Hyperinflation Scenarios

I have argued that I don't think hyperinflation is a likely scenario in America.  I know that the statists have changed the definition of inflation from meaning an increase in the money supply to an increase in prices.  For today's post, when I talk about hyperinflation, I am referring to prices.  I would consider price inflation of 100% or more per year to be in the category of hyperinflation, but I realize that definitions can differ.

I think hyperinflation is unlikely because it would lead to a massive breakdown of the division of labor, particularly without any existing competing currencies or other forms of money, mostly because of the legal tender laws and other restrictions on precious metals.  I don't see the Federal Reserve going all the way to hyperinflation as they would be destroying themselves along with the entire economy.  While most of the Fed officials are foolish, they are not completely stupid.

It is technically possible to have hyperinflation even if the Fed tries to stop it.  As I discussed in my previous post, the Fed cannot always withdraw all of the money that it creates.  If it buys shares of a particular stock for $100 per share and then the price drops to $30 per share, then the Fed can only sell the shares in the open market for $30 per share at that point.  It can only withdraw 30% of the money that it originally created to buy the stock.

While we don't know if the Fed has been buying stocks, we do know that the Fed has been buying government bonds and mortgage-backed securities.  We already know that the mortgage-backed securities are worth less than what the Fed bought them for.  If interest rates were to rise, then the government bonds in its portfolio would also decrease in value.

But even if all of this happened, the Fed could still sell the assets it has and withdraw some money that was previously created.  In addition, just by announcing that it will no longer monetize any debt for an extended period of time, this would probably be enough to avert a hyperinflation scenario.

Ironically, the libertarian movement might create the best chance for a hyperinflation scenario.  While the libertarian movement should keep the Fed somewhat in check, it might also have a great effect on people's views on money.

Hyperinflation usually occurs because of a massive increase in the money supply.  People come to believe that the money printing will never stop or even slow down.  People then demand less cash.  They try to spend it instead, driving up velocity.  As money changes hands quicker, it drives up prices faster and faster.  This eventually leads to hyperinflation.

If libertarians convince enough people that the U.S. dollar will eventually end up like every other fiat currency in history and go to zero, then this alone could take down the dollar.  Imagine if 20 million people started listening and believing everything that Ron Paul says.  Now imagine if these 20 million people take half of their money and start buying hard assets like gold, silver, real estate, etc.  Not only would the price of hard assets go up, but the dollar would go down.  The demand for the U.S. dollar would go down.  This in turn might get more people to question the dollar.  It is like a snowball effect.

So technically speaking, it is possible to see a currency destroyed even if the money supply is not increasing dramatically, or even at all.  It would take a huge shift in the attitudes of the American people to do this, but it is possible.  Not only would they have to understand the dangers of a fiat currency, but they would also have to believe that others see the same thing.  If everyone turned into a libertarian overnight, yet nobody announced it, then the dollar would probably survive because even libertarians hold dollars, thinking that everyone around them will continue to use it and trust it as money.

As you can see, psychology plays a huge role in the demand for money, which in turn affects overall prices.  So while the money supply is important to watch, it is not everything when it comes to price inflation.