Hyperinflation and

Monetary Collapse
But First a Fire Sale
David Eishen

December 2008
Hyperinflation and Monetary Collapse-But First a Fire Sale

Hyperinflation starts as a result of opposing forces. These include the destruction of suppliers’ capacity
to produce and the consumers’ accelerating preference for and hoarding of the essential necessities of
life such as food, shelter, electricity, fuel, transportation, clothing, and medicine.

During times of financial stress, suppliers of all types of goods begin to fail. These business failures
cause a reduction in production. Consumers shun items usually purchased with discretionary income
and show preference for purchasing the necessities of life. Hoarding the necessities of life and saving
money to purchase the necessities of life in the future is prevalent in the beginning of hyperinflation.

As the production of essential goods continues to collapse and hoarding becomes more widespread,
shortages of essential goods begin to develop. As consumer fear intensifies, hoarding becomes more
prevalent among consumers who still have adequate financial resources; however, the price they are
willing to pay for essential goods increases at an accelerating rate.

Consumers without financial resources sufficient to hoard essential goods experience shortages. As
time progresses and financial resources are exhausted, an increasing number of consumers are left
without food, shelter, electricity, fuel, transportation, clothing, and medicine.

Since most of the essential goods are consumed and need frequent replenishing, prices rise rapidly as
production decreases, increasing the portion of the nation’s money supply used for these goods. The
portion of the money supply used for non-essential goods decreases, putting downward pressure on
pricing when compared to prices for essential goods.

Businesses and consumers quickly pressure the government to provide resources to supply essential
goods. The government’s response is to inflate the money supply and distribute the new money to
needy businesses and consumers either directly or through the banks; however, this occurs while the
capacity of producers of essential goods is contracting. Thus, the quantity of goods is lowered at the
same time prices are increasing. Employees who produce, distribute, and sell goods lose their jobs,
accelerating the demand on government to inflate the money supply. This establishes an endless cycle
of an expanding money supply chasing fewer essential goods.

Inventories of less-essential goods that support the infrastructure needed to produce, distribute, and
maintain essential goods eventually become exhausted and rapidly increase in price as shortages
develop. Less essential goods include replacement parts for critical machinery such as tractors, trucks
and trains along with those needed to maintain the infrastructure for electricity, energy, and buildings,
just to name a few. These shortages depress further the availability of food, shelter, electricity, fuel,
transportation, clothing, and medicine putting upward pressure on prices.

Inventories of non-essential goods could become bloated in the short term driving down prices for
these items as businesses and consumers shun non-essential goods in favor of essential goods.

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Eventually as the bloated inventories decrease, lack of production will cause these prices to rise as
well.

As consumer fear and government anxiety increases, larger quantities of new fiat money will be
produced. Since fiat money is not backed by gold or silver, and is instead created by government
decree, it has no intrinsic value. Fiat money can become worthless as faith in its value declines.

Wages of those who remain employed will experience downward pressure due to the abundance of job
seekers, while rising costs of essential goods will pressure workers to demand higher wages. The ever
increasing number of unemployed and underpaid employed consumers will pressure politicians to
increase government financial support. As consumers spend this new money, they will find that its
value is decreasing, rapidly creating demands for even more new money.

Purchasing goods at current prices will be favored over saving money. Saved money will not be able to
purchase as many goods in the future as prices rise. All of these forces are self reinforcing until
monetary collapse. At this point many goods including essential goods will not be available with any
amount of fiat currency.

One has to remember that hyperinflation and monetary collapse is not a new phenomenon even to the
United States. The “Continental” was the currency first issued by the Continental Congress in May of
1775 to fight the Revolutionary War. Each Continental was to equal one Spanish milled dollar, each
of which was about 4/5ths an ounce of silver. This debt based currency was originally limited to an
equivalent of 2 million Spanish milled dollars. The colonies were committed to repaying the debt by
exchanging Continentals for Spanish milled dollars after the war.

By the end of 1775 the maximum amount of Continentals had been raised to 6 million Spanish milled
dollars, and by 1779 the maximum was raised to 242 million Spanish milled dollars, which was
equivalent to almost 200 million ounces of silver-- well beyond the colonies’ ability to repay. As it
became obvious that the debt could not be repaid, hyperinflation devalued the Continental to a point
that it took 168 Continentals to exchange for 1 Spanish milled dollar by 1781, and eventually
Continentals became worthless. Citizens of the newly formed nation bore the brunt of the
Continental’s collapse.

Later when the Constitution was written, the states were given control of money and could not make
anything but gold and silver coin tender in the payment of debts, eliminating the possibility of
hyperinflation and monetary collapse associated with paper currencies.

In the last 150 years laws have been passed that undermined the intentions of the nation’s forefathers,
substituting inherently risky fiat currency from a private bank, the Federal Reserve, for the safety of
gold and silver coins issued by the states. The process began by the federal government issuing paper
currency that promised to be redeemable in gold coins and later in silver coins. In 1933 during the
Great Depression United States citizens lost not only the right to redeem paper currency for gold coins
but the right to own and use gold coins for payment of debts as well. Dimes, quarters, and half dollars
were 90% silver until the Coinage Act of 1965 and silver certificates, a paper currency backed by

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silver coins, lost their convertibility in 1968. The world’s central banks retained the right to redeem
U.S. dollars for gold until the right was revoked in 1971 making the U.S. dollar a fully fledged fiat
currency backed by nothing more than the good faith of the United States government.

Thomas Jefferson warned us about central banks. He said, “The central bank is an institution of the
most deadly hostility existing against the Principle and form of our Constitution. I am an Enemy to all
Banks discounting bills or notes for anything but Coin. If the American People allow private banks to
control the issuance of their currency, first by inflation and then by deflation, the banks and
corporations that will grow up around them will deprive the People of all their Property until their
Children will wake up homeless on the continent their Fathers conquered.”

When Thomas Jefferson referred to “bills or notes” he was referring to paper currency and “coins”
meant gold and silver coins. With paper currency it is relatively easy for a central bank to expand
(inflate) and contract (deflate) the money supply. New gold and silver coins can only be produced
when new gold and silver are mined within the country or brought to the United States from overseas.

We are now in a moment when “Children will wake up homeless on the continent their Fathers
conquered” as Thomas Jefferson so eloquently penned so many years ago.

Just like during the time of the “Continental” the United States once again faces the probability of
hyperinflation and possibility of monetary collapse.

The United States is not the only country with a history of a failed fiat currency. All fiat currencies
eventually collapse including the assignat in France and the Reichsmark in Germany. Currently the fiat
krona in Iceland and the fiat hryvnia in the Ukraine have lost fifty percent of their value in the last few
months, entering the early stages of hyperinflation. The fiat Russian ruble has lost almost twenty
percent of its value in the last few months.

The money supply is inflated by the Federal Reserve Bank through new debt. New money is borrowed
by banks from the Federal Reserve and loaned to governments, businesses, and consumers. The money
supply has been expanded for decades through the debt/credit process. A plethora of schemes and
rationalizations were developed to mask the obvious risks so that the economies could absorb the
massive amounts of debt created by the world’s central banks. Over the last few decades, economies
have been built with increasing reliance on debt/credit. In 2008 as the United States debt to GDP ratio
reached 370% (which is greater than the previous peak of 300% reached prior to the Great
Depression), the credit markets began to collapse. In 2008 the United States was the largest debtor
nation in the world with more debt than the rest of the world combined, and it depended on foreign
investors to fund hundreds of billions of dollars in debt per year. Prior to the Great Depression the
United States was a creditor nation and was not dependent on foreign funding of debt.

Suppliers of both essential and non-essential goods over the last few decades developed business plans
that pinned their survival on ever increasing supplies of credit with the growth of credit coming
primarily from overseas. Many suppliers are companies that can service only the interest part of their
debts with business revenue and must take on new debt to service the maturing principal portion of

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their debt. Some suppliers cannot service either the principal or interest portions of their debts with
business revenue and must take on larger quantities of debt not only to service the maturing principal
potion of their debt, but to pay the interest on existing debt as well. On the downhill side of “peak
credit,” debt destruction replaces debt creation, destroying the suppliers most dependent on debt
expansion for survival. Suppliers who are also heavily dependent on the consumers’ access to credit
will be subject to even greater challenges for survival.

The downhill side of “peak credit” also signals the moment that could be referred to as “peak
globalization.” This is the moment that monetary and political relationships between countries come
under stress and begin to break down. Afterwards the volume of trade between countries begins to
decline.

In the last few decades, the United States has also outsourced the production of essential and non-
essential goods overseas, making the United States dependent on foreign suppliers. During this process
the knowledge base needed to produce these goods in the United States was destroyed and the related
infrastructure was dismantled. As the intricacies of globalized credit and supply become strained,
commercial relationships between countries are destroyed. The capitol required to re-domesticate the
suppliers of essential goods will be scarce, making it difficult to restore supply to match demand. The
most productive method of using taxpayer’s money to restore the economy would be to provide the
capitol to re-domesticate the suppliers of essential goods.

Another aspect peculiar to the United States is the large portion of the economy dedicated to the
distribution and sale of non-essential goods. Even though the majority of these goods are not produced
in the United States, a vast infrastructure has been built to distribute and sell these goods. As
businesses and consumers exhibit their preference for essential goods over non-essential goods, the
vast infrastructure for these goods will be dismantled along with a large number of associated jobs.

The wild card in all of this is the use of the U.S. dollar as the reserve currency. In the beginning phase
of hyperinflation, the U.S. dollar maybe preferred over other hyperinflating fiat currencies because of
its status as a reserve currency. A non-hyperinflating fiat currency would be preferred over the U.S.
dollar if such a currency existed. The U.S dollar’s status as the reserved currency of the world has
made investors more tolerant to excessive levels of risk and debt in the U.S. economy. Any change in
the reserve status of the U.S. dollar will accelerate the destruction of U.S. dollar denominated debt
financed by foreign investors, increasing the burden on the U.S. government to inflate the money
supply.

Inflation occurs when the money supply is growing more rapidly than the quantity of goods and
services produced. Hyperinflation occurs when there is a massive growth in money supply that is not
supported by a similar growth in the quantity of goods and services produced.

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The gross domestic product (GDP) in the United States has started to contract, and the economy is
officially in recession as of December 2007. Two of the last four quarters have shown a contraction in
GDP. In the fourth quarter of 2007 the contraction at a seasonally adjusted annual rate was 0.2 percent,
and in the third quarter of 2008 the contraction was 0.5 percent. In the fourth quarter of 2008 personal
consumption expenditures on durable goods was down 15.2 percent and for nondurable goods
expenditures were down 6.9 percent. The most likely explanation is that businesses and consumers are
making the shift to a preference for essential goods over non-essential goods and are paying down
debt.

Percent Change in Annual Gross Domestic Product 1930-1933

During the Great Depression of the 1930’s, the GDP contracted. The contraction in the 1930’s was
much greater than what the United States has experienced so far in this current economic downtrend,
and the contraction lasted several years. The depth and length of the current contraction is yet to be
seen but there is evidence that it probably will be severe.

Many of the current headlines refer to economic data that is the most severe in many years or since the
Great Depression of the 1930’s, or as the worst ever.

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 Monetary Base (M0) and the change from the year before: Federal Reserve Bank of St. Louis

What makes this economic crisis different than the Great Depression of the 1930’s is the response by
the United States Federal Reserve. In the Great Depression, the Federal Reserve allowed the monetary
supply to contract while the production of goods and service was declining. The contraction in the
money supply put downward pressure on prices even as businesses and consumers shifted their
preference from non-essential goods to essential goods resulting in deflation. During the current crisis
the Federal Reserve is increasing the money supply as shown in the table above. The current increase
in the monetary base is hyperbolic with a 33 percent year over year increase in October 2008 and a
whopping 72 percent year over year increase in November 2008.

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The same information can be shown in chart form.

Monetary Base (M0) and the change from the year before: 01/01/1928-01/11/1930

Monetary Base (M0) and the change from the year before: 01/01/2006-01/11/2008

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The headline and paragraph below says it all.

There are reports daily that suppliers of essential and non-essential goods are closing and laying off
workers. The decline in GDP is evidence that the output of the United States is contracting. At the
same time the monetary supply is rapidly expanding. Remembering that hyperinflation occurs when
there is a massive growth in money supply that is not supported by a similar growth in the quantity of
goods and services produced makes one wonder what happens when there is a massive growth in
money supply when the quantity of goods and services is contracting. Hyperinflation now seems
inevitable. Unless the rapid expansion of the monetary base is ended soon, hyperinflation will take
hold, leading to the possible destruction of all value in the U.S. dollar.

Hyperinflation begins many months after the massive growth in money supply and continues many
months or years after it ends. It also can be masked for a period of time when it follows a buildup in an
excess supply of goods and a destruction of demand. A perfect example is the current glut in homes.
This glut will grow for many years as more homeowners default on their loans, depressing the prices
for homes for years to come. Other examples include the deep discounts experienced at department
stores by shoppers during this Christmas season and the rapid drop in prices for gasoline that
corresponds with Americans driving fewer miles. Supply for now is exceeding demand, forcing prices
to decline. Lower sales volumes and increased need for supplier liquidity has spurred a temporary
“Fire sale” within the American economy.

Essential goods have a shorter replacement cycle than non-essential goods. Many are produced using
“just in time” supply chains and are not stored anywhere in any large quantities. Hyperinflation is
likely to be felt first in the essential goods with the shortest replacement cycles such as food and
medicine as more suppliers go into bankruptcy. As the current inventories of essential products are
exhausted, new supplies will reflect the reality of hyperinflation. Eventually the current inventory of
most products will be exhausted and will succumb to the effects of hyperinflation.

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The only way to prevent monetary collapse is to remove excess funds from the money supply to match
the falling production in output. Currently that seems highly improbable. Every time the Treasury or
Federal Reserve has intervened in the current crisis, it has expanded the money supply. Every bailout,
loan, or guarantee expands the monetary base.

Both Republican and Democratic party leaders have committed themselves to throwing massive
amounts of money at the problem until we are “saved,” simultaneously dodging questions how it will
be repaid. In truth they are more likely to continue throwing massive amounts of newly created money
at their cronies and the masses until our current system of fiat money collapses.

Unfortunately one thing that is different this time is that for the first time in history the whole world is
using a menagerie of fiat currencies. In the past failed fiat currencies have been a national phenomenon
and confined to that country while the rest of the world remained on a gold and/or silver standard. This
time the monetary system of the whole planet faces systemic risk, pressuring central banks across the
globe to inflate their money supply, sowing the seeds for hyperinflation.

The reserve currency status of the dollar guarantees that when it collapses it will destroy the fiat money
system of the world. In the meantime monetary collapses will most likely first occur in weaker
currencies such as the Icelandic krona and Ukranian hryvnia and then spread to what is perceived as
stronger fiat currencies such as the Russian ruble. Failure of any fiat currency increases the risk of
failure to all fiat currencies intertwined within the global economy.

10 Hyperinflation and Monetary Collapse-But First a Fire Sale | December 2008 | David Eishen