By Michael J. Kosares

Black Swans, Yellow Gold – Part Four

(The following is the fourth of a five-part series on how gold performs during periods of deflation, chronic disinflation, runaway stagflation and hyperinflation. The fourth installment examines gold’s safe-haven role during a hyperinflationary breakdown.)

ANDREW DICKSON WHITE ENDS HIS CLASSIC HISTORICAL ESSAY on hyperinflation, “Fiat Money Inflation in France,” with one of the more famous lines in economic literature: “There is a lesson in all this which it behooves every thinking man to ponder.” The lesson that there is a connection between government over-issuance of paper money, inflation and the destruction of middle-class savings has been routinely ignored in the modern era. So much so, that enlightened savers the world over wonder if public officials will ever learn it.

White’s essay tells the story of how good men — with nothing but the noblest of intentions — can drag a nation into monetary chaos in service to a political end. Still, there is something else in White’s essay — something perhaps even more profound. Democratic institutions, he reminds us, well-meaning though they might be, have a fateful, almost predestined inclination to print money when backed against the wall by unpleasant circumstances.

If there is a hyperinflationary shock in the United States, the opening salvo would probably be a sudden undermining of the dollar’s status as the world’s reserve currency. Up until recently, the United States enjoyed a strong world-wide demand for its government paper. Thus, the negative effects of government deficits have been subdued. Now, with consistently low interest rates and a growing fear globally that U.S. deficits may have run out of control, foreign support for the U.S. bond market has faltered. In the absence of international buyers, the Fed already has been forced to monetize an ever larger portion of the debt — the modern equivalent of printing money. Whether or not it can follow through on its promise to reduce government bond purchases in the face of lagging foreign demand remains an open question.

Though the global demand for dollars remains the principal factor standing between relative calm and monetary mayhem, an inflationary surprise could come from another direction entirely. With nation-states around the world engaged acutely in the money printing game (and in deadly competition with one another), one cannot rule out the possibility of a generalized global descent into the inflationary abyss — at first slowly, then more rapidly until a large portion of the world’s population awakens one day to a global hyperinflationary breakdown.

Episodes of hyperinflation ranging from the first (Ghenghis Khan’s complete debasement of the very first paper currency) through the most recent (the debacle in Zimbabwe) all start modestly and progress almost quietly until something takes hold in the public consciousness that unleashes the pent-up price inflation with all its fury. Frederich Kessler, a Berkeley law professor who experienced the 1920s nightmare German Inflation first-hand, gave this description some years later during an interview published in Ralph Foster’s book, “Fiat Paper Money: The History and Evolution of Our Currency” (2008): “It was horrible. Horrible! Like lightning it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money.”

Towards the end of “Fiat Money Inflation in France,” White sketches the price performance of the roughly one-fifth ounce Louis d’ Or gold coin:

Those two short paragraphs speak volumes of gold’s safe-haven status during a tumultuous period and may raise the most important lesson of all to ponder: the roll of gold coins in the private investment portfolio.

Most Americans take the attitude that “it can’t happen here”, but the truth of the matter is that no economy or monetary system is immune to the ultimate effects of printing too much money. “Like previous hyperinflations throughout time,” says Patrick Barron, an economics professor at Wisconsin University’s Graduate School of Banking in a paper published at the Ludwig von Mises Instiutite, “the actions that produce an American hyperinflation will be seen as necessary, proper, patriotic, and ethical; just as they were seen by the monetary authorities in Weimar Germany and modern Zimbabwe. Neither the German nor the Zimbabwean monetary authorities were willing to admit that there was any alternative to their inflationist policies. The same will happen in America.” The official mindset that unleashes the hyperinflation is already present in U.S. monetary policy and to think it might be suddenly brought to heel could become the source of our undoing. History tells us that once the inflationary genie is out of the bottle, it is difficult to get it back in.

Black Swan, Yellow Gold Series 2014

Part One — Gold as a deflation hedge

Part Two — Gold as a disinflation hedge

Part Three — Gold as a stagflation hedge

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 -- Published: Thursday, 6 February 2014 | E-Mail  | Print  | Source: GoldSeek.com

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