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Hyperinflation! (Primer)

Hyperinflation is a phenomenon that has caused a significant amount of hyperventilation within economic and market commentary. The pictures of people using wheelbarrows of money to go shopping are certainly memorable.NOTE: This is an unedited draft of …

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This article was originally published by Bond Economics

Hyperinflation is a phenomenon that has caused a significant amount of hyperventilation within economic and market commentary. The pictures of people using wheelbarrows of money to go shopping are certainly memorable.

NOTE: This is an unedited draft of a section that will make its way into my inflation primer. I have kept this section minimal, but may add more later during editing.

However, hyperinflation fears have been used as a recruiting pitch by fans of hard money for a long time, and the threat of hyperinflation in the developed countries has been discussed far more than there are examples to point to. As an example, when I first launched my website in 2013, one of my earliest discussions involved a commenters’ theories about hyperinflation. This person had developed a model that showed that the United States and/or Japan were a matter of months away from a hyperinflation. After a decade has passed without said hyperinflation(s), I think it is safe to say that model was slightly off.

The loopy discussions of hyperinflation in commentary explains why I inserted it into the chapter on myths and misunderstandings. Hyperinflation is not a myth, but it is widely misunderstood.

Definition

In popular commentary, “hyperinflation” can mean “the inflation rate seems to be high,” which is not particularly rigorous. From the perspective of many people, an annual inflation rate of 20% would be an unprecedented economic disaster and might be referred to as a “hyperinflation.” However, such an inflation rate would be well above recent experience in developed countries, but it is not that uncommon across a wider range of times and countries. A hyperinflation is much more severe.

The formal definition for a hyperinflation used in economics is that the inflation rate hitting 50% monthly. If a 50% monthly inflation rate was sustained for a year, it would result in (roughly) a 13,000% inflation rate. This is such a high rate of inflation that we typically need to look at daily inflation rates.

Steve Hanke and Nicholas Krus created a list of hyperinflations that could verified that was published in The Handbook of Major Events in Economic History in 2013. In that original list, they identified 56 hyperinflations (with Venezuela entering an amended list in 2016).

Calculating the inflation rate during a hyperinflation is not straightforward. The techniques used by the national statistical agencies would not be adequate, since it would be nearly impossible to ensure that all measurements happened at exactly the same time of day. Instead, the inflation rate has to be inferred from things like currency quotes. That is, if the currency falls by 4% versus a “hard” currency on the day in the foreign exchange market, that is assumed to match a 4% daily inflation rate.

Using the Hanke-Krus list. the Weimar Republic (Germany) hyperinflation of 1922-3 had a peak monthly inflation rate of 29,500% (20.9% daily) in October 1923. This puts it in fifth place for the peak inflation rate. The well-known Zimbabwe hyperinflation of 2007-8 had a daily inflation rate of 98%. However, that only puts it into second place – Hungary in 1945-6 had a daily inflation rate of 207%. (One needs to use scientific notation to express the monthly inflation rates.)

Why Do Hyperinflations Happen?

My objective in this book is to avoid injecting too much of my opinions or disputed theory. Furthermore, although I have looked at the academic literature on hyperinflations as well as the histories of the Weimar hyperinflation, I cannot claim to have spent much time worrying about the subject. Nevertheless, one thing is safe to say: it is much harder to generate a hyperinflation in a developed economy than suggested by popular commentary.

In popular (and some serious) commentary, hyperinflation is the result of “printing money.” The argument of critics is that this ignores the other conditions that were in place.

In the textbook Macroeconomics, the authors discuss the hyperinflations in the Weimar Republic and Zimbabwe in section 21.3. They argue that the productive side of the economy was impaired (what is called the real economy).

  •  In the case of Weimar, Germany was locked into making reparations in gold as a result of the Treaty of Versailles. The Germans were unable to meet the stringent terms, and the French and Belgian armies occupied the industrial heartland of the Ruhr. This meant that Germany was unable to meet domestic demand from local production, yet the government attempted to keep spending in the local currency.

  • In Zimbabwe, land reforms resulted in about 45% of the local industrial farming capacity being destroyed. Furthermore, the National Railways of Zimbabwe was degraded, and there was a 57% decline in export mineral shipments. This  meant that attempts by the government to keep spending was met by an inability of the domestic private sector to supply output, and the collapse in exports meant that imports could not be financed.

If we look at the exceedingly numerous wildly incorrect hyperinflation predictions made by commentators, the common thread is that all of them focussed on changes in the money supply and had no mechanism explaining how real production would be impaired.

The Mechanical Difficulties with Starting a Hyperinflation

Under the current institutional arrangements in the developed economies, starting a hyperinflation faces some mechanical problems. Workers’ income taxes are generally levied as a percentage of income and withheld from paycheques. Additionally, value-added taxes (VAT) are levied as a percentage of sales. (The United States is somewhat of an exception with an absence of a VAT, although there are state-level sales taxes.)

Any immediate jump in nominal incomes and/or spending will cause an immediate corresponding rise in tax revenues. Meanwhile, governmental budgeting is done a year in advance, and nominal spending amounts are typically fixed. Such a hypothetical jump in rising prices and wages would cause an immediate budget surplus – which would have the effect of crushing the private sector, ending whatever imbalance caused the hypothetical hyperinflation.

Even if spending is indexed, indexation is typically done on an annual basis. This is way too slow for a hyperinflation, which needs prices to rise by 50% a month.

It is certainly possible that a developed country can have a currency collapse, a shortage of key consumption items (notably energy), or a tendency for accelerating inflation (like the 1970s). However, that is not going to be enough to generate a true hyperinflation. Instead, we need a fundamental change in practices. The country needs to essentially shift to having local prices indexed to prices in a “hard currency.” In this case, the domestic price level will then act as the inverse of the value of the currency. Which in turn implies domestic prices marching off to infinity if the price of the currency in the foreign exchange markets heads to zero.

Should I Worry About a Hyperinflation?

Historically, you only needed to worry about hyperinflation if you happened to be in one of the roughly sixty countries that got hit by them. If we look at popular commentary, there were far more concerns about hyperinflation than actual hyperinflations. That said, things can change.

It is not that hard to imagine bad economic developments. Many of which exhibit themselves as shortages of key items, resulting in price spikes. However, for a hyperinflation, you need to see a drift in institutional practices that would allow inflation to remain unchecked. Since I do not know in what country or year the reader is in, I cannot make any definitive statements.

References and Further Reading

  • Hanke, Steve H., and Nicholas Krus. “World hyperinflations.” The Handbook of Major Events in Economic History, Randall Parker and Robert Whaples, eds., Routledge Publishing, Summer (2013).

  • Macroeconomics, by William Mitchell, L. Randall Wray, and Martin Watts. Red Globe Press, 2019. ISBN: 978-1-137-61066-9

Email subscription: Go to https://bondeconomics.substack.com/ 

(c) Brian Romanchuk 2021

Economics

Commodities and Cryptos: Oil slumps, Gold rebounds, Bitcoin plunges

Oil Crude prices are sharply lower after Evergrande debt default fears triggered a flight-to-safety that sent the dollar higher.  Evergrande’s woes…

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Oil

Crude prices are sharply lower after Evergrande debt default fears triggered a flight-to-safety that sent the dollar higher.  Evergrande’s woes are threatening the outlook for the world’s second largest economy and making some investors question China’s growth outlook and whether it is safe to invest there.  In addition to risk aversion flows pumping up the dollar, some investors are anticipating further hawkish signals that the Fed will set up a formal November taper announcement on Wednesday. 

Complicating the move in crude prices is the surge to record highs for UK gas futures.  Europe does not have enough gas and the energy problem could intensify if the early weeks of winter are cold. 

The US Gulf of Mexico production continues to recover from hurricane season, with now only 18.3% of offshore production being shut-in.  The oil market will still be heavily in deficit early in winter and if more demand comes that way, energy traders will buy any dip they get with crude prices. 

Gold

Gold’s rout is taking a break as investors run to safety over concerns Evergrande’s debt default concerns could spillover.  Gold got a boost as Treasury yields plunged, with the 10-year yield falling 5.4 basis points to 1.307%. 

Gold’s rally could have been much higher if not for the reports that Senator Manchin may be thinking of suggesting Congress take a “strategic pause” until 2022 before voting on the $3.5 trillion social-spending package.  Considering stocks are about to have their worst day since October, it is very disappointing that gold prices are only up around $10.  Gold may continue to stabilize leading up to the FOMC decision, with the next move likely being further downside.  Gold could struggle until the Fed finally starts tapering asset purchase.  It is then that it may start acting more like an inflation hedge.    

Bitcoin

A retest of the September low came far too easily for Bitcoin.  The fallout from the Evergrande is putting a tremendous dent in risk appetite that is sending everything lower. Cryptocurrencies, despite all the volatility, have been the best performing asset of the year, so it should not surprise Wall Street they are the first asset sold in the beginning of China-driven market selloff.    

Retail traders remain bullish, albeit many have capitulated in locking in some profit.  Some traders are anticipating a short pullback, while some lunatics are readying to buy more after tomorrow’s full moon.    

In El Salvador, President Bukele tweeted “We just bought the dip. 150 new coins!”  El Salvador’s total is now 700 coins and that enthusiasm has yet to be matched by other countries.   

If Bitcoin breaks below the $40,000 level, it could see momentum selling have it eventually return to the $30,000 to $40,000 range that it was in earlier this summer.  

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Economics

Asia’s Largest Insurer Hammered As Investors Sell First, Don’t Bother To Ask Questions

Asia’s Largest Insurer Hammered As Investors Sell First, Don’t Bother To Ask Questions

Few were surprised to see that the crash in Evergrande…

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Asia's Largest Insurer Hammered As Investors Sell First, Don't Bother To Ask Questions

Few were surprised to see that the crash in Evergrande dragged down property names (one among then, Sinic Holdings, crashed 87% in minutes and was halted), banks exposed to the property developer (according to report there are over 120), with the contagion spreading to commodities directly linked to China's property sector (such as Iron Ore which plunged 10%), as well as FX of commodity-heavy countries, one ominous decline was that of Asia Pacific's largest insurer, Ping An (whose name literally and unironically means "safe and well"), which dropped 3%, following a 5% drop on Friday, and hitting a four year low on concerns about its property exposure.

The selling took place even though the company issued a statement Friday saying that its insurance funds have “zero exposure” to Evergrande and other real estate companies “that the market has been paying attention to.” Real estate accounts for about 4.9% of Ping An Insurance’s investments, versus an average 3.2% for peers, according to Bloomberg Intelligence.

“For real estate enterprises that the market has been paying attention to, PA insurance funds have zero exposure, neither equity or debt, including China Evergrande,” Ping An said in a statement as it rushed to reassure investors.

While it may have no exposure, Ping An does have RMB63.1bn or $9.8bn in exposure to Chinese real estate stocks across its RMB3.8TN ($590BN) of insurance funds, and took a $3.2BN hit in the first half of the year after the default of another developer, China Fortune Land Development. The insurer is also head of the creditor committee for China Fortune Land, which specialises in industrial parks in Hebei province and suffered from delayed local government payments. One of its restructuring advisers, Admiralty Harbour Capital, was hired by Evergrande this week.

At a time when any Evergrande counterparties or even rumored counterparties are immediately deemed radioactive, Ping An's plight demonstrates how acute and widespread the selloff could become in China if Beijing fails to intervene.

“I expect a lot of financial institutions could be hit by the worries” about Evergrande, said Zhou Chuanyi, a Singapore-based analyst at Lucror Analytics. "As long as a financial institution has exposure to developers, Evergrande should take quite a significant share of that."

Yet as the market waits for some response official response, hopeful that Beijing will step in, we discussed earlier that China's policymakers have instead sought to crack down on excessive leverage across its vast real estate sector over the past years, which makes up more than a quarter of the economy, imposing a firm threshold known as the "3 Red lines" which developers must adhere to, and which has meant most developers are limit to % or 5% debt growth at best. 

For now it remains unclear how far the contagion will spread, although if Beijing stubbornly refuses to intervene, expect much more pain as capital markets seek to force Beijing's hand by make it unpalatable for the CCP to suffer even more selling which could spark social unrest.

“The price action across several asset classes in Asia today is horrendous due to rising fears over Evergrande and a few other issues, but it could be an overreaction due to all of the market closures,” said Brian Quartarolo, portfolio manager at Pilgrim Partners Asia.

As discussed earlier, Xi faces a tricky balancing act as he tries to reduce property-sector leverage and make housing more affordable without doing too much short-term damage to the financial system and economy. Mounting concerns that he’ll miscalculate are spreading ever-further beyond China-focused property developers and their suppliers.

“It’s what the Chinese would describe as trying to get off a tiger,” said United First Partners research Justin Tang, best summarizing Beijing's lose-lose dilemma.

Tyler Durden Mon, 09/20/2021 - 15:28
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Economics

Summarizing China’s Short Term Economic Outlook

Wells Fargo Economics analyses the extent of the current slowdown, and contemplates the impact on regional economies. Here’s the heat map: Source: McKenna/Guo,…

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Wells Fargo Economics analyses the extent of the current slowdown, and contemplates the impact on regional economies. Here’s the heat map:

Source: McKenna/Guo, “China Economic Gauge and Sensitivity”, Wells Fargo Economics, 20 Sep 2021, Figure 1.

From the report:

Our dashboard (Figure 1) suggests the short-term outlook for China’s economy is indeed deteriorating, consistent with the multiple downward revisions we have made to our GDP forecast over the past few months. Given the signals our gauge is showing, we believe easier monetary policy could be the next major policy move from the PBoC, and another RRR reduction could be imminent as authorities look to offset some of the deceleration.

This report is in line with the Goldman Sachs report (discussed here).

Wells Fargo highlights Singapore, South Korea and Chile as most sensitive to growth developments in China (on the basis of exports). Looking more broadly at “beta’s” of equity returns and currency values as well as export dependence, the list of at risk countries expands to include South Africa, Brazil and Russia as well.

 

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