How Likely is Hyperinflation in the U.S? Part Two

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

My previous article, “How likely is hyperinflation in the US? Part One,” covered hyperinflation's history, process, effects, definition, types and causes, as well as how to measure its emergence in nations using casual symptoms. Part Two answers the questions of how to gauge the likelihood of hyperinflation in the United States, what the emerging dangers are, how it might happen here and how to prepare if it does.

As stated in Part One, because there are so many conflicting or just different views among analysts relative to hyperinflation, it is difficult for the average advisor or person investing for retirement – or just self-preservation – to know what to believe and how to act. Many of the warnings related to hyperinflation sound like Chicken Little's cry that the sky is falling.

In the midst of the alarmism and confusion, these articles sift through the best resources available, including Bank for International Settlements (BIS), International Monetary Fund (IMF), Cato Institute and Fed papers to provide some clarity.

Measuring hyperinflation in the U.S.A.

The U.S. has come just short of hyperinflation twice before: once during the Revolutionary War and the second time, in March 1864, towards the end of the Civil War. The wars created high debt and supply disruptions within the continental states, congruent with fast acting hyperinflation, as explained in Part One.

The U.S. has geographic advantages. It has natural supply routes made up of rivers, natural ports and inter-coastal waterways connected by a sophisticated rail and interstate system. It is protected by the natural boundaries of oceans, mountains and friendly bordering states. It is also not dependent on one export, like oil. These geographical and man-enhanced attributes temper any economic trend towards hyperinflation in the modern U.S.

As previously noted, hyperinflation may be expected when there is persistent monetization and when the currency exchange premium – the premium the most-used foreign currency commands over the native currency – rises above 50%. This later sign typically occurs during a period of high inflation and up to three years before hyperinflation appears. This period may or may not include a currency crisis, which is distinct from, and can be an initial phase of, high inflation or hyperinflation. More broadly, the dangers of hyperinflation are measured by casual symptoms. These include fiscal, monetary and political causes and symptoms.

As to fiscal symptoms in the U.S., according to a recent JP Morgan (JPM) presentation, net U.S. debt is presently around 75% of GDP, high, but non-critical. Foreign officials hold 35% of this debt; the Fed holds 16 percent. Both are significant, but not excessive. And, as Prasad and Ye note, debt cements the U.S. dollar role as global reserve; that is, as long as it is not unsustainable, and interest is a manageable piece of the total budget (chart, below).

On this front, the U.S. does not have enough reserves to cover its short-term debt, but the Guidotti-Greenspan rule may not apply to Advanced Economies. And, as long as 10-year yields, currently about 2.35%, stay below 7% global bond investors tend not to panic, especially when the U.S. is the best of a bad lot.

Where Does All the Money Go

Deficits-to-expenditures is marginal at about 18%. According to the Wall Street Journal, the deficit has decreased to only 3% of GDP in 2014. The deficit was $1.4 trillion six years ago and the Congressional Budget Office (CBO) projects it to be just $486 billion this year. But, it is expected to increase in 2016 and according to The Heritage Foundation could be worrisome again by 2021.

Also on the down side, according to Heritage, net U.S. debt, above, will reach 100% of GDP, a dangerous level, around 2028. At $18.2 trillion, total federal debt is already 102.5% of GDP. But most analysts feel that net debt (total minus intra-governmental debt) is the more critical measure. By 2024, mandatory expenditures, or entitlements plus interest on the debt, will be 75% of revenues. By 2030 they will consume revenues (chart, below).