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Friday, October 14, 2011

How hyper inflation ignites out of seeming stability

Art Cashin, in his daily market commentary for UBS makes a stunning analogy between Germany in the 20's and the US now:

"Originally, on this day in 1922, the German Central Bank and the German Treasury
took an inevitable step in a process which had begun with their previous
effort to "jump start" a stagnant economy. Many months earlier they had decided
that what was needed was easier money. Their initial efforts brought little
response. So, using the governmental "more is better" theory they simply created more
and more money.

"But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity).

"To understand the incomprehensible scope of the German inflation maybe it’s best to start with something basic….like a loaf of bread.

"In the middle of 1914, just before the war, a one pound loaf of bread cost 13 cents. Two years later it was 19 cents. Two years more and it sold for 22 cents. By 1919 it was 26 cents. Now the fun begins:

"In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid month it was $100 billion. Then it all collapsed.

In 1913, the total currency of Germany was a grand total of 6 billion marks. In November of 1923 that loaf of bread we just talked about cost 428 billion marks. A kilo of fresh butter cost 6000 billion marks (as you will note that kilo of butter cost 1000
times more than the entire money supply of the nations just 10 years earlier).

"How Could This All Happen? "

Cashin points out that miscalculations over the cost of the first world war had much to do with Germany's ultimate collapse. This might seem different from the US situation today where we are engaged in 2 wars yet we are in no danger of having a generation of men wiped out. However, the similarity lies in the fact that the cost of our Global Military operations today as a percentage of GDP is substantially similar tot he cost of the War for Germany back then.

Cashin continues:
"In 1913 Germany had a solid, prosperous, advanced culture and population.
Like much of Europe it was a monarchy (under the Kaiser).
Then, following the assassination of the Archduke Franz Ferdinand in Sarajevo in 1914,
the world moved toward war. Each side was convinced the other would not dare go to war.
So, in a global game of chicken they stumbled into the Great War.

"The German General Staff thought the war would be short and sweet and that they
could finance the costs with the post war reparations (*think oil) that they, as victors,
would exact. But the war was long. The flower of their manhood was killed or injured.
They lost and, thus, it was they who had to pay reparations rather than
receive them. (*We don't have to pay reparations, but neither are we being compensated by oil as promised by our leaders.)

"Things did not go badly instantly. Yes, the deficit soared but much of it was borne by foreign and domestic bond buyers. As had been noted by scholars…..“The foreign and domestic public willingly purchased new debt issues when it believed that the government could run future surpluses to offset contemporaneous deficits.” In layman’s English that means foreign bond buyers said – “Hey this is a great nation and this is probably just a speed bump in the economy.”

"(Can you imagine such a thing happening today?)

"When things began to disintegrate, no one dared to take away the punchbowl. They feared shutting off the monetary heroin would lead to riots, civil war, and, worst of all communism. So, realizing that what they were doing was destructive, they kept doing it out of fear that stopping would be even more destructive...."

Whatever differences you can find between Germany then and the US today, bear in mind the fact that the entire Western economy ruled by the Fed and the ECB are attempting to offset a debt induced stagnation by creating ever more debt: which means ever more printed money.

The flip of the switch that ignites the hyper inflation arrives when there is a total loss of CONFIDENCE that the government is in control of the situation. People suddenly lose confidence in the currency. They want to trade it in for real goods - and real money - GOLD.

Will the result be different this time? Why?

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