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More on Hyperinflation

There is a piece on Mises.org that sums up the confusion among Austrians and conservative more generally about hyperinflation.   For those of you who don’t know me I am a libertarian and don’t like the idea of a central bank but I think this hyperinflation stuff is seriously misguided and bad for the liberty movement.  There is a lot deal with here.

First, the article clearly states what the author means by hyperinflation.

Hyperinflation leads to the complete breakdown in the demand for a currency, which means simply that no one wishes to hold it. Everyone wants to get rid of that kind of money as fast as possible. Prices, denominated in the hyper-inflated currency, suddenly and dramatically go through the roof.

This is important to point out because there is a standard sequence that these arguments usually follow in which the hyperinflation side changes their definition in the middle, talking about what a dollar bought a hundred years ago and claiming that we have actually had hyperinflation all this time (look at the comments to see what I mean).  But steady single-digit inflation over decades is clearly not what they have in mind when they talk about hyperinflation so let us get that out of the way up front.

Now I will concede that if the Federal Reserve secretly wanted to create a hyperinflation, it is possible that they could.  But the argument here seems to be that they will do so accidentally because they “do not understand the true nature of money and banking.”  The narrative put forth begins when foreigners suddenly decide they don’t want to hold dollars any more.  I don’t think this is likely to happen in the near future but it is possible so let’s take that as a starting point and evaluate the hyperinflation case.  I will take it one step at a time.

Is it possible that the Fed could prevent a hyperinflation?

Simply put, the answer is yes.  The Fed inflated the money supply in the first place by buying financial assets (mainly government debt).  They can take money out simply by doing the opposite.  There is no reason to believe that they could not reign in inflation in this way if it were running higher than they wanted.

Would the Fed accidentally create a hyperinflation?

The author doesn’t even argue that it would be impossible for the Fed to prevent a hyperinflation.  Rather, he argues that they would mistakenly compound the inflation because of their commitment to low interest rates.

Committed to a low interest rate policy, our monetary authorities will dismiss the only legitimate option to printing more money — allowing interest rates to rise.

Frankly, this betrays a total ignorance of the Fed’s stated policy goals.  They are not committed to low interest rates.  They are essentially committed to a certain inflation rate and they change interest rates to try to hit their inflation target.  They have been keeping rates low and doing quantitative easing because they are falling short of that target.  If inflation suddenly shot up, they would be thrilled to let rates rise.  This way of thinking opens up a big can of worms including such Scott Sumner classics as “never reason from a price change” and “low rates don’t mean easy money” but you don’t even have to start down that path before the hyperinflation argument falls apart on this count.

Inflationary recession?

This claim is very peculiar.

Only the noninflationary investment by the public in government bonds would prevent a rise in the price level, but such an action would trigger a recession.

Presumably, the investment in government bonds to which he is referring here would be due to the bonds the Fed would have to sell to soak up the excess liquidity which was driving the inflation.  But this would not cause a recession in an environment of hyperinflation.  It is true that if the Fed did this when inflation was not running above trend it would likely cause a recession.  To understand why this is (and why the hyperinflation argument is mistaken) see this post.  But the premise is that there is a bunch of new money flooding domestic markets driving prices up which we need to take out of the system to prevent a hyperinflation.  This produces a lot of slack for the Fed to contract the money supply without causing a recession.

Also this makes no sense.

Instead, the government will demand and the Fed will acquiesce in even further expansions to the money supply via direct purchases of these government bonds, formerly held by our overseas trading partners. This will produce even higher levels of inflation, of course.

Buying government bonds is normal expansionary monetary policy but he gives no reason whatsoever explaining why the Fed would do this in the midst of a sudden dramatic inflation, he just arbitrarily says that they would.  There is no logical connection here, he’s basically just saying “then the Fed will create some more inflation for no apparent reason.”

Feedback effects?

In addition to the strange response assumed by the Fed, the author imagines a lot of reinforcing feedback effects which layer more inflation on top of the original inflation but these also make no economic sense.  For instance:

State and local governments will also be under stress to increase the pay of their public safety workers or suffer strikes which would threaten social chaos. Not having the ability to increase taxes or print their own money, the federal government will be asked to step in and print more money to placate the police and firemen.

This is profoundly confused.  He starts by saying that the domestic economy is flooded with currency previously held by foreigners.  This extra money drives prices up.  Then he claims that people demand higher prices (wages are a price) and so the government has to print more money to pay them and that causes more inflation.  Here is another example.

 Goods will disappear from the market as producer revenue lags behind the increase in the cost of replacement resources.

There is no reason to think that producer revenue would lag behind the increase in the cost of replacement resources.  The extra money would cause increased demand for final goods and services which would increase their price.  This would increase the demand for intermediate goods and services and raise their prices but it is silly to think that it would somehow raise them so much that downstream buyers would not be able to afford them.  This is the kind of classic confusion that kids in introductory econ get into when they say “demand increases which increases price which decreases demand.”  There seems to be no concept of market equilibrium underlying this, it’s “reasoning from a price change” on steroids.

Similarly, it is arbitrary and incorrect to say that state and local governments would “not have the ability to raise taxes.”  If the price of everything doubles, property taxes double, income taxes double, they would automatically raise twice as much in taxes.  No need to print more money here.

An alternate story

The thing that is so frustrating about this hyperinflation myth is that most of the story would go from making no sense at all to making perfect sense if you just took out inflation and replaced it with deflation.  Think about it.

Either because of or in spite of Fed policy, demand for money suddenly increases and velocity and prices go down.

Workers in both government and the private sector refuse to alter their union contracts to reduce their compensation.

Companies are forced to lay off workers because they can’t pay them less.  Many can’t find work because of minimum wages, government mandated benefits etc. (“sticky wages” in Keynesian speak) and end up on the government dole.

State and local governments lose tax revenue but their government workers–and more importantly their debt–is just as expensive as ever so they have to be bailed out by the Federal government.

Workers who maintain work but at lower wages can’t pay their mortgages which are as expensive as ever so they have to be bailed out.

As people realize that prices are falling, they stop borrowing money which causes the money supply to contract further.

Eventually, the Federal government has to basically buy everything with newly printed money to keep the whole country from collapsing.  It is seen as the absolutely necessary, proper, patriotic, and ethical thing to do…..

The reason I think that Austrians can’t see this is that they are committed to arguing that inflation is bad and deflation is not.  A hundred years ago they made this argument against creating the Federal Reserve and they were right then.  But now that we have had the Federal Reserve for a century, things are different.  They are still trying to mash that old argument together with the current facts and what they end up with is totally incoherent.

But you don’t have to believe in hyperinflation to think the Federal Reserve is a bad idea.  The reason that deflation is dangerous is because of the Federal Reserve (here’s how, in case you missed it above).  We’ve got a fever and the only cure is more government.  We got the fever from the Federal Reserve.  But we (conservatives/libertarians) are in denial about having the fever.  The medicine is killing us slowly but if we stop taking it the disease will kill us quickly.  The first step is to admit we have a problem



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