I don't think anybody was able to demonstrate that (at least to Nick's satisfaction). I tried to interest Sadowski in accepting Nick's challenge, but he thought it'd be a waste of time.


      My guess is you would not be in favor of 5% NGDPLT even if carried out by an algorithm. You are probably more a fan of the Austrian business cycle theory (ABC), which is probably incompatible with the idea that excess demand for money sometimes causes unnecessary recessions and depressions.

    2. Also the post-Keynesian (PK) theory is the "balance sheet recession" (BSR) concept. I like that one too... so I'm a bit undecided between the MM/NK "excess demand for money" concept and the BSR concept. Maybe both can happen and are separate things. However, I know nothing about ABC.

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