Given that I am not well informed when it comes to economics, I'm looking for some input on a possible scenario. If there is a run on the banks around Y2k then the banks run the risk of domino effect failing. To help this out the Fed prints or uses previously printed reserves to restock the banks. Now I understand there are many ways to correct this as the money gets spent and redeposited in banks, BUT; for the sake of argument lets say there are some insidious lines of thought in the big money circles and they dont reabsorb the "reserve" or "emergency" money and allow it to stay in circulation and just say "well we had to issue the extra notes for y2k and everything got so fragile...blah blah."

This would result in inflation that would spawn EXPONENTIAL inflation or "hyperinflation". Yes or NO

Any contributions to this would be appreciated. Thanks.

-- Jack Mercer (mercerjohn@usa.net), September 27, 1999

Answers

Hyperinflation requires a massive increase of the money supply. While we may seem some increase in cash, the overall supply will drop, dut the money being taken out of the bank (which cannot be reloaned...).

-- Mad Monk (madmonk@hawaiian.net), September 27, 1999.

Yes!

See my threads on just this topic.

-- Andy (2000EOD@prodigy.net), September 27, 1999.

The answer to this question depends heavily on the compliance of the banking system. I think that if a liquidity crisis develops due to Y2K, the FED stands ready to flood the economy with captial. However, from figures I have seen, a significant percentage (90%?) of what we consider money is not printed paper; it is in some electronic form. If the banking system stumbles badly, it would seem that this electronic portion of the money supply would be locked up resulting in severe DEFLATION.

-- Chris Tisone (c_tisone@hotmail.com), September 27, 1999.

Ravi Batra's latest book explains what is about to hit us like a freight train... the coming crash...

Here is a 101 for our resident know-nothing "economist" double- decker... aka 'tbill-decker'

Credit-worthiness and the flow of the economy are what sustains current price levels. All prices are based on debt now. The US$ itself only exists as an instrument of debt, not actual value.

Debt must be incurred in order to do any business today (ultimately it is all borrowed money). In order for debt to be incurred, three things must work.

1.) The lender must be capable of issuing debt (solvent and have spare capital OR be solvent enough to be capable of borrowing - more typical - from bigger banks).

2.) The economy and endeavors of the market place must support the borrower's loan.

3.) The borrower must be creditworthy.

The entire economy of the world is based on these three elements.

Y2K will effect the ability of the world to functionally continue the present cycling of dollars (electronic accounts); the present rate of economic activity due to a strangling of trade, resource delivery and business activity.

Thus the economic underpinning of both the lender and the borrower will come into doubt. This includes the governments of the world as well as the individual paycheck of a single worker.

This effect will cause a contraction of credit (already happening) and a spiralling decline in economic activity regardless of the efforts of governments to provide free 'money' (see the Yen situation). This is so because the problem will not be the availability of money through no cost loans but will be a problem of creditworthiness - i.e. Less and less people and institutions will be qualifiable as borrowers (creditworthy). Current loans will be defaulted on which will hamper further borrowing by banks. We will be left with what is in 'circulation' rather than the expansion of debt.

Unfortunately the 'in circulation' money will be almost entirely be 'electronic' in nature. This will be a problem because of the reliability of the electronic systems as well as the solvency of the various financial intermediaries which constitute the system as a whole.

Debt failures always dump excessive amounts of property and labor on the markets (bankruptcies and unemployment). Without creditworthy borrowers and a functional financial system (the solvency of the intermediataries as well as the functionality of the systems they use) these properties and unemployed will be forced to a revaluation to the available cash market.

Since the available cash market is very small compared to the overall flow of the economy we can see that prices will drop. How much will prices drop? In the Great Depression prices and wages dropped by 25- 30% and unemployment increased to 25%, equities dropped to 10% of high prices. This occurred in an economy which was substantially based upon a dollar backed by gold and silver (value) and a much lower debt per capita ratio than today. The US$ was devalued by 70% compared to gold in order to right the system, which did not help as much as expected since there were few 'qualified' borrowers and those who were qualified were not interested in borrowing. Hence stagnation.

We must recognize that today we are in immeasurably worse financial shape than during that time. The entire economy is based upon debt. The cash economy is trivial in comparison to the electronic/debt economy. We are 'maxed out' - as in we have borrowed to the maximum of our present ability to borrow (see escalating, record, bankruptcies in 'good times').

Prognosis:

We will see a deflation of approximately 75 to 95% on the present dollar prices of real property. We will see unemployment of between 40 to 60% and wages drop by as much percentage as asset values and prices. We will see a total confusion in the financial system and the economy will basically grind to a halt due to spasms of systems and intermediaries. We will be reduced to a cash economy and there will be precious little cash available and so barter will become the accepted means of survival.

After the initial 'reconfigurations' of the financial and economic landscapes we will see a renewed interest in silver and gold as basic money (reinvention of the wheel - barter to metal, metal to paper) but the valuations will be much more precious than today's because of the scarcity of PM's.

It must be remembered or at least learned that the American experience in trade was one of barter for the first 50 years of our countries existance. The US$ silver half dollar was the unit of account and used almost solely between banks as the reserve of all paper money obligations (on that silver) . Pennies, nickles and dimes were the standard currencies. Whole silver dollars were not used because they were considered to 'large' a denomination.

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More

Next year... currency 'wars'... starvation in some US cities... gubmint 'initiatives'... hyperinflation... anarchy... a barter economy, similar in many ways to Russia now... only the Russians can cope, we can't...

Make sure you can protect your wealth... when the dollar is destroyed make sure you have some gold and silver as a fallback... make sure you have plenty of cash and coin... plenty of water and food... means of self protection... be willing to blend in if it gets as bad as outlined above... if you don't blend in you will not last long... 90+ days to go - get your financial affairs in order now as time is almost up.

-- Andy (2000EOD@prodigy.net), September 26, 1999

-- Andy (2000EOD@prodigy.net), September 27, 1999.

Hyperinflation is highly unlikely, if not impossible, in a Y2K catastrophe simply because it is physically impossible to print enough money. Nearly all the worlds' wealth is in the form of electronic money, which would be destroyed in a breakdown of the banking system.

If you'd like to know more, go to the Money page on my website, www.y2ksurvive.com, and you'll find a more comprehensive explanation of this, or go to Gary Norths' website (www.garynorth.com) and look for it there.

The printing of money is a tightly controlled process, using paper that has been supplied by one manufacturer for many decades, and using specialized printing presses. You cannot simply decide to run off a few hundred billion dollars overnight; the presses are already working full time just to keep up with the current demand. Inflation requires computer systems these days, and Y2K destroys computer systems. Hence no inflation in 2000 unless Y2K is trivial.

-- cody varian (cody@y2ksurvive.com), September 27, 1999.

I believe we are quickly proceeding thru four economic phases:

1. Disinflation: For past several years the inflation rate has been falling stimulating economic growth, consumer spending, and indebtedness.

2. Deflation: Pre-Y2K moves (flight to quality; increased liquidity; coprorate bond issues in 3rd qtr to grab financing for 4th qtr 99 and 1st qtr 00) increase the value and desire to hold cash. Discounts for cash payment? Huge indebtness results in tightness of credit markets. The Fed & Treasury have recently raised interest rates to reduce credit demand and keep money supply from rising due to extra printing, corporate mega-mergers, acquisitions and liquidations.

3. Inflation: essential items like oil, food, pharmaceuticals etc. increase due to demand and any Y2K availability shortfall. Tangibles like gold and silver increase as a store of value and transportable means of wealth.

4. Hyperinflation: If the Fed and Treasuries try to inflate out of deflation and/or foreign currency exchange rates continue to weaken the dollar, the dollar's value goes down so it takes more dollars to buy anything. If Y2K severely impacts the IRS so that Treasury income for 2000-2001 is restricted, than confidence in greenbacks could go the way of Weimar Germany after World War I.

I believe the forces of defaltion and inflation are at work simultaneously today resulting in very high market volatility. Flight to quality rallies may not offset credit/debt shortfalls reducing the velocity (turnover rate) of money slowing down the economy. As the US economy has yet to slow down much, it remains to be seen whether hyperinlfation will occur or not.

IMHO, the bankers are in between a rock and a hard place: if they let deflation rule and the economy slows than unemployement and reduced demand could push close to Ed Yourdon's prognosis for 1 year of disruptions and 10 years of depressions OR if the powers that be try to inflate the money supply to pay off debts with cheaper dollars than hyperinflation becomes more likely.

-- Bill P (porterwn@one.net), September 27, 1999.

For an econmics-challenged person, please give me some hints on deflation. I have been thru inflation. I am assuming that deflation is the opposite.

If I have a $300,000 house, I would assume by the posts that the value of the house would "deflate" to a value of $75,000 (75%) to $30,000 (90%). If I still owe $150,000 on the house, what happens? What happens to wages? (Gross income of say $75,000 per year). Where would the price of bread go for instance if it is $3.49 for 2 loaves at Costco today? Considering that today a sort of standard rule-of- thumb for obtaining a mortgage is 28% of gross income with other debt being 34% - how would that hold up in deflation?

I don't doubt that deflation could occur, I am just wondering how it works down here at the street/personal level. Thanks in advance for your answers. Just can't seem to get the concept down to a personal level.

-- Valkyrie (anon@please.xnet), September 27, 1999.

Valkyrie:

Just some thoughts per your post:

Housing: In the early 1980s following the colapse of oil prices real estate in the Texas and Lousiana area fell so much that many homes had a resale value below their mortgage level. This resulted in borrowers walking away from their houses leaving the bank or S&L stuck with the property. The bank/S&L liquidated the property which drove down prices further. This greatly contributed to the savings anmd loan collapse which was finally resolved some years later by the sale of S&L assets at some percentage of the actual value like $0.25 on the dollar - a failure for the S&L and an opportunity for the rich that got assets at a 75% discount.

For the homeowner, there is no loss unless you need to sell your house; desire to refinance; open a home equity line of credit or loose income and cannot make your mortgage payment. If you are able to continue your mortgage payments than the value of your home will recover as you build equity over time. If you are not able to make your mortgage payment due to Y2K, than I suspect there will be many, many people in the same position. I believe the bankers and S&Ls learned their lesson from the 1980s and would allow an extended grace period during which mortgagees would be allowed to make interest payments only or some fraction of their mortgage payment until stability returned to the housing market. I doubt the lenders want to own a great deal of nonperfromaing real estate that they cannot unload, so from their view some payment by the mortgagee would be better than none.

Wages: I expect it depends on the field of employment. Essential goods and services are likely to increase in value when a Y2K disruption reduces availability of supply. For a non-essential good like say beanie babies or travel agent for cruise line to Italy, maybe even auto production for a period, than unemployment could go up as demand drops. Repair skills for plumbers, carpenters are likely to be in high demand so their wages could go up.

Bread: Demand for esentials like bread would be constant. Prices would go up if there is any sustained Y2K disruptions due to panic, stockpiling or computer failure disruptions. This is why everyone recommends storing some level of essentials 3days, 2 weeks, 3 months, 2 years is a guess with insufficient information for a truly informed decision.

-- Bill P (porterwn@one.net), September 27, 1999.

Valkyrie,

This is what happens: you get screwed.

Allow me to explain. The real rate of interest on your mortgage is the nominal rate (say 8%) minus the inflation rate. If there is deflation, then the inflation rate is negative (say -5%). This means that the real interest rate on your mortgage is even higher than your nominal rate (13%). Would you have taken out the loan if it was 13%? It's possible for you to come out ahead if you remain employed and receive the same salary as before, but you makes your bets and you takes your chances.

-- nothere nothere (notherethere@hotmail.com), September 27, 1999.

A classic example of hyperinflation (Germany after the first world war):

From the middle of 1922 until the middle of 1923, prices increased by over 100 times. Measured by the price of food, prices were 135 times higher at the end of the period than they were at the beginning. Measured by how many marks it took to buy a dollar, prices were 222 times higher. Yet even this horrid inflation was mild compared to what happened from July to November of 1923, when prices increased by somewhere between a million and a billion times their previous level.

and

The German hyperinflation illustrates the redistribution which inflation causes in a dramatic way. It eliminated the value of all life insurance policies and all savings left in banks. When life insurance policies were paid in 1923, the value of the check was usually worth much less than the stamp used to post the letter. The hyperinflation eliminated all debts that existed prior to 1921. For example, the value of German mortgages in 1913 measured in U.S. dollars was about $10 billion; in late 1923 these mortgages were worth only one U.S. penny.

(From http://ingrimayne.saintjoe.edu/econ/EconomicCatastrophe/H yperInflation.html)

I understand Germany's debacle was the result of massive debt (for reparations), forcing the Gov. to print currency. Wouldn't the solution nowadays be simply to default on the national debt?

-- Tom Carey (tomcarey@mindspring.com), September 27, 1999.

Couldn't there be inflation if other countries - who hold dollars as a stable currency - suddenly dump U.S. dollars in favor of gold/silver? Do we know how much cash is "in circulation" beyond our borders?

-- Linda (lwmb@psln.com), September 27, 1999.

To Jack Mercer:

To your question about whether hyperinflation is a possibility, the short answer is yes, but not for the reasons you cited in your thought experiment.

The "emergency cash reserves" that have been printed in anticipation of Y2K are not inflationary in and of themselves. Cash is only a substitute for money in other non-cash forms, such as bank accounts. When you withdraw money from the bank, as cash, you don't have more money than you had before, only money in a different form.

Hyperinflation is caused by the creation of new money. New money can be created by the purchase of debt by the central bank, using funds that only came into existance for that purpose. The Federal Reserve Bank is the only government entity that is empowered to create money in this way.

New money can also be created by bankers and borrowers working together. When you go to your bank and get a loan, you get the full amount of the loan at once, as money. The bank "funds" the loan by making a new entry on your account, and suddenly your account is full of money that wasn't there before. How much of that money is new? Almost all of it! The bank is only required to have a very small amount of old money on deposit to back up that loan, called the "reserve requirement". The rest of the loan is "backed" by the collateral you put up. Today, a bank can loan you $100,000 and of that, $98,000 can be brand new money created by the bank on the basis of your collateral. Such wonderments as credit card debt are backed only by your credit history. No collateral involved.

People who learn about this system are often amazed at it. But to a certain extent it does make sense. Real wealth, as represented by the collateral for the loan, is the true basis for money. This system is designed to ensure that the money supply grows as real wealth grows. Under a gold standard the money supply can only grow as fast as the supply of gold grows.

The crux of this system is that the central bank and the banking industry in general are wholly responsible for the money supply. If we get too much inflation or too much deflation, it is their failure to do their duty that caused it, whether through ignorance or through dereliction. We gave them the keys to the economy. They need to be held accountable if they drive it recklessly and plow it into a tree.

Lately, the banks and the Fed have been driving credit like drunken sailors on a spree. The general population has been boozing it up on cheap, easy credit, too. When the next sharp curve comes up, we're d*mn likely to roll the economy.

-- Brian McLaughlin (brianm@ims.com), September 27, 1999.

Linda,

Yes, it seems the Japanese are selling off dollar denominated investments in favor of increasing their own liquidity in their own currency - Yen. This bodes poorly fo rboththe US and japan. In the US, the value of the dollar has fallen due to the increased supply. In Japan, the cost of exports for Japan business that sell into the US has become not as competitively priced and they may loose business.

I just read that Mazda is selling off real estate (to increase liquidity) to a Cayman bank backed by Citigroup and Mazda will lease back the land their factories are on.

-- Bill P (porterwn@one.net), September 27, 1999.

An exciting thread, and not at all repetitive to have a small economics review group at this crucial juncture (entering Q4).

Brian, it's great to read you anytime.

How about a distinction between "Inflation: The Money Supply", and "Inflation: The CPI (Price Level)"?

The Austrian economic school has focused on the former. Traditional economics, including those "Fed"-ers who were watching money througout the 1920s, focuses on the latter. We got a dose of the latter in the 1970s and so that is what WE are familiar with. We were never quite sure what the money supply was doing then -- so many weird factors and new measurements.

Brian is referring to the money supply, which has not yet turned up in raging consumer prices, only asset (stocks) prices.

Theoretically, in a y2k breakdown, we could see the weirdest sandwich effect of paper currency being hoarded, digital (checkbook/credit card) money being splurged on real goods (food/land/metals), and the money supply imploding from a credit contraction.

In that case the price burst would be temporary, and would represent the destruction of a great quantity of the "money" supply, as the velocity of circulation slowed to a fraction of normal.

-- Mr Gresham (wh@t.century.is.it?), September 27, 1999.

>> Theoretically, in a y2k breakdown, we could see the weirdest sandwich effect of paper currency being hoarded, digital (checkbook/credit card) money being splurged on real goods (food/land/metals), and the money supply imploding from a credit contraction.

In that case the price burst would be temporary, and would represent the destruction of a great quantity of the "money" supply, as the velocity of circulation slowed to a fraction of normal. <<

I have puzzled quite a bit over the possible economic effects of Y2K. The complexity of the different cross-currents at work are fascinating, but very hard to read. It reminds me of a place in Puget Sound called Deception Pass, where the tides rip through a narrow, rock-infested channel. No one in their right mind ventures out there in a small boat when the tide is really working. I feel like I'm in perched the prow of my family's tiny lifeboat, trying to read the cross-currents in an economic Deception Pass, on a foggy night.

My present "read" is focused on the following major factors at work in shaping the near economic future:

1) The stock market bubble / asset bubble / credit bubble in the USA. It could pop at any time. The net effect of these bubbles popping would be highly deflationary.

2) The erosion of the value of the dollar in global currency trading. The world has absorbed a huge number of dollars since the end of WWII. If the rest of the world gets tired of eating dollars and starts to disgorge them in favor of other currencies, the net effect will be highly inflationary.

3) Supply shortages caused by Y2K failures. If Y2K disrupts our overseas supply lines to any serious extent it will have a whole variety of bad effects, spread all over the map. Some items could become very expensive due to shortage pricing. Some factories would shut down and unemployment would rise. The GDP could take a quick bump downward -- how far is anyone's guess. The net effect would be to reduce the USA standard of living, with the working poor catching it in the neck. The effects solely due to Y2K will probably be spent by the end of 2000. Beyond that it is all hangover.

Right now, if I had to describe my POV on the near future, it would be like this: US citizens will be markedly poorer by this time next year. The stock market will be in a bear market. The "Goldilocks" economy that looked so invincible will suddenly look very much sicker.

Ordinary people will be caught between rising prices for imported goods (which now constitute a huge percentage of all goods for sale) and the fact that dollars are a lot harder to come by and everyone who has them is holding onto them tightly. The newspapers and television will report these facts, but the experts will say that they are completely stumped why this is happening, and will offer no clues as to how to restore the economy to greater health. Economists will bicker among themselves.

Actual inflation, as measured by the CPI will be very low, and this will be pointed to as a very encouraging sign. But unemployment will be rising fast, and that will be the cause of much ineffectual handwringing. The Presidential candidates will mostly peddle cliches. If any one of them starts to make sense, it will be a landslide election.

The nation will be extremely restless and agitated. Fads will start to appear in rapid succession. Rumors will be more common. Quiet desperation will be more common. Bank failures will be more common, but the FDIC will pull out all the stops in their public relations campaign to reassure the public that everything is OK. Exchange markets will be quieter in volume, but still volatile. Commodities will be dropping in price and most farmers will be in bad shape.

At which point I must say that I am *not* a prophet. I did not have a vivid "warning" dream in which I saw all this come to pass. I am simply extrapolating from a knowledge of the past, and a reasonable grasp of how large-scale financial distress is likely to play out under the conditions the USA finds itself in today. If stocks fall into a bear market, the dollar erodes, and foreign goods become harder to afford, you get the 1970s all over again, but starting from the structural weaknesses of the 1990s instead of the strengthes of the 1960s.

-- Brian McLaughlin (brianm@ims.com), September 27, 1999.