Will the US Experience Hyperinflation?

“Inflation is always and everywhere a monetary phenomenon.” — Milton Friedman.

First, we should observe the circumstances under which hyperinflation can occur.

Hard Specie

A government using a hard specie such as gold and silver coins, still tends, as a natural result of beaucracy, to spend more than its revenues. However, the laws of pysics limit the ways in which the government can procure new metals for coinage. For example, during the decline of the Roman Empire, expenses due to a large standing army, welfare programs, and public works projects, led to increased taxes, until the tax revenue diminshed from a decline in economic activity and evasion. Rome began to debase its currency by clipping coins, issuing coins with less purity, and of no purity (tin plated copper was passed off as silver).

However, the decline occured over several decades, so we cannot actually consider this hyperinflation, even though it represents very high inflation by the standards of the old world. We should note that a hard specie intrinsically limits the rate at which a government can devalue the money.

Hard Money

I shall define hard money as paper certificates backed by a fixed amount of precious commodity. In this situation, the government simply prints more certificates than it has hard backing. If done slowly enough, the economy does not readily notice. However, at some point confidence can be lost, and people will begin to exchange the certifice for the backing. This happened to the United States, when the central bank of France decided to exchange dollars for gold. Unable to meet the exchange ratio, President Nixon responded by taking the dollar off the gold standard.

It should be noted that a hard money standard only prevents inflation if the government can uphold the fixed ratio of exchange. However, because few actually call the government out on suspected fraud, a hard money will naturally experience moderate inflation. Only if the currency fraud is overt will the money experience a hyperinflation.

Fiat Money

Although some claim that fiat currency has no intrinsic utility, that is not entirely true. As long as it remains good for the payment of taxes, it remains valued for the purpose of keeping oneself out of jail. Therefore, a fiat currency will suffice in a country with a lawfully abiding citizenry. If the government loses the ability to control tax evasion, then watch out! for the currency has lost its only remaining value.

Let’s take two illustrative examples.

When Zimbabwe experienced hyperinflation, it had experienced an expensive civil war and had confiscated white-owned farmland which was awarded to a black populace, not educated in its use. The loss in economic output and corruption have prevented the government from paying for its operations (including military expenses needed for civic unrest) in a fiscally responsible manner. Zimbabwe continues to face high international debt, which have not been canceled due to economic sanctions against the country.

When Germany incurred large debt financing World War I, which it lost. The Treaty of Versailles, required that Germany pay reparations to the victors of war. However, because of the productive capacity lost during the war Germany was not able to meet these demands. French and Belgian troops occupied the Ruhr, the most productive region of Germany. In retaliation, the government sponsored worker strikes. These benefits added to the debt and expenses, which could only be met by printing currency.

Solution

Once a populace has lost faith in its government, that loss also extends to the currency. Faith can be restored by adopting a foreign store of value. This can be either hard specie or a foreign currency. In either case, the populace regains its faith, because new currency is something that the government cannot wantonly debase.

Conclusion: Not any time soon.

Most fiat currencies haven lasted only about 40 years[1][2] since the time of their creation. Although, the U.S. Dollar begins its 40th anniversary this year, I don’t think that we will see hyperinflation any time soon. First, we do not face the overwhelming amount of external debt as did Germany’s Weimar Republic and Mugabe’s Zimbabwe. “As of January 2011, foreigners owned $4.45T of U.S. debt, or approximately 47% of the debt held by the public of $9.49T and 32% of the total debt of $14.1T”[3] Second, we do still maintain a productive citizenry, which continues to have faith in its government “During FY 2010, the federal government collected approximately $2.16T in tax revenue.[4] Third, despite the showering of currency into the M1 money supply, the Fed is actively encouraging banks to retain a high reserve ration by paying interest on reserves. This has successfully prevented an inflation of the consumer currency supply. Fourth, the dollar continues to hold a privileged position as the worlds base currency. This position is only reinforced as economic uncertainties destabilizes the European Union, as Japan and China engage in an export war, and as domestic bubbles pop in Australia.

Gary North[5] and Mish[6][7] also offer up some other reasons.

References

[1] Episodes of Hyperinflation
[2] Fiat Money Systems
[3] United States public debt
[4] United States federal Budget
[5] Mass Inflation, Yes; Hyperinflation, No
[6] Hyperinflation Nonsense in Multiple Places
[7] Fiat World Mathematical Model