Now let’s return to the possibility of hyperinflation in the United States:
If there were a sudden collapse in the Treasury bond market, I argued that sellers would take their cash and put them into commodities. My reasoning was, they would seek a sure store of value. If Treasury bonds ceased to be that store of value, then people would invest in the next best thing, which would be commodities, especially precious and industrial metals, as well as oil—in other words, non-perishable commodities.
Some people argued this point with me. They argued many different approaches to the problem, but essentially, it all boiled down to the argument that commodities and precious metals have no intrinsic value.
Actually, I think they’re right. In a strict sense, only oxygen, food and water have intrinsic value to human beings—everything else is superfluous. Therefore the value of everything else is arbitrary.
Yet both gold and silver have, historically, been considered valuable. Setting aside a theoretical or mathematical construct that would justify the value of gold and silver, look at it from a practical standpoint: If I went to a farmer with five ounces of silver, would he give me a sack of grain? Probably. If I offered him an ounce of gold for two or three pigs, would he give them to me? Again, probably.
Where there is a human society, there is a need to exchange. Where there is a need to exchange, a medium of exchange will soon appear. Gold and silver (and copper and brass and other metals) have served that purpose for literally millennia, but then they were replaced by paper.
Right now, there are two forms of paper currency: Actual dollars, and Treasury bonds. One is a medium of exchange, the other a store of value.
If Treasuries—the store of value—were to collapse in price, and the Fed—as I predict—tried everything in its power to at least initially prop up their prices, would those sellers who managed to get out of Treasuries in time then turn around and invest in even dodgier bits of paper, like stocks? Or REIT’s? Or even precious metal ETF’s?
No they would not: They would get out of Treasuries—supposedly the “safest” investment there is—and get into something even safer—something even more tangible: Actual commodities. Not ETF’s, not even futures (or anything else that entails counterparty risk)—sellers of Treasuries would get into actual, hard commodities. Because if suddenly even the safest of all investment vehicles is now unsafe, do you really want to get behind the wheel of an even more unsafe vehicle, like stocks or corporate bonds or ETF’s? I mean, c’mon: If Treasuries crash, what else might crash?
That’s why people in a Treasury panic would buy commodities. This ballooning of non-perishable commodities would be as a means to store value. Because that’s what people do in a panic—they batten down the hatches, and go into what’s safest. When the stock markets tanked in the Fall of ’08, where did all that sellers’ cash go? To Treasuries—because it was then considered the safest store of value. Commodities suffered in comparison—gold took a bit of a hit, as did the other precious metals—but Treasuries ballooned as the equities markets tanked.
But if Treasuries—the ultimate store of value—now tanked? If the last sure-thing in paper-based stores of value took a hit, where would people go to both store value, and have ready access to that value?
Commodities. And this rush to commodities, I argued, would trigger hyperinflation.
Now, I said I would answer two questions—one was why commodities would outpace all other asset classes in a Treasury panic and subsequent hyperinflation. The other question was, “Where’s all the dough to feed my fireplace gonna come from, in a hyperinflationary event?”
The first wave of dollars in a hyperinflationary event will come from people’s savings accounts.
If Treasuries tank, and the markets all barrel into commodities, then prices will rise for regular consumers—this should not be a controversial inference. What would consumers do, with suddenly much higher gas prices, and soon much higher food prices? Simple: They’ll bust open their piggy banks, whatsoever those piggy banks might happen to be: 401(k)s, whatever equities they might have, etc.
But if the higher consumer prices continue—or become worse—what will happen to the 320 million American consumers? They’ll start buying more gas now, rather than wait around for tomorrow—and the market will react to this. How? Two way: Prices of commodities will rise even further—and asset prices will fall even lower.
Again, the man in the desert, the diamonds, and the water: If American consumers are getting hit at the gas station and the supermarket, they’ll start selling everything so as to buy gas, heating oil (most especially) and foodstuffs. The Treasury panic will thus be transfered to the average consumer—from Wall Street to Main Street by way of $15 a gallon gas prices, and $10 a gallon heating oil prices.
All other consumer prices would soon follow the leads of gas, heating oil and food.
In the above bit of Chilean history, I described how the Allende government printed up escudos to make up for the shortfall in nationalized businesses that was produced by their policy of hiking wages, while at the same time fixing prices.
This is a completely different way to hyperinflation than the way I envision it for the American economy—but once the American economy gets there, the effects of hyperinflation will be exactly the same: People will try to get out of assets in order to get hold of commodities. To get all eccy about it, money velocity would approach infinity, as money supply remains (at first) fixed, yet in the panic over commodities, aggregate demand as measured by aggregate transactions goes vertical.
Would there be Federal government intervention of some sort? Most definitely—people would be screaming for it. Would food rationing be implemented? Probably, and probably by way of the current Food Stamps program. Troops on the streets, protecting gas stations and supermarkets? Curfews to prevent looting? Palliative dollar printing? Yes, yes, and very likely yes.
That last bit—palliative dollar-printing: That’s the key. When palliative dollar-printing happens, it will be the final stages of hyperinflation—it’s when sensible people ought to realize that the crisis is almost over, and that a new normal will soon appear. But this stage will be fucking awful.
Palliative dollar printing will take place when the Federal government simply runs out of options. Smart economists will get on CNBC and argue that, “The velocity of money is destroying the economy—we must expand the currency base!” It’ll sound logical, but palliative money-printing will be a policy option born out of panic. The final policy option. It won’t be done for evil conspiratorial reasons—always remember Aphorism #6 (“Never ascribe to malice what can be explained by incompetence.”). It’ll be carried out because of fear and panic.
A whole boatload of fools in Washington, on seeing this terrible commodity-driven crisis unfold, with consumer prices shooting the moon, will scream for dollars to be printed—and their rationale will be perfectly reasonable, I can practically hear it now: “We've got to get cash into the hands of the average American citizen, so he or she can buy food and heating oil for their families! We can’t let Americans starve and freeze to death!”
Palliative money-printing will take place—hence the average American family will likely be using bundles of $100 bills to fire up the chimney that hyperinflationary winter.
Hoo-Ah.
Now, this fairly Apocalyptic scenario is simultaneously horrifying, and exciting as all get out. Hell, why do you think disaster movies are so popular? Shit blowing up is way cool! That's why Roland Emmerich gets paid the big bucks, God bless ‘im.
But for sensible people, Apocalypse is a distraction—it’s not the main event. For sensible people who want to be prepared, Apocalypse represents opportunities.
A true story: In ’73, at the height of the Allende-created hyperinflation, an uncle of mine, who was then a college student, was offered an apartment in exchange for his car. That’s right—an apartment. He owned a crappy little Fiat 147—a POS if ever there was such a thing—but cars in Chile in the middle of that hyperinflation were so scarce, and considered so valuable, that he was offered an apartment in exchange. To this day, my uncle still tells the story—with deep regret, because he didn’t follow through on the offer: “That Fiat was in the junkyard by ’78, but that apartment still stands! And today it’s worth nearly a half a million dollars!” Actually, I think it’s worth a bit more than that.
Another true story: A banker friend of mine manages the assets of a fabulously wealthy 70-something gentleman, whom I'll call Alfredo. In 1973, Don Alfredo was a youngish man, just starting out, with a degree in engineering but no money—until he inherited US$3,000 from a deceased aunt. Alfredo realized that the $3,000 were in a sense worthless: He couldn’t buy anything with them, and it wasn’t enough for him to leave the country and start over someplace else. After all, even then, $3,000 was not that much money.
So he took those $3,000, went down to the stock exchange, and spent all of it on Chilean blue-chip companies: Mining companies, chemical companies, paper companies, and so on. The stock were selling for nothing—less than penny stock—because of the disastrous policies of the Allende government. His stock broker at the time told him not to buy stocks, as Allende’s government, it was thought, would soon nationalize these companies as well.
Alfredo ignored his broker, and went ahead with the stock purchases: He spent all of his $3,000 on buckets of near-worthless equities.
On September 11, 1973, the commanders in chief of the four branches of the Chilean military staged a coup d’état. Within a year, Alfredo’s stock had rebounded about ten-fold. Since then, they’ve multiplied several thousand-fold—yes: Several thousand-fold. Don Alfredo has lived off of that $3,000 investment ever since—it’s what made him a multi-millionare today.
He realized, of course, that either those blue-chip companies would be nationalized by Allende—in which case he would lose all his $3,000 inheritance, which really wouldn’t change his fortunes very much—or somehow a new normal would arrive in Chile. Since the $3,000 couldn’t buy him anything, he took a gamble—and won.
What do these two true stories tell us? Simple: Buy when there’s blood on the streets.
That’s Baron de Rothschild’s famous line—but it hides a key insight, one which should be highlighted perhaps even more forcefully than the line itself:
Even in the midst of Apocalypse, things will get better.
That’s something people don’t quite seem to understand. In fact, it’s why teenagers tragically kill themselves over some girl or boy: They don’t realize that, no matter how bad things are now, they will get better later. To repeat:
Even in the midst of Apocalypse, things will get better.
I’m not repeating this insight as an empty comfort to my readers—I’m saying it as a trading strategy. When things are at their crazy worst, when everyone believes the Apocalypse is well nigh here, that’s when thing are about to turn for the better. This applies to every situation—including and most especially in a hyperinflationary situation.
Why? Simple: Because hyperinflation—by definition—cannot last. Because people need a stable medium of exchange. So if the currency goes up in flames in a hyperinflationary fire, of course there will be a period of terrifying instability—but it will pass. Either the currency will be repaired somehow (as Volcker repaired the dollar back in 1980–’82). Or the currency will be completely and irrevocably trashed—and then be replaced by something else. Because—to insist—people need a stable medium of exchange.
If Treasuries tank and commodities shoot up so high that they essentially break the dollar, civilization will not come crashing down into anarchy. At worst, there’ll be a three-four years of hell—economic hell. Financial hell. But then things will settle down into a new normal.
This new normal might well have unsavory characteristics. I tend to be a pessimist, and just glancing through history, I can see that just about every period of hyperinflation has been stabilized by some subsequent form of autocratic or totalitarian government. The United States currently has all the legal decisions and practical devices to quickly transition into an authoritarian or totalitarian regime, should a crisis befall the nation: The so-called PATRIOT Acts, the Department of Homeland Security Agency, the practical suspension of habeas corpus, etc., etc.
But as I said in my previous post, and reiterate here: Speculations about the new normal are pointless at this time. The future will happen soon enough.
What I do know is, One, a hyperinflationary event will happen, following the crash in Treasuries. Two, commodities will be the go-to medium for value storage. Three, all asset classes will collapse in short order. And Four—and most importantly—civil society will not collapse along with the dollar. Civil society will stumble about like a drunken sailor, but eventually right itself and carry on with a new normal.
During that stumble, opportunities will present themselves. I hope I have explained why.
