The case for hyperinflation: John Williams

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investorzzo's picture
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The case for hyperinflation: John Williams

TGR: With all this new paper money coming into the system, wouldn't we see a bigger bubble than we've ever seen prior to a hyper-inflationary great depression?

JW: No, in fact, it's a very unusual circumstance that we have now. Put yourself in Mr. Bernanke's situation—he had to prevent a collapse of the banking system. He was afraid of a severe deflation as was seen in the Great Depression, when a lot of banks went out of business. The depositors lost funds and the money supply just collapsed. He wanted to prevent a collapse of the money supply and keep the depository institutions afloat. Generally, that has happened. The FDIC expanded its coverage and everything that had to be done to keep the system from imploding was done. The effects eventually will be inflationary.

In the process, what Mr. Bernanke did was to expand the monetary base extraordinarily, more than doubling it over a period of a year. The monetary base is money currently in circulation plus bank reserves. If you go back to before September 2008, the bank reserves were in the $50 to $60 billion range. Where the currency was maybe $800 billion, we've gone over $2 trillion in total reserves. Most of that is in excess reserves and not required reserves that banks have to keep to support their deposits. Normally banks would take their excess reserves and lend them out into the regular stream of commerce, and in doing so, that would create money supply. Instead they're leaving the excess reserves on deposit with the Fed. Money supply and credit are now generally contracting. We're going to see an intensified downturn in the near future. I specialize in looking at leading indicators that have very successful track records in terms of predicting economic or financial turns. One such indicator is the broad money supply.

Whenever the broad money supply–adjusted for inflation–has turned negative year over year, the economy has gone into recession, or if it already was in a recession, the downturn intensified. It's happened four times before now, in modern reporting. You saw it in the terrible downturn of '73 to '75, the early '80s and again in the early '90s. In December of 2009, annual growth in real M3 turned negative. It's now at a record low in terms of decline, down more than 6% year over year. What that suggests is that in the immediate future you're going to see renewed downturn in economic activity.

In all the prior instances that I mentioned, this event led recessions, except for '73 to '75. That's when you had the oil spike and a recession that came from that. When the money supply turned down in that recession, the economy accelerated in its decline. We're going to see something along those lines, now, with about a six-month lead time. You're going to have negative economic growth this year. The implications for that are extraordinary, because the projections on the federal budget deficit, a number of the state deficits, and the solvency and stress tests for the banking system all were structured assuming positive economic growth in the 2% to 3% range for 2010. Instead it's going to be negative. Many states are going to be in greater difficulty than they thought. Most likely, you're going to have federal bailouts there. The banks are going to have more troubles. All this means more government support, more government spending, greater deficits and greater funding needs for the U.S. Treasury. We have a global market that already is increasingly reluctant to hold the dollars and U.S. Treasuries.

machinehead's picture
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Re: The case for hyperinflation: John Williams

John Williams highlights a fundamental fact -- the Ponzi-scheme nature of the U.S. economy -- which continues to be ignored by nearly everyone:

Back in the '70s, the then Big 10 accounting firms got together and approached the government and said, "Hey guys, you know you need to keep your books the way a big corporation does. You're the largest financial operator on earth." The government then, as well as today, operates on a cash basis with no accrual accounting and such. Yet, over a period of 30 years, the accountants and government put together generally accepted accounting principles, or GAAP, accounting for the federal government and introduced formal financial statements on that basis in 2002, which supplement the annual cash-based accounting.

If you look at those GAAP-based statements and include in the deficit the year-to-year change in the net present value of the unfunded liabilities for Social Security and Medicare, what you'll find is that the annual operating shortfall is running between $4 and $5 trillion; not $500 billion as we saw before the crisis or the $1.4 trillion that they announced for fiscal 2009. Now to put that into perspective, if the government wanted to balance its deficit on a GAAP basis for a year, and it seized all personal income and corporate profits, taxing everything 100%, it would still be in deficit. It can't raise taxes enough to contain this. On the other side, if it cut all government spending except for Social Security and Medicare, it still would be in deficit. With no political will to contain the spending, eventually the government meets its obligations by revving up the currency printing press.

Government budgeting on a cash basis is a flat-out deception. But the Mainstream Media, including the financial press [yeah, I'm talkin' about you, WSJ!], continues to let them get away with it ... thus fulfilling their role as corpgov mouthpieces and cheerleaders. The 'Gen Pop' will never hear about $5 trillion annual GAAP deficits and $100 trillion negative net worth until the first Treasury auction failure.

But when it comes to Williams' assertion that the U.S. is headed back into recession because of negative money supply growth, I'm skeptical. Real money supply is one of the ten components of the Conference Board's Leading Economic Indicators (LEI). And as Williams says, real money supply is falling alarmingly. Nevertheless, the LEI (all 10 indicators) increased 1.4 percent in March, and has been rising for a year.

What we have here, on a theoretical basis, is a war between monetarism and Keynesianism. Monetarists assert if that if money supply falls, prices and the economy are likely to crater. Keynesianism says that with the fiscal accelerator nailed to the floor to the tune of a 12% of GDP deficit, the wall of spending will just blow through any resistance from a stagnant money supply.

My 'third way' suggestion is that global money supply, which is still surging, may be more relevant than U.S. money supply. The Federal Reserve's $3 trillion custody account, most of which counts in other nations' money supplies, is still ballooning at a 15% annual pace.

Also, to the extent that 12-month rate-of-change measures are being used, of course there is a recent tapering off in growth, after the huge expansion of 2008-9. However, if you examine a longer-term chart of M2, the slope of M2 growth from the beginning of the recession (Dec. 2007) until now, is just as steep as the slope in the previous years of expansion.

John Williams maintained during 1992 and 1993 that the U.S. economy was headed back into recession, but it didn't. I reckon he's making the same mistake now.



Morpheus's picture
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Re: The case for hyperinflation: John Williams

Bill Fleckenstein has a good interview on King World News where he disagrees with Williams on this. He makes a good argument. 

I'm of the belief that deflation precedes hyperinflation. No help prepping for hyper if you're under a bridge after exposure to deflation. 

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