4 reasons we haven't hit hyperinflation yet

[Sassy]

Whiskey & Gunpowder
By Keith Fitz-Gerald
November 16, 2009
Money Morning


Four Reasons Why Hyperinflation
Hasn't Hit the U.S. Economy...Yet

Everything we know about classic economic theory suggests the U.S. economy should be experiencing Zimbabwe-like hyperinflation right now, thanks to the nearly $2.2 trillion the U.S. Federal Reserve has pumped into the system.

But we're not...yet.

Classic economic theory says that money supply can be used to stimulate the economy and our central bankers seem to agree. That's why they've pumped more than $1 trillion dollars into the economy, engineered countless bailout bonanzas for zombie institutions, put Detroit on life support, and delivered a bunch of financial Band-Aids to the trauma ward — all in a desperate bid to make Americans feel better about the global financial crisis.

To their way of thinking, the trillions of dollars have been a success. That's why any meeting of the Group of Eight (G8) nations looks more like a mutual affection society with central bankers anxious to claim credit and backslap each other in congratulations for having avoided the "Great Depression II."

But by taking the Federal balance sheet to more than $2 trillion from $928 billion 2008, they've created a situation that should have resulted in an epic inflationary spike to accompany the 137% increase in liabilities.

Yet that hasn't quite happened.

Core inflation — which denotes consumer prices without food and energy costs — has actually decreased from 2.5% in 2008 to 1.5% presently. And that has many investors who have heard the siren call of the doom, gloom and boom crowd wondering if they're worried about nothing.

So what gives?

Well, there are four reasons we haven't yet seen hyperinflation:

Banks are hoarding cash. Despite having received trillions of dollars in taxpayer funded bailouts and lived through a litany of shotgun weddings designed to reinvigorate the shattered lending markets, most banks are actually hoarding cash. So instead of lending money to consumers and businesses like they're supposed to, banks have used taxpayer dollars to boost their reserves by nearly 20-fold according to the Federal Reserve. The money the bailout was supposed to make available to the system is actually not passing "Go," but rather getting stopped by the very institutions that are supposed to be lending it out. Three-year average annualized loan growth rates were 9.6% before the crisis; now they are shrinking by 1.8%, according to Money Magazine.

The United States exports inflation to China, which remains only too happy to continue to absorb it. What this means is that low priced products from China help keep prices down here. And this is critical to something that many in the "China-is-manipulating-their-currency" crowd fail to grasp. If China were to un-peg the yuan and let it rise by the 60% or more it's supposedly undervalued by, we'd see jump in prices here in everything from jeans to tennis shoes, toys, medical equipment, medicines, and anything else we import in bulk from China. Chances are, the shift would not be dollar-for-dollar or even dollar-for-yuan, but there's no doubt it would be significant. Many economists I've talked to privately think 25%-35% is probable. So the next time you hear a "Buy American" extremist, you might want to share this little inconvenient truth.

Consumers are still cutting back. Therefore, the spending that normally helps pull demand through the system is simply not there. I don't how things are in your neighborhood, but where I live, people are still cutting back. Indeed, data from the U.S. Department of Commerce and the Federal Reserve Board shows that consumer spending growth averaged 1.4% a year prior to the crisis and is now shrinking at a rate of 0.7%. What this means is that people have figured out that it's more important to save money than it is to spend it. And, given that consumer spending makes up 70% or more of the U.S. economy, this is a monumental change in behavior that all but banishes the last vestiges of the "greed is good" philosophy espoused by Michael Douglas as Wall Street pirate Gordon Gekko in 1987.

Businesses continue to cut back rather than hire new workers. Therefore, wages and wage inflation figures are lower than they would be if the economy was truly healthy and the stimulus was working. This is especially tough to stomach because it means people are still being marginalized, laid off and "part-timed" instead of being hired. And that means that most of the earnings growth we've seen this season has come from expense reductions rather than top line sales growth — and those are two very different things. But while this is tough, it's also helped keep inflation lower than it would otherwise be. Prior to the financial meltdown, job growth averaged about 1% a year over the last three years whereas now it's falling by 4.2%.

The upshot?

Any one of these factors could change at any time. And that means investors who are relying on the Fed's version that everything is okay and that the government is managing inflation may be in for a rude awakening.

The only thing the Fed is doing is managing to manipulate is the data, and even then, not very well.

Regards,
Keith Fitz-Gerald
Money Morning

[rwanders]

   The writer makes some good points--unfortunately economics, especially at that level, seems to more like tea leaf reading rather than scientific prophecy. If he is proven to be prophetic, what should one do?

[ScottA]

I've been saying for the past 2 years...look for something you need to spend money on and spend it as soon as possible. At some point high inflation is going to kick in and when it does any cash assets will get hurt.

[devildog]

Im with you ScottA, I was going to hold off/ take my time building my house, but with what i've seen and heard I told my wife "lets push forward until all our savings is gone, while the dollar is still worth a dollar. And before prices go up".
It would be better in the long run to have no mortgage,than to have half my money
Darrell

[muldoon]

the author kinda misses the most obvious reasons in my opinion.

were in a credit led recession, or perhaps a depression.  the increase in monetary base does not offset the losses of credit.  The net affect is a net negative.  No one has more money in their pocket than 5 year ago.  No business's are booming or expanding, if your buying a house, good luck compared to 4 years ago.  same with college, cars, business loans.  The loss in available credit far far outweighs the increase of monetary base - especially when you consider that the increase in monetary base is not in anyones hands. 

MULT, or the multipplier of money is under 1.  Velocity of money is the amount of times is it spent in circulation, ie - you get paid go hire an electrician, he pays his people, they buy materials, the store pays their people, they buy coffe.  That one 1 dollar is used 5 or 6 times in a healthy booming economy.  Currently the MULT is 0.831 and falling.  The net affect is that for every dollar increase in monetary base, only 83 cents goes to GDP.  It's a net drain. 
http://research.stlouisfed.org/fred2/series/MULT

And finally, a look at history is always in order.
Japan has been persuing QE since the mid 1990s.  They have no hyperinflation.
The USA was heavily tied to a QE policy in the 1940s, the 1950s is known for alot of things, but hyperinflationary collapse of the USA is not one of them. 

http://www.richmondfed.org/publications/research/economic_quarterly/2001/winter/pdf/hetzel.pdf
and even the famous helicopter ben speech talks about it: http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm

Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable. At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills. Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long-maturity bonds outstanding.11 For example, the Fed held 7.0 percent of outstanding Treasury securities in 1945 and 9.2 percent in 1951 (the year of the Accord), almost entirely in the form of 90-day bills. For comparison, in 2001 the Fed held 9.7 percent of the stock of outstanding Treasury debt.

--
they are playing a risky game with the dollar now, and the hope is that they can spur either dollar repatriation, or net increase of dollar denominated assets.  I have no faith they will actually get it right, but I am not surprised in the effects of the policy. 

[glenn kangiser]

Thanks muldoon.  You explain it better.  Seems that will lead to a continued worsening of the economy with the .83 multiplier.