Friday, January 30, 2009

Not to Scare you, but we must be like the sons of Issachar

Hyperinflation is a possibility, say Morgan Stanley

That’s not in Zimbabwe by the way.

Morgan Stanley’s Jocahcim Fels and Spyros Andreopoulos look at the possibility of hyperinflation hitting the western shores of the UK, Europe and the US in their latest note. Their conclusion is a little scary (our emphasis).

One stark lesson from the ongoing financial and economic crisis is that so-called black swans — large-impact, hard-to-predict and seemingly rare events — can occur more frequently than generally believed.With policymakers around the world throwing massive conventional and unconventional monetary and fiscal stimuli at their economies, we think that it is worth exploring the black swan event of very high inflation or even hyperinflation.

While such an outcome is clearly not our main case, the risk of hyperinflation cannot be dismissed very easily any longer, in our view. We discuss the historical evidence, the conditions that can lead to very high or hyperinflation, and whether and how it might happen again.

So hypinflation is a black-swan event that, given all the other black-swan events of late, should not be dismissed.

As they remind, the classification of hyperinflation is: an episode where the inflation rate exceeds Hyperinflation50 per cent per month. In history this has occurred in the 1920s in Austria, Germany, Hungary, Poland and Russia. Germany in 1923, for example, experienced a 3.25m per cent inflation rate in a single month (see picture left). Since the 1950s hyperinflations have been experienced in Argentina, Bolivia, Brazil, Peru, Ukraine and Zimbabwe - so confined largely to developing and transitioning economies.

The root cause of hyperinflation is: ‘excessive money supply growth, usually caused by governments instructing their central banks to help finance expenditures through rapid money creation.’

Back to whether it could happen to Europe or the US? Morgan Stanley says possibly yes, under certain conditions.

Firstly, the rapid expansion of the monetary base by the Fed, ECB and BoE would have to continue and feed into a more rapid and sustained expansion of money in the hands of the general public.

G4 base money growth - Morgan Stanley

Secondly, Morgan Stanley says governments would have to face difficulties financing their bailout packages and funding their debt.

Lastly, public confidence in the government’s ability to service debt without resorting to the printing press would have to disappear, as well as the government’s actual ability to withstand the pressure to do so in the first place.

And while all of the above is an extreme scenario, the Morgan Stanley analysts say:

…given the size of the current and prospective economic and financial problems, and given the size of the monetary and fiscal stimulus that central banks and governments are throwing at these problems, investors would be well advised not to ignore this tail risk, especially as markets are priced for the opposite outcome of lasting deflation in the next several years. Put differently, we believe that buying some insurance against the black swan event of high inflation or even hyperinflation makes sense and is relatively cheap currently.

Of course, when hyperinflation occurred in the eastern block countries towards the end of the communist era, most citizens hedged via significant purchases of black-market US dollars, the US dollar becoming the effective proxy store of value. This time round, that would not be an option.

Weimar hyperinflation


1 comment:

Anonymous said...

The "fact" that everyone knows the answer generally means no one knows the answer.