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[ThatHawaiiGuy]

THE SHORT HAPPY LIFE OF FIAT CURRENCY
By Christopher Mayer

"We inflate our paper currency, we repair commerce with unlimited credit, and are presently visited with unlimited bankruptcy."

- R.W. Emerson, The Young American, 1844

According to the Chambers Dictionary of Etymology, the quotation above was the first appearance in English of the verb inflate - meaning an increase in currency. If only Emerson could see now what inflating has wrought.

In the pages of a book titled "Triumph of the Optimists: 101 Years of Global Investment Returns" there is a spread of telling graphs conveying the inflationary damage done to the world's currencies. Here we can see that not only the dollar, but also all paper currencies, are engaged in a race to the bottom.

Monetary inflation is uniquely a 20th century problem that continues to the present day. Prior to that, monetary systems, such as they were, consisted of commodity-backed money. Inflation, then, was most often a product of temporary suspensions of the commodity standard, usually occurring during wars or panics.

At times, inflation also occurred as the supply of gold and silver grew. There were spikes in some countries and regions during certain periods of time when the supply of gold jumped due to discoveries and such (in California during the gold rush, for example). But, by and large, a dollar in 1900 had held its purchasing power with the dollar of 1800.

The 20th century American had a vastly different experience. As the "Triumph" authors note, "A dollar bill put under the mattress 101 years ago would today have only 4.2 percent of its 1900 purchasing power, that is, four cents in 1900 had the same purchasing power as $1 in 2000." Said another way - that's a loss of 95%.

Furthermore, the pace of price increases was much greater in the period subsequent to 1970, where, as "Triumph" notes, annual prices rose at a 5.1% clip compared to 2.4% for the first seventy years of the century.

What is particularly scary about the dollar is that it has been the third-best-performing currency in the world. Only the Swiss franc and the Dutch guilder (by a very small margin) have held up better. In the UK, for example, the rate of price increases over the same full 101-year period was 4.2%, compared to the 3.2% in the U.S. - a seemingly small difference. And yet, compounded over time, U.K. prices increased 55-fold, a factor more than 2 times that of the U.S.!

In a line graph found on page 92, the authors show us a spread of sixteen currencies, plotted in terms of nominal exchange rates against the U.S. dollar. Because of the German hyperinflation in the early 1920s, the German mark just falls off the graph, literally becoming worthless. The other currencies turn in visibly worse performances than the dollar, with the aforementioned exceptions of the Swiss franc and Dutch guilder.

Keep in mind, as I pointed out earlier, the dollar has lost 95% of its purchasing power...and yet, it still beats almost all of its rivals, sometimes by very large margins. The performance of fiat currencies in the past century has been dreadful.

But what has changed? If anything, the monetary setting of today is worse than that of the 20th century, for at least in the earlier part of that century there was still a gold standard. Really, up until 1971, there was some semblance, however weak, of an international gold standard.

The monetary shackles on today's central bankers are, I would argue, much more lenient. Hence, the threat of inflation is far more lethal. As horrid a performance as the dollar turned in for the 20th century, the 21st might make it look pretty good.

Paper monetary systems have a tendency to blow up, in what is commonly called a hyperinflation. They are really not so rare, looking again at the 20th-century experience, as one might suppose. Yes, there is the famous German hyperinflation of 1922-23, where price inflation was 3,422% in 1922 alone (and where, in January 1923, one could buy a dollar for 20,000 marks - but by early November it took 630 billion marks to buy that same dollar). The numbers are simply staggering and hard to comprehend. Yet, Hungary's hyperinflation of 1945-46 was even more spectacular, with price inflation of 19,800% per month.

Phillip Cagan wrote, in the 1950s, what many consider to be a classic study of hyperinflation, in which he set the definition of the term at an arbitrary price inflation rate exceeding 50% per month. Even so, Cagan finds seven hyperinflations meeting his definition, the limiting factor being that these seven were the only ones where monthly price data was available. They include the great German hyperinflation, two in Hungary and also hyperinflations in Austria, Greece, Poland and Russia. These all occurred between 1921 and 1946. Witness, then, that the phenomenon was not a rare thing.

To update Cagan, I hunted around for some more recent hyperinflations. There were many, mostly in emerging markets. A recent essay by a pair of IMF researchers (Carmen Reinhart and Miguel Savastano, "The Realities of Modern Hyperinflation") revealed a bunch more, occurring in places like Argentina, Bolivia, Brazil, Peru and the Ukraine. And they don't cover them all. Further searching provided examples of devastating hyperinflations in Zimbabwe, Zaire, Georgia and Nicaragua. I suspect there are many more.

The most interesting part of the IMF researchers' essay was their conclusion. They wrote: "The benign inflation environment of recent years may lead some to believe that chronic high inflation and hyperinflation have been eradicated for good. History suggests that such a conclusion is not warranted."

[LOL!]

Indeed, that is precisely the point. Do not be deceived by recent experience. Structurally, all the pieces are in place to experience very high levels of price inflation.

Crystal ball gazing on monetary systems is extraordinarily difficult, of course. There are lots of things that can happen along the way. It was not that long ago - 1996, to be exact - that economist Steven Hanke wrote a piece titled "Argentina, the 'Germany' of South America." He meant the Germany of the post-WWII era, where the sturdy mark proved to be one of the world's most stable currencies. His case rested mainly on the passage of tougher laws and a currency board-like system.

This prediction, of course, proved very far off the mark, since the Argentina of today is recovering after its most recent financial meltdown. Far from being the Germany Hanke envisioned, it became more like the Germany of the 1920s.

This is not to say hyperinflation is imminent or even likely in the U.S., but it points to the dangers of men with printing presses. And it points to the weakness of the dollar - or any paper currency - as a long-term investment.

Regards,

Christopher Mayer,
for The Daily Reckoning

Editor's note: Christopher W. Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Christopher's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is also the author of "Capital and Crisis," a recently launched investment advisory for contrarian-minded financial observers. For details, see:


http://www.dailyreckoning.com/home.cfm?loc=/body_index.cfm&qs=


[Oh, I think nobody wants to say for fear of being branded a crack pot, you know, like THG, but I think the odds of hyperinflation are VERY high. The bankers would have their way they'd play the game for centuries and the sheeple would let them. But now we went an pissed off the Chinese, the Muslims, the Russians, the South Americans notably Venezuela and Brazil, the Africans the Europeons, a lot of Asians, Pacific Islanders...where was I? Oh yeah, they will attack our currency it is vulnerable and they know it...OIL, GOLD, DRUGS...our economy isn't exactly strong either. Nobody remebers the gas shortages do they? While we have leadership that keeps us dependent on oil and continues with fiat currency our nation is at risk and our medium of exchange runs the very high chance of hyperinflating. PERIOD. THG aka Casandra.]