Applied Systems Thinking

Some time ago, Gonzalo Lira wrote a couple of interesting pieces on hyperinflation, and I promised to respond to them. This has taken me a while, as there is much material to go through, many arguments to pick apart, areas of agreement and disagreement, differences in definitions and matters of timing. The first article, How Hyperinflation Will Happen, is a long, thoughtful and detailed piece that I found interesting. There are many aspects I fundamentally disagree with, however, some for reasons of substance and others for reasons of timing.

Essentially the central proposition is that the US dollar is in danger of imminent demise due to a widespread loss of confidence, and that treasuries will be dumped en masse within a year, leading to hyperinflation, by which Mr Lira means price spikes. I do not see a loss of confidence in the dollar going forward, at least not soon. We have seen a long slide in the value of the dollar coincident with the rally in stocks. This is a reflection of a resurgence of confidence in being invested rather than being liquid, but this confidence is fragile and subject to rapid reversal. Continue reading “Debunking Gonzalo Lira and Hyperinflation”

“Beautiful credit! The foundation of modern society. Who shall say this is not the age of mutual trust, of unlimited reliance on human promises? That is a peculiar condition of modern society which enables a whole country to instantly recognize point and meaning to the familiar newspaper anecdote, which puts into the speculator in lands and mines this remark: “I wasn’t worth a cent two years ago, and now I owe two million dollars.”

Mark Twain (1873), The Gilded Age: A Tale of Today

I wanted to put our current predicament into historical context, and to demonstrate that the situation we find ourselves in is not novel. It differs quantitatively, but not qualitatively, from what has gone before – many times before in fact. Great cycles of expansion and contraction are part of the human condition, and there are patterns of boom and bust that continually repeat themselves, as they are thoroughly grounded in human nature.

Collective human optimism and pessimism are extremely powerful drivers, acting over very long time scales. They are powerful enough to drive tremendous cycles of socioeconomic expansion and contraction. As population grows and optimism increases during a long expansion phase, pressure emerges that can only be relieved by increasing the elasticity of the money supply, often in spite of existing rules intended to prevent this very dynamic in the name of maintaining sound money.

As a historical generalisation, it can be said that every time the authorities stabilise or control some quantity of money M, either in absolute or volume or growing along a predetermined trend line, in moments of euphoria, more will be produced.

Or if the definition of money is fixed in terms of particular liquid assets, and the euphoria happens to ‘monetise’ credit in new ways that are excluded from the definition, the amount of money defined in the old way will not grow, but its velocity will increase [..]

….My contention is the the process is endless: fix any M(i) and the market will create new forms of money in periods of boom to get around the limit and create the necessity to create a new variable M(j).

Charles Kindleberger, Manias, Panics and Crashes

There have been many examples of this process throughout history and it is instructive to look at such periods. For instance, the medieval expansion of the eleventh and twelfth centuries had very much this character. Continue reading “The Infinite Elasticity of Credit”