0 Days - The Countdown Has Ended - Now What?

Fire and Ice - Flames from burning lava break through the crust of a lava lake on the Island of Hawaii in the top of this mosaic image. Below, icebergs and pack ice extend as far as the eye can see off the coast of Antarctica. In both places a solid crust has congealed on the surface of a liquid.

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Fire and Ice

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.

-– Robert Frost

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Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless. A fairly crude definition of hyperinflation is a circumstance, where, due to extremely rapid price increases, the largest pre-hyperinflation bank note ($100 bill in the United States) becomes worth more as functional toilet paper/tissue than as currency.

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Excerpt from "Hyperinflation Special Report" [PDF] by John Williams, www.shadowstats.com

The U.S. economy is in an intensifying inflationary recession that is evolving into a hyperinflationary great depression.

The U.S. government and Federal Reserve already have committed the system to this course through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, and gross mismanagement.

The U.S. has no way of avoiding a financial Armageddon. Bankrupt sovereign states most commonly use the currency printing press as a solution to not having enough money to cover their obligations. The alternative would be for the U.S. to renege on its existing debt and obligations, a solution for modern sovereign states rarely seen outside of governments overthrown in revolution, and a solution with no happier ending than simply printing the needed money. With the creation of massive amounts of new fiat (not backed by gold) dollars will come the complete collapse of the value of the U.S. dollar and related dollar-denominated paper assets.

What lies ahead will be extremely difficult and unhappy times for many. Friedrich Kessler, a law professor at Harvard and University of California Berkeley, who experienced the Weimar Republic hyperinflation said:

"It was horrible. Horrible! Like lightning it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money."

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Depression/Great Depression

The U.S. economy is in a deepening structural change that has resulted from U.S. trade policies that have driven the U.S. manufacturing base offshore. As a result, a large number of related, high paying jobs have been lost to U.S. workers.

The U.S. trade deficit has risen to the highest level for any country in history, U.S. average weekly earnings, adjusted for inflation, have fallen. Even using official CPI for deflation, current real earnings are below their peak back in the 1970s. Adjusted for the SGS-Alternate CPI measure, real earnings have been falling since the early 1980s. Real median incomes for U.S. males versus females, also show declines in recent years, per official government data.

The effect of this structural change has been that most consumers have been unable to sustain adequate income growth beyond the rate of inflation, unable to maintain their standard of living. The only way that personal consumption — the dominant component of GDP — can grow in such a circumstance is for the consumer to take on new debt or to liquidate savings. Both those factors are short-lived and have reached untenable extremes. Debt expansion and savings liquidation both were encouraged by the investment bubbles created by Alan Greenspan; he knew that economic growth could not be had otherwise. Part of what is happening today is payback for those policies.

This circumstance places both the federal government and the Federal Reserve in untenable positions, where they cannot easily or rapidly address the underlying problems, even if standard economic stimuli were available. From the standpoint of the federal government, traditional fiscal stimulus in the form of tax cuts or increased federal spending have reached their practical limits, with the actual annual budget deficit running out of control at $4.0-plus trillion per year.

From the Fed’s standpoint, it can neither stimulate the economy nor contain inflation. Lowering rates has done little to stimulate the structurally-impaired economy, and raising rates may become necessary in defense of the dollar. Similarly, raising rates will do little to contain a non-demand driven inflation, such as seen in the current circumstance that is so heavily affected by high oil prices.

By the time hyperinflation kicks in, the economy already should be in depression, and the hyperinflation quickly should pull the economy into a great depression. Uncontained inflation is likely to bring normal commercial activity to a halt.

The greater the variance in income, the more negative are the longer term economic implications. A person earning $100,000,000 per year is not going to buy that many more automobiles that someone earning $100,000 per year. The stronger the middle class is, generally the stronger the economy will be. Extremes in income variance usually are followed by financial panics and economic depressions. U.S. Income variance today is higher than it was coming into 1929, and it is nearly double that of any other "advanced" economy.

Hyperinflationary Great Depression

In the United States, the printing presses have not been revved up heavily, yet, but the commitments are in place, as seen in the annual GAAP-based deficit running on average more $4.0 trillion per year. That amount is far beyond the ability of the government to tax or the political willingness of the government to cut entitlement spending. While the inevitable inflationary collapse, based solely on these funding needs, could be pushed well into the next decade, actions already taken likely have set the stage for a much earlier crisis.

The current systemic bailouts by the Federal Reserve and the U.S. government, as well as earlier efforts by the Fed to buy time, have made the circumstance worse. Pushing recent Treasury funding needs on foreign investors — stuck with excess dollars from the ever-expanding U.S. trade deficit — has created a huge dollar overhang in the markets that already has started to crumble. The more the crisis has been pushed into the future, the greater the potential for pending calamity has become.

Milton Friedman and Anna Jacobson Schwartz noted in their classic A Monetary History of the United Statesthat the early stages of the Weimar Republic hyperinflation were accompanied by a huge influx of foreign capital, much as had happened during the U.S. Civil War. The speculative influx of capital into the U.S. at the time of the Civil War inflation helped to stabilize the system, as the recent foreign capital influx to the United States has helped stabilize the equity and credit markets of recent years. Following the Civil War, however, the underlying economy had significant untapped potential and was able to generate strong, real economic activity that covered the spending excesses of the war.

Post-World War I Germany was a different matter, where the country was financially and economically depleted as a penalty for losing the war. Here, after initial benefit, the influx of foreign capital helped to destabilize the system." As the mark depreciated, foreigners at first were persuaded that it would subsequently appreciate and so bought a large volume of mark assets …" Such boosted the foreign exchange value of the German mark and the value of German assets." As the German inflation went on, expectations were reversed, the inflow of capital was replaced by an outflow, and the mark depreciated more rapidly … (Friedman p. 76)."

The Weimar circumstance is closer to the current U.S. circumstance, although, in certain aspects, the current situation is worse. Unlike the untapped economic potential of the United States 140 years ago, today’s U.S. economy is languishing in the structural problems of the loss of its manufacturing base and a shift of domestic wealth offshore.

In the early 1920s, foreign investors were not propping up the world’s reserve currency in an effort to prevent a global financial collapse, knowing in advance that they were doomed to take a large hit on their investments in Germany. In today’s environment, both central bank and major private investors know that the dollar is going to be a losing proposition. They either expect and/or hope that they can get out of the dollar in time to lock in their profits, or, primarily in the case of the central banks, that they can forestall the ultimate global economic crisis.

It is this environment that leaves the U.S. dollar open to such a rapid and massive decline, and dumping of U.S. Treasuries, that the Federal Reserve would be forced to monetize significant sums of Treasury debt, triggering a monetary inflation. In this environment annual multi-trillion dollar deficits rapidly would feed into a vicious, self-feeding cycle of currency debasement and hyperinflation.

Lack of Physical Cash

The United States in a hyperinflation would experience the quick disappearance of cash as we know it. Shy of the rapid introduction of a new currency and/or the highly problematic adaptation of the current electronic commerce system to new pricing realities, a barter system is the most likely circumstance to evolve for regular commerce. Such would make much of the current electronic commerce system useless and add to what would become an ongoing economic implosion.

Some years back, I happened to be in San Francisco, having dinner with a former regional Federal Reserve Bank president and the chief economist for a large Midwestern bank. Market rumors that day had been that there was a run on a major bank in the City by the Bay. So I queried the regional Fed president as to what would be happening if the rumors were true.

He had had some personal experience with a run on banks in his region and explained how the Fed had a special team designed to handle such a crisis. The biggest problem he had had was getting adequate cash to the troubled banks to cover depositors, having to fly cash in by helicopters to meet the local cash flow needs.

The troubled bank in San Francisco, however, was much larger than the example cited, and the former Fed bank president speculated that there was not enough cash in the vaults of the regional Federal Reserve Bank, let alone the entire Federal Reserve System, to cover a true run on deposits at the major bank.

Therein lies an early problem for a system headed into hyperinflation: adequate currency. Where the Fed may hold roughly $210 billion in currency (sharply increased in the last year) outside of $50 billion in commercial bank vault cash, the bulk of roughly $780 billion in currency outside the banks is not in the United States. Back in 2000, the Fed estimated that 50% to 70% of U.S. dollar cash was outside the system. That number probably is higher today, with perhaps as little as $200 billion in physical cash in circulation in the United States, or roughly 1.5% of M3.

The rest of the dollars are used elsewhere in the world as a store of wealth, or as an alternate currency free of the woes of unstable domestic financial conditions. In Zimbabwe, for example, where hyperinflation is underway, U.S. dollars are used to maintain some semblance of economic activity, where wages and salaries seriously lag inflation, and goods often are available only on the black market.

Given the extremely rapid debasement of the larger denomination notes, with limited physical cash in the system, existing currency would disappear quickly as a hyperinflation broke.

For the system to continuing functioning in anything close to a normal manner, the government would have to produce rapidly an extraordinary amount of new cash, and electronic commerce would have to be able to adjust to rapidly changing prices.

In terms of cash, new bills of much higher denominations would be needed, but production lead time is a problem. Conspiracy theories of recent years have suggested the U.S. Government already has printed a new currency of red-colored bills, intended for some dual internal and external U.S. dollar system. If such indeed were the case, then there might be a store of "new dollars" that could be released at a 1-to-1,000,000 ratio, or whatever ratio was needed to make the new currency meaningful, but such would not resolve any long-term problems, unless it were part of an overall restructuring of the domestic and global financial and currency systems.

From a practical standpoint, however, currency would disappear, at least for a period of time in the early period of a hyperinflation.

Where the vast bulk of today’s money is not physical, but electronic, however, chances of the system adapting here are virtually nil. Think of the time, work and effort that went into preparing computer systems for Y2K, or even problems with the recent early shift to daylight savings time. Systems would have to be adjusted for variable, rather than fixed pricing, credit card lines would need to be expanded daily, the number of digits used in tallying dollar-denominated transactions would need to be expanded sharply.

While I have been advised that a number of businesses have accounting software that can handle any number of digits, I also noted on a recent cross-country trip that a large number of gas stations have older pumps that cannot register more than two digits’ worth of dollars in their totals or more than $9.99 per gallon of gas.

From a practical standpoint, the electronic quasi-cashless society of today also would shut down early in a hyperinflation. Unfortunately, this circumstance rapidly would exacerbate an ongoing economic collapse.

Barter System

With standard currency and electronic payment systems non-functional, commerce quickly would devolve into black markets for goods and services and a barter system.

Unlike Zimbabwe, the United States does not have widely available, for circulation, a back-up reserve currency for use in place of a highly-inflated domestic currency. The alternative here is in the traditional monetary precious metals. Gold and silver both are likely to retain real value and would be exchangeable for goods and services. Silver would help provide smaller change for less costly transactions.

Other items that would be highly barterable would include bottles of a good scotch or wine, or canned goods, for example. Similar items that have a long shelf life can be stocked in advance of the problem, and otherwise would be consumable if the terrible inflation never came. Separately, individuals, such as doctors and carpenters, who provide broadly useable services, would have a service to barter.

A note of caution was raised once by one of my old economics professors, who had spent part of his childhood living in a barter economy. He told a story of how his father had traded a shirt for a can of sardines. The father decided to open the can and eat the sardines, but he found the sardines had gone bad. Nonetheless, the canned sardines had taken on a monetary value.

Reserves of the Necessities of Life

Howard J. Ruff, who has been writing about these problems and issues since Nixon closed the Gold window, rightly argues that it will take some time for a barter system to be established, and suggests that individuals should build up a six-month store of goods to cover themselves and their families in the difficult times. Mr. Ruff covers this and many other excellent fundamentals in his new book How to Prosper During the Coming Bad Years in the 21st Century.

Financial Hedges

During these times, safety and liquidity remain key concerns for investments, as investors look to preserve their assets and wealth through what are going to be close to the most difficult of times.

In such a circumstance, gold and silver would be primary hedging tools that would retain real value and also be portable in the event of possible civil turmoil. Also, at some point, the failure of the world’s primary reserve currency will lead to the structuring of a new global currency system. I would not be surprised to find gold as part of the new system, structured in there in an effort to sell the system to the public.

Real estate also would provide a basic hedge, but it lacks the portability and liquidity of gold. Having some funds invested offshore — outside of the U.S. dollar — would be a plus in circumstances where the government might impose currency or capital controls.

While equities do provide something of an inflation hedge — revenues and profits get expressed in current dollars — they also reflect underlying economic and political fundamentals. I still look for U.S. stocks to take an ultimate 90% hit, peak-to-trough, net of inflation, during this period. Where all stocks are tied to a certain extent to the broad market — to the way investors are valuing equities — such a large hit on the broad market will tend to have a dampening effect on nearly all equity prices, irrespective of the quality of a given company or a given industry.

Other Issues

A hyperinflationary depression would be extremely disruptive to the lives, businesses and economic welfare of most individuals. Such severe economic pain could lead to extreme political change and/or civil unrest. What has been discussed here still has not been a comprehensive overview of all possible issues, but rather at least has raised some questions and touched upon some likely consequences. No one can figure out better than you the peculiarities of this circumstance and how you and/or your business might be affected. Using common sense is about the best advice I can give.

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Read the entire report and view the supporting charts here: "Hyperinflation Special Report" or here [PDF] by John Williams, www.shadowstats.com.

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"...absolutely safe... ...fully protected... ...never lost a penny of insured deposits... ...none ever will... ...none ever will..."

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Related: The Day the Dollar Falls

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For those who really want to understand the engine of the 'Too Big To Fail monster' driving the U.S. into hyperinflation, don't miss this article from Zero Hedge.

Favorite quotes: "...the value of the dollar would go down by 1E10-15: you listening yet American middle class?"

"...thank you Mr. Einhorn [hedge fund manager] for finally starting to focus people's attention on one of the many facets of the Fed's uncontrollable liquidity Frankenstein. CDS [credit default swaps], while destructive, is merely the appetizer. What will truly annihilate financial markets are all those instruments that are in place only to perpetuate the myth that a 5% interest rate in 30 year Treasurys is somehow exorbitant (based on a quick back of the envelope calc, should prevailing interest rates move higher by 1%, the net IR exposure will rise by $3 trillion... in the wrong direction... at an exponential pace). Yet what better way to keep rates where they are than than to tell China: "Hey guys, you bust one auction, and this spring loaded balloon full of $420 trillion pieces of worthless Washington feces will blow up right in your face (and take us all down with you)." In essence this is an amusing revision of that old fable: the Fed owes the world a few billion here and there: well, Ben, you are out of luck, "You're Fired"; the Fed owes the world $1.4 quadrillion in naked and worthless pieces of paper (whose nudity will become apparent the second someone calls Bernanke's bluff) and the Fed owns the world."

Favorite reader comment by Cognitive Dissonance :

"There has to be a way to make the real risk in this mess clear to the average American."

"At first I thought the average American was simply too frightened to process information about the severity of these problems and to a certain extent I still hold that view.

But the problem sweeps across the education and occupation spectrum and in my view actually gets worse as you move up the ladder. This isn't simply an education or exposure issue. After I began asking more detailed questions, the picture became clearer to me. Mr. & Mrs. average American is worried about their piece of the pie, that they won't get out of the poker game before it's busted.

They bought into the economic system, often working at miserable jobs for years or decades in order to accumulate wealth and pensions. Now, with retirement around the corner, the economic vehicle is coughing and sputtering and might not make it to the end. I've posted before on ZH how Americans are deep captured by the system. In their minds, their ticket is stamped and thus non refundable, they're on the plane at 35,000 feet, it's two thirds of the way to their destination and they're committed regardless of how they feel about the situation.

The higher up the social/economic curve you travel, the more they're dependent upon a functioning system in order to "cash out" and retire. And that's how they see it. Cash out. While they do understand that most of their assets must actually remain in the system in order to be usable, they see a finish line, not a 20-30 year retirement process. They see their money as a pile that once accumulated, can be moved off the table to somewhere "safe" which is the actual word they use.

Reasonable or not their view is mostly fearful optimism. While things are going to hell, they will probably survive the plane crash mostly intact. This is more along the lines of wishful thinking or even head-in-the-sand denial than a thoughtful careful analysis of their own situation. You might be surprised how many doctors, lawyers, engineers and upper management types secretly pray to the God of their choice to just get them to their destination.

Not everyone feels this way and awareness varies. Those lower down the curve have less accumulated and thus less to lose. We ZH readers must remember that we do not represent "average" people, Americans or otherwise. We are engaged, curious, reasonably informed and for the most part mad as hell. Average Americans are not and I'm becoming convinced that up to a certain point and for the most part, this is a deliberate and conscious decision.

BTW, here is a link to a .PDF chart showing outstanding derivatives as measured by the BIS. Please don't leave it lying around for little children to pick up and possibly shoot someone with.

http://www.bis.org/statistics/otcder/dt1920a.pdf

BIS.org -> Statistics -> Derivatives

This table is chart 19 but there's other data there that will curl your hair."

Click graphic to enlarge.

Happy Sunday. :/ - c