How Hyperinflation Will Happen Right now, we are in the middle of deflation. The Global Depression we are experiencing has squeezed both aggregate demand levels and aggregate asset prices as never before. Since the credit crunch of September 2008, the U.S. and world economies have been slowly circling the deflationary drain. The Fed is terrified of the U.S. economy falling into a deflationary death-spiral: Lack of liquidity, leading to lower prices, leading to unemployment, leading to lower consumption, leading to still lower prices, the entire economy grinding down to a halt. The deflationary outlook seems sensibleâif we fall for the trap of thinking that hyperinflation is an extention of inflation. If we think that hyperinflation is simply inflation on steroidsâinflation-plusâinflation with ballsâthen it would seem to be the case that, in our current deflationary economic environment, hyperinflation is not simply a long way off, but flat-out ridiculous. But hyperinflation is not an extension or amplification of inflation. Inflation and hyperinflation are two very distinct animals. They look the sameâbecause in both cases, the currency loses its purchasing powerâbut they are not the same. Inflation is when the economy overheats: Itâs when an economyâs consumables (labor and commodities) are so in-demand because of economic growth, coupled with an expansionist credit environment, that the consumables rise in price. This forces all goods and services to rise in price as well, so that producers can keep up with costs. It is essentially a demand-driven phenomena. Hyperinflation is the loss of faith in the currency. Prices rise in a hyperinflationary environment just like in an inflationary environment, but they rise not because people want more money for their labor or for commodities, but because people are trying to get out of the currency. Itâs not that they want more moneyâthey want less of the currency: So they will pay anything for a good which is not the currency. So this is how hyperinflation will happen: One dayâwhen nothing much is going on in the markets, but general nervousness is running like a low-grade fever (as has been the case for a while now)âthere will be a commodities burp: A slight but sudden rise in the price of a necessary commodity, such as oil. This will jiggle Treasury yields, as asset managers will reduce their Treasury allocations, and go into the pressured commodity, in order to catch a profit. (Actually it wonât even be the asset managersâit will be their programmed trades.) These asset managers will sell Treasuries because, effectively, itâs become the principal asset they have to sell. It wonât be the volume of the sell-off that will pique Bernanke and the drones at the Fedâit will be the timing. Itâll happen right before a largish Treasury auction. So Bernanke and the Fed will buy Treasuries, in an effort to counteract the sell-off and maintain low yieldsâthey want to maintain low yields in order to discourage deflation. But theyâll also want to keep the Treasury cheaply funded. QE-lite has already set the stage for direct Fed buys of Treasuries. The world didnât end. So the Fed will feel confident as it moves forward and nips this Treasury yield jiggle in the bud. The Fedâs buying of Treasuries will occur in such a way that it will encourage asset managers to dump even more Treasuries into the Fedâs waiting arms. This dumping of Treasuries wonât be out of fear, at least not initially. Most likely, in the first 15 minutes or so of this event, the sell-off in Treasuries will be orderly, and carried out with the idea (at the time) of picking up those selfsame Treasuries a bit cheaper down the line. However, the Fed will interpret this sell-off as a run on Treasuries. The Fed is already attuned to the bond marketsâ fear that thereâs a âTreasury bubbleâ. So the Fed will open its liquidity windows, and buy up every Treasury in sight, precisely so as to maintain âasset price stabilityâ and âcalm the marketsâ. The Too Big To Fail banks will play a crucial part in this game. The TBTF banks, on seeing this run on Treasuries, will add to the panic by acting in their own best interests: They will be among the first to step off Treasuries. They will be the bleeding edge of the wave. So when the Fed begins buying Treasuries full-blast to prop up their prices, these asset managers will all decide, âTime to get out of Dodgeânow.â Note how it will not be China or Japan who all of a sudden decide to get out of Treasuriesâthose two countries will actually be left holding the bag. It will be a flash panicâmuch like the flash-crash of last May. The events I describe above will happen in a very short span of timeâless than an hour, probably. But unlike the event in May, there will be no rebound. The first of the asset managers or TBTF banks who are out of Treasuries will look for a place to park their cashâobviously. Where will all this ready cash go? Commodities. By the end of that terrible day, commodites of all stripesâprecious and industrial metals, oil, foodstuffsâwill shoot the moon. But it will not be because ordinary citizens have lost faith in the dollar (that will happen in the days and weeks ahead)âit will happen because once Treasuries are not the sure store of value, where are all those money managers supposed to stick all these dollars? In a big old vault? Under the mattress? In euros? Commodities: At the time of the panic, commodities will be perceived as the only sure store of value, if Treasuries are suddenly anathema to the marketâjust as Treasuries were perceived as the only sure store of value, once so many of the MBSâs and CMBSâs went sour in 2007 and 2008. By the end of the day of this panic, commodities will have risen between 50% and 100%. By weekâs end, weâre talking 150% to 250%. (My private guess is gold will be finessed, but silver will shoot up the mostâto $100 an ounce within the week.) Of course, once commodities start to balloon, thatâs when ordinary citizens will get their first taste of hyperinflation. Theyâll see it at the gas pumps. If oil spikes from $74 to $150 in a day, and then to $300 in a matter of a weekâperfectly possible, in the midst of a panicâthe gallon of gasoline will go to, what: $10? $15? So what happens then? Peopleâregular Main Street peopleâwill be crazy to buy up commodities (heating oil, food, gasoline, whatever) and buy them now while they are still more-or-less affordable, rather than later, when that $15 gallon of gas shoots to $30 per gallon. If everyone decides at roughly the same time to exchange one goodâcurrencyâfor another goodâcommoditiesâwhat happens to the relative price of one and the relative value of the other? Easy: One soars, the other collapses. When people freak out and begin panic-buying basic commodities, their ordinary financial assetsâequities, bonds, etc.âwill collapse: Everyone will be rushing to get cash, so as to turn around and buy commodities. So immediately after the Treasury markets tank, equities will fall catastrophically, probably within the next few days following the Treasury panic. This collapse in equity prices will bring an equivalent burst in commodity pricesâthe second leg up, if you will. Right now, Iâm guessing that sensible people whoâve read this far are dismissing me â or at least victim of my own imagination. These sensible people, if they deign to engage in the scenario Iâve outlined above, will argue that the governmentâbe it the Fed or the Treasury or a combination thereofâwill find a way to stem the panic in Treasuries (if there ever is one), and put a stop to hyperinflation (if such a foolish and outlandish notion ever came to pass in America). Uh-huh: So the Government will save us, is that it? Okay, so then my question is, How? Letâs take the Fed: How could they stop a run on Treasuries? Answer: They canât. See, the Fed has already been shoring up Treasuriesâthat was their strategy in 2008ââ09: Buy up toxic assets from the TBTF banks, and have them turn around and buy Treasuries instead, all the while carefully monitoring Treasuries for signs of weakness. If Treasuries now turn toxic, whatâs the Fed supposed to do? Bernanke long ago ran out of ammo: Heâs just waving an empty gun around. If thereâs a run on Treasuries, and he starts buying them to prop them up, itâll only give incentive to other Treasury holders to get out now while the gettingâs still good. If everyone decides to get out of Treasuries, then Bernanke and the Fed can do absolutely nothing effective. Theyâre at the mercy of eventsâin fact, they have been for quite a while already. They just havenât realized it. Well if the Fed canât stop this, how about the Federal governmentâsurely they can stop this, right? In a word, no. They certainly lack the means to prevent a run on Treasuries. And as to hyperinflation, what exactly would the Federal government do to stop it? Implement price controls? That will only give rise to a rampant black market. Put soldiers out on the street? America is too big. Squirt out more âstimulusâ? Sure, pump even more currency into a rapidly hyperinflating everyday economyâright . . . (BTW, I actually think that this last option is something the Federal government might be foolish enough to try) I think weâre going to have hyperinflation. I hope I have managed to explain why.