A “Hyper-Depressionary” State. Is it Really Coming?

You see millions of websites devoted to the topic. These would mostly be the self-proclaimed “Gold bugs” who warn us that an impending hyperinflationary event, which would significantly boost prices of all precious metals and necessities such as food, would lead to chaos as the country’s savings would vanish literally over the course of a couple of weeks.  Riots would occur. Commodities would gain in value as Fiat currencies see their end game.  Overall it portrays a very ugly picture indeed (let me pull out that Mayan Calendar).  My definition of hyperinflation revolves around a deep and sharp loss of confidence in a currency. This is different than inflation where it is simply a function of too many dollars in the economic system; however, the line between high levels of inflation and hyperinflation is quite gray primarily dominated (in my view) by “future inflation expectations”. Quick upward movements in this metric would signal to me that the public is less confident in the purchasing power of their currency, a prerequisite to hyperinflation. Another reason that I’ve thought of, though not heard much about, would be a supply-side shock in important material resources.   Regardless, I’ll come out and say upfront that there are so many headwinds, crosswinds, you name it, that predicting whether hyperinflation would occur would be akin to throwing darts. However, this will not stop me from researching the reasons why such an event may occur.

First my stance: Overall I believe that the probability of a hyperinflationary event occurring due to a loss of confidence in the US dollar remains very remote.

The other reason for hyperinflation is more unique and deserves more attention. The Fed, for all intents and purposes, is becoming a growing national security threat in my view. My main reason for such a diatribe is rooted in its quantitative easing strategy in an attempt to avoid deflation. This strategy seems shortsighted in my view from a longer-term perspective. Given the last round of quantitative easing and the low rates that it produced it is now obvious that consumers are not keen on increasing demand for loans. Despite the Fed’s best attempts to restart lending and keep the credit machine growing, the consumer has made its intentions known. They are in the process of de-leveraging and saving. Decades of profligate spending are coming home to roost; the bill now needs repaying.  Retirees must save as their largest asset (home) has taken a beating and doesn’t seem to be bouncing back anytime soon. The consumer is looking to fix its balance sheet, translating to an overall period of secular weakness in the economy.  The fundamental question that I have is whether the Fed, and perhaps more importantly, policymakers see continued debasement of the dollar via quantitative easing as a viable strategy to combat our problems. If they do, quantitative easing will continue and if it continues, I see an increasing probability of the following long-term scenario unfolding.

We continue to experience a deflationary environment over the short and medium term. At first, as it does now, it will seem that pursing a quantitative easing strategy is a more viable strategy as we have strong deflationary forces in the form of deleveraging. However, this is where I see it getting interesting. China is taking the steps necessary to boost its domestic consumption and rebalance its economy. Social safety nets are in the process of being enacted. As a Chinese official, it obviously makes sense to boost the domestic sector given that growth in export demand is not likely to continue as developed economies repair their balance sheets. We also know that presently China accounts for a large portion of demand in commodities. Its population remains mostly rural with poor incomes. What this means is that there is large pent-up demand and the prospects for accelerated and prolonged growth phase are very favorable. The day/month/year that the Chinese consumer begins to loosen its wallet and see credit as a viable tool, leading towards increased demand will bring about the moment of reckoning. For starters, commodities such as oil, copper, gold, silver, platinum and palladium would see a large acceleration in demand.  Agricultural commodities would also increase as Chinese citizens upgrade their diets. Investors would see renewed opportunities in the US manufacturing sector as exports would grow to quench the demand of the massive Chinese consumer. Job growth would stage a comeback as well as wages. Capacity utilization would increase rapidly after years of trimming down excess fat, which would have resulted in a very lean manufacturing base. We would have a major supply side-shock from higher commodity prices, coupled with low industrial capacity as the major contributors to a major increase in inflation. In the end, China’s economic restructuring would be the key that unlocks the hyper inflationary box. While an increase in jobs and higher wages are good things, the effects that they would bring (sharp moves higher in inflationary expectations) would negatively affect the retiring baby boomers and the unemployed. Furthermore, any hint of higher inflation would be met with sharply rising yields as a massive supply of bonds, which were issued  as the US built up massive deficits, would begin to be sold. Overall, we would be in an environment where persistently high yields, coupled with higher commodity and food prices would continuously sap the purchasing power of the US consumer and suppress investment in the domestic economy.  We would be in a depression, but with very high inflation as Chinese demand would ensure that important commodities retain a very high premium, while only decreasing marginally in value should there be a sell-off.  Whether our population begins to panic over the purchasing power of their dollars will determine whether we have a very bad stagflationary or hyper-depressionary event.  That would be the major wildcard.

The top risk to delaying this sequence of events would be a bout of protectionism/trade war with the US, which I do see happening. However, this would only set back this process, not prevent it. As long as our politicians and the federal reserve continue on their quest to debase our currency, the threat of a hyper-depression remains. I personally do not believe this will happen, as there would eventually be enough opposition to quantitative easing to cease it, due to fear that it may result in destroying the savings or our baby boomer population and the financially prudent (the people who are actually important towards having a healthy and sustainable economy).   However, we may very well be in a situation where Fed officials don’t realize what they’re doing until it’s too late.