June 23, 2024

Hyperinflation Worries – The Next Black Swan Or A Contrary Indicator?

Inflation Concerns Increase

There has been much speculation lately about the end results of the US Government’s massive deficit spending.   Many analysts are predicting that the end result will be hyperinflation as the Fed is forced to monetize debt that the US Government is unable to borrow in the credit markets.  These concerns have already turned to reality as rates on the 10 year Government have increased sharply from approximately 2% to 3.5% since the start of the year

Always quick to response with a new product to meet investor demand, Wall Street has come up with a product to protect investors from the risk of hyperinflation.

Wall Street Journal – A hedge fund firm that reaped huge rewards betting against the market last year is about to open a fund premised on another wager: that the massive stimulus efforts of global governments will lead to hyperinflation.

The firm, Universa Investments L.P., is known for its ties to gloomy investor Nassim Nicholas Taleb, author of the 2007 bestseller “The Black Swan,” which describes the impact of extreme events on the world and financial markets.

Funds run by Universa, which is managed and owned by Mr. Taleb’s long-time collaborator Mark Spitznagel, last year gained more than 100% thanks to its bearish bets.

Unlike last year’s sudden market implosion, inflation isn’t an unimaginable event that few currently anticipate. In fact, many fear inflation right now amid government efforts to goose the economy. Universa’s bet, however, is that inflation will reach levels few expect.

The fund will also bet against Treasury bonds, which tend to weaken in inflationary environments. Last week, Treasury yields shot to their highest level since November as prices fell on inflation concerns. Oil topped $66 a barrel. Gold is creeping nearing $1,000 an ounce.

Also, some investors are worried not about inflation but about deflation and its pernicious effects were the economy to remain stalled.

David Rosenberg, chief economist at Gluskin Sheff, a Toronto wealth-management firm, believes inflation won’t take hold until consumer spending rebounds, which he thinks could take years.

Mr. Taleb said any deflation would be matched by an aggressive move by governments to stimulate their economies, leading inevitably to an uncontrollable surge in prices.

Deflation Vs. Inflation

The emergence of Wall Street products to protect against hyperinflation may, in fact, be a contrary indicator.  Many times in the past, eager buyers have rushed into investments pushed by Wall Street as a trend was nearing its peak.

Washington’s massive deficit spending and the lack of fiscal discipline it represents will no doubt end badly.   At this point, however, stimulus spending, bailouts, guarantees and deficits have done nothing to reverse the decline in real estate values, corporate profits, consumer spending and consumer incomes.  Events of the recent past have shown how quickly the country’s finances can change, but deflation rather than inflation seems to be today’s enemy.  The rampant price cutting and decreasing incomes that we observe today are not the classic ingredients of inflation.

The event that may mark the tipping point into hyperinflation is how the Federal Government responds to the deficit crisis facing virtually every State in the country.  Discussing the perils of a federal bailout of California, Peter Schiff recently noted that :

However, if Obama comes to the rescue, none of the needed cuts will be made. Instead, California will continue to operate its bloated bureaucracy and will be in constant need of more bailouts. In other words, if Schwarzenegger gets his bailout, look for him to utter his famous line – “I’ll be back.”

But it’s not just Schwarzenegger who will be back, but governors from all the other states as well. After all, if the Federal government bails out California, by what right can they deny similar aid to other states? The bailout will send a clear message that states do not need to cut spending.

The need to make good on state and federal obligations will further depress the appeal of all U.S. dollar-denominated debt. As a result, as real buyers flee the market, the Fed will have to run its printing presses even faster to pick up the slack. This will set into motion a self-perpetuating spiral of money printing and Treasury sales with a predictable result: hyperinflation.

Should we reach the point where the Federal Government winds up bailing out virtually every State in the United States, we will have reached the point of total financial absurdity.   As I have previously pointed out, “The United States is not an abstract construction with a separate economic destiny,  immune to events in the rest of the nation.  The United States are 50 States joined as one.  If nearly every one of the 50 states is an economic train wreck, the conclusion for Uncle Sam  is obvious.”

If the Federal Government adds the States to the bailout list, Universa’s hyperinflation fund will have more customers than it can handle.