Periods of hyper-inflation are also periods of mass insanity, writes Robert Blumen. Panic buying takes place in hyper-inflation when people believe that money will lose its value rapidly. The panic buying of stocks that was in evidence during the late 90s was based on the view that there would be a continued depreciation of the dollar in relation to stocks, so it was preferable to exchange dollars for stocks in the present, rather than waiting for the future when a dollar would purchase even fewer shares.[FULL ARTICLE]
Source link: http://archive.mises.org/2499/weimar-and-wall-street/
Weimar and Wall Street
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This is a good article, and quite scary when you think of the implications of runaway inflation as result of people stopping trusting the exchange medium. This happened in Mexico a few times in recent history. In 1980-1982, we had 2-digit inflation due to grossly irresponsable monetary policies of the goverment, the people in power thinking they could get away with supporting a fiat monetary system through petroleum sales profits (Mexico exports oil which is extracted by a state-owned monopoly). Of course, oil prices dropped and we were left with a huge debt and worthless money. People stopped making transactions in Pesos and started dealing in Dollars since it was just a bit more stable compared to our worthless money. The goverment simply seized the national banks, froze all assets in Dollars and exchanged them into Pesos – a similar thing happened in Argentina in 1998-1999. After that, we had THREE digit inflation, a huge crisis and people running to the stores to purchase anything they could get their hands on. It was a VERY tough time for me and my family. The best part was: the Mexican goverment closed the borders to imports, so now we were left with worthless money and few goods, of poor quality to boot. People have just started to trust the peso in the last decade, after the goverment of president Salinas simply eliminated three zeros in order to have seemingly smaller bills in our hands. This was of course all ilusion, but people being what they are bought it lock, stock and barrel.
In December 1994, the recently sweared-in president, Ernesto Zedillo, had to “devaluate” the peso (read: he printed more money) because it was woefully overpriced (read: they could not make the payroll for the bureaucrats), which means we did not have a comparative advantage (read: we were at last getting cheap goods from the USA, Canada and China, which made some industrialists and merchantilists unhappy). The goverment simply increased the money supply to DOUBLE what it was and the whole economy just STOPPED dead in its tracks. The huge crisis created by the goverment meant people stopped believing in the peso, started purchasing as many dollars as they could – driving the price upwards even more – and… well, lets say story repeated itself.
It WILL happen to you, I can assure you. Better start looking at those bed pans, maybe they will be worth a pretty penny in the future
Best regards,
Francisco Torres
Mexico
Very interesting and good article. I have also always believed that it is wrong for people to only regard consumer price inflation as inflation while neglecting the effects that monetary expansion has on asset prices. It is virtually only Austrians and The Economist who note how monetary expansions can create asset price bubbles.
I would however not neglect the fact that so-called “irrational exuberance” does play a role in stock market bubbles like the “NASDAQ 5000″ bubble. Because the central bank have only a limited control over where the newly created money supply goes, the arrival of a asset price bubble presuppose not only monetary expansion but also a strong preference for these assets among the early receivers of the newly created money. Without that “irrational exuberance” for these assets among the early receivers of newly created money , monetary expansion will just create a general inflation effecting consumer prices to a equal degree as asset prices.
There is also one crucial difference between Germany 1923 and America 1999-2000, namely that in the former case money lost its purchasing power against everything while there were no relative price movements. In America in 1999 and early 2000 stocks rose in value not only versus money but also against real goods and services. This implied that at some point the bubble had to burst and relative prices would have to be reversed. By contrast there was no mechanism in the 1923 German hyperinflation that would force the price increases to be reversed.
I think asset price inflation of the 90s was caused by shortage of capital return opportunities. There has been enormous inflow of cash into pension funds (due to baby-boomer demographics), all this cash needs to be invested in order to provide for future pensions. Hence — chase after any promise of returns, internet mania etc.
Why long-term returns on capital in the West are low? I would think several long-term trends are having an effect: general greying of the population, high labour costs etc. But most importantly – there is new exciting market in Asia that opens up and offers low labour costs and young consumers.
So, here we are. In the West there are pensioners holding financial assets at inflated prices. And they will soon sell these assets to enjoy the retirement. On the other part of the world there are industrial assets being put to use to satisfy growing consumer class.
There will probably be a great transfer of wealth from West to the East, for example through currency re-valuation.
Great article by Mr Blumen and great post by Sr Torres.
I question the analogy of hyperinflation in stocks (Wall St.) to hyperinflation in consumer goods (Weimar) and Mr Blumen’s suggestion that individuals were pushed into trading $ for shares. It seems the Wall St hyperinflation was more of a pull, the attraction of “sure thing” monumental gains attracting individuals on the greater fool theory. People weren’t compelled to buy shares so as to have a sufficient medium of exchange, as occurs in consumer goods hyperinflation (where one sees the ability to purchase means of survival disappearing in holding currency). Consumer goods remained within a reasonable range of inflation.
Perhaps with the lengthening of preference horizons brought about by IRAs and the like (planning for retirement or college education), individuals began to understand the disastrous effect of even a “low” inflation rate of 3% and hence the need to invest in high-octane capital gain assets (particularly given the higher secular inflation rates in things such as college tuition).
On the other hand, the natural human impulse to achieve high returns with minimal investments seems more easily explains the stock market bubble (with the added ingredient of easy money). That does not compare with the hyperinflation of Weimar or Mexico, where potential gain was not at issue so much as minimizing loss of ability to purchase means of survival because of the rapidly depreciating currency.
Let’s not forget that price inflation as computed by the CPI is often adjusted to suit the FED and government. For example, it uses rents instead of real estate prices. Since the CPI is used to determine various payouts by government, it is to their advantage to manipulate the index.
Also, productivity that produces growth should be reducing prices, so when we see only a modest price inflation, say, 2% per year, we need to factor in how much prices would have decreased but for the FEDs mischief. With all the new tools, such as the internet, and high speed cheap computers, we might have seen, for example, a 5% decrease in the general price level. So, 2% plus the 5% reduction we didn’t get equals 7% (in my example).
Bottom line, there’s a lot of inflation effects going on that we are not seeing using price indices crafted by government employees.
Very good article. However, I agree with Stefan Karlsson. There was irrational exhuberance. «Panic buying» does not seem to correspond well with assets inflation. The author himself grants at the end that consumer price inflation is the more scary – eventually inescapable – thing. Stock and bond investments are rather a luxury some engage in, and it is still a type of investment that presupposes a certain sophistication. But I find his explanation of the fact new money went into the stock market, and mostly into real estate now, to be very compelling – I believe it – and I don´t think many people, if anyone, have zeroed in on this as directly and effectively as he does.
Igor, I suspect the best is to cash in those pension funds and retire in Latin America, for instance, where those dollars are always far more valuable. It’s the instant way to multiply the million(s) earned in Wall Street.
I write from Bolivia so I know about scrambling for dollars.
Speaking as a non-American, watching a huge economy like the US’s go into hyper-inflation would be a remarkable event. What would Americans scramble to replace greenbacks with? Loonies, pesos, or bullion maybe? It would have to be something people could actually get their hands on.
Regarding the monthly fudging of the CPI, are there any organizations or individuals publishing their own aggregate price indices? I’d be curious to see the numbers.
Re: Steffan’s comment above, two points.
SK: “Without that “irrational exuberance” for these assets among the early receivers of newly created money , monetary expansion will just create a general inflation effecting consumer prices to a equal degree as asset prices.”
RB: Note that the early receivers of the new money might find stocks to be quite undervalue at the time the money print occurs. This was probably the case in the early 80s. It was only after some 8-10 years of strong markets that other investors were drawn in. But the initial recipients of the printed money may be rationally exuberant.
SK: There is also one crucial difference between Germany 1923 and America 1999-2000, namely that in the former case money lost its purchasing power against everything while there were no relative price movements. In America in 1999 and early 2000 stocks rose in value not only versus money but also against real goods and services. This implied that at some point the bubble had to burst and relative prices would have to be reversed. By contrast there was no mechanism in the 1923 German hyperinflation that would force the price increases to be reversed.
RB: I belive that there were significant relative price changes between assets and consumption goods in the Weimar period. Bresicani-Turoni devotes part of a chapter to this in his book. For some time there was a mini-stock-market boom during the hyperinflation, but in the end stocks lost in real terms and relative to consumption goods. One might expect this because real interest rates tend to become quite high during an asset price bubble so capital goods prices will be affected relative to consumption goods.
Thanks for everyone who has read and commented on this piece. There has been a vast amount of ink spilled and trees cut down on the stock mania, most of it reiterating the themes of “irrational exuberance”, greed, the hope for easy money, the lure of reward without effort, etc. What all of these have in common is that they are looking at the problem from the goods side rather than the money side. What I was trying to do here was to encourage people to look at this phenomonon from the money side: how would we see the stock bubble if we look at it from the point of view of how the purchasing power of money was changing.
This is like a mathematical change of coordinates, or taking a picture of a reflection in the mirror: same reality, different perspective. Both views in this case are views of the same reality, but by changing our frame of reference, we can see it differently. To say that prices are rising and the purchasing power of money is falling are exactly equivalent.
Note that if you believe that an asset price bubble is a form of inflation, you must accept that the purchasing power of money is falling rapidly. These are all just restatements of the same underlying reality. If some form of inflation is ocurring, then is it surprising that people would value their money less, that they would buy companies that they know nothing about, that they would casually put money into poor quality issues?
I would be more persuaded by the irrational exuberance explanation if there were know inflation; if people were allocating increasing amounts of money out of a fixed supply to finacial assets; if people were voluntarily consuming fewer consumption goods in order to buy more stocks.
I think that there are some differences between an “asset hyperinflation” and a “goods hyperinflation”. As far as I know, asset inflations have always ended by the asset prices deflating while goods inflations have often ended with the value of money going to zero. If I can figure out why that is true, then perhaps I will write another article.
“As far as I know, asset inflations have always ended by the asset prices deflating while goods inflations have often ended with the value of money going to zero. If I can figure out why that is true, then perhaps I will write another article.”
Robert, I’ve already explained that to you. Because asset inflation involves a relative price increase, a increase not only against money but also against goods and services, and because the fundamental value of assets is based upon the thing they rise in value against, the asset price rises have to be reversed or at least halted sometime.
No similar mechanism to stop the process exists when it comes to goods inflation, as goods are not based on anything else but derives its value on its use value.
Regarding the earlier linked article:
I cannot seem to grasp how selling bonds to investors results in “printing money”. I understand how the government inflates via book entries for commercial banks, but I cant grasp how the money supply is increased when an investor buys a government bond.
Very interesting article. However, I question some of the historical recovery methods in relation to the present.
A large amount of what we call “money” is now truly “fiat”. It does not event exist in paper form, but only as ledger entries in computer systems. As such, government can exert control over flows of such “fiat” money over these electronic highways.
By no means, this does not prevent us from going to a “barter system”, but the government can certainly use this to delay it.
Eric Taylor mentions the use of rents as the source of the measure for price inflation in the housing sector.
It seems to me that the CPI is not only misleading, its distortions can also drive harmful decisions. Consider the following developments:
1) Housing prices increase rapidly, in part due to low interest rate environment.
2) Renters, seeing housing prices getting away from them and low mortgage rates, are persuaded to buy.
3) Rental prices suffer, thus reducing the CPI relative to what it would have been if housing prices were used instead.
4) Greenspan sees low CPI and says “We don’t need to raise interest rates, since inflation is low”.
Thus, Fed rate remains low, not due to low inflation, but due to the impact of low interest rates on an item which is an inappropriate measure of inflation!
I am confused by our local dynamic, which is opposite of the situation put forth in the article; any comments?
In the Austin TX area, housing prices continue to be lackluster. Skilled job growth, it appears, is weak. However, builders build at an amazing clip.
Why? I beleive that all housing construction workers were “let go” and replaced with undocumented folk (based on articles I’ve read, schools swelling with immig. children and job site surveys). So builders have squeezed out huge cost components (higher wages, benefits, work. comp., sick leave, unempl ins, etc). And now one can buy a bowling-alley sized 5 BR tract home for say, $120,000.
However, folks like myself who own existing homes continue to see home price degredation due to this huge increase in inventory. Perhaps I should bail out?
I enjoyed the article.
1. What about the role of post-WWI remuneration payments suffered by the Weimar Republic?
2. Speculative bubbles are simply speculative bubbles (driven by greed and not worry). When fiat money is becoming worthless, people typically pursue hard assets, not more paper.
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