Debt, Deflation, Inflation and Hyperinflation

This is where the rubber meets the road.  Kyle Bass at the Barefoot Economic Summit in Texas made some very interesting points discussing the risk of hyperinflation, cause by the Fed reserves QE2 program (which by the way is now “baked-in”).  The big word used by everyone is “Price Convexity” which is a big word for feedback loop, in effect the prices rise because the prices rise, which leads to the destruction of fiat currencies (dollar, Euro, Yen etc).  The example of the best performing stock market in the world in 2007 was Zimbabwe, yet despite extraordinary returns, fiat currency wealth was completely destroyed.

One of Kyle Bass’ first comments was that America doesn’t have the luxury of going to way of Japan – by the way that was not the objective of the interviewer.  In fact, he was angling to find out if things could get as bad as they did in Japan, and Bass’ point was that because ½ of America borrowings are from foreign investors, that every week “America” borrows $120 billion (rolling over and new money), where the current borrowings are growing between 6-9% per annum (by 2014) the implication is that America’s debt will have risen by 30%.  

Bass’ point is that America would face a convexity point – going from very low inflation to very high inflation in a very short period of time, because the bulk of America’s borrowing are short term the impact of an increase in inflation would quickly feed to higher interest rates (1% increase in interest would raise America’s borrowing cost by $120 billion).

His is the first analysis that posses the right question, that the problems of America with its foreign held debt are bound to come to a head sooner rather than later, and although America is considered a the safest bet as creditor, it remains that there exists a tipping point, so the question is not “if” but “when”. 

Which may explain the recent price movement in many natural resources – first is the epic drop in the value of the U.S. dollar over the past 12 months (13%) – although against the Canadian dollar price remain stable, but from agricultural products (32%), Metals (17%), gold (26%) price of raw materials have exploded.  This could be the first wave of early investors – the smart (or conservative) money, diversifying away from fiat currencies towards tangible assets.  BTW hyperinflation is very very bad for stock prices.  Projections for Gold, Platinum, Silver are all for substantial increases as investors look for ways to insulate their wealth from the vagaries of fiat currency.

Every indictor seems to point to 2012-14 for the “big crunch” – I guess far enough in the future that there is still time for things to change.  For Canada the impact is unclear.  There is a risk of contagion, and Canada’s debt to GDP is not but hyperinflation tend to be isolated, but an open economy highly dependent on trade with our American neighbors is bound to be affected – you can be careful, but a bad neighborhood is still a bad neighborhood!