A Melman Minute
By: Leonard Melman
July 11, 2008
One of our favorite sayings is "The elephant in the
room" which relates to an important subject that everyone present wants to
avoid. Presumably, if you don't talk about it, the subject doesn't really exist.
A few days ago, we mentioned one of those subjects, the remote but growing
possibility of nuclear conflict between Iran and Israel, with Israel perhaps
being aided and directed by the United States. Another subject which is slowly
rising into public awareness is the potential hyperinflation of the United
States Dollar - the reserve currency of the world. The potential impact of such
an event would be incalculable. It would also enhance the desirability of gold
enormously.
The reason the subject is becoming relevant has to do with the options available
to the Fed and other government authorities to support the troubled US economy
and the weakening US currency. Historically, a currency is defended by limiting
the money supply; driving interest rates higher; diminishing the level of
economic activity; eliminating budgetary deficits and bringing trade deficits
into surpluses.
Unfortunately, given the state of America's already-declining economic activity
combined with their absolute requirement to import staggering quantities of
petroleum on a daily basis, none of these policies can be adopted at present
without risking a severe recession, perhaps even a Depression. And so, the
alternative policy of stimulating the economy through accelerating currency
creation which increases the supply of money and decreases interest rates has
been adopted. However, that policy, if carried too far, is one which could lead
to hyperinflation. Even if the chances of such an event seem remote, it is still
important to have an understanding of what hyperinflation represents.
Simply put, 'hyperinflation' is result of massive currency creation without a
commensurate increase in the volume of economic goods. Therefore, it takes
greater and greater amounts of depreciating currency to purchase desired goods
until a point is reached where the very credibility of the government creating
the (always!) unbacked, fiat currency is called into question. Three examples
will suffice.
First, and the most frequently used example, following World War One, the German
nation was saddled with enormous reparation obligations. They attempted to repay
them with currency of value, but the burden became too severe for their limited
economy and, so, the German government began to simply print fiat money, hand it
over to the Allies and to the public, and pretended that the problem had been
resolved. However, the increased volume of currency began to affect prices and
so the same procedure - printing additional currency units - was repeated. That
remedy caused prices to rise further and the cycle began to accelerate. The
effects were astounding.
In 1914, 15 pfennig (pennies) would buy two kilos (four pounds) of potatoes.
Shortly after the war ended, it took 50 pfennigs. By 1921 it took eight marks
(or 800 pfennigs)! And then, things began to accelerate dramatically. By
January, 1923, the figure stood at 1,400 marks and by July, 1923 it had soared
to an incredible 200,000 marks - but much worse was yet to come, for it was
about then that true hyperinflation took over. Between July and November 15,
1923, the cost of two kilos of potatoes became four million marks, then 1.3
BILLION Marks and then, finally, about ONE HUNDRED FIFTY BILLION MARKS.
Only then was the old currency abandoned and a new Rentenmark, backed by gold,
was introduced at the rate of one new Rentenmark for one TRILLION of the old
Marks. It goes without saying that this monetary destruction wiped out all the
stored savings of the population, caused enormous social disruption and left the
populace looking for stability and order - conditions just perfect for the
emergence of a demagogue named Adolf Hitler.
Second, in the chaos left behind by World War Two, the Soviet Union took over
the Eastern Bloc nations including Hungary. In order to wipe out the Hungarian
middle class, the Soviets deliberately inflated the currency, and the number of
"pengos" it took to transact business approached infinity. At the height of that
fiasco, bank notes as high as one hundred quintillion (one hundred million
trillions) were printed.
Finally, in today's world, we are witnessing the destruction of the Zimbabwean
currency, which is now passing into hyperinflation. As recently as one year ago,
the measurement of the "Z" (Zimbabwean Dollars) in U.S. Dollars amounted to
several hundred thousand. Now, with hyperinflation, the rate is approximately
sixteen billion to one. The head of the Zimbabwean Reserve Bank earns trillions
of "Z" every month, but the figure is meaningless.
Therefore, with this history in mind, even the remote threat of hyperinflation
in America is sufficient to support the price of gold, silver and the other
precious and base metals. In our opinion, should that threat emerge into a
higher degree of possibility, the potential price increases in the metals would
be very significant, to put things mildly.
This morning's markets do not particularly reflect hyperinflation, but rather
rapid rises in petroleum prices which hit new record levels overnight, exceeding
$147 per barrel (all prices US$) and once again confounding petroleum bears.
Precious metals rallied sharply on the news, with gold up over $20 to the $965
level.
Although we printed the chart on gold yesterday, it is worth another look this
morning as the resistance near the $950 spot level has clearly been exceeded and
the old high levels are now being rapidly approached. Silver is up by almost
fifty cents to the $18.77 per ounce area while platinum is once again well over
$2,000 per ounce. Base metals are slightly higher on balance.
Securities markets in Canada and the US are diverging with the TSX up by about
60 points while the Dow Industrials are down by 172, holding just above the
11,000 level as of 8:00 AM PDT.
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