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14 April 2013

Hyperinflation Warning - Debt Phase Transition

The Federal Reserve has been “printing money” on a massive scale for the last several years in support of various stimulus programs; a process they now call Quantitive Easing, or QE. Keynesian theory allows that spending, even deficit spending, results in economic growth. And this has actually been the case during various periods in the 20th century. For example, increased spending during World War II resulted in a post-war economic boom. Keynesian theory supporters can point to several other examples. 
However, according to the Federal Reserve; 

"QE did not dramatically increase bank loans and the growth of broader monetary 

What makes the current situation different? -  Economic growth is dependent on the utility of debt.

Let us consider the famous Widget Company. Say the Widget Company manufactures 100 widgets a day. They can take out a loan to buy additional or better equipment to increase their output to 500 widgets a day. Obviously then, the ability of the company to borrow money has some utility. If every dollar borrowed enables the company to earn more than a dollar, the Utility of Debt is said to be greater than 1.

Extrapolated to the entire economy, the same general principle applies. Historically every dollar created by the Federal Reserve has resulted in more than one dollar in increased economic activity. But there is a limit. Eventually a point is reached where the new dollar creates less than one dollar in new economic activity. This point was reached somewhere in the 1950’s. 

Debt Phase Transition is the term applied when the creation of a new dollar actually causes a contraction of economic activity. We have recently reached that point. We have reached a point of debt saturation. No amount of money creation (money printing) can cause economic recovery. Furthermore, the increase in money supply only makes the problem worse since each new dollar actually decreases activity. 

The only possible solution is the reduction of debt, and this can happen in only three possible ways – 1.) Repay the debt, 2.) Default the debt, and 3.) Erase the debt through hyperinflation.

It should be obvious that neither of the first two possibilities will ever happen. (If you do not agree, please see upcoming posts for proof.)

This leaves only hyperinflation. The massive amounts of money being put into the system has not caused inflation yet because it isn’t being used. Money Velocity is very low. (See chart below). But this money still exists, along with huge amounts that has been transferred out of the country because of our multi-decade trade imbalance. All of these excess dollars constitute a large reservoir that will flood the economy when the holders of these dollars decide to exchange them for something else – a process that has already begun.

At no time in the history of man and money has there been such a buildup of excess currency. The hyperinflation that must result will be unprecedented and will make previous hyperinflation events seem insignificant.