The members here at LBC talk a lot about money. Good money, bad money. The dollar, the Euro, the Yuan. But especially about silver and gold.
I think most of us agree that the
governments around the world are in a race to the bottom as far as fiat currency destruction. That leaves things of near-universal value as being very attractive. This would include precious metals, businesses, farm land, and so on. And many of us also agree that at some point, we will see a hyperinflation-style destruction of the US dollar (or Euro, or whatever is relevant to you) because the governments of the world seem to prefer that type of value default instead of an open nominal default.
But people have been talking about this hyperinflation for years. And, in the American case, the Fed has vastly expanding the monetary base. So why haven't we seen this hyperinflation yet?
The answer lies in how hyperinflation really occurs.
If you search around the web, you will find many different definitions for hyperinflation. Some say it is a 20% or higher rise in the average price level (whatever that means) in a year. Others say 50%. I've even seen some claims of 100%. What I have realized is that the percentage change isn't the critical issue. The issue is the mechanics of how that increase happens.
Hyperinflation is a run-away escalation in the quantity of money, which then leads to a run-away escalation of prices, which then leads to people abandoning that type of money. The key here is the term run-away
. It's not a matter of degree, it's an event that triggers an ever-increasing supply of money. How this happens varies from one monetary system to the next because each has its own particular mechanics.
In the American case, money is created by The Fed. The US government creates a loan. Some entity (usually a bank) loans the government money in exchange for a promise of payments over time. The entity then turns around and sells this loan to The Fed. The Fed buys this loan with money it just makes up. Voila, the monetary base has expanded. If you didn't know how this worked before, you now know more than someone with a bachelor's degree in economics.
In this process, the government gets the cash to spend now, but also has to make payments on previous debt. This is the key for American hyperinflation.
Governments can collect money, which it then pays out, in a couple of different ways. It can tax, it can borrow, or it can print. In America, the government has decided to print-through-borrowing, so effectively there is only taxing and borrowing.
To use a common analogy, it is like the government can pay for things in two ways: money "earned" from wages (taxes) and using a credit card (t-bills and bonds). This situation can keep going, getting farther and farther into debt, until the "wages" no longer bring in enough to pay the minimum payments on the credit card. At the point, the government will get another credit card (monetization of the debt) to pay for the old credit card (previous t-bills and bonds).
This is the point that hyperinflation begins.
Once there is new debt to pay for old debt, the upward spiral of debt commences and destruction of the currency is just around the corner.
So now the question is: how close are we to this in America?
Right now the US government debt is approximately $15.8 trillion (usdebtclock.org). Last year, the government took in $2.5 trillion (usgovernmentrevenue.com) from all taxes. Dividing the taxes by the debt, we get a rate of 15.8%. This means that the current level of "wages" can support an average interest rate of 15.8% on the "credit card."
In 2011, the US government paid $454 billion (treasurydirect.gov) in interest payments. This works out to about somewhere around a 3% interest rate.
So, as you can see, we are currently a ways from a hyperinflationary collapse (aka crack-up boom). We can get there in some combination of 3 ways though: rising interest rates (The Fed is doing everything it can to prevent this), rising total debt (a virtual certainty), lowering the amount of taxes paid (the government fights this as much as possible).
Let's say for the sake of argument that interest rates remain at 3% and that taxes stay around the $2.5 trillion level. That would mean the hyperinflation will kick in when the total debt reaches $83 trillion. At current rates,
we are a probably about two decades away from this level. This is the "best" case scenario.
On the other hand, let's say interest rates rise to a historical average of around 6%. If taxes stay the same, now the hyperinflation threshold is $42 trillion. At current rates,
this is more like 10-15 years in the future.
Of course, politicians will tell you that you don't need to worry about this because we can grow our way out of it. This is politician-speak for higher taxes from individuals making more money. This is theoretically possible, but the rate of government spending is vastly outstripping the rate of productivity increases.
There is another way to avoid this fate for the current version of the US dollar: the government could stop borrowing, which would mean spending a lot less. In the current political climate, I wouldn't hold my breath.
So what does this all mean for you and me? In short, you can ignore people who are saying the world will end tomorrow. But, the countdown has begun. The next ten years (or so) will be a very important time for positioning yourself. Keep in mind that the current rates of monetary expansion can change quickly, so that 10 year horizon might be cut into 5. With all the problems that we are seeing across world economies, it seems likely that governments will spend more at an ever-increasing rate. In a drastic "crisis," that 10 year horizon could be cut into 3 years.
One way or another, we are in for tough times in the near future. Prepare yourself to weather the storms.