Let’s look at hyperinflation in a bit more detail this is not a recommendation if you want advice tell it to your specific circumstances seek independent financial advice above me you can see stanley druckenmiller who’s an incredibly respected ex-hedge fund manager and in a recent series of interviews he said that the chairman of the federal reserve despite the three and a half trillion dollar deficit which the u.s government is currently running the fed chair jerome powell is still lobbying congress.
To do more spending which is certainly true jerome powell’s been very clear about the fact that he thinks the us economy needs more stimulus and druckenmiller also says that the fed’s going to guarantee those on wall street or any investor for that matter that he’ll underwrite that extra debt and he goes on to say that that could lead to five to ten percent inflation and that that’s going to kick in within the next four to five years but in his opinion that also raises the tail risk of deflation if we look at the history of u.s debt relative to u.s gross domestic product you can see that the first spike happens just after federal debt was first issued which is just after the u.s split from britain in the revolutionary war and it took many decades to pay off that debt the next spike in debt happened with another war which was the u.s civil war then it spiked again with world war one and that wasn’t quite fully paid off before we got the great depression.
That pushed up the debt to GDP ratio again but the really big increase in u.s debt came with world war ii but again the u.s managed to grow more quickly than its debt which is why the debt to GDP ratio fell following the second world war and in order to counteract the negative effects of the great recession the us had to use fiscal policy again which increased debt to gdp to about 100 percent and that wasn’t paid off before we got the pandemic which has now pushed debt to gdp to record levels but druckenmiller’s point is that if the fed’s buying this debt a large proportion of it then that’s increasing the supply of money and with more money chasing an equal amount of goods and services that tends to be inflationary and druckenmiller’s point about deflation is that while the fed is buying those assets it’s actually inflating an asset bubble both in the equity market but also now the credit market as people have to move to riskier assets in order to get a decent return because a return on treasuries has effectively been pushed down to zero in the uk as well if we look at the debt to GDP ratio it’s now at around a hundred percent it’s not quite as high as the us debt and it’s well below where we were at the end of world war ii but notice how even with a debt to gdp ratio of 250 percent we eventually paid off that debt.
Let’s just quickly recap what drives inflation demand pull inflation happens when you get a very strong economy because then there’s a greater demand for goods and services and then the prices that you pay for those goods and services will go up because companies will see the greater demand and raise prices cost push inflation happens if the raw materials which form the inputs to companies increase in price.
And a typical example of that in the past was when we had oil price increases so for example there’d be a war in the middle east and then oil prices would increase and that increase in the cost of transporting things but also manufacturing things would be passed on to consumers.
If your current CD values then when you import goods and services those become more expensive so that’s called pass through inflation it’s not necessarily a bad thing because your exports also become more competitive in the foreign currencies. And wage push inflation occurs if the general level of wages increases over time because then companies will raise prices for their goods and services, because they know people can now afford higher prices for those goods and services and that typically would happen when unemployment is low.
If you think about a wage negotiation if a company can’t find people to fill its roles then the people who do have the qualifications are able to negotiate higher wages and generally people who are talking about hyperinflation think that this rapid expansion of money and credit to counteract the effect of this crisis will be what triggers demand pull inflation but i remember people were saying something very similar in 2012.
Many hedge funds were saying that but they were wrong so while it’s true that money printing is the main thing responsible for what happens to inflation demand is also very important and at the the moment we’re actually seeing deflation in some assets so besides me here you can see the daily road traffic index as published by the DT. in the UK and this index is scaled so that the value is 100 in the first week of February notice how the amount of traffic drops dramatically, but then it gradually starts to recover and as the level of road traffic increased so would the demand for fuel, and also notice that as England enters a second lockdown there’s been a fall in traffic.
So we might expect that demand would fall for a second time, this is the price of west texas intermediate crude oil since the beginning of this year in 2020 and notice how it tracks that road traffic index fairly well but of course, this will depend on global demand not just demand from the UK but as demand for oil fell across much of the world you can see the effect on the price of oil.
It was disinflationary and because of the further lockdowns we’re seeing in Europe we might expect to see further weakness towards the end of the year but the price of oil is a nice example of deflation driven by a lack of demand whereas inflation can be caused by an increase in demand and in particular, I’m thinking of the example of beef in the united states . So this is the price of a pound of ground beef in the united states in dollars and the blue bars here are u.s recessions now notice that it’s not usually the the case.
There’s a huge change in the price of beef during a recession and presumably, that’s because supply and demand isn’t usually affected that much by a recession but notice what happens in 2020 which is unusual we have this massive spike in the price of beef now presumably that’s not driven by a huge surge in demand for beef just because we’ve got a coronavirus now the way we usually show inflation is as a year-on-year change in price so instead of that blue a line we’ve now got those percentage annual changes in the price of beef and that shows up this spike that we’ve had in 2020.
Very clearly and if we zoom into the percentage price change just in 2020 and the year-on-year increase in the price of beef surged in June to almost 25 percent. And the primary driver for that was the fact that many meatpacking plants had to be shut because they had many outbreaks of coronavirus so this isn’t an example of inflation due to increased demand but inflation due to a restricted supply of ground beef .
In April president trump signed an executive order saying that meat processing plants were critical infrastructure and many states took this as justification for keeping those plants open and then what we saw was disinflation when the rate of inflation starts to fall it remained positive so the price of the beef was still increasing but at a smaller rate and the important the thing we can learn from this is that it’s not just money supply which affects inflation it’s also supply and demand for goods .
At the time records the huge increase in the price of food at the time and there’s a nice little detail in this list which is that a rat would cost one franc but if it was fat from the drains that would increase the price by 50 percent.Now let’s go back to druckenmiller’s point about fiscal the stimulus is it really necessary this is the rate of unemployment in the The united states broke down by the level of educational attainment and while it’s always true that people who are better educated tend to have a lower rate of unemployment. That’s something we might all expect but what’s quite shocking is that the effect has been hugely different on different parts of society and some have considered this as a k-shaped recession the outcome has been much worse for certain parts of society than others.
So the rate of unemployment if you have less than a high school diploma is almost 10 percent whereas if you have a bachelor’s degree or higher it’s less than half that at 4.2 percent and if we break it down by race then you can see there’s a huge difference between black or African American people where the rate of unemployment is almost eleven percent. whereas if you’re white the rate of unemployment is only six percent and if we look at other variables like the participation rate you can see that we’ve moved back about 20 years in terms of female participation in the labor market.
So those people who are white educated male and wealthy have certainly not been impacted as much as those who don’t fall into that demographic makes the case for stimulus very strongly and she points out that there are still one million people every week who are newly unemployed who are applying for unemployment insurance. Now once unemployment insurance runs out you can apply for pandemic unemployment assistance but that’s going to expire in just over six weeks towards the end of 2020.
So for those who have used up their unemployment insurance the question is where can they turn if they can’t find a job and if we also include people who’ve seen a pay drop because of the pandemic brings us up to just under 26 million workers and furthermore, she points out that job growth is now slowing and if we see that graphically. You can see the proportion of people who are covered by regular state unemployment insurance which is tailing off quite dramatically and those people are depending increasingly on the other unemployment insurance schemes, which are about to expire and this is the reason why the chairman is asking on the US government to increase its fiscal stimulus.
The point is that it’s worth risking inflation pressure to ease this kind of suffering on such a large scale but unfortunately that suffering is not being felt by those who are in power who usually belong to the demographic which hasn’t been so heavily hit by this pandemic so how likely is it that we’re actually going to see hyperinflation these four graphs are taken from the book this time as different eight centuries of financial folly by Reinhardt and Rogoff and it breaks down countries into four regions Africa Asia Europe and Latin America. And it looks over two centuries beginning in 1800 and what it shows is the percentage of countries in each of those regions with annual inflation above 20 percent now the normal definition of hyperinflation is monthly inflation of 50 percent but 20 annual inflation is still very high and you can see the effect of war here very clearly.
So this is the first world war triggering very high inflation in Africa also in Europe and to a lesser extent in Asia but not at all in Latin America and then we see another spike in the second world war in the same three regions but since then Latin America has certainly made it up by having many of its own inflation crises. So what’s quite noticeable here is that it used to be the case that hyperinflation was quite common and the period we’ve seen over the last two decades or so when inflation’s been very much kept under control are quite unusual they usually tend to be three factors which recur.
The first one is having a weakened the economy that may be because of war or it could just be because of political mismanagement another fact which often crops up but not always is having a large amount of debt relative to the size of your economy but the really important factor is having an uncontrolled increase in the money supply.
And the key thing here is the word uncontrolled if there is an independent central bank whose job it is to reduce the money supply if inflation gets too high you’re much less likely to get hyperinflation a very clear example of that is Venezuela in 2016 describes how the central bank fair lost its independence and that left Venezuela vulnerable of sliding into hyperinflation.And it goes on to say how the president Maduro made the central bank his personal minting ministry despite the fact that the constitution requires there to be an independent central bank and sure enough when the central bank independence was lost then Venezuela slid into hyperinflation in fact, inflation was so severe that this graph.
Actually shows the time period for the Venezuelan bolivar to lose 90 percent of its value and before that development it took over a year for that to happen but as Venezuela switched into uncontrolled money printing the rate at which the bolivar lost value increased massively such that most recently it’s taken less then three months for the currency to lose 90 percent of its value and if we look back at previous episodes of hyperinflation you can see those three factors appearing repeatedly so where does that leave us .
Now in terms of hyperinflation are there any signs of it in the data we can currently see if we look across the UK eurozone and japan we certainly do have a weakened economy as a result of the pandemic and because of all the fiscal stimulus that’s going on all across the world we also have a large government debt to GDP and in many countries that hadn’t fallen after the global financial crisis and the effect of the pandemic was simply to push up that debt to GDP higher than it already was but in all of these developed markets there is an independent central bank which is absolutely obsessed with keeping inflation under control in In other words the increase in the money supply is far from uncontrolled.
If there is an increase in the rate of inflation these central banks will act to reduce that inflation and as Jerome Powell has repeatedly said in press conferences these lending powers have been supported with the backing and support from congress and the treasury and after the crisis has passed we’ll put these emergency tools back in the toolbox.