Ballsy or Crazy? Where Are We On Inflation and Hyperinflation

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

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.

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About Gonzalo Lira