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Hyperinflation Horizon – Is the Fed Building a Hyperinflation Bomb?

The air-raid sirens are silent, but it doesn’t mean the bomb is not falling. The question to be answered is not whether the Federal Reserve is creating the possibility of runaway inflation, but “can the Fed dismantle the hyperinflation bomb that is already falling before it hits the earth?” No one — even at the Fed — doubts that quadrupling the nation’s money supply in less than a decade can create hyperinflation. No one doubts that printing money to buy your own debt can create rampant inflation that is capable of crippling a nation. We have seen it happen — in Germany century ago and in third-world countries with failing economies like Zimbabwe in our own time.

If you look at the infographic at the end of this page, you’ll see that the inflation of money supply in the last five years has been unprecedented. So, why is no one running for cover? Why are people still out walking in the marketplace as if there is nothing to be concerned about? Why are the sirens silent?

There is the obvious answer that no one is concerned because inflation has remained slow, in spite of the Federal Reserve’s quantitative easing program, and it shows no signs of rising. In fact, right now the Fed is doing all it can to try to create 2% inflation — it’s annual target throughout recent decades. The Fed wants to keep the housing market from falling more, so inflationary efforts have a ring of sensibility. The opinion in the marketplace seems to be that we have plenty of time to see inflation and then start to deal with it if it starts to rise too quickly.

But what if this bomb is a time bomb that has already hit the ground right in the middle of the public square? People are walking normally through the marketplace because they see the bomb was obviously a dud. It isn’t even ticking. The inflation everyone talked about at the beginning of the Gentle Ben Bernanke’s bold experiment never happened. But what the people in the marketplace don’t see is that everything is in place and building for an unstoppable chain reaction. The chemistry of hyperinflation is moving silently inside the bomb, and when it reaches critical mass, it will explode.

Could the great minds of the marketplace miss seeing this coming? Well, did they not all miss seeing the Great Recession coming? The chemistry was obvious then, too … looking back.


Why has the inflation of money supply not created hyperinflation in prices?

Consider first that the Fed’s prime directive is to keep inflation in check and to keep the job market strong. Has Gentle Ben’s bold experiment helped the job market any? The Fed believes that increasing the money supply will increase investment and boost employment, and in the past it has. One sign that the Fed doesn’t really know what it is doing in the present situation is that the employment situation has fallen and then held flat. The usual chemistry the Fed works with has done little or nothing to improve employment figures. So, in the brave new world we now live in, the same economic chemistry that usually creates inflation and job growth is creating neither. Something is wrong with the chemistry.

Consider, then, the possibility that the inflation is not happening and the jobs are not happening for the same reason — something is holding back the normal chemical reaction — something which, if it lets go, will let all that reaction happen at once. And this is why it is a hyperinflation bomb. What could be holding it back?

The reason the new money is not creating inflation or jobs is that it is being hoarded. Look at the simple numbers: The Federal Reserve has added $2.7 trillion to nation’s money supply in the last six years. During that same time, the amount of money that national banks keep stashed in their Federal Reserve accounts has increased by $2.1 trillion. This is money the banks can lend but are not lending. It is a firewall that is holding the new money out of the economy, but pull away the divider and let all of that new money flow into the waiting economy, and the chemistry happens all at once. The problem is that holding all that new money out of the economy means that it also does nothing  to create new jobs. It is basically money that is out of circulation. So, the chemistry is building up inside the bomb where no one sees it while nothing is happening on the outside.

The next question, then, is, “Can that money suddenly flow into the economy? Can banks suddenly liquidate these huge cash reserves?”


What would cause the hyperinflation bomb to go off?

The answer is that banks could suddenly liquidate these reserves, and it may be hard for the Fed to stop them. One likely triggering mechanism is building up just as quickly as the cash is piling up right now. With interest rates so low,  banks would rather put their own money into the stock market than lend it out for interest, but they are required to keep a certain percentage of their money in reserves in case stocks do poorly. If the stock market dives so that banks decide to get out of it in a hurry, their regulatory reserve requirements will drop proportionately. That means they can let money out of reserve accounts that they may now be holding there to boost how much they can invest in stocks. At the same time, their reasons for putting that reserve money to other use increase since they are losing money on stocks.

The more the Federal Reserve pumps up the reserve accounts with newly created money that is virtually given to banks — as it has been doing with its quantitative easing program — the more those banks can buy stocks. Thus, the federal reserve has fueled a stock-market bubble driven by bank investment. The stock market has been inflating to record levels because banks have a lot of money that they cannot get much for on loan. With interest rates down on loans, banks invested in stocks, instead, stoking up a speculative bubble. The stock market is where all inflation is happening, and that’s why we don’t see the inflation. It’s not where we usually look for it because most of the new money has to be hoarded in reserve accounts if banks are going to invest in stocks and meet their reserve requirements.

We think the market is rising because the economy is improving. No one thinks of the rise in stock prices as inflation because the rise in stock prices is surely a good thing, and we think of inflation as a bad thing. A rising stock market is what we want to see, right? That’s what happens in good times! Stocks go up! Well, stop a minute. A decade ago, the rise in housing prices was surely a good thing — proof of boundless economic growth potential in real estate. Those were good times. Then almost overnight, the real estate market hit a ceiling that none of the experts saw coming. All the hot air came out of the balloon, and the market fell.

There are now fewer investors in the stock market than normal, but the investors who are creating all the action have much larger piles of cash to play with. The possibility of a sudden crash increases when there are fewer players. A falling stock market is one possible trigger for a hyperinflation scenario because it could cause a rapid dump of all this hoarded reserve account money into the economy. If banks stand to lose money quickly in stocks, they will seek to pull their money out of stocks, and their willingness to make low-interest loans with all of that reserve money will rise. The money will start to move. The chemical reaction will begin.

Individual beliefs can aggregate into collective reality. With fewer players in the market, the weight of collective opinion shifts more easily. Right now banks are betting stocks will rise so long as the Fed keeps creating new money. They are betting that other banks will keep speculating their new money into the stock market. That’s why the Fed has itself caught in a trap it doesn’t seem to be able to disengage some. It has not been able slow down the creation of new money without sending shivers through the stock market.

The Fed could try to entice banks to keep sitting on the money in reserves by offering better interest as a way to stave off the hyperinflation that will result if this money moves out of reserves, but its rates to the banks on reserve money would have to rise faster than the economic opportunity that gives them incentive to move that money into the mainstream economy. Raising its rates would also drive up the interest the federal government has to pay on the national debt in order to attract buyers, and so the entire nation’s economic position would shift. Its debt would become unmanageable. We’re talking continental size pieces of landscape that can start to move. When pieces that great start to shift, the momentum is usually too great to stop. As an alternative, the Fed could just claw all the new money back by decree. I don’t think the Fed has ever just erased reserve money from the balance sheets of banks, and I’m not sure it has the power to do that. So, it would be reluctant to take such a novel approach when nobody knows from experience what the collateral damage would be from removing money from the economy by hitting the delete key on the reserve accounts of national banks.

Another alternative would be for the Fed (or Congress) to suddenly increase the reserve requirements of banks and basically force-freeze the movement of reserve money from sliding into the economy before it moves enough to become an unstoppable reaction. Remember, though, that it took the Fed months to figure out what had happened in 2008. Gentle Ben and Allan Greenback were both saying the real estate market was solid when the big slide was already starting to give way. So, by the time the Fed recognizes what’s happening and why, the bomb has gone off.

And why would the Federal Reserve be so blind again so soon?

Because it’s not looking in the right place to see the inflation that is already happening due to its policies. It no doubt has noticed that the stock market drops every time the Fed nudges the money switch; but I’m not sure it recognizes the stock market gains are the very inflation that the Fed is concerned about. It sees those gains as something it would like to sustain, so it keeps printing money and IS ALREADY creating the inflation that it is watching for as the sign that it needs to stop printing money. The damage will only be evident when the triggering event happens, and the money suddenly moves.


What might the hyperinflation crash look like?

  • The Fed moves away from “printing” new money and decides to let the stock market settle.
  • Banks start to move money out of the stock market because it is not making money for them because there is no new money to do additional speculation. In fact, their financial position is weakening.
  • Banks see that other banks are moving out of the market and realize that the speculation bubble is bursting.
  • Banks run to get out of the market, and the stock market crashes.
  • Ordinary people and other kinds of institutions see that the banks are hurting and take their money out of the banks.
  • The banks have to use their reserves as they were intended … to be able to pay those depositors who are withdrawing money when there is a run on the banks.
  • The Federal Reserve sees that banks have vast amounts of money in reserves so does not act quickly enough to stave the run by freezing accounts. Likewise, with the federal government.
  • As a result, a lot of the reserve hoard gets into normal circulation, so prices of everything start to rise quickly because of the rapid velocity of money. People, not trusting banks or the stock market, buy hard assets, and drive up the prices of assets like gold or even just food.
  • The hyperinflation reaction is fully underway, and now becomes too complex for the government to stop prior to it becoming a calamity.

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An Infographic to help understand hyperinflation:

Image Source

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