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[untenured]

A friend is convinced that this will happen, maybe even to 1,000% annually.  The US goverment, he says, is literally printing money and that will cause costs to skyrocket. We should all invest in precious metals rather than stocks.  The economy is going down and fast and stocks are not the place to me.

I was caught off guard by all this.  Inflation over 100%, how could this happen?  It does not seem plausible, but I did not have a good response at the time.  What sayeth oh forum community about such doomsday scenarios, and how can I respond?

Untenured

[goldenapple]

Tell your friend to turn off the radio immediately, and in the future to reduce his diet of Michael Savage to no more than an hour a week. It will also lower his blood pressure.

In the mean time, just in case, ask him where he's burying all his mason jars full of gold.

[mad_doctor]

Economically speaking, not only is it possible, it is likely given the amount of money they have to print to cover their obligations.

It works the same way for nations as it does for people and businesses.  Ideally, a nation should have an amount of money in circulation that is more-or-less equivalent to the value of that nation's productivity.  It's somewhat the same concept as personal and corporate credit - a person or business shouldn't get any more credit (which allows them to circulate money) than their productivity will allow them to afford.  The difference between people and businesses and nations is that nations are allowed to print money and people and businesses are not.  Follow this [admittedly simplified] example:

Suppose HDTV Co., a maker of HDTVs can produce 1,000 HDTVs a month.  If they never get any more than 1,000 orders they don't need to ask for credit to fill additional orders.  It they get 1,500 orders they can take the money for all the orders, send out their full production capacity of 1,000 HDTVs to the first 1,000 customers and make the remaining 500 customers into creditors by giving them a piece of paper that says the holder of the paper can redeem it for an HDTV.  Suppose now that they have some other physical assets that they can substitute for HDTVs to cover all the paper they put in circulation - oohh, let's say this asset is a little pile of gold.  If somebody wants to redeem their piece of paper, and HDTV Co. can't fill the order with a real HDTV, they can always give their creditor an amount of gold with an equivalent value to an HDTV.  This will work fine as long as HDTV Co. still has enough gold to cover whatever obligations they have in excess of their production capacity.  If the little pile of gold runs out, all that paper in circulation becomes worthless since HDTV Co. no longer has the ability to redeem the paper, and their productivity can't keep up with the excess demand for HDTVs.

Got it?  It works the same way for nations.  All that paper we're putting into circulation must represent our nation's ability either to produce the goods or cough up a substitute asset with an equivalent value, and that's where the central bank's gold reserves come into play.  It's all about supply and demand for the substitute asset, which in this case is gold and precious metals.  The more worthless the paper becomes, the more valuable the gold becomes on account of the increasing demand for substitute assets.  The paper is valuable only if other nations believe we have the ability to redeem it for goods and services or gold.  Now, if you were one of these other nations, what would you be thinking if you knew we had just printed more money in one year than we have in the our nation's entire history combined?

[parispundit]

I have been reading this headline for the past 30+ years. Ain't been true yet. And I will be happy to give any forumite 2-1 odds that it won't be true in the US any time in the next 5 years either.

[normative_]

In practice, it's unlikely to get that bad. Possible but unlikely. There will be inflation, for sure, but everything else is very speculative.

I can understand that the Ron Paul crowd thinks the currency has been destroyed already, and that we're like the cartoon coyote suspended in mid-air until it realises gravity applies. The increase in the money supply that has taken place in the last year or so is indeed massive, and could lead to hyperinflation. Against this argument, though are the following:

1. Part of this incentive to print more money comes from the possible ease of paying back government debt, which increased dramatically in helping the banks. Some of that money will be recouped when government-owned bank assets are re-sold.

2. The Fed, which has not yet placed time limits on the extra credit it currently makes available to banks, will probably do so eventually. This has already happened in Europe (indeed, there were rolling time limits from the outset), but the US has been hit far more severely than Europe. So the time is not ripe. That doesn't mean it won't happen in the future. It's just as likely that American economic growth remains anemic for a while, until something turns around eventually.

3. An external run on the dollar could spike inflation and get a spiral going, but the current shift away from the dollar has been pretty gradual, which is the plan. You need something else to shift it to. Currently, we are witnessing the world switch from extreme dollar dominance in currency baskets to about 70% of total holdings. That's a change, but less than the kind that would start something.

4. There is indeed an increase in raw materials prices denominated in dollars, but that only affects the US economy through consumer prices. Manufacturing in the US has been decimated for so long that it won't have the effect it otherwise would have. It will squeeze the manufacturers in East Asia more, as they struggle to keep prices under control, so that you will still buy them.

5. Inflation, like everything else to do with prices is a case for (mass) psychology. It's a self-fulfilling prophesy in many cases. Momentum for that would have to build up.

[mad_doctor]

I have been reading this headline for the past 30+ years. Ain't been true yet. And I will be happy to give any forumite 2-1 odds that it won't be true in the US any time in the next 5 years either.

I'm not a betting man, parispundit, but I'll be happy to buy your dinner next time you're in QBSU-town.  I'm thinking that the central banks have been propping up their currencies with gold for the last 30+ years.  However, I read recently (Seeking Alpha, I think) that sometime in the last two years the central banks have become net buyers of gold rather than net sellers.  All this time the gold conspiracy people have believed that their purpose has been to manipulate the price of gold, but I think it's more likely that they have been using gold to manipulate the price of their currencies all these years.

[parispundit]

You want me to leave Paris for dinner in QBSU-town? That would make me one Mad Pundit!

[prytania3]

If you buy anything foreign on a regular basis--you really feel the effect of the falling dollar. For example, I'm a Red Bull fiend (which I believe is illegal in France), but I am really trying to find a substitute. Red Bull is made in Switzerland, and I have cut a deal with a certain place that sells them to me at a good deal, but they are near the school, and yesterday I stopped by a place near my house and paid $5 for a can. 5 bucks! Ridiculous.

Anyway, Parispundit, I have not been reading headlines of 100% inflation in 5 years the last 30 years unless it was in reference to Brazil. I must live in a cave.

If the dollar keeps falling and we keep printing, then that sort of inflation is very possible although we do have some deflationary action to offset it. I think the dollar will rally in 2010--not for any reason--but just because I think it will. If THAT should happen and we continue with this type of unemployment, we could be looking at deflation, which is worse for the overall economy than inflation; although, it would be very good for me.

[spork]

I'm more worried about the current account deficit and the negligible savings rate.

[parispundit]

The dollar should help bring the current account deficit down to a reasonable level in 2-3 years. The savings rate is harder. If Americans started saving like French people tomorrow (15% household savings rate), the result would be worldwide depression. The current 4%, however, is still too low. Gradually over the next few years the gummint should stop cash for clunkers and houses and start matching contributions to IRAs - while making IRA pre-62 withdrawal rules tougher. Restricting access to credit cards (through regulation making them less profitable for banks) might help too. But nothing will help unless the people choose to let it. On this one, for a change, I'm not optimistic.

[mad_doctor]

You may not get the news across the pond, parispundit - the cash for clunkers is already gone.  They have extended the first-time home buyer's credit.  No word on matching contributions to IRAs, although most still get matching from their employers.

BTW, I see that gold is over $1,130 this morning.

[fizmath]

A friend is convinced that this will happen, maybe even to 1,000% annually.  The US goverment, he says, is literally printing money and that will cause costs to skyrocket. We should all invest in precious metals rather than stocks.  The economy is going down and fast and stocks are not the place to me.

I was caught off guard by all this.  Inflation over 100%, how could this happen?  It does not seem plausible, but I did not have a good response at the time.  What sayeth oh forum community about such doomsday scenarios, and how can I respond?

Untenured

I lean his way on this matter but it is too hard to predict.  There are too many variables that are affected by future government and FED decisions.  I do prefer the inflation rate given at shadowstats.com rather than the government's numbers.  100% is  perfectly plausible.  In some cities home values doubled in 3 years.  Some commodities like oil more than doubled in a year's time just a few years ago.

Ultimately, there is no safety in paper money.  You are at the mercy of those who control it.

[mad_doctor]

Many people think of gold like just another commodity, and when the gold bugs start talking about paper money, gold, manipulation, and conspiracy, it sounds a little unbelievable.  This is one of those cases where the truth really is somewhere between the two.  Gold isn't just another commodity, neither is it really money, and there's probably not a conspiracy to control its price.  I do believe that it is important to understand the role that gold plays in the global economy, and how central banks use gold to prop up their currencies.  It is a fact that for the first time in over twenty years the central banks have become net buyers of gold rather than net sellers.  There is a very strong possibility that the banks are now, and will be for the next few years, competing with eachother to devalue their currencies.  Why devalue your own currency?  Parispundit knows why - because it's one way to increase exports, and strong exports improve a nation's economic strength.

[raoul]

The US goverment, he says, is literally printing money

Actually it is the Federal Reserve that is literally printing money. They have to do this, because, um, that's where paper currency comes from, and paper currency wears out with use. They do this all the time. If they stopped "literally printing money," then after a few years there wouldn't be any more paper currency.

If your friend is talking about increasing the amount of currency in circulation, then what they are doing is literally adding numbers to electronic databases. Not much of that has actually found its way into circulation yet, and economists aren't sure how much of it ever will. There is no credible economic analysis to suggest a likelihood that inflation would reach 100% annually even if a lot of it did--the amount that's been created so far is not nearly sufficient to devalue the purchasing power of the currency by half in one year. If your friend is talking about 100% inflation in a longer time frame, then of course that will happen. If you have inflation every year, then after 10 or 20 or however many years, it takes two dollars to buy what you used to buy with one. This is normal.

It works the same way for nations as it does for people and businesses.

Any economic argument that begins with a statement like this is sure to be wrong. A nation's fiscal situation is absolutely nothing like that of a household or business.

Suppose now that they have some other physical assets that they can substitute for HDTVs to cover all the paper they put in circulation - oohh, let's say this asset is a little pile of gold.

You want to return to the gold standard?

[alsorun]

Hope this will not happen. But there is danger when we stop making things. A friend recently ordered an Eagle T-shirt, which has to be sent all the way from a foreign country. Go figure.