Recently, the Federal Reserve, AKA the Fed, announced that they are going to start QE3, which is the third round of quantitative easing. This is nothing but fancy speak for, “save the banks.” I talk about this in the podcast, but you can get a thumbnail of what I said here: What Was The QE3 Announcement – What Does It Mean?
Below are the show notes for this podcast. These are the actual notes I used to create the podcast, so a lot of this will sound familiar. I decided that when I have a lot of notes for a podcast, instead of trying to convert them into paragraph form, I’m just going to paste them into here as the show notes.
Hyperinflation – What is it and how does it happen?
While it’s easy to describe what hyperinflation is, it’s a little more difficult to explain how and why it happens.
- To start, let’s first take a look at simple inflation.
- And to understand inflation, you need to understand the concept of money.
- In short, money is a currency that has its value based on a accepted standard, like gold or silver.
- You can think of money as a exchange unit, or an exchange unit for a certain amount of work value. Another way of saying this is, if you work for $20 per hour, then every 20 dollars you own represents 1 hour of your time, experience and knowledge.
- When money isn’t backed by anything, it’s called a Fiat Currency. Fiat currencies get their value from government decree or law. IOW, it has value only because some government says it has value, and it only maintains that value when it is accepted by those that use it.
- In a nutshell, though, fiat currency isn’t backed by anything and has no real value.
- This is the general increase of prices over a period of time. Bankers love to tell us that a small amount of inflation is good for a healthy economy, but this is pure BS. Both bankers, and most economists, like to tell us that inflation is good because it helps reduce the severity of economic recessions.
- What they don’t tell you is that they like this little bit of inflation because they get to pay you back in worthless dollars. You loan them your money, because that’s what you do when you put it in the bank, and they use it to make themselves a lot more money. Then, they pay you a paltry amount of interest with dollars that have lost value.
- It’s even worse now. Have you noticed that the savings rate of a typical bank savings account is below the official inflation rate? ? For example, interest rates on savings account are at about 1%. The official inflation is currently running at 1.69%, though it was as high as 3% earlier this year. Keep in mind that this is “official” inflation rate and not the actual inflation rate (the federal government needs to keep official inflation rates as low as possible for many reasons, one of which is so they don’t have to raise SS payments).
- If we check the inflation for the past year using usinflationcalculator.com, we see the overall inflation for the past year was 2.4%, but you’re only making 1% on your savings. Assuming, of course, that you deposited in a bank that’s actually paying you any interest. This is how inflation eats away at your savings. Hyperinflation is much worse.
- As it affects us, inflation occurs when the real value of an item requires more currency to buy it. IOW, the value of the item isn’t changing, the value of the money is decreasing, thus needing more of the currency for purchase.
- This can be measured by comparing the cost again foreign currencies. If something costs 10 Euros and $10, but suddenly costs $12 but still 10 Euros, the price of the items isn’t increasing, the value of the dollar is dropping, thus requiring more of them to buy the same item.
- Since 1913, it costs 2227% more to buy the same goods. Okay, perhaps a hard percentage to grasp, since most of us weren’t around in 1913. Let’s look at only 20 years ago.
- In 1992, what you could buy for $100, now costs you $164. That’s a 64% increase.
- FYI, you can’t look at single items when doing these comparisons due to advances in technology, mass production and overseas labor. Nor can you look at a single data point, such as a single date in 1992 or 2012. You need to look at the averages for a wide selection of items, which is what the CPI, or Consumer Price Index, does. This is a measure of the average change in prices over time.
- We could go on and on discussing and explaining the CPI and how it’s calculated, but there are plenty of places online where you can find out if you’re interested in knowing more.
- A couple of places are:
- This “normal” inflation is responsible for the erosion of the value of the dollar, though it’s typically slow enough that we hardly notice the year to year change in prices.
- Exporting Our Inflation
- Another thing to keep in mind is that because the US Dollar is the global reserve currency, when the create inflation, we export it to other countries. Much of the unrest in the Middle East is due to rising food costs.
- I could try to explain this, but there’s an excellent explanation on how we export inflation at:
- It’s very important to keep this in mind, because this is the sort of thing that increases world tensions.
- In hyperinflation, the inflation rate increases rapidly, requiring more and more of the local currency to buy the same goods and services.
- It’s interesting to note that the real value of these goods stays stays pretty much the same if purchased with foreign currency, this is because the foreign money isn’t losing it’s value.
- There are several definitions for determining whether hyperinflation is occurring.
- In general, “normal” inflation is considered anything under 10% per year.
- The generally accepted definition for hyperinflation is a 100% increase over a 3 year period. IOW, prices double every 3 years.
- This breaks down to roughly 26% per year. So, by the end of the first year, you’re paying 126% of what you did a year ago. By the end of the 2nd year, you’re paying 159% of what you did 2 years ago, and at the end of the 3rd year, you’re paying 200%, or about double, of what you did 3 years ago.
- Oddly, there is no official term for inflation that occurs between “normal” inflation and hyperinflation. I refer to it as Mass Inflation, and consider it anything between 10% and 25% per year, simply for a lack of something to call it.
- In general, hyperinflation occurs when the increase in the amount of money available is not supported by an increase in the goods and services of a country. IOW, instead of the money supply expanding to match that of the GDP of a country, the money is created out of thin air by just printing more of it.
- In this age of computers, most of the money created out of thin air is in digital form, not paper. Though there is a fair amount of paper money as well injected into the economy.
- To better understand this, imagine that your household budget is the economy. You get to determine how much value your money has, by how much work you do when you create things. We’ll call these things, goods and/or services.
- Every dollar in your economy is tied to a certain amount of work, which you trade with other people and their budgets (AKA other economies).
- Every dollar in your money supply has a specific value, based on the amount of work you do, and they can convert that value into their own work-value-based money.
- Every year, you print up new money to replace the old, worn out money, and when you do, you print just a little more than needed and call this “normal” inflation, telling everyone that it’s good.
- The other people with budgets know that you’re printing a little more than you need, but they let this slide because it’s only a small amount per year.
- Now let’s say that you decide that you’re tired of working and decide that it’s easier to just print more money. This newly printed money isn’t tied to any amount of work that you have done. The more printed money you make, the less valuable it is, and the people you give your money know this. At first, they warn you that all this printing money out of thin air needs to stop, because there’s no work value tied to it.
- You don’t listen and keep printing money. The other economies tell you that it’s going to take more of your worthless money to buy their stuff, because when they try to spend your money elsewhere, they’re having a hard time getting anyone to take your money. Soon, you start incurring a debt to these other economies and you print even more money, thinking that you’ll just pay it off and be done with it.
- Unfortunately for you, the other economies know that the money you’re trying to give them has no work value tied to it and stop accepting your money for the stuff you’re trying to buy, altogether.
Another “fun” project you could do is to compare this chart:
with historical interest rates:
Here is a link that I didn’t reference in the podcast, but are interesting, nonetheless.
- Historical prices of gold: http://www.nma.org/pdf/gold/his_gold_prices.pdf
Here are the links to the websites that I referenced:
- Egan-Jones cuts US debt rating to AA- from AA
- US Inflation Calculator
- BIS.gov Inflation calculator
- How does the U.S. Export Inflation?