But could they not institute wage and price controls? Wouldn’t that at least stabilize inflation (although not reverse it)?
I would see a good argument about a 5th amendment “taking” or a due process violation. If I owe Wells Fargo $100k and tomorrow $100k buys a cup of coffee, that was their benefit of the bargain, no different than if I buy stock in Lehman Brothers in June, 2008.
Another good fictional example of hyperinflation is in Harry Turtledove’s Timeline 191 Series which describes hyperinflation in the Confederate States of America in the 1920s (in an alternate universe where the south won the civil war).
You can demand that businesses charge only a million dollars for a cup of coffee, when the market rate for a cup of coffee is a billion dollars. What happens then is that Starbucks stops selling coffee, or sells the coffee for a million dollars but charges you a billion for the cup. Forcing below market prices means shortages. If the price controls are far enough away from the market prices it means you’ve essentially outlawed the product because no one can legally provide the service and make a profit. You can order them back to work at gunpoint, but then you’ve reinvented slavery. And so official markets disappear and goods are impossible to find at the official price, only at the black market price.
Yes, you can just declare “All prices are frozen at the price as of 10:42 AM, January 16th.” But the underlying problem that created the hyperinflation is still there–the creation of too much money. The government is creating money by fiat and using the money to finance government services because they can’t raise enough via taxes or borrowing. Declaring prices frozen but increasing the money supply will work about as well as declaring that tomorrow all prices have to be cut in half.
Money is just a medium of exchange. It doesn’t matter if a loaf of bread can be exchanged for 1 quatloo, or 10,000 quatloos, as long as when the baker takes the quatloos he can exchange the N quatloos he got for the bread for something worth N quatloos. The problem with hyperinflation is that when you pay the baker 10,000 quatloos for the bread, he can’t exchange the 10,000 quatloos for something of the same worth as the loaf of bread. In fact, he’d rather have the loaf of bread than the quatloos, and he refuses to sell for 10,000, he’ll only take 15,000. But you don’t have 15,000. And so money stops being a medium of exchange, and people turn to barter or key goods.
Chapter 10 in Liaquat Ahmed’s “Lords of Finance” has a great description of hyperinflation in Germany in 1923 and how it was brought under control. People in Berlin spent with reckless abandon. Foreigners because they could live like kings on very modest amounts of foreign currency and Germans because they had to before their Reichsmarks became worthless.
There was an NPR story about hyperinflation in Brazil in the 80s and 90s, and how a team of economists eventually beat it.
It involved, among other things, creating two currencies. The rapidly inflating currency and the new, stable currency. Slowly you transition to the new currency after the public are accustomed to having a stable currency.
http://www.econ.puc-rio.br/gfranco/How%20Brazil%20Beat%20Hyperinflation.htm
http://www.npr.org/blogs/money/2010/10/04/130329523/how-fake-money-saved-brazil
It seems to me that the people who make out in hyperinflations are those who:
-can borrow large sums
-buy up large amounts of real estate
-have access to hard assets (gold, silver, foreign securities, etc.)
Basically hyperinflation is how the government writes off debt-and the massive US Government debt looks like a scenario for something like Wiemar Germany happening again.
We had some serious inflation here in Israel in the early 1980’s - 445% in 1984 - and while I was just a little kid at the time, I quickly learned that if anyone gave me money, I should spend it as soon as possible. To this day, I have little in terms of savings, and I hate carrying cash.
The basic problem was they promised people too much and they habitually did not collect taxes completely. The obvious solution when you can’t print money is across the board cuts. “We said you get a pension/ civil service pay of Eu50,000, let’s make it Eu25,000.”
In case you did not notice, even a mild version of this went over like a lead balloon - riots, things burned down, new elections leading to indecisive results, etc.
Of course, if you had planned your life around an income of Eu50,000 then a sudden cut would cause much hardship - especially if food prices and everything else are going up too.
Economics is like squeezing jello, or trying to dam a river. If you hold somewhere, it oozes out in a different direction. Wage and price controls? Take as an example the bread subsidies in Egypt, a classic case of a situation common in many third-world countries. (They also subsidize gas and deisel). The government buys wheat, and then gives it to bakers to make bread. Bakers must sell that bread at a fixed price (IIRC about half a cent a loaf/pita). First, the government saves money by not paying farmers a good price for wheat - so better to raise sugar cane, or mangoes, or bananas, or anything where you can get a fair market price. Egypt is the world’s largest importer of wheat now, so it needs hard cash just to feed its people. The price of bread is so cheap, farmers who can get enough also use it for animal feed, since it is cheaper than (unsubsidized) animal feed. Meanwhile, there are perpetual stories about bakers taking some or all of their allotment and selling it out the back door at black market prices for other uses - thus profitting off the misery of the poor. Meanwhile, the economy is distorted because a “living wage” for a poor person in Egypt is enough to buy bread at 1/20the the real market price; without the subsidy they’d starve.
The IMF wants Egypt to discontinue such practices, since it is a severe waste of money - but if they do, people will starve, and the economy will be in chaos as nobody can afford to pay market value for food. The hole is so deep they are not going to get out quickly or easily.
…All because many decades ago, someone in government decided to help the poor who were having difficulty affording bread.
If you sold widgets or coffeee and the government set the price too low, you’d simply stop selling coffee. “wage and price controls” (as experienced in Canada thanks to Pierre Trudeau) was a euphism for “wage controls”, i.e. “we’re going to force you to work for less if you are an ordinary wage-earner.”
There’s no theory about it. The overall rate offered on CD’s is always roughly a percentage point or two below the rate of inflation. That’s part of how banks stay in business.
The caveat about “at least in theory” was sort of a comment about the whole mortgage industry, default-swap, insurance fiasco a few years ago. Should we hit a hyperinflationary period soon (or even just above-average inflation), it would not surprise me at all if we discovered that banks had grossly underestimated risk and were far less prepared than they thought they were.
You can see a real life example of this in how Greece got into the mess it did. Greece lied about its finances, but the rest of the banking world - especially europe, who was right there and should hav known better - assumed it was OK to keep lending Greece more and more unsustainable amounts of money.
Part of the problem is that as we saw with both the USA mortgage problems in 2008 and the recent Greek problems - the banks don’t go belly up for making bad choices and the bank managers don’t ither. (In fact, as we learned in NYC in 2008, they get “retention bonuses” so that they don’t quit and go elswhere - where??? - because we need the top execs to keep running the banks.) Banks will ignore the writing on the wall unless it’s written on a 2x4 and they are whacked across the head with it.
Plus, some contracts are 5 or 10 years; those are the ones where the debtors win. If you time it wrong, you renew for 1 month at 2000%; if you timed it right, your contract does not expire until after the economy has collapsed, and you forego that cup of coffee one morning so you can pay off your mortgage instead.
The current central bank systems have their major goal to avod inflation - the lesson from the 1980’s was that it is not good. However, if some simple simon (either party, R or D) gets in and decides that printing money solves all the problems, it could happen in a matter of a year or less - before the banks have time to adjust long-term contracts.
Look at what banks are offering as a 5-year mortgage, and that tells you what their economists are telling them about the longer term.
I just checked, and USAA is offering a 5-1 adjustable rate mortgage at 2.25% for years 1 to 5 and 3% in year 6. What does that say about their predictions of inflation in the next few years?
It says they (the banks) think, like the rest of the economic world, that hell will freeze over before the government of the USA will allow significant inflation. Also, they don’t have a lot of confidence in the recovery.
The interest rate should be close to inflation, or else like the story of the watch, you are giving away money.
The other risk is that if growth gets too strong, then the government will raise interest rates (as they should have done during the mortgage boom?) to slow demand for loans, to slow growth of the economy, to prevent excessive boom which could lead to the next hangover/bust. the fact that they don’t see a need for 4% or 5% says something. (Or, it could say “all of us banks are equally stupid.”)
my next door neighbor who has worked the same company for 30 years and has risen to the top of what he does (he manages the building maintenance and such for several big corp buildings) gave his two weeks notice yesterday. A few years ago he was making enough to afford the long commute to work, cover his car insurance and wear and tear and still have money to pay his bills and buy beer and cigerettes.
Now he can barely cover the commute. they are trying to negotiate giving him a company care and reimbursing him for travel expense, but he doesn’t really trust them to stick with it.
All I know is my Mom (who grew up in the depression) always talked about how bread was like 5 cents a loaf and a gallon of milk maybe 30 cents…and before she passed she flat out refused to buy many things because of their cost.
I can remember comic books being 25 cents. They are what now, 3.50 or 4 bucks a piece?
Prices don’t go back down. Hell I have a photo of a gas station sign, in my lifetime…gas, 55 cents a gallon. I was old enough to drive at the time.
A large part of that is that they are now printed on better quality paper, full colour, and with glossy covers. They’d be more expensive even with 0% inflation.
Early 70’s I paid 25 cents a gallon in southern California. But soon after, the Arabs found out that Nixon was only going to give them paper instead of gold for their oil and all hell broke loose. By 1977 gasoline prices doubled as compared to gas prices in the mid 1960’s. And then prices got even worse.
Thanks Dick!
I was in Turkey some decades back during a period when they were not having hyperinflation, but rapid enough inflation that no-one wanted to keep money in the bank. Everywhere you would see little construction projects going on: because people’s favorite method of saving value was to add on to their house.
…or it could say that they are awash in Fed cash and competitive pressures lead them to loan at funds at 2.25%: they already have enough cash parked at the Fed earning 0.25%.
The link between inflationary expectations and the long term interest rate is a mysterious one; the textbook says the link is strong but a look at the data gives this observer a shot of agnosticism. (I’m not criticizing your post, btw, just elaborating on it.)
Flyer: While we are experiencing financial repression at the moment, average 5 year CD rates offered by banks are typically above the rate of inflation: http://research.stlouisfed.org/fred2/series/BNK5YRW156N?cid=121
Figure inflation was about 2.5% last decade.
http://wm40.inbox.com/thumbs/66_130b58_7a13b9de_oP.png.thumb
Before 2009, 5 year rates were typically above 2.5%.