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US Dollar in Hyperinflation

by Trace Mayer, J.D. on August 19, 2008 · 25 comments

Reading time: 6 – 10 minutes

When I was leaving accounting school the director of the program imparted some sagical advice.  He jokingly told us that when a potential employer asked what 2+2 is to respond ‘Whatever you want it to be.’  One of my favorite law professors told us a similar joke.  He asked, ‘Do you know what the difference between medical school and law school is?’  In medical school you learn and memorize all 23 parts of the hand.  In law school you learn to ask is that even a hand.’  To summarize, 2+2=(47) and what is 2?  Perhaps I should work on derivative valuations.

Being formally trained in both Accounting and Law I think this is a critical question to answer: whether the US$ is in hyperinflation?  If yes then how can the average person be protected from hyperinflation?

A key element of financial statements is comparability.  The International Accounting Standards (IAS) provide the accounting rules and are comparable to GAAP.

Standard 1 requires a presentation currency.  Standard 21 provides for translation between functional and presentation currencies.  The Bank for International Settlements under Footnote 14 of their Annual Report treat Gold as a financial instrument.  For this analysis I will use gold as the presentation currency and the US$ as a functional currency and apply the relevant Standards.

Standard 29 provides “The objective of IAS 29 is to establish specific standards for enterprises reporting in the currency of a hyperinflationary economy, so that the financial information provided is meaningful. …The basic principle in IAS 29 is that the financial statements of an entity that reports in the currency of a hyperinflationary economy should be stated in terms of the measuring unit current at the balance sheet date.”

What are the elements and factors for hyperinflation?  Under IAS 29.3 the four factors are (1) the general population flees the local currency, (2) dual currency pricing is practiced, (3) prices for purchases on credit incorporate the loss of purchasing power and (4) the cumulative inflation rate over three years approaches, or exceeds, 100%.

First, under IAS 29.3 “the general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain purchasing power.”  Under 31 U.S.C. 5112  the Mint is required to provide ‘in quantities sufficient to meet public demand’ gold and silver coins.  Due to exceptional demand and contrary to federal law the United States Mint has suspended both gold and silver coin sales.  It appears a significant amount of the United States general population is demanding the inflation hedge currencies, gold and silver, in large amounts.  Therefore, it appears this first factor is met.

Second, under IAS 29.3 “the general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that currency.”  In New York some merchants have begun pricing in and accepting other currencies.  An article in February 2008 reported that “We had decided that money is money and we’ll take it and just do the exchange whenever we can with our bank, … We didn’t realize we would take so much in and there were that many people traveling or having euros to bring in. But some days, you’d be surprised at how many euros you get.” Robert Chu, owner of East Village Wines, told Reuters television.  Gas station owner Gary Mallicoat accepts silver quarters.  While the practice of pricing and accepting alternative currencies does not appear widespread among the general population the trend is starting.

Third, under IAS 29.3 “sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short.”  One of the easiest ways for businesses to compensate for the loss of purchasing power through the use of credit is to stop extending credit and require cash.

This steep decline in the rate of growth of M3 has likely resulted from lines of credit being tapped out when the credit crisis began, lines of credit being revoked and an unwillingness or inability to borrow or extend credit.  Therefore, it appears that, indirectly, the price of both sales and purchases are being modified to compensate for the expected loss of purchasing power of the US$.

Fourth, under IAS 29.3 “the cumulative inflation rate over three years approaches, or exceeds, 100%.”  Because central banks have a conflict of interest and often shroud their operations in secrecy the use of their official numbers are unreliable.  The only reliable currency is gold.  It is subject to only exchange-rate risk and there are large amounts of above ground stockpiles indicating its primary use as money.  Therefore, the relative price of national currencies and gold, absent central bank manipulation to the downside, should be a reliable indicator of the national currency’s inflation rate because of the purchasing power difference.

The average price of gold in:

2004 – $409.72

2005 – $444.74

2006 – $603.46

2007 – $695.39

2008 – $912.90 (Jan-Aug)

Thus the ‘inflation rate’ of the US$, relative to gold, is:

2005 – 8.5%

2006 – 35.7%

2007 – 15.2%

2008 – 31.3% (Jan-Aug 2008)

The cumulative inflation rate from the 2005 average price of $444.74 to the 2008 average price of $912.90 equates to a rate of 105.3%.  Because 105.3% approaches and exceeds the 100% required by IAS 29 therefore the inflation rate of the US$ relative to the stable and reliable currency of gold indicates hyperinflation.  Additionally, the general commodity index has had similar triple digit changes.

 CONCLUSION

Because of the flight from the US$ by a large segment of the population of the United States, the pricing of goods and services in foreign and metal currencies, changes in credit terms to account for purchasing power differences and a cumulative three year inflation rate of 105.3% therefore with gold as the base currency the US$ appears to be in a hyperflationary environment when applying IAS 29.

If you are a CEO or CFO of a publicly traded company subject to SOX you may want to consult your general counsel and auditors concerning this issue.  I doubt I need to remind you that ‘penalties for violations of to up to $25 million dollars and up to 20 years in prison.’  Better to be safe than sorry.

As evidenced with the Weimar experience the rate of inflation rapidly accelerates.  Like a jet engine the faster it goes the faster it goes.

In a Deflationary Winter the last layer of credit to evaporate is the national currency through hyperinflation.  It appears the evaporation through hyperinflation is heating up up.

PROTECT YOURSELF FROM HYPERINFLATION

Inflation leads to shortages and shortages lead to rationing.  When considering physical preparation I think the best insurance is a three month supply of food and a 72 hour kit.  For food storage I recommend storing what you eat and eating what you store.

Regarding protecting one’s wealth against hyperinflation there is obviously gold and silver.  Learning where and how to buy gold or silver is extremely important and you will want to avoid shady characters.

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25 comments

ABOUT THE AUTHOR: Trace Mayer, J.D., author of The Great Credit Contraction holds a degree in Accounting, a law degree and studies the Austrian school of economics. He works as an entrepreneur, investor, journalist and monetary scientist. Follow him on Twitter. This is merely one article of 241 by .
Free Free Great Credit Contraction Sample

{ 7 comments… read them below or add one }

1 Nima December 16, 2008 at 10:37 am

I would rather recommend this as a measure for money supply:

http://www.economicsjunkie.com/recessions-and-the-true-money-supply/

2 Alex December 18, 2008 at 10:18 pm

Hi, INteresting article, but i dont see how you can come to the conclusion…

The first condition of general populace fleeing the currency – the demand for gold does not imply that there is NO demand for the dollar… The demand for gold being so high is due to the relativly low price of gold in the current scenario. So therefore demand for a particular commodity due to irrational pricing cannot be construed as the shunning of its substitute…

Regarding dual currency being practiced, the fact that one or two people accepting the euro as payment – using this as evidence for hyperinflation is quite inadmissable… the fact is that the person said “money is money” is, infact, proof that hyperinflation does NOT exist and that they are quite willing to take either currency to convert at the bank at a later date. This would imply that the currency is considered rather stable, since he has no qualms of exchangin the euroes with the bank at A LATER date. Further, people are not using the euro in LIEU of the countries legal tender.

Your final point also has flaws since the inflation rate is over 100% over a THREE YEAR period, and you’ve taken the price of at almost the peak, not after its dropped below $700 an ounce…

3 Richard January 4, 2009 at 10:51 am

You say that Gold prices have risen more than 100% in USD terms over the past three years, and this therefore qualifies as one of the criteria for hyperinflation, of this there can be no debate.

However, isnt this the exact opposite of what you say, namely hyperdeflation of the US dollar with respect to Gold.

4 Trace Mayer, J.D. January 4, 2009 at 3:13 pm

Alex, This article is written persuasively much like one would write a persuasive motion for their client. I understand your points and arguments which argue the other side of the issue. I am not playing any games with the facts as I analyzed the data at the time the article was written. Yes, the US$ price has fallen substantially since then so a different conclusion would likely be reached. It would be interesting to perform this exercise using the British Pound or Australian Dollar.

Richard, the Austrian definition of inflation is an increase in the money supply. Deflation is a decrease in the money supply. Of course, that begs the question: What is the money supply? Some stratification between assets is shown in the liquidity pyramid that you can find in this article: http://www.runtogold.com/2008/02/first-snowfall-of-kondratieff-winter/

Consequently, the theory I am asserting allows for hyperinflation to function like deflation because capital moves out of the currency asset into gold as it is lower (safer and more liquid) in the liquidity pyramid.

5 Lyle February 9, 2009 at 10:48 pm

First of all, 2 plus 2 is 4, and a hand is a hand.

“Under IAS 29.3 the four factors are (1) the general population flees the local currency,” – Obviously this is not happening. A few gold bugs do not constitute the general population. The general population is not fleeing the local currency.

“(2) dual currency pricing is practiced,” – Obviously this is not happening. The IAS means practiced everywhere, routinely, not practiced in a few stores in New York.

“(3) prices for purchases on credit incorporate the loss of purchasing power” – Obviously this is not happening. If you go to a dealer and buy a new car on credit, they do not add 30% a year to compensate for the loss of purchasing power. Likewise for anything else you buy on credit. It may be true that businesses are reluctant to extend credit, but that’s because they are unsure of the customer’s ability to pay, not because they are worried about the loss of value of the currency.

“(4) the cumulative inflation rate over three years approaches, or exceeds, 100%.” – Obviously this is not happening. Inflation, in this context, does not refer to the Austrian definition, it refers to the conventional definition: inflation means a rise in the general price level, and 100% inflation means a doubling of the general price level. Prices of big ticket items (houses, furniture, appliances, cars) are going down. Prices of clothes are going down – if you look for sales you can get the clothes you want for 50% off. Groceries have gone up a little. The price of gold has nothing to do with it. Even if the price of gold had doubled in the last 3 years, this would imply nothing about inflation as IAS construes it.

The statement that the US dollar is in hyperinflation by the IAS definition (or any other reasonable definition) is on the same level as 2 + 2 = (47). It’s utter rubbish.

6 Trace Mayer, J.D. February 9, 2009 at 11:15 pm

Lyle, thank you for the well written response persuasively arguing the other side; which are questions of fact. You may want to review comment #12.

I think you have missed the point of the joke about 2s and hands. This is a question of law. To frame the issues more pointedly so you cannot misunderstand; (1) What is a dollar plus a dollar? (2) What is a dollar?

Without answering those questions it is impossible to answer the others as they are underlying premises and you have failed to lay a proper foundation (which is why I alluded to these questions at the start).

As far as the inflation issue; perhaps you have a rule citation for why it does not refer to the Austrian definition. The Austrian definition was first and therefore is the conventional definition. The current obfuscations on the issue of what inflation is, has widespread disagreement, multiple definitions, is open to discussion and as all additional attempts at defining it are derivatives of the initial Austrian definition it follows that using the Austrian definition would be natural and the burden of proof would shift to someone attempting to use a different definition.

But to hit more directly at your assertion, ‘The price of gold has nothing to do with it.’ As I laid the foundation at the start, “For this analysis I will use gold as the presentation currency and the US$ as a functional currency and apply the relevant Standards.” Your assertion is in complete contradiction to the Bank for International Settlement’s treatment of gold as a monetary instrument and presentation currency under IAS 1. Perhaps you have a rule citation or some example, which is highly unlikely given how central banks account for gold on their balance sheets, of a similarly respectable banking institution that does not treat gold as a monetary instrument.

7 Joshua Nielsen November 29, 2010 at 3:44 pm

Love the article. I’m a recent reader, also of the Austrian persuasion, looking for ways to return to commodity money. A couple comments.

First, from what I saw, no one was trying to argue that Americans in general have moved away from the dollar–only that the trend has begun and may be expected to continue. So arguing on the basis that only 10% of Americans distrust dollars is moot. These things always start small.

Second, I read on a Stock Gumshoe article (here: http://stockgumshoe.com/2010/11/whats-the-1-silver-shot-poised-to-skyrocket-12785.html) that the mint has not really suspended all silver minting, only collector editions. However, it does indicate that this is due to increased demand in gold and silver bullion, which makes the same case for a rush to commodity money. I don’t know which is the truth but if either one is true … perhaps you know more on that, Trace.

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