2012-09-02

There is no such thing as hyperdeflation

ZeroHedge has a post up: The Monetary Endgame Score To Date: Hyperinflations: 56; Hyperdeflations: 0

First off, the title is a tautology. You can't have a monetary endgame from "hyperdeflation" because cash is the most valuable asset in the economy. It's absurd when you think about it. Second, if you measure in gold or a foreign currency, almost every hyperinflation is accompanied by a "hyperdeflation" as the value of other money rises. In other words, hyperinflation is the abandonment of the "currency of record" and what takes place in that currency is indeed hyperinflation, but what's occurring at the same time is also "hyperdeflation" priced in other currencies and gold.

The response of any government experiencing the hyperdeflation of its currency would be hyperinflation (see Switzerland's response to the euro collapse). Therefore, to experience a true "hyperdeflation", one would probably need to be on a hard gold standard that only used gold coins as money. There needs to be no escape from the deflation; there is no way to inflate because the core currency is gold. But if there's no way to inflate (or hyperinflate), then there is not enough inflation in the first place......

Second, if hyperinflation is the decrease in value of the currency to a rate of "effectively zero," then a "hyperdeflation" would mean the rise in the value of the currency to "effectively one" as in the whole economy. The value of all the goods and services would be "effectively zero"; the money supply would shrink to almost nothing and the cash in the economy could buy all goods and services. Velocity would be zero though, so there'd be no transactions at the end of a hyperdeflation.

In what situation would people be trying to dump goods and services the way they dump currency in a hyperinflation? Can you imagine someone driving a tractor trailer filled with bread or shoes in order to collect $1? This would need to happen, and at the end, the guy with the $1 would refuse to buy. Everyone wants currency and no goods, services or assets. It's absurd, and so is hyperdeflation taken to the extreme. The point being, unlike hyperinflation, hyperdeflation has a quick end date: total abandonment of debt, not the total abandonment of the currency. "Hyperdeflation" terminates with the end of debt.

The above is a theoretical exercise. In common parlance, "hyperdeflation" means a rapid collapse in prices. As we know from history, deflationary periods are extremely brief relative to inflationary periods. Stocks go up for years and crash in weeks or months (or even one day). A simple reason for this is the same reason shorting is harder that going long: if the value falls 100%, game over. But the value can rise and rise to infinity. Were an actual hyperdeflation to take place, it would happen extremely fast and would terminate when debt levels collapsed. It would be recognized by most people as a financial collapse, not a "hyperdeflation".

Of course, the total economy would be collapsing and people would eventually fear the destruction of the currency even if the currency properly managed........which could lead to hyperinflation. If the whole banking system collapses and financial markets are shut down, even though cash has a very high value in the crisis, people may start asking whether the government would survive. If hyperdeflation does happen, you would want to get out of cash, load up on debt if at all possible, and get into productive/hard assets. This would be a good strategy in any case: either the society will attack itself and change the political system and probably the currency, or it will survive and rebound.

In the end, we come back to the point in my earlier post Mish talks sense on hyperinflation, that hyperinflation occurs during societal collapse. A major deflationary event could set the stage for hyperinflation, but not necessarily.

So when does deflation occur?

There is major deflation at the end of hyperinflations. Look at Wiemar Germany, some investors went to cash a month or two before the new currency was introduced and became wealthy overnight. At the end of hyperinflation, prices collapse and those with cash can buy up everything on the cheap. The argument of deflationists is that we already had the "hyperinflation", if you look at the rise in debt and the financial sector, it parallels the growth of the financial sector during the Wiemar episode.

Right now the Fed is holding deflation at bay because it found the borrower of last resort: USG. It is US deficit spending that keeps the deflation at bay.

By one estimate, the Fed needs to monetize $8 trillion of debt to get ahead of the deleveraging. The figure is even larger if one considers a debt jubilee. If one needs to implement a policy that would be called hyperinflation under other cases, but it leads to no inflation or low inflation, there must be a serious case of deflation.

"Hyperdeflation" is at worst a completely meaning less term and at best the description of an extremely large collapse in debt and asset prices whose size is matched by its speed. There probably can be no "hyperdeflation" over the course of weeks or months because the end game comes suddenly via bankruptcy. The event ends as cheap assets attracting buying, risk taking and once more, the use of credit. Deflation is the story of the survival of the currency regime, not its destruction.

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