Inflation is with us – and in time it will flood the economy. Regardless of how powerful and prosperous a nation may appear in its peak, no empire ever was able to exempt itself from the elemental laws of economics any more than we can exempt ourselves of the laws of gravity.
Warren Buffett warned that for a debtor nation, inflation was the economic equivalent of the hydrogen bomb. Runaway inflations tend to emerge when an economy’s debt burden becomes unsustainable, usually as a consequence of too much government spending and too much war. Today, nearly all categories of debt in the U.S. economy are breaking records: government, corporate as well as household and student debt. Worse, the levels of delinquency have been rising and credit standards have been deteriorating over the recent months, particularly for corporate debt.
Meanwhile, inflation has remained tame leaving many observers persuaded that we’d somehow transcended inflation and that it was no longer a risk. This will turn out to be wrong. A few months ago I wrote about the inflationary collapse of the Soviet Union – an episode that’s far from irrelevant today. In “Dying of Money,” Jens Parsson documented certain aspects of the 1923 German hyperinflation that should equally concern us from today’s perspective.
German inflation took off in the summer of 1922 and peaked in November of 1923. But the inflation that manifested itself so destructively in consumer markets gestated for some eight years, the ultimate result of debts accumulated through war spending and mounting post-war government spending. As the debt burden grew, German economy even recorded a remarkable boom period in 1920 and 1921.
The boom times of 1920/21
Basing his account on the testimony of journalists and economists who lived through and wrote about the period, Parsson conveys the mood of the moment as follows : “Industry and business were going at fever pitch. Exports were thriving… Hordes of tourists came from abroad. Many great fortunes sprang up overnight. Berlin was one of the brightest capitals in the world in those days. Great mansions of the new rich grew like mushrooms in the suburbs. The cities… had an aimless and wanton youth and a cabaret life of an unprecedented splendor, dissolution, and unreality. Prodigality marked the affairs of both the government and the private citizen.” Unemployment was virtually nonexistent and profitable speculation in the stock markets became one of the nation’s foremost obsessions. “The volumes of turnover in securities on the Berlin Bourse became so high that the financial industry could not keep up with the paperwork, even with greatly swollen staffs of back-office employees, and the Bourse was obliged to close several days a week to work off the backlog.”
Thus for a while, German economy was booming, the place appeared prosperous (while the rest of the world was enduring a severe recession), stock markets soared and consumer prices remained stable in spite of the feverish activity, rising government spending and a gaping current account deficit. The exchange rate of the mark against the dollar and other currencies actually rose for a time, and the mark was momentarily the strongest currency in the world.
Still, many analysts of the time sounded alarm about the mounting post-war debts and the government’s lax fiscal discipline. The cabinet of Prime Minister Matthias Erzberger tried to tackle the problem by curtailing government spending and drastically increasing taxes, but these unpopular measures could not hold in Germany’s young democracy. Part of the pundit class of the day argued that deficits didn’t matter and that inflation wouldn’t escalate out of control because it seemed tame at the time. The nation’s wealthy investor class rebelled against Erzberger’s tax regime and soon he was forced out and replaced by Karl Helfferich who reversed Erzberger’s taxes and reopened the flow of easy money (this is what brought about the boom of 1920-1921).
All at once and seemingly out of nowhere…
However, inflation ultimately did catch up with the German consumer prices. All at once and seemingly out of nowhere inflation took off in the summer of 1922. In the four months from July 1922 consumer prices rose tenfold and two hundred-fold in 11 months. In late 1923 prices were at least quadrupling every week. The mystery we should all ponder today is, where was inflation up to that point and what made it burst out so suddenly and so violently, catching nearly all by surprise?
Reichsbank’s easy money policy seemed entirely beneficial and controlled and German economy appeared healthy and prosperous for a time. Monetary inflation was for a time absorbed by the stock markets and by foreign investors (the root cause of Germany’s large current account deficits). Writes Parsson: “Until 1922 and the very brink of the collapse, Germans and especially foreign investors were absorbing marks in huge quantities. Only the international reputation of the Reichsmark, the faith that an economic giant like Germany could not fail, made this possible. … investor’s willingness to save marks kept the marks from being dumped immediately into the markets, and thereby for a long while held prices in check. The precise moment when the inflation turned upward toward the vertical climb was undoubtedly timed by no event but by the dawning psychological awareness of the German and foreign investor that Germany was not going to back its money. With that, the rush to get out of the mark was on. Like a dam bursting, the seas of marks flooded into the markets and drove prices beyond all bounds.”
Why we got financial repression after the TBTF bailouts
With this in mind we can revisit the coordinated policy of “financial repression” by the G7 central banks in the aftermath of the 2008 financial crisis and the bailout of the too-big-to-fail banks. This policy was necessary to ensure that the massive new bailout funds remained confined to capital markets at low interest rates and to keep them from spilling over into the economy. Ten years later we can see the results in the “everything bubble,” which thus far remains largely intact.
For all we know, the bubble may continue to inflate. For the time being, inflation really has remained tame – and for far longer than we believed it could. Still, we must again heed Parsson’s warning: “A buoyantly rising stock market marks the opening stages of every monetary inflation. A sharply rising stock market proves to be an unfailing indicator of monetary inflation happening now, price inflation coming later, and a cheap boom probably occurring in the meantime. … Stock market speculation is a principal relief valve concealing latent inflation pressure. Booming stock market prices are themselves a form of price inflation, normally the most inflated of all, but never thought of as such. … The stock market therefore relieved pressure temporarily from inflation elsewhere. The government had artificial devices for locking money into investment, such as its growing supplies of government debt and the tax inducements drawing money … into pension funds, and these government dikes around investment markets stored up inflationary potential in great brimming reservoirs and out of harm’s way.”
Does any of that seem eerily familiar? Today, as in 1920s Germany many economists have declared that debts and deficits don’t matter, that inflation wouldn’t happen and that the current levels of prosperity constitute proof that the economy is healthy and risks under control. But we should not remain complacent. Experts rarely expect any surprises and significant changes in inflation almost always come as a surprise.
And where do we stand today? While CPI inflation appears low at 2.5%, Personal Consumption Expenditure for March 2019 was much higher at 4.4% – a level that’s been rising slowly but steadily over the last few years. Meanwhile wage inflation also seems deceptively contained: last month’s downtick from 3.4% to 3.2% was enough for pundits to once more declare that wage pressures were abating. Are they? That one monthly downtick seems less significant than last few years’ trend:
Perhaps we need not anticipate an inflationary explosion as the Weimar Republic experienced last century. However, we are living through an unprecedented monetary experiment and drawing any parallels from the uncharted waters we are now sailing is bound to be guesswork. “The unnerving quality of an inflation,” wrote Parsson, “is that no one knows anything for sure.” With regards to the American inflation he concluded prophetically in 1974: “… even if the nation’s inflationary plight was not yet so grave as it had been in other lands at other times, in the fullness of time it would be.”
Keep a watchful eye on inflation and signs that it might be heating up in the U.S. economy.
Alex Krainer [firstname.lastname@example.org] is a hedge fund manager and commodities trader based in Monaco. He wrote the book “Mastering Uncertainty in Commodities Trading”