What Inflation Means for America

Right now in this country, with inflation at its highest rate in four decades, there is a significant debate taking place over whether inflation is good or bad for the average American, and whether it is good or bad for the wealthy elites.

As I noted in a prior post, if inflation was still calculated the way it was in 1980, the real rate would be 15%, according to Shadow Government Statistics:

The official rate is closer to 6.5%, but again, that’s largely because the formula the government uses to calculate inflation has been watered-down over the years.

An important caveat here is that if we were still keeping track of inflation using the 1980 formula, the 15% inflation rate, while shockingly high, did not start from a base of 1-2% inflation. Inflation, according to Shadow Stats, has increased at around 7-10% a year dating back to like 2010, and it was around 10% just before the pandemic hit.

So while 15% is definitely elevated, and concerning, and the highest it’s been since 1980, it’s not like we’re deep into uncharted territory here. Inflation spiked to about 13% as recently as 2007-2008, right before the Great Recession.

But at any rate, the real inflation rate matters because it gives us a more accurate picture of just how much money Americans are losing.

Some are pointing to the fact that wages have increased by 5.8% this year, which means wages have, on average, nearly kept up with inflation, if we go by official figures. If wages keep up with inflation, then sure, you’ll have to get used to seeing things cost more, but it won’t actually hit your wallet harder. A lot of the talk about inflation focuses mainly on the headline numbers without taking wage hikes into account, i.e. “net inflation.”

That’s what this article in the Intercept entitled “Inflation Is Good For You” tries to claim:

[I]nflation generally accompanies economic booms, when the unemployment rate is low and workers have the market power to demand higher pay. That’s what’s happening now: As prices increased 6.2 percent over the past year, wages for regular people went up 5.8 percent. In other words, inflation barely touched their purchasing power.

However, if inflation is really around 15%, and wages have only gone up by 5.8%, then that is unequivocally bad for the average American. It means you’ve gotten about almost a 10% pay cut due to inflation. So in this situation, inflation would most certainly not be a good thing.

The Intercept article does attempt to build another case that inflation is good for the average American. It has nothing to do with wages and everything to do with debt:

[W]hy has inflation seized the imagination of the corporate press? It’s simple.

First, inflation lessens the real value of debt. In 2020, American households had around $14.5 trillion in debt from their mortgages, credit cards, student loans, and other sources. Inflation of 6.2 percent means that the real value of that $14.5 trillion is now just $13.65 trillion in last year’s dollars. In other words, the inflation over the past year has effectively transferred $850 billion in wealth from creditors to debtors. That’s a lot of money.

Most people are a mixture of creditors (e.g., you have a bank account) and debtors (you have a mortgage and student loans). But overall, this $850 billion has generated a big check written by the tippy-top of the income scale to everyone else. And as you’d expect, the people at the tippy-top don’t like this.

This is true. Assuming you have a fixed-rate loan, your principal is being reduced due to inflation.

And if inflation gets out of control–and we’re talking really out of control–then it will, when all is said and done, bad for creditors (the wealthy) and good for debtors (the masses), because it essentially wipes out all debt.

If there is ever a situation of Weimar Germany-like hyperinflation in the US, where a loaf of bread costs $500 million, your mortgage debt–and any other debt you might have–has long since been wiped out, I would imagine. We’ll get more into this later on.

The Intercept piece continues:

Put these two things together — lowered values for their assets and higher wages for workers — and you can understand why the rich people who run the U.S. absolutely detest inflation.

However, there is one rock that can kill both these birds at the same time. The Federal Reserve can raise interest rates. This would slow the economy and increase the unemployment rate, lessening worker bargaining power. Less bargaining power would mean lower or nonexistent raises, which would eventually translate into lower inflation.

That’s what all today’s inflation panic is ultimately aimed at: creating an economy with higher unemployment, lower growth, and more frightened workers. Whether America’s creditors can make this happen remains to be seen, but we shouldn’t have any illusions about what they’re trying to do. And we definitely shouldn’t help them do it.

There is a good case to be made that the wealthy despise inflation. For one thing, the Federal Reserve bank, which is run for and by the wealthy elite, has a dual mandate: to promote low unemployment, and to stable inflation at 2%. When inflation starts running hot, it is the Federal Reserve’s job to get it back under control by hiking rates.

And second, as the author of the Intercept piece, Jon Schwarz, notes, the wealthy are primarily creditors, and inflation is bad for creditors. Inflation might actually be the worst possible thing for creditors, even worse than a debtor defaulting. Because at least when a debtor defaults, a creditor can seize all his assets and liquidate them, recouping some of their losses.

But in the case of inflation, there is no solace for creditors. They have no way of shielding themselves from the inflation-driven transfer of their money into their debtors’ pockets.

However, a case can also be made that inflation is good for the wealthy elites and bad for everyone else, and it is simple: wealthy elites can tolerate paying more at the pump, and paying more for groceries, and paying higher utility bills.

The wealthy are generally big into owning real estate, and real estate prices have been skyrocketing, which means their assets are increasing in value even more these days.

The wealthy elites like inflation. It’s good for them on net. Not all of them are creditors, after all. The elites can afford to pay more for basic necessities while watching their assets balloon in value. I’m sure most wealthy people would take that tradeoff 10 times out of 10.

The middle and working classes, however, who generally live paycheck to paycheck and own few assets, would not. So I don’t know if I buy the argument that inflation is good for the masses and bad for the wealthy.

Of course, the wealthy will be the ones to take the biggest hit if rising interest rates cause a prolonged drop in the stock market. If we ever see a protracted bear market like we saw from 2007-2009, the wealthy will take the biggest hit, although the wealthy are also in the best position to deploy additional funds to buy the dip.

All this is to say that there is a considerable deal of debate over inflation: what’s causing it, who it benefits, who it harms, and perhaps most importantly, where it leads us.

This is why I want to do a deep-dive on the matter.

To begin, I want to share a little story from a great book called “The Dying of Money: Lessons from the Great German and American Inflations,” written by a man named Jens O. Parsson in 1974. It’s an economic text, so you might be expecting it to be dry, boring and full of big words, but this is a very readable book.

Most of us have at least a general idea of what we think inflation is. Inflation is the state of affairs in which prices go up. Inflation is an old, old story. Inflation is almost as ancient as money is, and money is almost as ancient as man himself.

It was probably not long after the earliest cave man of the Stone Age fashioned his first stone spearhead to kill boars with, perhaps thirty or forty thousand years ago, that he began to use boarʹs teeth or something of the sort as counters for trading spearheads and caves with neighboring clans. That was money. Anything like those boarʹs teeth that had an accepted symbolic value for trading which was greater than their intrinsic value for using was true money.

Inflation was the very next magic after money. Inflation is a disease of money. Before money, there could be no inflation. After money, there could not for long be no inflation. Those early cave men were perhaps already being vexed by the rising prices of spearheads and caves, in terms of boarʹs teeth, by the time they began to paint pictures of their boar hunts on their cave walls, and that would make inflation an older institution even than art.

Some strong leader among them, gaining greater authority over the district by physical strength or superstition or other suasion, may have been the one who discovered that if he could decree what was money, he himself could issue the money and gain real wealth like spearheads and caves in exchange for it. The money might have been carved boarʹs teeth that only he was allowed to carve, or it might have been something else. Whatever it was, that was inflation. The more the leader issued his carved boarʹs teeth to buy up spearheads and caves, the more the prices of spearheads and caves in terms of boarʹs teeth rose.

Thus inflation may have become the oldest form of government finance. It may also have been the oldest form of political confidence game used by leaders to exact tribute from constituents, older even than taxes, and inflation has kept those honored places in human affairs to this day.

This tells us that, no matter how much the fact is obscured, at its core, inflation is nothing more than the dilution of the money supply. Prices rise because a dollar is worth less, and a dollar is worth less because the people in charge turned on the money printer.

Since those dim beginnings in the forests of the Stone Age, governments have been perpetually rediscovering first the splendors and later the woes of inflation. Each new government discoverer of the splendors seems to believe that no one has ever beheld such splendors before. Each new discoverer of the woes professes not to understand any connection with the earlier splendors. In the thousands of years of inflationʹs history, there has been nothing really new about inflation, and there still is not.

It reminds me of this meme:

Around the year 300 A.D., the Roman Empire under the Emperor Diocletian experienced one of the most virulent inflations of all time. The government issued cheap coins called ʺnummi,ʺ which were made of copper washed with silver. The supply of metals for this ingenious coinage was ample and cheap, and the supply of the coinage became ample and cheap too. The nummi prices of goods began to rise dizzily. Poor Emperor Diocletian became the author of one of the earliest recorded systems of price controls in an effort to remedy the woes without losing the joys of inflation, and he also became one of the earliest and most distinguished failures at that effort. The famous Edict of Diocletian in 301 decreed a complex set of ceiling prices along with death penalties for violators. Many death penalties were actually inflicted, but prices were not controlled. Goods simply could not be bought with nummi. Like every later effort to have the joys without the woes of inflation, the Edict of Diocletian failed totally.

What Diocletian was doing was something known as “debasement” of the coinage. Instead of issuing only full silver coins, copper coins merely featuring a thin coat of silver were issued, thus “debasing” the currency.

Even though our method of debasing our money today is the Fed’s money printer, we have been debasing our coins for many years now. A penny, for example, is 97.5% zinc and only 2% copper. Prior to 1982, a penny was made primarily of copper.

So it has gone throughout the millennia of manʹs development. For at least the four thousand years of recorded history, man has known inflation. Babylon and Ancient China are known to have had inflations. The Athenian lawgiver Solon introduced devaluation of the drachma. The Roman Empire was plagued by inflation and, more rarely, deflation. Henry the Eighth of England was a proficient inflationist, as were the kings of France. The entire world underwent a severe inflation in the sixteenth and seventeenth centuries as a result of the Spanish discoveries of huge quantities of gold in the New World. ʺContinentalsʺ in the American Revolution and the assignats in the French Revolution were precursors of the wild paper inflations of the twentieth century.

Steadily rising prices have been the general rule and not the exception throughout manʹs history. The twentieth century brought the institution of inflation to its ultimate perfection. When economic systems are so highly organized as they became in the twentieth century, so that people are completely dependent on money trading for the necessaries of life, there is no place to take shelter from inflation. Inflations in the twentieth century became like inflations in no other century.

The two principal inflations that occurred in advanced industrial nations in the twentieth century will probably prove to have done more to influence the course of history itself than any other inflation. One of these was the German inflation that had its roots in World War I, grew to a giddy height and a precipitous fall in 1923, and contributed to the rise of Adolf Hitler and World War II. The other was the great American inflation that had its roots in World War II, grew in the decade of the 1960ʹs toward an almost equally giddy height, and contributed to results which could not even be imagined at the time this book was written…

It helps to build up this historical background knowledge, because inflation really isn’t difficult to understand at all: When more money is added into circulation, prices of goods and services necessarily need to increase in order to adjust.

They certainly cannot stay the same, right?

If an iPhone costs $1000, but then the money supply is massively increased to the point where $1000 is now chump change, Apple cannot continue selling iPhones at $1000, can they? They’ll go broke–especially because the costs of the iPhone’s components are all increasing dramatically.

So when we say that inflation is rising prices, this is accurate, but not the entire picture. The rising prices are merely the last step in a chain reaction that began with an increase of the money supply.

Economics is often called the “dismal science,” but it is important to think of economics as a scientific discipline like physics, which has immutable laws of nature that govern all things related to money.

Physics has the laws of motion, economics has the law of supply and demand. When the supply of money is increased, demand for it will go down, requiring more money to be spent in order to buy the same things.

Much as they try, there is nothing that governments can do to change the immutable laws of economics–no different than if a government were to issue a decree attempting to outlaw the tendency of a ball to fall to the ground when dropped from your hand.

We saw in the passage above that Diocletian, the Roman Emperor, tried to end inflation by way of imperial decree, but he failed. The only way inflation stops is if the money printing stops, which will eventually allow prices to settle at an equilibrium once again.

The problem is that the inflationary forces that are set in motion by money printing–price increases and wage increases–are mutually reinforcing, and thus lead into an inflationary feedback loop, or spiral, where one causes the other and inflation keeps on rising and rising.

Higher prices require higher wages, and then higher wages increase the demand for goods and services, which then increases prices once again, necessitating a further rise in wages, and on and on and on until either the currency collapses or economic activity is ground to a halt by government intervention.

Inflation itself is a reason to spend rather than save, because people understand that money just sitting in a savings account is losing value every day due to inflation. This increased spending leads to higher prices.

Inflation is not difficult to understand. And yet it is happening now in the US, as it has happened in so many other societies since the dawn of human civilization.

In order to understand how and why inflation happens time and again, we should look back on prior periods of inflation and how they played out. We’ll begin with the story of Weimar Germany.

Weimar Hyperinflation

We will again look at Parsson’s book here as it is the best, most thorough account of Weimar Germany’s hyperinflation I’ve ever come across. I am going to quote this book at length, so just be advised. I know it’s generally considered poor form to quote from someone else extensively, but I promise you, you are going to want to read this. I really did try to be selective about what I quoted, but it was impossible. I had to basically quote the entire chapter.

But again, I really do think you will appreciate this. Let’s go back in time on a journey to Germany 100 years ago:

In 1923 Germanyʹs money, the Reichsmark, finally was strained beyond the bursting point, and it burst. Persistent inflation which had steadily eroded the mark since the beginning of World War I at last ran away. Germanyʹs Êºdisastrous prosperityʺ came to an end, and in its place the German people suffered a period of hardship and real starvation as well as a permanent obliteration of their life savings. When the debacle was finally stopped, the old mark, which had once been worth a solid 23 cents, was written off at one trillion old marks to one new one of the same par value. The most spectacular part of that loss was lost in the markʹs final dizzy skid; all the marks that existed in the world in the summer of 1922 (190 billion of them) were not worth enough, by November of 1923, to buy a single newspaper or a tram ticket. That was the spectacular part of the collapse, but most of the real loss in money wealth had been suffered much earlier. The first 90 percent of the Reichsmarkʹs real value had already been lost before the middle of 1922.

The tragicomic denouement of Germanyʹs inflation — the workers hastening to the bake shops to spend quickly their dayʹs pay bundled up in billions of paper marks and carried in wheelbarrows — is perhaps at least vaguely remembered nowadays. The more sinister and more permanent scars which the inflation left are less well known. Still less clearly remembered are the years before the mark blew, with their breakneck boom, spending, profits, speculation, riches, poverty, and all manner of excess. Throughout these years the structure was quietly building itself up for the blow. Germanyʹs inflation cycle ran not for a year but for nine years, representing eight years of gestation and only one year of collapse.

The beginning was in the summer of 1914, a day or two before World War I opened, when Germany abandoned its gold standard and began to spend more than it had, run up debt, and expand its money supply. The end came on November 15, 1923, the day Germany shut off its money pump and balanced its budget. Over the nine years in between, Germanyʹs inflation followed not a constant course but a characteristic ascent and descent, a ripening and a decay.

Germany started by not paying adequately for its war out of the sacrifices of its people — taxes — but covered its deficits with war loans and issues of new paper Reichsmarks. Scarcely an eighth of Germanyʹs wartime expenses were covered by taxes. This was a failing common to all the combatants. France did even worse than Germany in financing the war, Britain not much better. Germanyʹs bad financing was due in part to a firm belief that it would be able to collect the price of the war from its enemies, whom it expected to defeat; but to a greater degree it may have sprung from distrust that its people would support the war to the extent not only of fighting it but also of paying for it. Whatever the reason, Germanyʹs bad war financing did not immediately demand its price. Inflation in the sense of rising prices was moderate. Domestic prices only a bit more than doubled to the end of the war in 1918, while the governmentʹs money supply had increased by more than nine times. The governmentʹs debt increased still more. So long as the government in this way could spend money it did not have faster than its value could fall, Germany had both its war and life as usual at the same time, which was the same as having the war free of charge.

After the war, Germany and all the other combatants underwent price inflations which served as partial corrections for their wartime financing practices. The year 1919 was a year of violent inflation in every country, including the United States. By the spring of 1920, German prices had reached seventeen times their prewar level. From this point, however, the paths of Germany and the other nations diverged. The others, including the United States, stopped their deficit financing and began to take their accumulated economic medicine by way of an acute recession in 1920 and 1921. Their prices fell steeply from the 1920 level. Germany alone continued to inflate and to store up not only the price of the war but also the price of a new boom which it then commenced enjoying. Germanyʹs remarkable prosperity was the envy of the other leading countries, including the victors, who were in serious economic difficulties at the time. Prices in Germany temporarily stabilized and remained rock‐steady during fifteen months in 1920 and 1921, and there was therefore no surface inflation at all, but at the same time the government began again to pump out deficit expenditure, business credit, and money at a renewed rate. Germanyʹs money supply doubled again during this period of stable prices. It was this time, when Germany was sublimely unconscious of the fiscal monsters in its closet, which was undoubtedly the turning of the tide toward the inflationary smash. The catastrophe of 1923 was begotten not in 1923 or at any time after the inflation began to mount, but in the relatively good times of 1920 and 1921.

One could at this point begin drawing some parallels to the US in the present day. What Parsson says about the US and all the other nations that partook in WWI “taking their economic medicine” in 1920-21 while Germany did not is important, because it shows us that nations can only stave off the immutable laws of economics for a time before ultimately and unavoidably reaping what they sow.

You can only finance “prosperity” with debt and printed money for so long before eventually the chickens come home to roost.

America in the present day has been living off of exploding debt levels, a rapidly expanding money supply, and low interest rates for well over a decade now, but eventually it will blow up in our faces.

The parallels between present America and past Germany continue:

The stimulation of the governmentʹs easy money spread through virtually all levels of the German economy. The life of the inflation in its ripening stage was a paradox which had its own unmistakable characteristics. One was the great wealth, at least of those favored by the boom. These were the Êºprofiteersʺ of whom everyone spoke. Industry and business were going at fever pitch. Exports were thriving; that was one of the problems. 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, particularly in the eyes of the austere country folk, 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. When money was so easy to come by, one took less care to obtain real value for it, and frugality came to seem inconsequential. For this reason, Germans did not obtain so much real wealth as the growth of money alone would have indicated.

America will probably be able to prolong its economic reckoning for longer than Weimar Germany did, because the US dollar remains the world’s reserve currency, and there exists great demand for it outside of America’s borders. This means that it will take a whole hell of a lot of money printing to truly devalue the US dollar to the point where it is put on a path towards worthlessness.

However, “permabears” and “goldbugs” have been predicting a massive financial reckoning for America for over a decade, warning over and over and over that inflation will happen sooner or later in this country. They began sounding the alarm when the Fed expanded its balance sheet (a measure of money printing through the process of “quantitative easing”) from $900 billion to over $2.2 trillion at the depths of the financial crisis in 2008, and have been predicting inflation ever since.

So it’s not as if all this inflation business is a new thing. People have been sounding the alarm about it for 13 years now. It would be foolish to assume that America is only in the early stages of its inflationary spiral because we’re all just now starting to notice it. This has been more than a decade in the making.

Now, official government statistics show that while the dollar has lost a decent amount of value since 2008, it hasn’t been anywhere near as bad as what happened in Weimar Germany in the years preceding the hyperinflation.

However, Shadow Stats has an inflation calculator as well, and it offers what it claims is the real degree to which the US dollar has been devalued:

Official figures show that $100 in 2008 would have the buying power of about $131 in 2021. But Shadow Stats says it’s a lot worse than that.

You will notice that Shadow Stats does not provide a dollar value, only an asterisk, and that you have to be a subscriber to view the actual figure. It’s pretty expensive to subscribe, but I found a creative way around it. I took a screenshot of the image, made a square that was identical in size to the $100 bar, and then placed those identically sized squares over the green Shadow Stats bar so that we can get an estimation of how much they believe the US dollar has been devalued since 2008:

I was able to fit at least 3 $100 boxes in the green bar, as well as one $30.86 box, and there’s even still a little green leftover at the top. So we can estimate that based on Shadow Stats’ numbers, $100 in 2008 dollars is equal to about $335 in 2021 dollars. Translation: prices have gone up more than threefold since 2008, according to ShadowStats.

Back to Weimar Germany:

Side by side with the wealth were the pockets of poverty. Greater numbers of people remained on the outside of the easy money, looking in but not able to enter. The crime rate soared. Although unemployment became virtually nonexistent and many of the workers were able to keep up with the inflation through their unions, their bargaining, and their cost‐of‐living escalator clauses, other workers fell behind the rising cost of living into real poverty. Salaried and white‐collar workers lost ground in the same way. Even while total production rose, each individualʹs own efforts faltered and showed a measurable decline, and the quality of production deteriorated. Accounts of the time tell of a progressive demoralization which crept over the common people, compounded of their weariness with the breakneck pace, to no visible purpose, and their fears from watching their own precarious positions slip while others grew so conspicuously rich. Feelings of disunity and dissent were epidemic among the Germans, and nationalism among them was never weaker. Regional separatism was so strong that it came close to breaking up Germany into fragments.

Sound familiar? Germany in the early 1920s was built on a false, sham prosperity that was not built to last. Same with America today.

Along with the paradoxical wealth and poverty, other characteristics were masked by the boom and less easy to see until after it had destroyed itself. One was the difference between mere feverish activity, which did certainly exist, and real prosperity which appeared, but only appeared, to be the same thing. There was no unemployment, but there was vast spurious employment — activity in unproductive or useless pursuits. The ratio of office and administrative workers to production workers rose out of all control. Paperwork and paperworkers proliferated. Government workers abounded, and heavy restraints against layoffs and discharges kept multitudes of redundant employees ostensibly employed. The incessant labor disputes and collective bargaining consumed great amounts of time and effort. Whole industries of fringe activities, chains of middlemen, and an undergrowth of general economic hangers‐on sprang up. Almost any kind of business could make money. Business failures and bankruptcies became few. The boom suspended the normal processes of natural selection by which the nonessential and ineffective otherwise would have been culled out. Practically all of this vanished after the inflation blew itself out.

Speculation alone, while adding nothing to Germanyʹs wealth, became one of its largest activities. The fever to join in turning a quick mark infected nearly all classes, and the effort expended in simply buying and selling the paper titles to wealth was enormous. Everyone from the elevator operator up was playing the market. 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.

Again, sound familiar?

Concentration of wealth and business was still another characteristic trend. The merger, the tender offer, the takeover bid, and the proxy fight were in vogue. Bank mergers were all the rage, while at the same time new and untried banks sprouted. Great ramshackle conglomerates of all manner of unconnected businesses were collected together by merger and acquisition. Armies of lawyers, brokers, accountants, businessmen, and technicians who spent their time pasting together these paper empires bolstered the lists of the more or less employed.

The late David Graeber’s 2018 “Bullshit Jobs” book comes to mind here.

The most fabulous of the conglomerates was the empire of Hugo Stinnes, which comprised hundreds of companies at its peak in coal, iron, steel, shipping, transport, paper, chemicals, newspapers, oil, films, banks, hotels, and more. Stinnes was Mr. Everything who had also begun to colonize abroad and is supposed to have contemplated organizing all German industry into a single super‐conglomerate. After the inflation ended, Stinnesʹ empire and many lesser ones were found to be functionally and financially unsound, and they disintegrated more or less messily. Stinnes died.

It was typically true that the Germans who grew the richest in the inflation were precisely those who, like the speculators, the operators, and the builders of paper empires, were least essential to German industry operating on any basis of stability or real value. With the end of the inflation they disappeared like apparitions in the dawn, and scarcely a one of the Êºkings of inflationʺ continued to be important in German industry afterward.

Remind you of anyone today?

It’s quite amazing to read about all these similarities between Weimar Germany and the present-day United States.

We believe there’s no way that what happened to them will happen to us. But I’m sure back then, they also thought that there was no way that what eventually wound up happening to them would ever happen to them.

Now we move on to the collapse of Weimar Germany’s economy:

That was how it was in the heyday of the boom, which was the ripening stage of the inflation. Inexorably the inflation began to stalk the boom. From having been steady during the fifteen months preceding July 1921, prices doubled in the next four months and increased by ten times in the year through the summer of 1922. Consumers put on pathetic buyersʹ strikes against the rising prices. Interest rates soared as lenders tried to anticipate the loss of value of their principal. Businessmen quoted prices to one another with gold or constant‐value clauses, or they did business in foreign currency. The governmentʹs actual deficits were relatively innocuous. In fact, the governmentʹs budget was closer to balance at the brink of the crash in 1922 than at any time since 1914. But while the governmentʹs new deficits diminished, the inflation had become self‐sustaining, feeding on the old ones. The government was unable to refinance its existing debts except by printing new money. The governmentʹs creation of paper wealth steadily fell behind the rising prices, and the inflation entered its catastrophic decaying stage.

It’s almost surreal to read about this because I can see virtually all the futile behavior described here happening if indeed America does one day find itself in an unbreakable inflationary spiral.

The final convulsion when it began was at first bizarre and at last became sheer nightmare. Beginning in July 1922, prices rose tenfold in four months, two hundredfold in eleven months. Near the end in 1923, prices were at least quadrupling each week. Prices raced so far ahead of the money‐printing plants that, in the end, the total real value of all the Reichsmarks in the world was smaller than it had ever been, a phenomenon which enabled the governmentʹs economists to argue that there was no true inflation at all, it was just numbers.

This phenomenon also made money so scarce, even in the face of astronomical prices, that urban Germans could not find the price of their daily bread. The worker had to compute his pay in the trillions, carry it in bales, and spent it instantly lest he lose it. The forlorn buyersʹ strikes of earlier days against the mildly higher prices were no more; in their place the buyers were vying with one another to buy up any kind of goods at any price before their little money could evaporate. The seas of marks which had been stored up by Germans and especially by trusting foreigners flooded forth and fought to buy into other investments, foreign currencies, tangible goods, almost anything but marks. Legally Êºfairʺ interest rates reached as much as 22 percent per day. The price of a schnitzel dinner might rise 20 percent between giving the order and paying the check.

Germanyʹs money printing industry (another impressively large employer with 30 paper mills, 133 printing plants, workers in thousands) could not turn out enough trillions to keep up. States, towns, and companies got into the act by issuing their own Êºemergency moneyʺ (Notgeld). Barter became prevalent.

Still money grew scarcer while prices continued to soar. The boom was long since over. Farmers, who were comfortable enough, would not sell their food to the townsmen for their worthless money. Starvation and abject poverty reigned. The middle class virtually disappeared as professors, doctors, lawyers, scientists and artists pawned their earthly goods and turned to field or factory to try to earn a little food. A former conductor of the Boston Symphony Orchestra earned a dollarʹs worth of trillions a week conducting an orchestra in North Germany. Every level of life above the barest existence was shed. Malnutrition and the diseases of malnutrition were rife. Production began to fall. As factories closed, the workers too became unemployed and joined the starving. The whole system ground to a halt. Food riots and Marxist terror broke out throughout Germany. Eighty‐five persons died in a riot in Hamburg. The famous beer hall Putsch led by Adolf Hitler in Munich in November 1923, the last month of the inflation, was only one of the many and not the worst.

This is what happens when the economy collapses. We believe we are immune to it, and I’m sure they believed that, too, during the Weimar Germany boom times before reality proved they weren’t.

Once the old Reichsmark had been thoroughly obliterated, the return to a stable currency was so absurdly simple as to become known as the Êºmiracle of the Rentenmark.ʺ The Rentenmark, or Êºinvestment mark,ʺ was the new interim currency. The government of industrialist Wilhelm Cuno, which had ruled during most of the worst of the inflation, finally fell in August of 1923. Gustav Stresemann, who was later foreign minister throughout the trying 1920ʹs and has been described as by far the greatest German of the Weimar era, was promptly summoned as chancellor. In October, the Reichstag voted him dictatorial powers under the Weimar constitution. He in turn called upon Dr. Hjalmar Schacht, who was later Hitlerʹs financial wizard and was tried (but acquitted) at Nuremberg, as the commissioner for the new Rentenmark. As Dr. Schacht relates, he accomplished the introduction of the Rentenmark with no staff but his secretary and no establishment but his dark back office and a telephone.

The Rentenmark was placed in circulation beside the devalued Reichsmark and carried no real value of its own but the naked avowal that there would be only so many Rentenmarks and no more. The Germans miraculously believed it and, still more miraculously, it turned out to be true. The old Reichsmark was finally pegged at one trillion to one Rentenmark on November 15, 1923; simultaneously the German finance ministry under the estimable Dr. Hans Luther, who was to become chancellor of one of the later governments, balanced its budget, and that was the end of the inflation.

Stabilization through the Rentenmark was by no means painless. To convince the skeptical required first a series of severe bloodlettings administered by the resolute Dr. Schacht to foreign‐exchange speculators, issuers of the Notgeld, and businesses which required credit, all of whom depended on the continued depreciation of the official currency. When the president of the Reichsbank throughout the war and the inflation, Rudolf Havenstein, died at the moment of the stabilization, Schacht was appointed to succeed him. Schachtʹs greatest achievement was not so much in the introduction of the Rentenmark but in making a new non‐inflationary money policy stick. The grand‐daddy of all credit squeezes ensued from Dr. Schachtʹs order of April 7, 1924, which stopped all credit from the Reichsbank. New inflation, which had begun to stir again, was then abruptly and finally stopped. The intrenched interests in Germany, especially the industrialists like Stinnes, characteristically fought Schacht every inch of the way, although a few later acknowledged the tightness of his course.

Eventually, you reap what you sow.

Germany now took its stored‐up dose of hard times. Germans who had been caught in the inflation were relieved of their worldly goods. Businesses which were based on nothing but the inflationary boom were swept away. Credit for business was practically impossible to come by. Unemployment temporarily skyrocketed. Government spending was slashed, government workers dismissed, taxes raised, working hours increased, and wages cut. Almost 400,000 government workers alone were discharged. The shock to the German people of the final inflation, the stabilization, and the unemployment was so great that in the elections of May 1924, six months after the close of the inflation, millions of voters flocked from the moderate center parties to either the Communists or the Nazis and Nationalists on the extremes. These parties gained dramatic strength in the Êºinflation Reichstag,ʺ as it was called.

What else would you expect when the ruling regime oversees the complete economic collapse of the nation?

Germany very quickly began to feel better economically, however, as the stabilization medicine did its work. New elections only seven months later, in December 1924, repudiated the Nazis and Communists and restored the strength of the middle‐class parties and of the Social Democrats, the orthodox labor party. Only by the greatest efforts did Germany get itself going again in this way. Even so, because of the permanent shortage of credit Germanyʹs revival was unhealthily based (against Schachtʹs warnings) on new foreign loans. The world depression which followed 1929 knocked debtor Germany flat again, and Hitler followed close behind.

The problem today is that if this happens to America, the rest of the world will not be spared the pain. The world economy today is so much more connected and interwoven than it was in the 1920s, and dependent on America, that it is impossible to imagine American hyperinflation not triggering a complete global economic meltdown.

When the inflation was over, everyone who had owed marks suddenly and magically owed nothing. This came about because every contract or debt that called for payment in a fixed number of marks was paid off with that many marks, but they were worth next to nothing compared with what they had been worth when they had been borrowed or earned. Germanyʹs total prewar mortgage indebtedness alone, for example, equal to 40 billion marks or one‐sixth of the total German wealth, was worth less than one American cent after the inflation. On the other side, of course, everyone who had owned marks or mark wealth such as bank accounts, savings, insurance, bonds, notes, or any sort of contractual right to money suddenly and magically owned nothing.

It was a great debt jubilee in Germany, and the wealthy who did not own tangible financial assets were hung out to dry.

The largest gainer by far, because it was the largest debtor, was the Reich government. The inflation relieved it of its entire crushing debt which represented the cost of the war, reconstruction, reparations, and its deficit‐financed boom. Others who were debtors emerged like the government with large winnings. Until the last moment of the inflation borrowers continued to make huge profits simply by borrowing money and buying assets, because lenders never stopped underestimating the inflation.

The good fortune of the debtors demonstrated the prudence of following the government’s lead: one must beware of being a creditor whenever the government was a huge debtor. Farmers in particular were the classic case of invulnerability to inflation, because they always had food, their farms were constant values, and the many who had mortgages on their farms were forgiven their debts outright.

If America ever enters a situation like this, take out the biggest loan you can and buy the biggest house you can find–all your debts will be gone in a matter of days due to hyperinflation. Buy as much land as you can and hunker down, as the farmers of Weimar Germany did.

It may even be prudent to do this now, as inflation is already in the process of wiping the slate clean for debtors in America.

But I think the key takeaway here is this prescient quote: “One must beware of being a creditor whenever the government was a huge debtor.

Typically, the way governments pay off their national debts is to simply make their interest payments on time and allow inflation to eat away at the principal over the years.

Your creditors will always continue loaning you money as long as you make your interest payments on time and in full.

But eventually, if the national debt continues growing and growing as it has, there will have to come a time where our creditors conclude that they’re never going to be repaid.

Now, this is not to say that indebted governments want hyperinflation. This is absolutely not the case. Governments want healthy inflation that reduces their debt level over a long period of time, not all at once.

It took the US nearly 40 years to pay off its World War II debt, and Ronald Reagan was the first US President since the end of the war that didn’t have to pay off any WWII debts. There were periods of serious inflation in the US starting in the 1960s and getting out of control in the 1970s, even into the early 1980s, and this helped shrink the principal. Plus, the US economy was way stronger following WWII than it is today, and the rapidly expanding GDP (which also causes inflation) eventually came to dwarf the size of the earlier-incurred debt.

The Weimar government in Germany did not intentionally plunge the nation into hyperinflation. It simply lost control. This is from the Wikipedia page on the Weimar Hyperinflation:

The Treaty of Versailles imposed a huge debt on Germany that could be paid only in gold or foreign currency. With its gold depleted, the German government attempted to buy foreign currency with German currency, equivalent to selling German currency in exchange for payment in foreign currency, but the resulting increase in the supply of German marks on the market caused the German mark to fall rapidly in value, which greatly increased the number of marks needed to buy more foreign currency.

That caused German prices of goods to rise rapidly, increasing the cost of operating the German government, which could not be financed by raising taxes because those taxes would be payable in the ever-falling German currency. The resulting deficit was financed by some combination of issuing bonds and simply creating more money, both increasing the supply of German mark-denominated financial assets on the market and so further reducing the currency’s price. When the German people realized that their money was rapidly losing value, they tried to spend it quickly. That increased monetary velocity caused an ever-faster increase in prices, creating a vicious cycle.

The government and the banks had two unacceptable alternatives. If they stopped inflation, there would be immediate bankruptcies, unemployment, strikes, hunger, violence, collapse of civil order, insurrection and possibly even revolution. If they continued the inflation, they would default on their foreign debt.

However, attempting to avoid both unemployment and insolvency ultimately failed when Germany had both.

No government wants hyperinflation. It’s a death sentence for a government (well, except for in Venezuela).

But governments that print money–whether to finance increased spending, pay down debts, or to “stimulate the economy”–are playing with fire. You have to watch inflation like a hawk and nip it in the bud anytime it begins to rear its head, otherwise it will set in motion a course of events that are completely out of the government’s hands: the laws of nature will take over.

The most dangerous thing is a government that prints money and sees no immediate negative consequences in the aftermath. This makes it more likely that the government will continue to print money going forward, and on a larger scale. “If we were able to print a trillion with no negative ramifications, we should be able to print 2 trillion as well…”

Eventually, one day, the government will hit a wall and lose control. Every government believes they have it under control, every government believes hyperinflation won’t happen to them, but history has often proven them spectacularly wrong.

So where does that leave the US today in 2021?

I said just a second ago that history has often proven government spectacularly wrong in their belief that they can get inflation under control before it turns into hyperinflation.

There are, in fact, cases of governments getting a lid on inflation and bringing it back down to acceptable levels and averting catastrophe. And this is good news for us because it means not all hope is lost.

1970s Stagflation

As you probably already know, the US in the not-so-distant past underwent a period of prolonged inflation, and it was worse than what we’re going through right now (at least so far):

As you can see, starting in the mid-1960s, inflation began rising, although in fits and spurts, before finally skyrocketing in the late 1970s to a peak level of about 14%.

What was the cause of the inflation? A variety of compounding factors. There were the oil shocks of 1973 caused by the foundation of OPEC, which caused gas prices to skyrocket and even have to be rationed. There was the Vietnam War, and war spending is always an inflationary risk. Plus, the government had, during the LBJ and even Nixon administration, massively increased government spending on welfare and safety net programs (LBJ called it “the Great Society”). There were also low interest rates as well during this time, and the easy money was a driver of inflation.

The US money supply also nearly quadrupled from 1965-1980:

This is not inherently a bad thing, but as you can see, there were two recessions between 1970 and 1976 and the money supply just kept increasing. When there isn’t economic growth, the economy cannot fully absorb all the newly created money, resulting in inflation.

But there was also another extremely important factor that we have to take into account: the end of the Bretton Woods gold standard system in 1971. The US was facing elevated unemployment and elevated inflation at the time, and on August 13, 1971, President Richard Nixon met with his top advisers–Treasury Secretary John Connally, Fed Chairman Arthur Burns, and future Fed Chairman Paul Volcker–at Camp David to figure out a plan of action. The decision Nixon agreed to was three-pronged.

The first course of action was to suspend the US dollar’s convertibility into gold, and to deny foreign governments the ability to convert their US dollars to gold. The second action was to impose Presidential wage and price controls to counter inflation for a 90-day period. It was the first time such an action had been taken since World War II. The final action was to impose an import surcharge of 10% in order to protect American products from the coming upheaval in exchange rates. This essentially discouraged Americans from importing foreign goods.

The most consequential of these three acts–collectively known as the “Nixon Shocks” today–was the suspension of the gold standard. It was initially supposed to be temporary, but it has never been reinstated to this day. In order to understand the importance of this action by Nixon, one must first understand the Bretton Woods international economic system, which was established at the end of World War II. Bretton Woods was the moment the US dollar was established as the reserve currency of the world. All nations were to settle their trade accounts with other nations using US dollars.

The nations of the world that participated in the Bretton Woods system had confidence in the US dollar because it was convertible to gold upon request: one ounce of gold for $35. The US had over 2/3 of the world’s gold at the time, it was the strongest economy by far, and it had the most internationally desired currency. But it was this commitment by the US to convert dollars into gold upon request that really was the foundation of the confidence nations had in the dollar. The dollar was “good as gold,” and all other currencies were “pegged” in relation to the dollar.

So just to explain that another way, the US dollar was pegged to gold at $35 an ounce, and then the foreign currencies of the world–the pound, the yen, the mark, the franc, etc.–were all pegged to the US dollar. So say 100 Japanese Yen equaled 1 US dollar, that would mean it would take 3,500 Yen to buy an ounce of gold.

And if Japan wanted to trade with, say, France, they would either simply do using their reserves of US dollars (as the dollar was “the common currency”) or they would calculate the exchange rate between themselves based on each of their nations’ currency values relative to the dollar. If 20 francs equaled 1 dollar, and 100 yen also equaled 1 dollar, the exchange rate between France and Japan would be 5 yen for every 1 franc. It was all anchored to the US dollar, which in turn was anchored to gold.

But the Bretton Woods system was deeply flawed. For one, it all revolved around the US running a trade deficit with the rest of the world. If the US began to run a surplus, global liquidity would dry up. In other words, the US constantly had to be spending more money on imports than it was taking in via exports. If the US suddenly started running a trade surplus, the other nations of the world were at our mercy.

The US could also buy foreign bonds (i.e., loan money to other nations) if it wanted to put more dollars into global circulation without running a trade deficit. And this was a problem because the US had the ability to print money, and it did in order to fund the Vietnam War and the Great Society.

The fundamental problem that Bretton Woods ran into was that there were too many US dollars and not enough gold out there to back them up. The US had been taking advantage of its reserve currency status by printing money and not adjusting the price of gold to reflect the new quantity of dollars out there in the world.

In reality, given the increase in supply of US dollars, gold was worth way more than $35 an ounce. So, France, knowing this, began converting its dollars for gold en masse, and that was finally when Nixon had to put his foot down and say, “Enough. No more converting dollars to gold.

The US dollar was no longer backed by gold. It had to be devalued, and so it was. But do not confuse the term “devaluation” with “inflation.” When a country devalues its currency, it is not the same thing as money printing and inflation. Sure, inflation does have the effect of “devaluing” a nation’s currency, but the term “currency devaluation” as it is widely understood, is when the government intentionally weakens its own currency in relation to other nations’ currencies, in order to stimulate foreign demand for its products.

Basically, what the US government was doing in devaluing the dollar was making it cheaper for other nations to import American goods. It’s like basically announcing to the world that American goods are “on sale.”

However, this is not to say that currency devaluation does not contribute to inflation. It absolutely does. If you make it cheaper for other nations to import your goods, you also by definition make it more expensive for your own citizens to import foreign goods. Their dollars don’t go as far anymore in relation to foreign currencies. Rising prices for foreign goods equals inflation.

As we’ve already gone over, there were several different contributing factors to the inflation of the 1970s, but it all started with money printing.

Inflation persisted for years in the 1970s. It was so bad that the 1970s are now often referred to as a “Lost Decade,” economically speaking. The US was experiencing both inflation and high unemployment–“Stagflation”–something economists previously said was impossible.

The only way out of “Stagflation” was, unfortunately, to massively increase interest rates to near-usurious levels, which is what Federal Reserve Chairman Paul Volcker did:

From 1977-1981, interest rates increased from about 4% to over 22%. It led to not one but two recessions between 1980-1983, which is known as the dreaded “double-dip” recession.

Combined with the early 1970s recessions, we’re talking about 4 recessions in a 15-year span, combined with soaring inflation.

But by the early 1980s, the choices were bleak for the government: either America is to “take its economic medicine” and massively increase interest rates, or it continues allowing inflation to continue running until it eventually destroys the US dollar.

That’s the choice our government faces today. Paul Volcker’s Fed had the courage to raise interest rates to sky-high levels, no matter how much pain it caused the American people economically. Because he knew that as bad as the rate hike-induced recessions would be for Americans, hyperinflation was way worse.

Credit to Ronald Reagan as well for not dumping Paul Volcker as Fed Chairman in 1983 when his term was up. Carter appointed Volcker initially in 1979, and because he was Carter’s guy and he was jacking up interest rates and crashing the economy, Reagan thought Volcker was sabotaging him. But Reagan eventually saw the necessity of Volcker’s actions and reappointed him to another term as Fed Chair in 1983.

Will our government have the courage to hike interest rates to any level necessary in order to get inflation under control?

Will Powell Act?

Fed Chair Jerome Powell seems to understand the urgency of the situation. He’s already officially ceased using the word “transitory” to describe inflation. Today he said the Fed would end (“taper”) its bond-buying program by March, which is much earlier than was previously expected, and target at least 3 interest rate hikes next year:

The Federal Reserve on Wednesday said it will phase out its bond-buying stimulus program by March — much faster than previously planned — and signaled it would raise interest rates more aggressively to combat high U.S. inflation.

The more assertive approach comes after soaring prices pushed inflation to the highest level in several decades. The Fed acknowledged the surprising and sustained increase in prices by banishing the word “transitory” to describe inflation from its policy statement.

In its new wording, the Fed said inflation was elevated. Prices rose at a 5% yearly rate as of October, using the central bank’s preferred PCE price gauge.

“This is a major pivot from the Fed, prompted by clearer evidence that inflation is broadening,” said Brian Coulton, chief economist of Fitch Ratings.

Aside from worries about inflation, Fed Chairman Jerome Powell said the economy has made enough progress to justify removing stimulus that the bank put in place early in the pandemic to prevent a major depression.

The U.S. has recovered rapidly, and the labor market is moving toward full employment, Powell said in a press conference after the Fed’s two-day strategy meeting.

Whatever you say, pal.

New projections based on the median forecast by Fed officials sees the federal funds rate rising to 0.9% by the end of 2022, to 1.6% by the end of 2023 and 2.1% by the end of 2024.

That implies three quarter-percentage point interest increases next year, three in 2023 and two in 2024.

The pace of rate increases projected by officials is somewhat faster than what they saw in September, where the Fed saw only one rate hike next year and its benchmark rate rising to 1.8% by 2024.

The Fed sees 2.5% as the “neutral” level of interest rates, neither pushing on the accelerator or applying the brakes the the U.S. economy. 

Some former Fed officials think the central bank will have to be more aggressive to tame inflation. On the other hand, many in the markets think the Fed won’t be able to raise policy rates anywhere close to 2.5%.

Remember that when the US was experiencing 15% inflation in the late 1970s/early 1980s, interest rates were jacked up to over 22%.

We’re talking about 2.1% rates by the end of 2024.

Sure, the Fed thinks inflation rates are lower today than they were back in the Stagflation era, but just because the Fed uses a different formula to calculate and water down inflation nowadays does not mean they’re correct. It’s like being on the Titanic and saying, “Well, if you exclude all the water in the crew cabins, the third-class levels and the second-class cabins, we’re not sinking at all.”

Just because you exclude certain categories from your inflation formula does not mean inflation in those categories doesn’t exist.

The Fed is always trying to walk a fine line between crashing the economy and allowing runaway inflation. If the Fed increases interest rates too much, it sends the economy into recession. But if the Fed doesn’t increase rates enough, it risks losing control of inflation.

I just wonder if the Federal Reserve is prepared to put the wealthy elites of this country through a prolonged period of economic hardship that features crashing stock prices and a cratering housing market.

They can no longer kick the can down the road and act like America is immune from the immutable laws of economics. Inflation is happening right now. It is not sorting itself out as the experts predicted it would.

The choice before the Fed is simple: do what it takes to get inflation under control now, and thereby force America to “take its economic medicine,” or rearrange the deck chairs on Titanic and consign us to hyperinflation.

The choice is between a painful recession now, or total and complete economic collapse down the road.

Dalio’s Warning

Ray Dalio is one of the greatest investors of all time. He is the founder of the hedge fund Bridgewater Associates, the largest hedge fund in the world, which manages about $154 billion today.

Dalio himself is worth about $20 billion and is the 36th richest man in America. Now 72 years old, Dalio has stepped back a bit from running Bridgewater, and his main goal right now is to position Bridgewater for success even after he retires.

He also seems to care a great deal about teaching others how the global economy works and sharing his unique insights as one of the greatest hedge fund managers in history.

In 2013, he released a video on YouTube entitled “How the Economic Machine Works,” and today it has over 25 million views.

In the video, he talks about credit cycles and deleveraging and how they drive the overall economic cycles we experience. It is one of the most popular economics videos on YouTube–so popular in fact that it has been translated into other languages.

To my knowledge, there is no other billionaire hedge funder out there who has put in anywhere near as much time and effort as Dalio has into explaining in simple terms how the global economy works, so that ordinary people may learn more and become better investors.

I have said many times on this site that I consider Wall Street to be a net-burden on America, a parasitic den of thieves and scoundrels who create nothing of value yet are rewarded with obscene wealth.

However, if there is any exception to that rule, it would be Ray Dalio. He doesn’t have to share his wisdom with anyone. He could easily live a quiet life of relative anonymity and enjoy his billions of dollars, never sharing any of his secrets with any of us. And yet he goes out of his way to educate regular people and de-mystify the many complex and esoteric factors that shape the global economy.

In an interview with CNBC earlier this year, he had this to say:

“The reason I want to share [what I know is because] I’m now at a stage of my life–I’m 71–and my notion at this moment, and I’ll do this for maybe a year or two more, is to pass along the things that I found valuable, to other people, for them to take their leave as they like.”

Dalio says that one of his biggest concerns right now is that there simply isn’t enough demand in the world for US government bonds

There’s a supply-demand picture for bonds. And the way it looks is, if you should get the selling of bonds, it worsens that supply-demand picture because, the way it works is that the Treasury borrows and runs a deficit. But it can’t produce money. So, it has to sell bonds. And when it sells bonds, if there aren’t enough buyers of those bonds, then the Federal Reserve has to come in and buy those bonds.

And the world right now is over-invested in US dollar-denominated bonds… they have negative real returns. And cash has negative real returns. So, if there was a selling of [bonds] and a movement to other assets like stocks, commodities, other currencies, real estate and the like, that selling worsens the supply-demand picture. And if there’s not enough demand, that means the central bank is going to have to come in and print more money.

So, it’s not only the inflation that’s in the pipeline in this supply-demand balance, but it’s also what it could be if there’s a selling of debt instruments.”

But what is the significance of this? What is the big deal if the Treasury cannot find enough buyers for its bonds?

Well, as Dalio said, it means the Fed has to print even more money to buy those bonds, which will worsen inflation.

But there’s an even greater significance to it than that:

“For every individual, every company, every government, over a period of time you have to earn more than you spend. There’s an income statement and a balance sheet.

When one becomes a reserve currency, others want to save in that, and that gives one the exorbitant privilege of being able to borrow in that currency, and to create debt and money. And it also gives us [America] powers in that a lot of our sanctions come from the dollar being a reserve currency, and so on.

However, through history, it has always happened that currencies are devalued or destroyed. And in that cycle, when it becomes unattractive to own bonds, or debt instruments in that currency, there’s a supply-demand problem.

Because what a bond is is a promise to receive currency. So, what you are when you own a bond is, you’re “long” in that currency, because that [currency] is what they promise to give you. And they have the printing press. Then there are shifts that happen.

…[W]e are in a fiat monetary system in which we are running very large deficits that we are monetizing. Those deficits produce bonds that have to be sold. When I look at the supply and demand for those bonds–I know who the buyers are; you know there’s a really limited number of big buyers–I look at their portfolios and calculate what that is [the demand for US bonds.]

There’s not going to be enough demand for those bonds. And there’s going to be a need for more monetization of that debt.

We’re now in a new era. We are pressing the limits of [the world’s demand for our bonds]. That money, at the end of the day, whoever’s accepting that reserve currency has got to believe it.”

Ray Dalio is saying that America’s status as the global reserve currency is in danger.

What does this have to do with inflation?

As the nation with reserve currency status, we are able to print much more money–and for far longer–than any other country in the world. Because there is and has always been, since the end of WWII, a strong demand for US dollars everywhere in the world.

We have been able to print and print for so long without consequence because there has always been a voracious appetite for US dollars.

But not anymore, says Ray Dalio.

In a world of reduced demand for the US dollar, all those unwanted US dollars around the world flood back into the US economy in exchange for things like other currencies, other countries’ bonds, stocks, real estate, and any sort of asset you can think of. And that will cause inflation to really get bad.

We have been able to print and print and print because the demand for US dollars has been global, not just within the US.

But if the world no longer has the same demand level for US dollars, then all that money that the Fed printed for the world now can only find demand in the US, and it will flood the country with dollars.

And this is what Ray Dalio is talking about. We’ve already got inflation right now, and it causes other countries to lose faith in the dollar even more, which will exacerbate the already existing inflation.

When we had inflation in the late 1970s and early 1980s, America was unquestionably the world’s reserve currency. China was in the early stages of its economic development and was still mostly an agricultural economy. The presence of the Soviet Union made it so that for all non-communist nations, there really was no other choice but the US dollar.

But now, China represents almost the same share of the global economy as the US does:

This chart is from 2008, and China’s share of the world economy has only increased since then.

The point is, the US’s status as primary reserve currency of the planet was nowhere near in jeopardy back in the 1970s.

It is far more tenuous nowadays.

China is now openly challenging the US for global hegemony. America is in perhaps its weakest position on the world stage in over a century.

Dalio says the demand for US government bonds just isn’t what it used to be, and this could lead to a situation where the US dollar falls out of favor with the rest of the world.

Such a situation would not only be the result of rampant inflation, but both the cause and the effect of it.

As nations see the US undergoing serious inflation, they lose faith in the dollar, and dump US dollars for assets viewed as more attractive. This then exacerbates the existing inflation problem and from that point on our government may be powerless to stop it.

“When the Tide Goes Out”

Reading about Weimar Germany, I was unable to avoid drawing the conclusion that the hyperinflation period was not only an economic reckoning for the nation, but a moral one, too.

All the financial greed and excess that had been rewarded during the “boom times” was subsequently and viciously punished. All those who had become “undeservedly rich”–the speculators, the scammers, the over-leveraged, and the people who were rewarded despite producing no value for society–they all eventually got what was coming to them.

Now, don’t get me wrong, not a soul in Germany was spared from the pain of hyperinflation. But it was the most irresponsible and imprudent that suffered the most.

Warren Buffett has a famous quote:

“It’s only when the tide goes out that you learn who’s been swimming naked.”

There is a difference between money and wealth.

People in Weimar Germany learned that having money was not the same thing as having wealth, and that having wealth was not the same thing as having money.

The humble farmers, who may have generally been cash-poor during the boom times, were during the hyperinflation the people who were able to weather it the best.

It was they who were going to bed at night with full bellies, while the more cash-rich urbanites couldn’t even buy loaves of bread.

You can only suspend the immutable laws of economics for so long. Eventually, you reap what you sow.

America has been able to get away with ignoring the fundamental rules of economics for a long time due to its status as world reserve currency.

But now, suffering the worst inflation in 40 years with no end in sight, it’s starting to feel like America will have to take its economic medicine one way or another.

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