The broad definition of hyperinflation is generally regarded as excessive price rises, usually over 50% a month. Such rises are hugely damaging to economies leading to a huge loss of productivity, severe economic depression and mass unemployment. Central bankers have fought for decades to take control of inflation and, in most cases, have done a very good job.
Now they are acting with complete disregard to monetary theory and ignoring all the valuable lessons of the past. Are we in for the hyperinflationary ride of our lives?
In early April Japan’s Central Bank announced its commitment to double the monetary base over the next two years from 29% to 55% of GDP (Y135tn to Y270tn) – an increase of a over 1% of GDP per month.
Should the newly created currency flow equally throughout the economy and if we assume that all else remains equal, the simple expectation would be that the purchasing power of the Yen should halve (i.e. that the average price of goods should double in Yen terms). This rather naïve analysis assumes the world is simple and equal. People adapt when things change leading to far graver consequences than our naïve analysis would assume.
Investors have picked up on the Bank of Japan’s aggressive stance and have reacted by pumping money into the Japanese stock market, while selling the Yen. The next leg usually involves large institutional investors which, move slower but control enormous assets, selling their bond holdings and using the proceeds to buy equities, both Japanese and overseas, and other real assets where they can protect their purchasing power. Pension funds (who invest over 85% in bonds) are next and finally, the man or woman on the street, who also control vast sums of savings, adapts to the realisation that their risk free assets are in fact return free risks.
This, again, is a very simplistic and perhaps a naïve assessment of possible events, bit given Japan’s immense debt load (total debt is 500% of GDP, gross government debt is 240% of GDP, net debt is 140%) Japan needs to maintain yields at very low levels so they can afford to pay the interest on their debt. A 1% rise in yields would soak up nearly 25% of tax revenues!
Eventually investors will realise that they are lending money for 0.5% a year to a government that is effectively insolvent. If they then begin to worry about inflation they will offload bonds en masse demanding the BoJ to purchase even more bonds to maintain yields at the depressed levels they are today. How do they do that? Print more! And so the self-fulfilling prophecy ensues.
So will Japan experience hyperinflation?
With each stage the crisis deepens and central bank control slips further away. A currency and bond market collapse may seem a slim possibility but the probability of such an event has increased dramatically. In such a case it is likely that Japan would experience bouts of hyperinflation.
Japanese investors who are worried about their savings would be wise to diversify out of Japanese bonds and into overseas bonds and, for the less risk averse, overseas equities, preferably of companies with strong balance sheets that generate strong free cash flow. And, of course, gold!
For those wishing to read further Gordon Long’s post is a fascinating read.