« »

Friday, July 18, 2014

How national debt and monetary policy can trigger hyperinflation and dollar devaluation

National debt, monetary policy and inflation
U.S. national debt is near all time highs and continues to rise with each year of deficit spending

Rising national debt and monetary policy that vastly increases liquidity in financial markets runs the risk of causing inflation and even worse, hyperinflation. Targeted equity inflation has already been a focus of monetary policy, but a wider spread inflation could take hold once the U.S. economy grows at at  faster rate. This is because rising prices are a response to weaker fiscal credibility. If the U.S. becomes less able to support its debt and justify its loose monetary policy, then financial credibility and consequently the cost of debt in addition to goods and services increase.

Should the economy grow at a faster rate, which it is forecast to do in 2015, inflation is a likely result. Moreover, job growth, wage increases and higher corporate investment activity is likely to result in a normalization of inflation per Jeremy Hill of Forbes magazine. However, if the current low cost of corporate debt and massive amount of financial liquidity from monetary stimulus  cannot be curtailed effectively, a risk of too much inflation is possible.

John Williams of American Business Analytics & Research, LLC thinks the U.S. Economy is risking a 'great collapse' or 'hyper-inflationary great depression'. According to Williams, this collapse will be represented by serious devaluation of the dollar and a period in which the cost of goods and services simultaneously and rapidly increase.

For such an event to occur, specific economic prerequisites are required per the 'Hyperinflation Special Report' published by Williams. Those reasons or initial conditions include a 'monetization' of U.S. Debt, a large lack of confidence in the dollar both by investors and the global financial system, and an out of control federal budget deficit.

So far all these things have not happened; the U.S. Dollar is still the global reserve currency, and compared to many other countries the dollar is still somewhat stable as the U.S. remains the World's largest economy.  Government debt however, is a problem; the federal government reached its $14.3 trillion spending limit in May 2011.

The Federal Reserve Bank has monetized some of this debt by investing approximately $2.5 trillion in large amounts of national securities such as U.S. Treasuries. It has also devalued the yield of short-term bonds so much, that the cost of that debt can actually become cheaper for the Department of the Treasury to service according to a May 2011 article by Jason Zweig in the Wall Street Journal.

Williams and others argue the the real government debt is also several tens of trillions of dollars higher than the current official amount. Ken Williamson of The National Review says this is because if federal liabilities are approached in the same way as corporations are expected to under Generally Accepted Accounting Principles (GAAP), then federal debt also includes financial obligations such as social security entitlements.

In 2011 federal tax revenue amounted to $2.163 trillion with a deficit of $1.293 trillion according to the Tax Policy Center. Just to keep federal debt at current levels while sustaining the economy at current levels, the government would have to increase federal receipts by approximately 60 percent. Williams seems to think this is impossible and that hyper-inflation caused by printing of more dollars and devaluation of those dollars will be the result of that impossibility.

Hyper-inflation is synonymous with the inability of the U.S. Government to find a solution to its debt according to Williams. However, this would be a premature conclusion as well designed and implemented monetary policy, fiscal policy and adjustments to the federal budget could have a positive impact. Additionally, if the U.S. economy continues to grow, the ability to finance a re-balanced debt improves and the currently recently downgraded, but high AAA credibility of that debt stands a greater chance of being sustained.

Images: US-PD