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Thursday
Feb162012

Inflation, Hyperinflation, and Gold

Here are two interesting pieces that address the same issue.

First, a great bit of explanation from this alarmist essay:

[…] hyperinflation is not an extension or amplification of inflation. Inflation and hyperinflation are two very distinct animals. They look the same—because in both cases, the currency loses its purchasing power—but they are not the same.

Inflation is when the economy overheats: It’s when an economy’s consumables (labor and commodities) are so in-demand because of economic growth, coupled with an expansionist credit environment, that the consumables rise in price. This forces all goods and services to rise in price as well, so that producers can keep up with costs. It is essentially a demand-driven phenomena.

Hyperinflation is the loss of faith in the currency. Prices rise in a hyperinflationary environment just like in an inflationary environment, but they rise not because people want more money for their labor or for commodities, but because people are trying to get out of the currency. It’s not that they want more money—they want less of the currency: So they will pay anything for a good which is not the currency.

In other words, in inflationary conditions, everyone is pulling the currency.  They want (and need) more of it because everyone who they buy goods and services from wants (and needs) more of it.  On the other hand, in hyperinflationary conditions, everyone is pushing the currency, they want anything but currency and require more currency as a sort of bribe to except currency at all.  In either case, the currency flows more rapidly, the pushing and pulling happen in the same direction.  The symptom in terms of on-the-shelf prices is similar, but the effect on everything else in the economy is quite different.

One significant difference is what happens relative to alternate currencies, which brings me to the other piece:

I can guarantee that the majority of people who make the claim that gold is an inflation hedge have never looked at the data. Imagine you were a retiree in 1980 looking to protect yourself against inflation. If you were to accept conventional wisdom and bought gold to hedge against inflation, your retirement would have been a nightmare. […]

The reason I am very bullish on gold is because of the obvious debt problems we face. The truly monster spikes in gold are going to come because of sovereign debt defaults.

In inflation, people want more of the inflating currency relative to other currencies (not to sit on, to spend).  In hyperinflation, people want any other currency (since they still need to buy day-to-day stuff).  In the former situation, gold will do poorly against things that are significantly more useful.  In the latter situation, gold will do well to the extent that it functions as a not-currency currency.  It’s not tightly-coupled to other currencies, and “you can’t print gold”, after all.

Disclosure: I’m long in gold and silver, for pretty much the reasons above.
Disclosure disclaimer: The above should not be construed as investment advice.  Any investment advice I do give may be terribly bad.

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