Hyperinflation Article III - Survive & Thrive in a Hyperinflationary Future

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July 28, 2010 

Survive & Thrive in a Hyperinflationary Future

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The United States has enjoyed some dazzling periods of productivity, growth, and success—but I believe that we are now headed for disaster. This disaster will not be natural, but man-made economic disaster, caused by years of unrestrained spending and a fiat currency system gone bad. If you haven’t had a chance to read it yet, my two-part article on deflation and hyperinflation, How Does Fiat Currency End?, will help you understand why I think this disaster is coming.

Most folks refuse to believe that disaster will strike them, even when confronted by it directly. It’s not that people think they are in invincible; they simply refuse to accept facts that challenge, bewilder, and frighten them. Most people take for granted the fragile systems that are first to collapse during disasters—the interconnected systems of food, energy, and transportation are all fragile webs that might collapse at any disturbance. Likewise, when the currency flow in the economy stops, most people will have trouble meeting basic needs. The bottom line is this: even if you think a hyperinflation is only a remote possibility, it’s wise to think about how you would react and how you can be prepared protect yourself and your loved ones… just in case.

Although runaway hyperinflation would drastically impact our day-to-day lives, several modern nations have experienced hyperinflation and come out the other side with strong, viable economies. In this article, we’ll take a look at how other nations have recovered from hyperinflation, and at what steps you can take personally to survive a hyperinflation.

Restraining Spending

There are numerous historical examples of hyperinflation in nations, followed by a return to "hard money.” Time after time throughout history, the circulating currency of an ancient society would become excessively devalued, then the economy would revert to real money (usually gold and silver) and/or barter.

In more recent times (thanks to fractional reserve banking), hyperinflation has been typified by runs on banks and bank failures, proliferation of 24-hour loans, use of alternate currencies, as well as a return to the use of gold or silver as currency and even barter.

But these more recent incidents of hyperinflation provide us with instructive examples of the measures other nations have taken—often politically unpopular measures—to halt deficit spending and runaway inflation.

Brazil Took the Reins Away From Politicians and Special Interests 
Beginning in the early 1980s, Brazil headed down a course of simply printing more currency in order to finance its government and infrastructure development. Much of the country’s commerce was controlled by the government, and corruption was rampant. Health care and university-level education were constitutionally guaranteed rights. Free market principles had no place in the country’s economy or political culture.

Brazilian politicians, influenced by labor unions and other special interest groups, voted for programs and services the nation simply could not afford. The result was runaway inflation that peaked at nearly 3,000% in 1990, even as the economy went into recession and Gross Domestic Product (GDP) declined by 4%.

In order to receive assistance from the International Monetary Fund, Brazil was required to implement dramatic financial reforms, including denationalization of key industries and reduced spending on social programs. Brazil’s finance ministry, treasury, and Central Bank, invoking a constitutional amendment passed in 1994, refused to implement the legislatively approved budget. Gustavo Franco, former governor of Brazil’s Central Bank from 1997 to 1999, was a key member of the economic team that helped to lift Brazil out of hyperinflation and restabilize its economy. Franco was honest about the drastic means employed in pursuit of those ends: “We empowered the treasury and the Central Bank to subvert democracy.”

But true democracy only works with true free-markets. What Brazil had in the ’80s and ’90s perverted free market incentives and stole from the populace. The result was an economy that was inefficient.

The key to pulling Brazil out of its economic tailspin, Franco concluded, was “to create an impersonal mechanism, not to get into negotiations with parties and unions--or housewives associations. You need market mechanisms. Dialogue doesn't work in this kind of situation.” In the end, Brazil turned to free-market ideals to rescue its economy.

Bolivia Turned Off the Gas
Like many Latin American nations in the 1980s, Bolivia coped with government debt by printing money. From 1983 through 1985, consumer prices skyrocketed 23,000%. In the mid-1980s Bolivia’s central bank implemented a series of financial reforms, instituting market mechanisms that brought inflation down and stabilized the economy.

Bolivia, home to the largest natural gas and oil reserves in Latin America, had been selling gasoline at a huge loss as a way of quelling political dissent. That artificial suppression of gas prices raised the price of other goods and led to hyperinflation. As part of its economic reforms, the government closed state-owned gas stations and increased the cost of exported oil by 10 times, bringing the hyperinflation to a halt almost immediately and vastly increasing its income from foreign oil sales. With the influx of oil revenues, the crisis of confidence ended, and people returned deposits to banks, stabilizing the peso.

Without prices to determine true supply and demand, Bolivia had no mechanism to efficiently allocate resources. People could not make sound decisions without prices—the result was underproduction and overconsumption. As soon as Bolivia let the free markets decide what prices should be, it, too, was able to come out of hyperinflation.

Germany Switched Currencies
Following World War I, Germany was declared at fault for starting the war and was required to pay reparations. This financial obligation, and the failure of an international reparations conference to reduce it, resulted in a drastic drop in the value of the Mark, from 60 Marks to the U.S. dollar in early 1921 to 8,000 Marks to the dollar by the end of 1922. Consumer prices in Germany skyrocketed. French and Belgian troops (on the winning side of the World War) occupied German industrial areas in order to seize coal and other goods as reparation. Adding fuel to the inflation, the German government printed Marks to pay striking workers to resist the foreign seizure of its assets.

The hyperinflation finally ended in November 1923 with the introduction of a new currency, the Rentenmark, which was backed by bonds indexed to land and industrial plants. The creation of new Rentenmarks was tightly controlled to avoid inflation and keep the currency stable. Even though this currency would eventually fall in value, the German government was able to stabilize its inflation by tying the value of the Rentenmarks to real goods. But real goods also scored huge gains in comparison to Germany’s currency—gold and silver were the only things to outpace inflation.

The moral behind these history lessons is that without free markets to determine the value of goods and services, it is impossible to prevent a hyperinflation. When governments begin tinkering with their economies, impeding the workings of free markets, their interference creates conditions that may, and often do, trigger deflations, hyperinflations, or economic disaster.

The other lesson to be learned from history is that during times of financial upheaval, massive transfers of wealth occur. In a hyperinflation, wealth is transferred from those who hold currency (cash) to governments and central banks. But it is possible to protect yourself and reap massive gains during such times of upheaval. During Germany’s painful hyperinflation, it would have been possible to purchase an entire city block in downtown Berlin for 25 ounces of gold.

Even though a hyperinflation will be painful and wipe most people out, the opportunity exists for you to benefit from the wealth transfer, if you prepare and position yourself intelligently.

What Can You Do to Protect and Your Family During Hyperinflation

The best way to protect yourself and your family from the effects of hyperinflation is to invest in hard assets such as gold and silver. These metals can serve not only to preserve wealth and purchasing power, but also have the potential to create vast fortunes in the process, for those who are positioned ahead of the herd. I’ll discuss later the opportunity this holds for you, but as I explained in detail in my book Guide to Investing in Gold & Silver and in my article, The Road Ahead, there is no possible scenario in which gold and silver do not rise.

Investing: Traditional means of protecting yourself financially during periods of high inflation include buying Treasury inflation protected securities (TIPS) or investing in currencies of financially stable countries.

However, keep in mind, while some currencies of some nations may hold up in value better than others, all existing currencies in the world today are fiat currencies, which by definition can be created out of thin air and can just as easily become worthless. I truly believe that during the next currency crisis, the problem won’t be specific to an individual nation or region, but will instead be a global problem.

The United States has abused its currency just as other nations have. Once the world loses confidence in the dollar, I think all fiat currencies, in all nations, will be done for.

Stock up: Consider stocking up on the basic necessities of life before prices rise to unaffordable levels or price controls create shortages. What you purchase today will cost more tomorrow. Items such as non-perishable foods, water, medicine, batteries and fuel will become infinitely valuable during a hyperinflation.

Some folks even use these to store value or to trade on the black market. During a hyperinflation, it’s possible currency will not be used at all as a medium of exchange; barter might take its place.

Extend loan terms: Cash management is critical during a hyperinflation. For business owners, smart cash management can be the difference between survival and non-survival.

During hyperinflation, the longer time period you have to pay off your debt, the less the currency you make your payments with is worth. So it is to your advantage to pay your debt slowly, over as long a time span as possible.

Reduce your receivables: Reversing that strategy, don’t make loans to others, or make loans only on a very short-term basis. During hyperinflation, the longer your creditor delays in paying you back, the less the payment (in currency) you receive will be worth.

The key to operating in a hyperinflationary environment is to understand that the value of currency is constantly declining. Anything that involves using currency must be treated with the utmost urgency.

Remember that hyperinflations are incredibly volatile. During the 1980s Argentina learned to cope with crippling 100% inflation. But when its inflation hit 500% in the late ’80s, the country fell into utter chaos. People may believe that 5% inflation is tolerable in the United States, but even that low level of inflation creates instability that can lead to massive inflation. When Nixon broke the cardinal free-market rule and instituted price and wage controls in the early ’70s, inflation was at only 4.7%.

The bottom line is that governments cannot continue to break free-market rules indefinitely without consequences; free markets will always win. Even though responsibility for the destructive consequences of hyperinflation lie squarely with the government, the government is unlikely to accept responsibility for making you and your family whole. Remember—every fiat currency in history has failed, and no fiat currency will ever survive in the long run. Take the steps today to protect yourself and your family, regardless of what the future holds. With proper foresight and planning, you can survive—and even thrive—in hyperinflationary times.