With the recent weakness in the economy, we can now expect the Federal Reserve to reinstate their quantitative easing (money printing) program. Most pundits now expect the Fed to print another $2-3 trillion to prevent deflation at all cost. With this level of money printing, we are likely to enter hyperinflation some time in the future (3-5 years). The deflationists will disagree, but let's face it: History tells us that large amounts of money printing will eventually lead to hyperinflation (defined as more than 50% a year). But the deflationists will deny this with Japan as an example and claim that money printing does not lead to inflation. My answer to them is pretty simple: Look at all of the countries throughout history that have printed money and see what occurred. Every such country except Japan has experienced high inflation, if not hyperinflation. So knowing that the US will suffer this fate, what can you do to protect yourself?
I have seen quite a few pundits mislead people regarding what occurs under hyperinflation and what will protect you. Many of my ideas come from the book The Economics of Inflation-A Study of the Currency Depreciation in Post War Germany by Constantino Bresciani-Turroni, who was an Italian living in Germany during the hyperinflation after WWI. He was an economist with first hand experience. It's strange to read that back during the Weimar inflation, German economists were arguing that printing money was not inflationary. Thank goodness Bresciani-Turroni set the record straight.
One thing that I would like everyone to understand about inflation and hyperinflation is that it does not occur by accident. Instead, hyperinflation is a deliberate action taken by government to impoverish its citizens and make them dependent on government. Because most people are ignorant of economics, they have little understanding about inflation and believe it to be a natural phenomenon. They are further mislead by their governments which present inflation as an external threat that must be defeated (e.g. Ford's Whip Inflation Now campaign). Governments create inflation through two primary devices: simply printing money and by encouraging excessive credit growth courtesy of negative real interest rates. We can see that the Federal Reserve has chosen both routes and is determined to achieve high inflation under a guise of "saving the economy." And the frightening part is that money printing always works in eventually producing inflation. Bernanke himself summarized this process in a 2002 speech:
the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.So we can see that by the Fed's actions, inflation is the likely result, and you need to take action to protect your savings from this real threat. The real question is what asset works best during inflation. The simple answer is that any hard asset such as gold, silver, or any other commodity will perform better than paper assets (defined as stocks, bonds, CDs, cash, etc).
Many advisers will tell their clients that stocks do well during inflation and represent a good investment to protect your purchasing power. This is only partially true because stocks do indeed do well during periods of low inflation of 2-7% but do poorly under hyperinflation. During the German hyperinflation, Bresciani-Turroni notes that stocks did rise but failed to match the rate of inflation and thus resulted in a dramatic loss of purchasing power. This came as a serious blow to many average Germans who thought they were protecting themselves from currency depreciation. In fact, by the end of the hyperinflation, stocks had lost approx. 98% of their purchasing power. The worst period for stocks was towards the end of the inflation in 1922 when they declined in nominal terms! Shares became so cheap that Daimler--the car company --was only worth $980 million paper marks at the same time a Daimler car sold for 3 million paper marks. The market was only valuing the company at 327 cars, which was far below annual production. So much for an efficient market!
Bresciani-Turroni concluded that the reason for stocks' poor performance was related to numerous factors, including loss in confidence of all paper assets, lack of money (banks restricted credit because of a severe decline in deposits), and new taxes imposed by the government. I believe that the real cause was that people became tired of investing in any paper asset because they saw their purchasing power decline. At a certain point, people just want out of anything denominated in paper money and want hard assets which maintain their purchasing power.
Gold & and Other Commodities
One of the more interesting parts of Bresciani-Turroni's study is that it shows as compared to the general population who suffered greatly. Farmers did especially well as all of their debts shrank to zero in inflation adjusted terms while their products rose in value and kept pace with inflation. People who owned gold and other hard assets did not make money but were able to maintain their purchasing power. These people were lucky since people who owned paper assets watched their entire life savings go up in smoke. Also workers became severely impoverished because their wages failed to keep up with the cost of living. Starvation along with mass homelessness occurred. Only a few businessman and speculators did well and amassed large fortunes. This was mainly due to them going heavily in debt to purchase real assets (business equipment, factories, land, buildings, etc), which they could pay back with worthless marks.
While Bresciani-Turroni did not address the topic of being self sufficient, it is a good point to bring up. The ultimate source of wealth, in my opinion, is being self sufficient in terms of food, water, energy, and home ownership. Marc Faber also recommends this and notes that if possible people should have a farm with a water source (well, sistern, etc) and power supply (e.g. solar). This way you can easily withstand any potential problems resulting not only from hyperinflation but also war and famine. If you are really self-sufficent, you will never be depedent on the government like the poor people in the Superdome during Hurrican Katrina. Because as they found out, the goverment is never there to help you when you really need it, unless you are a Wall Street Banker!
One thing to remember about high inflation and hyperinflation is that no one really benefits except a select few. The majority of people will be financially ruined because they do not understand inflation and will be left dependent on the government for food, shelter, and medicine. The only thing the average person can do is to preserve their purchasing power through the ownership of hard assets like gold and commodities.
Black Swan Insights