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Ballsy or Crazy? Where Are We On Inflation and Hyperinflation

For better or worse, in the financial blogosphere, I’m Hyperinflation Boy.

You decide.

I haven’t actually written that much on the subject: Only five posts from a total of 82 over the last year. I posted the most recent one back in late October—over three months ago—where I made a series of concrete predictions about inflation and hyperinflation of the U.S. dollar.

The predictions were either really ballsy or really stupid—even I can’t quite decide. But be that as it may, it’s only fair and right to revisit the subject, recapitulate my arguments, and then check to see if I was on the money, or full of shit.

To begin: Last August 23, I posted an article called How Hyperinflation Will Happen. I guess the piece must’ve struck a nerve, because between my site and a couple of other places where it was reprinted, it got over half a million page views.

My basic thesis was simple: If there is another financial crisis, I argued that capital would not flee to Treasury bonds—instead, it would flow to commodities. And this spike in commodity prices would lead to dollar hyperinflation.

This argument seemed not just counter-intuitive—it appeared to fly directly in the face of empirical evidence: In the Panic of ‘08, Treasuries shot the moon, as people exited equities and every other risk asset—including commodities and precious metals—and ran for the safety of Treasuries. As an added bonus, the U.S. dollar shot up, bouyed by this rush to a safe haven.
Therefore, in another market crisis, it would seem reasonable to expect a similar outcome: Capital flows exiting whatever asset class was considered risky—as well as a few that were clearly not risky—and going to the safety of Treasury bonds and the U.S. dollar.
However, my point was that—between the deteriorating U.S. fiscal situation, as well as the Federal Reserve’s fast-and-loose money policies—Treasury bonds were the likely source of the next global financial crisis.
In other words, I argued that U.S. Treasury bonds have become a risk asset class. This was the key proposition of my argument, and I defended it both in the original piece, and in a subsequent piece called A Termite-Riddled House: Treasury Bonds.
I pointed out that, since the fall of ‘08, the Federal government’s balance sheet has deteriorated significantly (a fancy way of saying “They’re more in the hole than in ‘08”). The U.S. Federal government’s outstanding debt is currently 100% of GDP, and fiscal deficits are projected to be 10% or more every year for FY 2011, 2012, 2013 and 2014. State and local governments are at the point of collective bankruptcy, and will likely need to be bailed out by the Federal government—putting more strain on the Federal finances.
The U.S. Federal government is drowning in debts that cannot be paid. And since Treasuries are essentially unsecured debt, I argued that there would eventually be a panic in Treasury bonds—much like last May’s Flash Crash, but without the happy ending—which would lead to commodities spiking.
This surge in commodity prices would reach the consumer, and become a self-reinforcing spiral. Since the Federal Reserve cannot raise interest rates aggressively because of the weakness of the Federal government’s balance sheet, this price spiral would feed on itself, and lead to hyperinflation of the dollar.

I wrote a few other pieces around that time—What Hyperinflation Will Look Like (Aug. 26), the aformentioned A Termite-Riddled House: Treasury Bonds (Aug. 31), and Was Stagflation In ‘79 Really Hyperinflation? (Sept. 16)—which buttressed and amplified the basic argument.

Then a couple of months later, on October 28, I wrote a follow-up piece, called Signs Hyperinflation Is Arriving.

In this follow-up post, there were two noteworthy points: One, I backtracked a bit on the issue of a Treasury bond panic. And two, I made some hard-and-fast predictions as to the timing of hyperinflation of the dollar.

At the time (late October) yields on the 10-year Treasury were at around 2.50%, spreads with the 2-year were about 200 basis points—yet commodities of all classes (precious metals, industrial, agricultural, oil) were all steadily rising. This was just before the announcement of Quantitative Easing-2, but the Treasury bond market had already priced in QE-2, because of all the signals put out by the Fed in the weeks prior to the November 3 announcement.
Therefore, I began to wonder if whether the Federal Reserve could successfully backstop Treasury bonds, while the commodity markets continued rising unabated. After all, I had originally argued that, if there was a panic in Treasuries, this would necessarily force a rise in commodities. But if commodities were rising regardless of the Treasury bond market, then hyperinflation could be arrived at in spite of Treasury bond yields.
In other words, I began to think that a panic and crisis in U.S. Treasury bonds was not a sine qua non condition for dollar hyperinflation.

So I hedged on the issue of a Treasury bond panic. In the Oct. 28 piece, I wrote:

However, I am no longer certain if there will ever be such a panic in Treasuries. Backstop Benny has been so adroit at propping up Treasuries and keeping their yields low, the Stealth Monetization has been so effective, the TBTF banks’ arbitrage trade between the Fed’s liquidity windows and Treasury bond yields has been so lucrative, and the bond market itself is so aware that Bernanke will do anything to protect and backstop Treasuries, that I no longer think that there will necessarily be such a panic.

That was the major shift from my original August pieces.

The other major point of the October 28 post was that I became increasingly confident in calling for precise inflation targets, which would signal imminent hyperinflation. I wrote:

Therefore, I am confident in predicting the following sequence of events:

• By March of 2011, once higher commodity prices reach the marketplace, monthly CPI will be at an annualized rate of not less than 5%.

• By July of 2011, annualized CPI will be no less than 8% annualized.

• By October of 2011, annualized CPI will have crossed 10%.

• By March of 2012, annualized CPI will cross the hyperinflationary tipping point of 15%.

After that, CPI will rapidly increase, much like it did in 1980.

Fucking ballsy! or, Fucking crazy!—You decide.

How do these predictions stack up so far?

Well, rest assured, I’m not going to turn to John Williams’ Shadow Stats: According to his very well-researched data, 5% inflation has already been breached—and rising nicely.

But in my October 28 piece, I didn’t claim that inflation would be at 5% by the end of March according to John’s Shadow Stats data—rather, I claimed that the official inflation number, non-seasonally adjusted, would be at 5%.

Right now, we’re on track for that official 5% inflation rate by the end of March. There are a lot of signs that do not depend on subjective forecasts, which point to rising dollar inflation:

Most apropos, according to the Bureau of Labor Statistics’ January 14 bulletin, CPI-U inflation, non-seasonally adjusted, for the period January 2010 through December 2010 was 1.5%. The pace of inflation was rising in December: 0.4% higher than November’s annualized rate (Dec. ‘09 to Nov. ‘10) of 1.1%, which had been flat since June.

This BLS data is as of December 31, 2010—January data comes out February 17. Expectations among economists is that it will be higher.

Insofar as the Treasury bond market is concerned, as of this past Friday, February 4, the yield spread between 2-year and 30-year Treasury bonds—the traditional gauge of investor inflation sentiment—is at 397 basis points: Closing in on record levels, investor sentiment clearly on the side of further inflation.

The rise in yields is despite that fact that, as I wrote here, the Fed is purchasing 60% of the U.S. Federal government’s FY 2011 deficit. Depending how you count QE-lite, the Fed is creating $600 billion or $767 billion out of thin air, and using it to buy Treasuries. So the obvious question you have to ask is, What would Treasury yields—and the 2-year/30-year spread—be like without the Fed’s massive purchases? A lot uglier than they are now.

Insofar as signs of inflation elsewhere in the rest of the world, they’re feeling the pain presently—it’s the reason Egyptians rioted: Food prices are rising throughout the world, especially China and Indonesia. The poor devote a higher percentage of their earning for food, so it makes sense to see food prices affect poorer countries first, before hitting the U.S. and Europe.
(An aside about rising food prices: Several people, including Paul Krugman, have claimed that these spikes in agro prices are a result of curtailed supply, due to natural events (wildfires in Russia, flooding in Australia, drought in Argentina). However, a 5% decline in food production does not produce a 15% rise in price all on its own. By definition, it is impossible to separate the various causes for the rise in prices in agricultural products, but historical data on grain production and prices leads even a casual observer to conclude that decline in production is not the sole factor that determines agricultural commodity prices: There have been several other years where grain production has fallen—and fallen a lot worse than this past year—yet prices have not spiked to the levels that they are spiking to now. (Krugman—once again—also creates a specious and highly misleading inference, by writing: “The USDA has estimates of price elasticities. For the United States, they put the price elasticity of demand for breads and cereals at 0.04 — that is, it would take a 25 percent rise in price to induce a 1 percent fall in consumption.” This leads an unsophisticated reader to infer—erroneously—that a 1% fall in production could mean a 25% rise in price, yet allows Krugman to claim that he never said such a falsehood. Another example of his throwing a rock and hiding his hand—someone really should go over his serious work and logic-check it.))

Apart from a., the official CPI-U numbers for December, and consensus expectations of their continuing to rise, b., the Treasury bond market’s signal of inflation expectations, and c., food price inflation in the rest of the world, there is the indisputable fact that commodity prices (precious and industrial metals, oil, agro) have all steadily risen in price since December 2010; only gold has been a bit topsy-turvy.

So as of today, there are clear, unmistakable macro-signs that inflation is rising, across the board.

My March 2011 prediction of 5% annualized inflation is still two months away—but it looks as though it’ll be met. This upcoming April 15 we’ll know for sure.

If we do, then I think the July prediction is an easy money bet—the real issue will be September-October of this year: That’ll be decision-time for the Federal Reserve. They’ll have to decide whether to raise rates to stem rising inflation, or whether they’ll stand pat.

I think they will raise rates—but I think they will be timid, and raise them to match the annualized inflation rate, as opposed to doing a Volcker and shoving the rate a good 300 to 500 basis points above the pace of inflation.

But that’s for September-October. For now, this is where we are.

I don’t know if I’m being ballsy or crazy to have predicted specific inflation targets: All I can say is, it’s exciting.

This coming Thursday, February 10, at 9pm EST, I’ll be having a live debate with Nicole “Stoneleigh” Foss, of The Automatic Earth, on precisely this subject: Deflation vs. Hyperinflation.

We will be taking audience questions. You can register here.

Hope you will join us!

GL

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