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Wednesday, October 14, 2009

Protection against hyper-inflation

One of my clients called today to ask what he could do to protect himself against hyper-inflation. With the Democrats in congress and Team Obama using trillions as counters and billions as rounding errors, that concern is spreading. And it's a very good question. Let's use the experience of Germany during its experience during the early 1920s. Germany was a first-world country that was dealt hyper-inflation as a deliberate policy. Here’s Art Cashin:

Originally, on this day (-2) in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to "jump start" a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental "more is better" theory they simply created more and more money.

But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity).

So, on this day government officials decided to bring figures in line with market realities. They devalued the mark. The new value would be 2 billion marks to a dollar. At the start of World War I the exchange rate had been a mere 4.2 marks to the dollar. In simple terms you needed 4.2 marks in order to get one dollar. Now it was 2 billion marks to get one dollar. And thirteen months from this date (late November 1923) you would need 4.2 trillion marks to get one dollar. In ten years the amount of money had increased a trillion fold.

Numbers like billions and trillions tend to numb the mind. They are too large to grasp in any “real” sense. Thirty years ago an older member of the NYSE (there were some hen) gave me a graphic and memorable (at least for me) example. “Young man,” he said, “would you like a million dollars?” “I sure would, sir!”, I replied anxiously. “Then just put aside $500 every week for the next 40 years.” I have never forgotten
that a million dollars is enough to pay you $500 per week for 40 years (and that’s without benefit of interest). To get a billion dollars you would have to set aside $500,000 dollars per week for 40 years. And a…..trillion that would require $500 million every week for 40 years. Even with these examples, the enormity is difficult to grasp.

Let’s take a different tack. To understand the incomprehensible scope of the German inflation maybe it’s best to start with something basic….like a loaf of bread. (To keep things simple we’ll substitute dollars and cents in place of marks and pfennigs. You’ll get the picture.) In the middle of 1914, just before the war, a one pound loaf of bread cost 13 cents. Two years later it was 19 cents. Two years more and it sold for 2 cents. By 1919 it was 26 cents. Now the fun begins.

In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid month it was $100 billion. Then it all collapsed.

Let’s go back to “marks”. In 1913, the total currency of Germany was a grand total of 6 billion marks. In November of 1923 that loaf of bread we just talked about cost 428 billion marks. A kilo of fresh butter cost 6000 billion marks (as you will note that kilo of butter cost 1000 times more than the entire money supply of the nation just 10 years earlier).

How Could This All Happen? – In 1913 Germany had a solid, prosperous, advanced culture and population. Like much of Europe it was a monarchy (under the Kaiser). Then, following the assassination of the Archduke Franz Ferdinand in Sarajevo in 1914, the world moved toward war. Each side was convinced the other would not dare go to war. So, in a global game of chicken they stumbled into the Great War.

The German General Staff thought the war would be short and sweet and that they could finance the costs with the post war reparations that they, as victors, would exact. The war was long. The flower of their manhood was killed or injured.

They lost and, thus, it was they who had to pay reparations rather than receive them. Things did not go badly instantly. Yes, the deficit soared but much of it was borne by foreign and domestic bond buyers.

As had been noted by scholars…..“The foreign and domestic public willingly purchased new debt issues when it believed that the government could run future surpluses to offset ontemporaneous deficits.” In layman’s English that means foreign bond buyers said – “Hey this is a great nation and this is probably just a speed bump in the economy.” (Can you imagine such a thing happening again?)

When things began to disintegrate, no one dared to take away the punchbowl. They feared shutting off the monetary heroin would lead to riots, civil war, and, worst of all communism. So, realizing that what they were doing was destructive, they kept doing it out of fear that stopping would be even more destructive.

Currencies, Culture And Chaos – If it is difficult to grasp the enormity of the numbers in this tale of hyper-inflation, it is far more difficult to grasp how it destroyed a culture, a nation and, almost, the world.

People’s savings were suddenly worthless. Pensions were meaningless. If you had a 400 mark monthly pension, you went from comfortable to penniless in a matter of months. People demanded to be paid daily so they would not have their wages devalued by a few days passing. Ultimately, they demanded their pay twice daily just to cover changes in trolley fare. People heated their homes by burning money instead of coal. (It was more plentiful and cheaper to get.) The middle class was destroyed. It was an age of renters, not of home ownership, so thousands became homeless.

But the cultural collapse may have had other more pernicious effects. Some sociologists note that it was still an era of arranged marriages. Families scrimped and saved for years to build a dowry so that their daughter might marry well. Suddenly, the dowry was worthless – wiped out. And with it was gone all hope of marriage. Girls who had stayed prim and proper awaiting some future Prince Charming now had no hope at all. Social morality began to collapse. The roar of the roaring twenties began to rumble. All hope and belief in systems, governmental or otherwise, collapsed. With its culture and its economy disintegrating, Germany saw a guy named Hitler begin a ten year effort to come to power by trading on the chaos and street rioting. And then came World War

It is little wonder that the “big fear” of the German government is not of another Great Depression, but of a repeat of hyper-inflation.

So let’s look at those things that are most hurt by hyper-inflation.

The most cautious, conservative people are hurt worst. People who keep their money in cash or in checking accounts can be wiped out as currency becomes worthless. Pensioners are next since most pensions are not tied to inflation. Bond holders are next as bond values evaporate.

Who is the beneficiary of hyper-inflation? People who are in debt have their debts essentially erased by hyper-inflation. Of course the biggest debtor in this country is the US government who can magically erase its debt through hyper-inflation.

But what about the ordinary middle class American who has a home, a 401k, a modest savings or investment account? Well “real” assets like natural resources (including gold) will keep up with inflation. So will real estate.

And in many cases, so will stocks. As inflation takes hold, corporations will raise prices to keep up with inflation which will result in higher nominal profits and higher share prices.

That’s what happened in Germany during the period of hyper-inflation.

That is, of course, unless the government decides to control prices. In which case companies will go bankrupt, go out of business and we will be dealt a depression that will make the Great Depression of the 1930s a pleasant memory.


W.C. Varones said...

What a coincidence. I had just written an e-mail on this subject last night.

I agree with your thoughts. My thoughts, with more specific investment vehicles, are here.

Robert said...

This is well-known history but the post tells one nothing about how to protect oneself against hyperinflation.

Moneyrunner said...


Try reading the entire essay.

Anonymous said...

Real estate is not a good way to protect yourself against hyperinflation since it is still denominated in the local currency. The stock market also made major gains. All the big, fancy homes had their possessions sold for next to nothing, just to eat, because no one had enough cash to pay for food. Example: a grand piano fetched a sack of flour. Gold increased in value 1800 times more than the stock market. The only thing that really held value was gold and silver, plus foreign currencies. The whole story is free and here; "When Money Dies":

Anonymous said...

How will American hyper-inflation affect the European and Asian economies? How will American hyper-inflation affect the euro?

BC Monkey said...

Where is the essay? I see the two links at the bottom, but neither are the essay.

Anonymous said...

Where is the part about protection against hyperinflation?

Mark Buehner said...

Canned food and shotgun shells. That's all that has REAL value in this world, and all that will be left if we hit that level of inflation.

Anonymous said...

Canned food, huh?
So who's going after the cans?

SH said...

Anonymous said...

"Real estate is not a good way to protect yourself against hyperinflation since it is still denominated in the local currency."

I hear what your saying, but it is also a chance to buy up a bunch of land cheap... if you buy now before the inflation starts... You may not be able to convert it into other goods... but if you have a use for the land....

Anonymous said...

The strength of real estate as an investment has little to do with how strong the local currency is. If I buy a parcel of land in dollars, which are rapidly losing value, that's only a dumb investment if hyperinflation is permanent. It never is, not even in Zimbabwe. If anything, hyperinflation is the ultimate test of the buy-and-hold real estate strategy. (And if you want to sell your property, you don't have to accept dollars as payment.)

Let's not wet our pants just yet. Consumer prices rose .2% last month, an annualized rate of 2.4%. Frankly, I can't understand why the increases are so modest, given how much money the federal government owes, how injudicious Obama's being with our national debt ceiling, and how Bernanke keeps the presses running night and day. I'd love some insight on the topic.

Can you stomach a somewhat related post on gold vs. fiat currency? Thank you for your time:

Journey said...

Although a good essay, it speaks more of the inter-relatedness rather than interdependence of those items of which you speak.

Throughout the Great Depression only Gold and Silver held its value while all currencies not backed by these were worthless.

As debtors defaulted, the value of assets, including real estate plummeted. Contrary to your statement all debt was not erased. The debt of individuals and corporations skyrocketed until credit through collaterized assets was in effect useless or impossible as the value of assets disappeared. The debt of some nations was eventually forgiven but not the debt of corporations. Those Corporations who were able to survive did so by either restructuring their debt, merging with other companies, selling off divisions or letting portions of their companies go bankrupt.

Individuals were not so lucky. They were saddled with debt at very high rates that went even higher when unable to pay, much like the system we have today. The only difference between Germans of the Great Depression to those of today is that only those in the upper class (those who had valuable assets) had access to credit. The poor and middle class did not precisely because they lacked assets.

As for the question: what will happen with the US debt? I suggest you ask the Chinese, Japanese, Syrian and Russian governments what they would do if we defaulted. I would ask them not only because not only do they own the majority our notes/debt, they also are our largest investors.

I could easily see Alaska being taken by the Russians (due to the proximity and the amount of oil), the entire Pacific north and mid-west by the Chinese (after all, they need plenty of cattle to feed their people), while Hawaii and California would go to the Japanese.

Think its far-fetched or I'm crazy? Google a map of the world pre-WWI and I'll show you who has their head in the sand.

Moneyrunner said...

Several comments seem to discuss the Depression in the US. Please keep in mind that the US did not have hyperinflation. In fact the US experienced deflation during that time.

Here's the thing to keep in mind about inflation: cash decreases in buying power, fixed incomes buy less, hard assets generally appreciate in nominal terms if not in buying power, debts can be paid off with inflated dollars which helps the debtor and hurts the lender. I don't want to get into a discussion of precious metals as being superior to other hard assets since gold bugs have a tendency to become irrational about the subject.

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