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.
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.