John Williams Hyperinflation Interview Part 2

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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, last week we had John Williams on the program and of course, again, as promised, we have him on this week. The subject was hyperinflation, as much as we would like to avoid it.

David: There is the classic funny question and answer, “How did you go broke?” “Very slowly, and then all at once.” That really captures the idea of hyperinflation, where it didn’t appear on anyone’s radar screen, and then all of a sudden it was the state of affairs. There was no gradual slippage. We saw that in Germany, going from 6% in 1918 to 100% in 1919, and then into the thousands of percents per year, a very rapid acceleration.

One thing we want to talk about, John, as we enter the conversation today, is the velocity of money, being either an indication of a return to economic health as it picks up, or as people are dumping their currency and it spins out of control and the velocity ends up being a multiple of what anyone could expect it to be.

John, this last year, on our film, one of the things that we talked about was the importance of the velocity of money. Essentially, velocity is flat, the transmission mechanism. The central banks can print, and they have created a tremendous amount of liquidity, but what we find is that excess reserves are being held with the Fed.

There is not a lot of circulation of liquidity, printed liquidity, provided into the larger economy. You might see velocity pick up if the economy was picking up, but you could also see velocity spin out of control and rapidly ramp up in a hyperinflation. How would you suggest we view velocity? Conceptually, how would it be a helpful tool for us to anticipate entering the next round of inflation, super, or even hyperinflation?

John Williams: Conceptually, velocity is very important. Velocity – the number of times that the money supply turns over in the economy – is part of the basic formula that relates economic and inflation activity to the growth in the money supply. It is very difficult to measure because, as a residual, the GNP numbers are worthless, the GDP numbers are worthless. They are not heavily modeled, as I mentioned earlier, just to take a look at what is happening with payroll, the number is an indication of relative economic activity.

The GDP, as it gets reported, is net of inflation, but the inflation numbers are underestimated, deliberately. The methodologies have been changed to reduce reported inflation. If inflation were accurately reported, the inflation-adjusted GDP would have shown a deeper decline and absolutely no recovery, and the official GDP right now actually is higher than it was before the economy turned down.

But it is challenging to find any other economic statistics that show that pattern. It hasn’t happened. It is all in the gimmick-weighted GDP reporting. So you divide that by the money supply and the best the government does right now is report M2. I still follow the old M3, which was, at the time, the broader measure. They used to report an L measure, including private holdings of treasury bills. They chose not to continue reporting on that, but even with the M3, there are issues in terms of what is being measured, and when you are dealing with the world’s reserve currency, you also have to consider the money supply that is sitting outside the system, sitting outside the United States.

Whereas M3 right now is maybe around 14 trillion dollars, there is at least a 7-trillion dollar overhang of dollars that can be dumped into our system, and you have to consider that a little bit in terms of how it works into the overall velocity picture. Basically, what you are talking about is a basic number. The faster the velocity turns over, people don’t want to hold the dollars. That becomes a key element of the hyperinflation, and again, we may already be seeing that.

Consider that, within the traditional spectrum of investment sold by Wall Street, there is no safe investment out there in which an investor can put his money and beat inflation, even as reported by the U.S. government. In that type of a circumstance, you would do better to take your cash and go out and buy the consumer goods that are inflating, because at least you will keep up with inflation that way, and you would be ahead of what you would get on a Treasury bill. And people are beginning to see a little bit of that. That tends to spike the velocity.

Again, there is no easy way to measure it. It is a matter of having to look at it anecdotally as to whether or not it is picking up, but there will be a rapid pickup here again as we see the panic decline globally, dumping of the dollars. No one wants to hold the dollars. You will see that beginning in the U.S., as well. As that pace accelerates, the velocity will be a major factor driving the prices higher.

David: You are talking about not only M3, but the international supply of U.S. dollars, which the 14 trillion plus the 7 trillion – $21 trillion total – would be a basic footprint for greenbacks. Now, of course, you are talking about a multiple of that, depending on how fast it goes through the economy. 21 x 2, 21 x 3, 21 x 5 – however many times that $21 trillion is being circulated – that is, in fact, what can be deceptive at the front edge of a hyperinflation. Because with that increase in transactions, if you will, we are seeing business return to “normal,” but it is not actually normal. It is like the surfer who thinks he has the perfect wave, not realizing it is a tsunami. He’s going to enjoy it.

John: It isn’t even necessarily returning to normal. There is an important point, here, in terms of inflation. There are a couple of kinds of inflation, the way consumers see it. The healthy kind is when you do have a strong economy and people have money, and they are out spending, and there is more money chasing too few goods. That is a relatively happy circumstance – production increases – those are good economic times, even though you may have higher inflation.

Then you have the not-so-happy inflation, which is what Mr. Bernanke has been creating, and again, we have to go back to 2002 when the Fed chairman got his nickname of Helicopter Ben, he made a speech on how the Fed could always prevent a deflation. There was a fear of deflation. The fear is of the type of deflation that was seen during the Great Depression where prices dropped maybe a third, in aggregate. That reflected the contraction in the money supply. The money supply contracted a third.

The reason they had that terrible deflation, although people argue that deflation has positive elements to it, as well, I am not getting into the merits of deflation or inflation here, but just how it works mechanically. The reason we had that sharp decline in prices was because of the collapse in the banking system, and with the number of people having cash in the banks actually losing their deposits. They no longer had the money they thought they had, that they had had on deposit with the bank that failed.

In the current era where we have the FDIC and the Fed steps in or the Treasury steps in, in a crisis such as we had in 2008, and pretty much guarantees everything there, then the people holding cash in banks are covered. But as they lost the cash, that created the collapse in the money supply. The debt crisis didn’t crash the money supply, so it was a little different. The bank lends a million dollars, you spend that in the system, it goes all over the place, and, in theory, if the system is operating normally, which we have not seen in some years, that million dollars will end up as 10 million dollars of money supply.

Then you default on your loan to the bank, the bank comes to you and says, “Give me back the million dollars,” and you say, “I’m sorry, I can’t do it.” The bank can’t go into the system and pull out of the system that million dollars, or the 10 million dollars, and the money supply that million dollars created. So it doesn’t contract the money supply. What it does, though, is hurt the balance sheet of the bank, and as the bank’s balance sheet takes a hit, its ability to lend is reduced.

That is part of the reason behind the lack of growth in bank lending that we are still seeing – very, very weak. That is the reason we are not seeing the growth in bank lending, because the banks are not stable, they are not long-term solvent, or the system isn’t. So they are not lending the money, and they’ve slowed the money supply, but now the money supply is growing and I can tell you that of the last numbers that we have tracked, three were at the highest level in something like 28 months, and the most recent numbers are suggesting it is beginning to spike a little bit.

David: There are concerns, domestically, and you mentioned that. Something as basic as food delivery and what can happen on the basis of that, causing civil disorder in the event of a super or hyper-inflation. We also live in a world where the U.S. dollar is the reserve currency and there are over 50 countries that are dollarized, that actually use the U.S. dollar. What are the geopolitical implications for these dollarized countries, and for our foreign relationships, as we move toward a hyperinflationary end game?

John: It is not going to be very good for those countries that are dollarized or those that try to peg to the dollar. They will be suffering the same type of debasement in the currency that we will be seeing here. We will see all sorts of effects. There is some moaning and groaning in China about importing inflation from U.S. monetary policy, but that’s because they are still pegging their currency to the dollar, to a certain extent, and as the dollar sinks, and this is where the inflation comes in, I sort of got distracted from that, but as the dollar declines, and we have plenty of dollar-selling ahead of us.

Right now we are seeing an artificial propping of the currency, but, as the dollar declines, we have commodities such as oil that are denominated in dollars, and the way that the effect works through in the markets is that the dollar decline will tend to spike prices in dollar terms. That becomes inflationary. To us, the inflation that we have seen in the United States over the last year, the pickup there, we are still up nearly 3½%, year over year, it has a long way to go to the upside, but that is not because of any underlying strength in the economy. It is largely due to higher gasoline prices, which are not due to strong demand, it is due to the dollar distortion and the spike in oil prices.

The higher oil prices also are working their way into the broad economy. I can’t think of any commodity more important than oil in terms of its impact on consumer inflation. Any goods that get transported, driving energy, the pharmaceutical industries, a lot of materials based on that, chemical industry, fertilizers, plastics – all that is tied to the price of oil.

Bernanke likes to push the concept of core inflation, which is the inflation measure, net of inflation, including energy. Absolute nonsense to look at that on a long-term basis, because those are two of the most important components of consumption for individuals. If you look at it on a monthly basis and say, “Oh yeah, there was a big jump this month,” but that is because oil prices were up, or food prices were up.

That’s a legitimate consideration, but when you look at it on a year-over-year basis, you are no longer looking at short-term distortions, and guess what? If you look at the core CPI, as published by the government, it started turning up when Mr. Bernanke started to jawbone the dollar lower before QE-II, and it has risen every month, year over year, since then.

And we are likely going to see another jump of that in the month of December, which, as we are talking, is just ahead of us. It is spreading throughout the economy. This next round of inflation or weakness in the dollar will be much more severe in terms of its effect on commodities and plus, people have to go to work. They are going to buy gasoline. They may not go for leisurely drives in the country, but it is going to be cutting into their available income, and they are going to turn all the cash they have over faster and faster to just try to stay even, let alone gain, in what people would hope for as a healthy economy. But we are not going to have a healthy economy, as we go into this.

David: Let me ask you just to peg a probability. As we look at 2012 and see that there has been very little political will to address the circumstances that we are in, from a fiscal and economic standpoint, what do you think the probabilities are of our government leaders, and the folks, both between Washington and New York, kicking the can down the road, specifically into 2013, past the election? Can we see them buy time for 12 months, or is the probability too great of seeing this domino effect from Europe?

John: Well, they would certainly like to kick the can that far down the road. I will contend they can’t. They will try, but in order to be able to do that, they still have to get people to buy the Treasury funding needs, which they are having trouble doing, to wit, the Fed has done all that the last year. And they find that the Fed has to come in and become the lender of last resort to the U.S. government. The hyperinflation follows very quickly with that, and along with that, the rest of the world is dumping the dollar.

What is distorting the dollar right now is the distraction of the problems in Europe. That will pass, and the Federal Reserve, the U.S. players in this will do whatever is necessary to protect the U.S. banking system from collapse. But as the European situation eases back the markets will begin to say, “Gee, what’s going on here?” And the elephant in the bathtub is the dollar, and people have been missing that.

They started to see it in August, and then we could have been off to the races at that point in time, but again, we can expect that there will be interventions, sleight of hand, all sorts of things that will come into play, but it doesn’t change the underlying fundamentals. They don’t have until 2015 to keep the markets at bay. The global markets will turn on the dollar, and they are very close to doing so.

If you are OPEC – and this is where the dollarized countries come in, too – the dollar is going to be debased, and that is the policy of the Fed. That is what Mr. Bernanke wanted to do. We can always prevent deflation, which is the fear of what we had in the 1930s and the effects of the banking system collapse. We can always, with the central bank working in concert with the sovereign power – they can always debase their currency, create inflation. They can. It’s easy for them to create inflation or to knock the economy down. The negatives are easy to do.

What is very tough to do is to contain the inflation and to stimulate the economy, but they can’t do either of those at the moment. The actions that it takes are aimed at maintaining banking system solvency, and all of the talk about stimulating the economy is just fluff for popular consumption and acceptance of the policies.

David: We’ve seen the Saudi Oil Minister raise the expected oil price from $75 a barrel to $100 a barrel just this week. I think it was in 2008 that they contended $75 was sufficient and that is what they would target. Now they say $100 is sufficient and that is what they will target. I think you are right. What we are seeing from the 2008 to 2011 period is an adjustment, if you will, an accommodation, of lower dollar values and dollar instability, anticipating that into the future, reflecting on a per barrel basis.

Let me ask you a quick question on our domestic politics and then we will wrap up. We are in an election year. We should see some statistics absolutely tortured to sing the song that they are supposed to, whether it is for the incumbent or not, and we are interested in – if this is 2013, 2014 – an era of hyperinflation. We are talking about the political party that wins; it will probably be anathema for the next 10, 20, 30 years. It really isn’t a time to go out and pursue victory, is it?

John: This could break before the election. We have all sorts of unusual things at play here. Over the last century, generally, the presidential elections were very predictable, given income growth, net of inflation. And, at least in the way it used to be measured, whenever disposable income, the take-home pay, of the average individual, was above 3.2%, the incumbent party retained the White House, and when it was below 3.2% of income, the incumbent party lost the White House, and that worked consistently over time.

We are seeing no growth in disposable income now, net of inflation. This is the type of environment that, with two parties, Mr. Obama would be facing forced retirement at the end of the year in 2012, just due to the economy. The economy hurt George Bush. That’s one reason that Obama was elected. But what we are seeing here is so severe, and so painful, that it can bring about unusual change – enough so that the establishment guys may have some surprises, and I say the establishment guys – governments are corrupt. They have been as far back as governments have existed.

As long as people are doing well, the average person doesn’t seem to care too much. But once they start feeling economic pain, they tend to look very closely at the people running the circumstance, and that is when the guys that have been having a great time run into some trouble. This is the type of environment in which if there is no real change offered by either major party that you could have a third party come to the fore, and maybe knock either the Republicans or the Democrats into third party status.

My betting is that we are probably not going to see a change in the establishment kind of president in this election which will, again, just accelerate and doom the process for hyperinflation. If you had someone who could, today, go in and actually argue for the change and make changes and talk honestly to the American people and say, “Hey look, we’re bankrupt. This has been a problem with both parties over the years. We have gone beyond our means and if we don’t bring it under control now, our style of life, and our financial world, as we know it, is not going to survive. We have to make painful cuts that are going to affect almost everyone in these circumstances.” Then the American people could understand and rally around. They already sense there is a problem.

If that is not addressed by the major parties, we are going to have a third party. I don’t know if it is going to be powerful enough to make the change, but if we can get a real shift so that instead of lacking the political will to address the system, we have the political will to overhaul it, maybe there is something that can be done to enforce the law. I don’t see it happening, but it would be good if it could.

I think I mentioned this with you the last time we talked. I have only been physically assaulted once for my views, and that was by a very nice elderly lady at a bank board meeting in Maine. She broke into tears and said, “All you have here is bad news. Where is the good news?” She was so upset she took a jelly donut and threw it at me and hit me right in the middle of the chest. She had a very good arm. Before I could say anything, the bank chairman stepped in and he said, “The good news is, you know it’s happening, and if you know it’s happening, you can protect yourself.”

If I saw a way the government could actually resolve this, if I thought there was a chance of it, I would be out pushing that real hard. I don’t see it happening. There’s a chance, but if I had to put the odds on it, it’s not going to happen, which means I’m out talking about how you can protect yourself. That’s what the individual has to look at. The system, I think, has gone too far to right itself within the day-to-day politics that we have seen for the last 30-40 years. It will become self-righting as the system gets into this terrible financial turmoil.

Individuals, hopefully, will be able to ride out the storm, and they can do that by looking to preserve their wealth and assets and look at physical gold, such as sovereign coins, as a primary hedge, getting some assets outside the U.S. dollar. It is going to be primarily a U.S. dollar problem, getting into stronger currencies. When you look at the artificial intervention, those things don’t last, and usually provide an opportunity for people who are betting against the intervention.

If you can protect your assets, keep them liquid, you will ride out the storm. Then you are in a position to not only have survived, but you will be in a position to make some very unusual investments after the fact, or you will be happy that you were able to maintain your assets and liquidity. If we don’t get something like the Ron Paul bill, which gives you backup to the dollar, and again, my betting is that you are not going to see anything there.

You also need to look at personal safety. If the grocery store shelves get cleaned out, you should have a stock of canned food, like you might for a natural disaster. I’m crazy enough to be sitting here on the Hayward fault in California. I didn’t come out here to sit on the Hayward fault, I came out here to be close to family, and we discussed these issues, but I am, nonetheless, here, and beyond whatever I am looking at from the financial standpoint, I do have a stock of goods that would see me through an earthquake.

You should look at disasters that could hit you and where you need to be prepared and have a basic store of goods that will get you through a couple of months before a barter system would kick in, for example. Do that for a man-made disaster, as well as a natural disaster. Use stuff that you can circulate and turn the inventories over. There is very little cost to that. And in fact, in an inflationary environment, in which we are now, when you look at consumer goods against what you can get in the way of return on a T-bill, you are actually saving money.

David: John, we appreciate you joining us again, and we will certainly want to have this conversation again before we get to that outside date of 2014. There is a story to be told within the statistics that you look at, and we want our clients and listeners to be well advised ahead of time, to make the requisite choices, the needed choices, so that they are not surprised and held captive by being on the wrong side of things, forced to play the patience game and wait it out.

We, again, look forward to the future conversation and appreciate your contribution. Shadowstats.com is where our listeners can go and download the Hyperinflation Special Report. Looking at last year’s is of great value, and we would also encourage you to subscribe to the service and look at the update. That will be out in the next few days.

John, thanks again for joining us.

John: Thank you so much for having me.

Kevin: David, I think the summary of what John was saying is, in a way, a little bit spooky. He is talking about hyperinflation, but he also has made a very clear point, both last week and this week, that this is probably unsolvable with any political solution.

David: Kevin, there are political solutions, but they are not on offer, and that is what I think we are missing in terms of the stock of folks who are coming into the election cycle this time around. We would have to go back to the Harding administration. We would have to consider cutting the budget by 50%. We would have to take dramatic action to see a major fix on the fiscal side of things, and that is why we see this correction as primarily a correction via the currency. And we translate hyperinflation, or superinflation, as correcting the financial excesses of the last 20-30 years via an adjustment in the currency to a much lower value.

Kevin: Honestly, David, this show is not really trying to correct the country’s problem, or the world’s problems. We are too small for that. But what we can do is to talk to each listener and say exactly what John Williams said, and that is, if it can’t be solved politically, and it may not be able to be solved economically on the large scale, you have to protect yourself. You have to preserve your assets, and not just survive, but maybe thrive, maybe be able to have pennies on the dollar types of buys on the other side of this tunnel.

David: I think having an open mind, Kevin, and being willing to take certain actions now, just makes sense. As he said, it is very common sense when you live in California to prepare for an earthquake, because these things do happen. Yet, you live your day, hoping for the best, prepared for the worst, and being ready for anything. That is, I think the way we need to enter 2012 and 2013.