How to survive runaway inflation

Reading time: 13 – 22 minutes

At this writing (February 2010), it seems possible that there will be runaway inflation in the United States by the end of the decade.

Americans are accustomed to low-level inflation of 2% to 5% a year — a rate common in developed nations over the last half century.

Many have tried to understand inflation, with varied results.

I define ‘runaway’ inflation as endemic “controlled” inflation at a rate in excess of 20% a year.

Beyond ‘runaway’ inflation, we have ‘hyperinflation’ which I take to mean “uncontrolled” inflation at a rate of 100% to 10,000%, or more, a year. (Note: there are no precise boundaries between this concepts.)

By “controlled” inflation I mean inflation that is permitted by the monetary authorities to vary between some target range.

For example, mild inflation of 2% to 5% is the target range generally regarded as acceptable by monetary authorities in the United States, while inflation in the range of 20% to 40% was considered acceptable to monetary authorities in Brazil during the years of the “Economic Miracle”.

Monetary authorities have various reasons for wishing to control inflation within certain limits, among which are economic theory and political expediency, combined with the notion that some limitation is better than uncontrolled spending that may lead to economic collapse of the regime.

“Uncontrolled” inflation occurs when monetary authorities do not understand how to limit inflation, or have no interest in such limitation, usually because  government spending takes precedence over stability of the currency.

“Controlled” inflation is a form of taxation

When inflation is caused by government spending not being financed by taxes or bond sales, it becomes a surrogate for taxation.

Deficit spending not covered by borrowing or bond sales results in the government ‘printing money’.  This occurs automatically as the government issues checks to pay its bills.

The practice debases the currency, making money worth less.

When the shortfall results in inflation of 20% to 40% a year, it  is a tax that transfers wealth from creditors to debtors — a form of wealth distribution that Barack Obama seems to admire.

Living with inflation

In the early years of long-term, runaway inflation, when there are more debtors than creditors, inflation can be beneficial, even popular, with that part of the public that has been profligate with credit cards and that owns homes with sub-prime mortgages.

However, once the debt-wipe-out phase is over, inflation of 20% to 40% works to the disadvantage of the working classes, benefitting the self-employed and entrepreneurs — a type of hidden taxation that does not favor public employees and wage earners.

Eventually, the population becomes accustomed to living with inflation of 20% to 40% a year.

I lived in Brazil for 23 years during a time which inflation ran constantly at this level.

During 15 of these years, I lived entirely on the local economy, without income in dollars or hard currency. These years included the Brazilian Economic Miracle.

Here is what I found:

The years 1965-1979 were the time of  the Brazilian Economic Miracle — rapid industrialization, with economic growth of over 10% a year. The capital market came to life, including a government bond market despite high inflation.

Itaipu Hydroelectric Dam: One of the wonders of the modern world.

The country had talented economic management, with such leaders as Denio Nogueira in the Central Bank, Finance Ministers Octávio Gouvêia de Bulhões, Delphin Netto, and Mario Henrique Simonsen, Development Bank Director José Garrido Torres, and Planning Minister Roberto Campos.

During this period, world-class hydro-electric dams and power plants were created at Itaipu, connected to a grid that distributed energy over a territory larger than the continental United States.

A complete automobile industrial was created, virtually from scratch, as well as industries to manufacture commercial airplanes, machine tools, computers, and thousands of other export goods.  And all of this during a time of inflation of 20% to 40% a year.

During these years, I was able to successfully set up and run two businesses, earn a good living, marry a wonderful lady, raise two children, afford two maids and a chauffeur, and accumulate sufficient assets to retire at 40, starting from scratch.

I never considered inflation a problem, having learned to live with it.  Inflation was a fact of life, like the air or warm breezes in summer. Of course, this was not hyperinflation, which is entirely different.

Most  Americans are not accustomed to inflation at this level — but they will learn fast enough if Barack Obama gets his way.

In this article, I have some tips for living and prospering with inflation of 20 to 40% a year. In such an environment, gold is not the best investment.

However, hyperinflation, as described in the ‘Hyperinflation Nation’ videos, is an entirely different matter. At such destructive rates, inflation is usually short-lived, often — but not always — bringing down governments.

In anticipation of hyperinflation, gold and other precious metals may be a good investment.

The question, therefore, is whether to prepare for runaway inflation that may persist for years, or for highly destructive hyperinflation that quickly burns itself out.  Or both?

Chances of hyperinflation

The video clips on ‘Hyperinflation Nation’  explain the causes of inflation and why the United States could face hyperinflation if the Obama administration does not reverse course.

These videos name those responsible for the current mess, including: George Bush, Barack Obama, Nancy Pelosi, Ben Bernanke, Alan Greenspan, and the US Congress.

However, since the election of Scott Brown (R-Massachusetts) to the Senate and the rise of the Tea Party Movement, there is less chance of hyperinflation than for a lower rate of controlled inflation that may be impossible to avoid after the excesses of the Obama administration.

The United States in not Zimbabwe and Obama is not Robert Mugabe — yet. There are still checks and balances on government, although almost half the population still believes in Obama. There are tens of millions of highly intelligent people who understand what is going on and who, if fired up and mobilized, can change the course of history, restore sanity, and bring economic recovery before it is too late.

The Constitution, although under attack by Obama and his allies, is still the law of the land. There are still states with fiscal responsibility and a federal form of government.

Much legislation of the Obama regime must be repealed — but there is hope that this might be possible.

Despite the dire tone of the videos on Hyperinflation Nation (which should be taken seriously), hope is not lost — yet.

Change we can hope for

If Americans hold Barack Obama to one term and take  Congress away from the Democratic Party, it is possible — but not certain — that a high level of inflation may be avoided.

Whether the American people escape hyperinflation, or even inflation of 20% to 40%, will depend on several factors:

1. How long it takes for voters to remove Barack Obama from office (or, less likely, for Obama to reverse course, and adopt conservative economic policies);
2. The amount of economic damage that Obama inflicts before leaving office, and the degree to which his policies are reversible;
3. Whether the people who take over after the Obama administration have the know-how and political will to reverse course and mend damage to the nation’s financial structure.

At this writing, it is too early to evaluate the long-term results of the Obama administration. In 2010, markets were stilled roiled by uncertainty. Unemployment was high as entrepreneurs adopted a wait-and-see attitude.

Political basis for inflation

When the fiscal deficit is determined by non-discretionary spending (salaries of civil servants, social security, government pensions, medical subsidies, and similar), political will to cut costs may be lacking.

It may be impossible or impractical to raise revenue from taxes to close the deficit.  The only alternative may be to print money, imposing implicit taxation in the form of inflation.

When the political decision is made to ‘live with inflation’,  politicians soon find that  inflation can be used as a selective tax, favoring certain constituencies by cost-of-living-adjustment regulation.

For example, if politicians favor public servants over retirees in the private sector, they can apply cost-of-living adjustments to government salaries monthly, while allowing only annual adjustments on social security payments. They can also use different indices for different constituencies.

Living with inflation

Populations can learn to live with controlled inflation — but not hyperinflation.

Hyperinflation is impossible to live with comfortably. The Yugoslav inflation of 1993-94 is an example.

Americans have lived their whole lives with a low-grade inflation running generally 2% to 5% a year.

Although over many decades, money becomes virtually worthless, Americans have learned to avoid this problem by holding tangible assets, such as homes.

When people say they fear the threat of inflation from  Obama’s policies, they are hoping to return to the low level of controlled inflation to which they have been accustomed.

Obama, like Robert Mugabe,  promises hyperinflation that will destroy the country.

I do not recommend or advocate inflation at any level.

However, I think it prudent for Americans to know how to survive controlled inflation of a higher order than they are now accustomed.

Conservative vs. radical government

The Brazilian Economic Miracle occurred in the years 1965-1979, a period during which inflation ranged from 20% to 40%.

Business boomed and employment rose.

'Jango' Goulart, a revolutionary leftist, attempted a coup d'etat to take over Brazil in 1965, but failed.

Brazilian inflation during this period was high, but under control.

In 1965, in response to soviet-backed coup led by João Goulart, the Brazilian military assumed power and installed conservative technocrats  that were determined to rapidly industrialize the nation — a goal which they met admirably and in a controlled fashion.

Brazil had experienced endemic inflation since colonial times  The country had accumulated a large, entrenched class of public employees.  The cost of public servants was a huge, non-discretionary spending item that could not be eliminated for political reasons.

Rather than trying to fire public employees or to raise taxes to the point of harming the private sector, the government decided to live with controlled inflation.  This amounted to a hidden tax on all those living on salaries and fixed incomes, including the public employees that were at the root of the problem.

Leonel Brizola, a Marxist revolutionary who was exiled after attempting the coup d'etat of 1965, was pardoned in 1980 and became Governor of Rio de Janeiro, bankrupting the state within three years.

In 1980, at the strong insistence of the American government under Jimmy Carter — a man who was similar to Obama in many ways — the Brazilian military invited the communists and left-wing agitators, like Leonel Brizola, who had participated in the failed coup of 1965, to return from exile with full political rights.

These radicals, with financing from the Soviets, soon took over government. By 1983, the country was in severe financial straits, crime soared, death squads roamed the streets of Rio de Janeiro, and fifteen years of economic chaos ensued.

Following policies similar to those advocated by Barack Obama today, these radicals pursued nonsensical, suicidal economic measures, until the country entered into hyper-inflation in 1986, a condition that grew progressively worse until 1994, when a conservative government finally brought the situation under control.

President Fernando Henrique Cardoso introduced conservative economic reforms, ending Brazilian hyperinflation and 15 years of bad government.

After 15 years of multiple Obama-like economic policies, the Brazilians chose to follow the conservative mayor of Sao Paulo, Fernando Henrique Cardoso, who introduced a successful monetary plan that ended the era of hyperinflation.

Controlled inflation: what to expect

People who have lived anywhere on earth since 1971, when the world went off the gold standard for good, know about controlled inflation and how to survive when money is constantly losing value.

As long as inflation is controlled — that is, varying between expected guidelines — people can use commonsense and figure out the best course of action.

Controlled inflation, whether on the order of 2% or 20%, has certain constants:

1. Business cycles persist. There are still economic ups and downs. Employment levels fluctuate.  Salary and wage levels still follow the laws of supply and demand.
2. The rate of inflation is not fixed, but varies. The importance given to this variance depends upon the expected range of inflation in a particular country.
3. Interest rates usually reflect the rate of inflation and taxation.  Generally, the higher the inflation, the higher the rate of interest. Nevertheless, interest rates still fluctuate with supply and demand.
4. The higher the rate of inflation, the shorter the tenure of bonds that are marketable, unless some form of monetary correction is applied.
   In this article:

   • “Controlled” inflation is a form of taxation
   • Living with inflation
   • Chances of hyperinflation
   • Change we can hope for
   • Political basis for inflation
   • Living with inflation
   • Conservative vs. radical government
   • Controlled inflation: what to expect
   • Surviving transition points
   • Your comments
   • Comments (2)

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5. Contracts may be drafted in terms of currencies with lower rates of inflation, when permitted by law.
6. The higher the rate of inflation, the shorter the terms of insurance policies that are available.
7. Budgets must take inflation into consideration.
8. Generally, people who are self-employed and run their own businesses can adjust income to inflation more readily that those  who work for others or who live on pensions.
   

   Business cycles persist, even in inflation.

9. Contracts that provide fixed income (rentals, annuities, bonds, pensions) become progressively less valuable at higher rates of inflation.
10. Real estate and other tangible assets provide better protection against inflation than monetary assets. However, this protection is not absolute. For example, the value of real estate will still vary with rentals, location, supply and demand, and age.

The important thing to note here is that once an economy settles into a certain, more or less, predictable range of controlled inflation, ordinary investment logic can be used to set up portfolios and select securities.

However, it is the periods of transitions to higher or lower rates of controlled inflation, or in and out of periods of hyperinflation, that pose the most danger.

Surviving transition points

At the time of this writing (2010), there is a general expectation that higher inflation lies in the future. However, how much higher and whether this inflation will be controlled or slide into hyperinflation is unknown.

Although Obama’s policies of higher taxation and bashing business is expected to keep unemployment high, deflation seems unlikely — excesses in government spending are simply too great.

Therefore, a strategy for transiting into higher inflation would be:

1. Avoid long- and medium-term debt and equities.
2. Avoid fixed annuities.
3. Borrow against real estate long-term, with fixed interest rates — as long as you can be assured of the ability to make the payments.
4. Hold gold, silver, and other precious metals. (See: “Will gold protect you against inflation?” for limitations on this strategy.)
5. Hold cash in money market funds. (When inflation hits, short term interest rates should rise quickly, protecting this investment.)

If it appears that hyperinflation may be developing, get out of cash held in money market funds, except for modest amounts for day-to-day needs.

Once it seems likely that the economy will settle into controlled inflation and that prices of the various asset classes will adjust to levels appropriate to current rates of interest, you should consider quickly getting out of gold, silver, and other precious metals. This type of asset pays no income and has a carrying cost.

Holding gold once there is hope that inflation will be contained can be extremely risky. As fear of inflation subsides, gold often falls in value, sometimes precipitously — well before inflation is under control.

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