Hyperinflation …. As the most popular economics channel on YouTube, Economics Explained calls it is: “game over” for any economy.
Therefore, if this massive channel makes the case that the US dollar has secretly declined in value and that the country is plausibly on the brink of hyperinflation, we should assume that his bold claims are grounded in economic theory and supported by data, or at least… not directly contradicted by publicly available data … right?
Hey, I’m Joeri, a research economist at the Universities of Groningen and Cape Town, and in this video, I’m going to responds to Hyperinflation is already here: you just haven’t realised it yet by Economics Explained, or EE for short.
EE’s Argument
Alright, EE starts the video with a super engaging introduction, stating that the economic situation that set the scene for hyperinflation in countries like Weimar Germany and Zimbabwe are in fact comparable to those today in the United States
Then, he poses three central questions:
- When does inflation become an unsolvable problem?
Weirdly enough, EE doesn’t really answer this question in his video. So, I guess I will have to do that for him…. But, he does imply that hyperinflation would be right around the corner in any normal country because asset prices have been going up like crazy.
- Why do people think the USA is immune from these problems?
Here, EE suggests that people think the USA is immune from this because the Dollar is the global reserve currency … but, that we should be careful about how long this will protect the USA from hyperinflation.
- How can people protect themselves from hyperinflation?
Finally, here, EE not only advices us to invest in properties and companies, but to do that using borrowed money… After all that money won’t be worth anything anymore soon anyway.
And you know what, all of this sounds very logical, but….. does it hold up to scrutiny if we dive a little deeper?
Is the US really like Weimar Germany and Zimbabwe?
Okay, right of the bat, I have to say this introduction is really well made… very engaging… to the point that I almost forgot to write down the logic… of it all…
But, basically, EE mentions 4 points about Weimar Germany
onerous war reparations demanded from them by the victors of WW1. This combined with domestic stimulus efforts to rebuild a post-war nation combined with hits to PRODUCTIVE capacity like the French occupation of the nations most powerful industrial centres gave the government little option but to print more money in an attempt to get their economy working in any capacity.
However, when EE summarizes it
This reckless printing, combined with equally reckless borrowing, and a reduction of productive capacity of the nation saw the value of the German papier mark tank> …
he doesn’t mention these capital outflows as a consequence of the reparation payments anymore … strange…
But since capital outflows due to reparations were an essential part of the Weimar story according to both EE and my own sources, I decided to keep them on the list anyway. Next, I did some research on how to fit EE’s points into well-known economic theory frameworks.
The argument of massive capital outflows is related to what economists call the exchange rate channel of inflation, meaning that if there are large outflows of money… the currency of a country loses value and as a consequence imported products will become much more expensive … this is for a large part what is happening in Lebanon today which is actually experiencing monthly inflation rates over 50%
And, as EE tells us in his follow up video, his last three points are based on the Quantity Theory Of Money that states that
The Money Supply * Money Velocity = the Products sold in an Economy * the prices of those products…
For example, if in an economy there were 2 dollars, and these exchanged hands once, and there were two loafs of bread in the economy, then we can deduce that the price of each bread was 1 dollar.
Now, in itself, this equation only tells us that there can be a relationship between these variables. But, crucially, it doesn’t tell us what that relation will be.
For example, you could argue that, if we assume that money velocity remains equal and so does production, an increase in the money supply will then logically lead to an increase in prices…
Say that there are now twice as many dollars (4)…. And they still change hands only once…. The number of bread loves is the also same… then we can deduce that the price must have increased to $2 per loaf…..
After all, if bread production doesn’t change and the number of transactions don’t change… but money does, it is likely that prices will increase thanks to the extra demand for bread that this new money brings….
But,…. When inspecting economic theories you should always pay attention to the assumption that are being made… Why should this new money not be saved, rather than spent? Reducing the velocity of money. Or why should we assume that this new money has not been used to spur an unemployed baker into action?
So, in itself an increase in the money supply doesn’t have to mean an increase in prices, and a drop in productive capacity also doesn’t mean that there has to be more inflation. But, as EE rightly notes… an increase in the money supply and a drop in supply could very well mean that inflation will pick up.
So, what happens if we take this simple bit of economic theory, to EE’s list? Well, we see that printing & stimulus are money up arguments while the productive capacity argument is a production down argument.
So, while typical economists would structure these a bit differently, EE’s points are rooted in basic economic theory … Let’s move on to his next point:
Hungary 1945, over half of the nation’s factories and business had been destroyed. The government had no choice but to direct more and more money through private banks to issue loans to business to rebuild from the ground up.
Yugoslavia 1992, industrial capacity is reduced and this slowdown of output is accelerated by a trade embargo placed on the country by the united nations. To combat this the government turned on the money printers and made borrowing a lot easier.
Zimbabwe 2007, mass exodus of capital from the nation driving down the exchange rate of their dollar. This made importing farming supplies very expensive which in turn crippled the output of the nation. This combined with the now infamous land reform act gave the government little options but to try and print their way out of trouble… to no avail.
Okay… here again… sanctions.. massive outflows of capital.. keep that in mind
North Korea 2009. Farming output was hit by sanctions and a poor year for weather. Money printing, hyperinflation.
Venezuela 2016. International sanctions gave the government no choice but to print money in an attempt to maintain generous living standards. This reckless money creation combined with a massive reduction in output. Hyperinflation.
Okay,
let’s move on the America 2020.
the fallout of the Coronavirus has hit the nation particularly hard… the pandemic has had an undeniable impact on the economy… Tourism, hospitality, in-person retail and entertainment.. these sorts of industries are not going to be back at full capacity for a very long time..”
Okay, again… .this sounds logical right??… but does it hold up if we dig a little deeper… is there a difference between shutting down certain sectors of the economy in a pandemic and … losing your industry to a foreign invader?
Ehh yeah, there are at least two….
- In the historical hyperinflation episodes… it was only supply that fell… but, not demand. In other words, cruise ships are empty now… but that is also because people now don’t want to go on a cruise ship…. On the other hand, French troops taking German industry by force did not coincide with a drop in demand for these products.
Of course, these differences has massive implications for inflation because it means that yes…. Production fall… but velocity also takes a massive hit… So, overall prices don’t have to rise.
- The second point is that if your productive sector gets occupied, taken away to a foreign country, or is forcefully evicted from their lands…. it wouldn’t easily bounce back. On the other hand, during the pandemic …. Your production also takes a hit…. But, your productivity CAPACITY is still there!!!
Okay, so here EE’s theory is not complete. But, what about the data? To find out if my argument holds up better than those of EE, I did some research and looked up data on production in the USA and indeed…. I found this graph which shows that, when EE published in his video, it was already clear that the US economy was producing roughly as much as it did before Covid.
However, there is more to EE’s argument that could lead to hyperinflation in the US… because according to him..
the US has printed more than a third of the active money supply in the economy today
Hold … hold on… It’s when I saw this graph … several alarm bells started ringing in my head… While, I also noticed other YouTubers like Jake Tran using it to make the same point… Suspiciously, no other media picked it up ….. Now, That is very strange huh…..
Well… it turns out that the reason is that …. This graph.. While from a credible source, and technically correct, doesn’t show you what EE tells you it shows you. To understand why… there is something that we have to understand about money…
In the last century, inspired by the quantity theory of money… economists started to measure money. However, when they did so, they quickly ran into a problem…. What counts a money?
With the quantity theory in mind, the obvious answer is…. Anything that can be used to purchase goods & services…
So, they started with, bank notes and coins… … and categorized these as M 0… But, with bank money dominating our modern economies… they added both checking and saving accounts to M 0 to get a measure known as M 1… this is what has risen by over a third…
However, many banks also have savings accounts that are fixed for a couple of months or weeks. And, since many of these funds become available each day and most people don’t spend their savings account anyway… aren’t these very comparable to normal savings accounts? This is why M2 contains all money instruments in M1 plus savings accounts with specified dates…. But, then.. you guessed it, it gets even more complicated… what about money in accounts at financial institutions that are technically not banks, but are very similar to banks… well these are included in M3.
This distinction is important if we want to understand why EE’s graph is so misleading… Yes, in the USA M1 seems to have exploded, but when I tried to dig a little deeper by going to the original source, I noticed that the last area of the graph was shaded (although now they appear to have removed that shading) … indicating that I should read the footnote…
And this revealed to me (https://fredblog.stlouisfed.org/2021/01/whats-behind-the-recent-surge-in-the-m1-money-supply/) that what happened here is that, because of a change in regulations… many people shifted from fixed savings accounts counted in M2 into M1 savings account balances…..
That’s is not money ‘printing’ is it…
So, then, I decided to check M2 .. and indeed that did rise… but not by ”more than a third of the active money supply today”.
But, even though EE’s graph overstates money printing by a lot, there has arguably still been an increase in the money supply due to increased government spending…
So, what about our last factor: large capital outflows… that will cause the exchange rate to plunge.
Well, while capital flows are notoriously difficult to measure, one measure that is commonly used is “net incurrence of portfolio investment liabilities” from the IMF Balance of Payments dataset. And as you can see… nope after the initial shock in the first quarter of 2020 private ivestors were rushing to get money into the USA…. Not out of it…
So, then if EE’s says…….
If this set of circumstances sounds familiar…
My response would be …. No not really, because while the US has seen an increase in the money supply…. It’s not by as much as you made it out to be … and while it did also see a fall in production, its productive capacity is still largely intact. Furthermore, because of the pandemic, demand for luxury cruises and air travel has fallen along with supply, and finally, there was no capital flight…
But limited money printing and stimulus could still lead to hyperinflation down the road right? And EE’s other questions…. are still very interesting … So, let’s see if they hold up any better.
When does inflation become an unsolvable problem?
Look at this graph of consumer prices in Lebanon…. You see how inflation was fairly mild for a long time, then accelerated and then exploded to hyperinflation levels….
So, this question is very relevant… But, the problem is that EE never answers it in his video…
Instead, he seems to ask the question whether the Dollar has secretly declined in value… because the stock market has gone up…. Even though it’s fundamental underlying value has ‘clearly’ declined…
In other words: since the beginning of 2020 the SPY index has become ‘undoubtedly become less good’…
Here there are two interesting questions that need a bit more exploration…
(1) Did the stock market index indeed undoubtedly become ‘less good’? and (2) does an increase in asset prices secretly indicate a reduction in the value of the Dollar?
First, let’s explore EE’s claim that the underlying value of the SP500 index, which contains America’s largest 500 companies, has indeed decreased in value.
Sure, there are a few companies that have benefitted from working from home or delivering products to combat the pandemic. But, most companies are struggling…. Global supply chains have been slow, people are moving about less, therefore burning less fuel and this is all to say nothing about companies directly involved in tourism or hospitality, which are now basically on government life support.
Again, this sounds logical, but did EE actually do the research, or is he just saying stuff… In other words, if I we dig a little deeper, is it true that America’s top 500 companies have become less ‘good’ due the pandemic?
To find out, I looked up data on the earning of these companies and sure… while tourist industry earning are down (see e.g. Expedia group) and therefore “undoubtedly ‘less good,’” I discovered that earnings of the 500 biggest companies in general were almost back up to their pre-Covid levels along with their stock prices as can be seen in EE’s own graph.
So, his argument that this index has without a doubt become less good… is just not supported by the data.
Desperately trying to proof that EE’s isn’t just making stuff up, I decided to stretch his example a little and extend it to house prices. Look, it’s undeniable that these went up like crazy during the pandemic even though the economy has taken a hit…. And that really is concerning. But, house prices aren’t part of the consumer price index, CPI, and therefore are not directly contributing to inflation.
However, then EE says:
CPI: normally the value of these items (in CPI) is highly correlated in the short to medium term with these other assets (stocks & houses).
And again, technically this is correct… When I did my calculations… I found that, in the USA, the CPI does indeed correlate with housing prices….. But, that is because they are both equally affected by inflation…… However, EE then goes on to give the example that
if real estate becomes more expensive then rent is going to cost more, which means that businesses are going to have to charge more to remain competitive and those additional charges will be registered as increased prices in the consumer price index.
Implying that asset price booms typically cause inflation… In other words… he is implying that given that house prices look like this….. consumer-good prices look like this…. But if we plot actual consumer prices… they look like this…. Also, doing a bit more research, I found that economic studies could never find this link that EE is talking about. To the contrary, research typically found that asset price booms…. Are followed by… deflation… after they burst. For example, the massive bubbles of the Roaring twenties ended in the biggest deflationary episode America has ever seen, and Japan’s massive asset price boom of the 80s ended in 30 years of deflation.
And if that wasn’t bad enough… if the Dollar truly has become ‘less good’ overall… there is actually a simple way to check that by using exchange rates. After all, in all of EE’s hyperinflation examples the exchange rate tanked as inflation was rising…. On the other hand, the value of the Dollar, if we compare it to a basket of international currencies, looks like this.
So, if we are super generous to EE. Maybe the dollar has devalued a little bit. But, not by a shocking amount compared to its history.
So here again, to state that the massive rise in asset prices either reflects a massive devaluation of the Dollar or will soon be translated to consumer price inflation are just empty claims that are contradicted by economic research.
By the way, I’ve linked all my data sources in the description of this video. So, if you are afraid that I’m cherry picking my examples to make EE look bad, please have a look there, and if you have better evidence than I presented here let me know in the comments and I will, as always, feature the best critiques of my work there with a reference to the commenter.
But, at this point you might ask, so when does inflation become an unsolvable problem? Well, since EE doesn’t really answer this question, let me have a go at it by looking at the example of Lebanon… why did inflation suddenly turn to hyperinflation there?
Well there the big problem was that Lebanon was consistently important more than it was exporting, and money was therefore flowing out of the country. Now, Lebanon could sustain this trend for a long time because it had a big financial sector. But when outsiders lost trust in these banks, currency started dropping, inflation became more pronounced leading to an uncontrollable negative feedback loop and to unstoppable hyperinflation.
And hey as most of you know…. The USA is consistently importing more than it exports, but yet it is receiving the money to do so thanks to its dominant financial sector… and this would have been a good bridge to EE’s next question…
Is the USA immune from inflation?
In other words, what makes the USA different from Lebanon?
It’s currency status as the world reserve…
Why is that important? Well, because this means that there is much more demand for US dollars than just the demand for American products…. Or very unconventionally said:
The value of American money depends on the productive capacity of the planet more so than the productive capacity of the states…. This does genuinely give American dollars some resistance to depreciation. But, it is not limitless. And it also doesn’t protect the United States from a situation where the entire global economy is impacted like let’s say a global pandemic…
Here, it sounds to me like EE is implying that the global production capacity has been reduced thanks to the pandemic…. Again, this claim can easily be verify this by looking at production numbers in the two the main industrial centres of the world, Europe and China and the outcome is that nope…. After a big dip, production was already back above its pre-pandemic level when EE released his video.
But, even though global production capacity didn’t drop and therefore won’t cause hyper-inflation in the USA, let’s entertain the following scenario. What if, China and Europe get their currency game together and start offering a global currency or that one of the cryptocurrency starts seriously challenging the Dollar.
If that happens, and the US political system is still in gridlock… this could potentially be what triggers hyperinflation in the USA…. So, in that case you might still want to know the answer to EE’s last question….
How do you prepare for inflation / hyperinflation?
Okay, I am going to keep this one short for you…. EE proposes that the
Traditional answer would be metals…. Productive real estate or stocks. Or new-age solutions are crypto …”
And then comes up with a unique solution that I really have never heard of before… ‘shorting currency.’ Which basically means … borrowing a currency and using it to buy real estate or stocks….
… ehhh…. I actually think this is very creative from EE. What he is saying is actually not that different from the ‘traditional’ solution… he’s just saying borrow money to do it better…
Also, when EE proposes that ….
imagine you buy a house with leverage in Weimar Germany in 1920…. 17:05 fast forward two years and hyperinflation has gripped the nation… Hyperinflation happens… and that … all kinds of issue …. But you now have a place to live for a price of a marble. This is a very extreme and oversimplified example….”
Oefff, this is more than an oversimplification… there are so many complicating factors that make it extremely unlikely that if you follow EE’s example would crash and burn…. For starters:
- Banks in economies near hyper-inflation charge extremely high interest rates, so you need a stable monthly cash flow…. However
- in many cases, for example in Lebanon asset markets collapse first, then you lose your job… so it is very likely that in the stock market your margin credit gets called first and you make a loss. In the housing market, having no job means you cannot afford to pay the monthly mortgage payments before hyperinflation really sets in.
- Second, you cannot pay off most mortgages before they are due… and in the in the case of Weimar Germany the constitutional court ordered that some remaining mortgages had to be partially revalued… in other words … you would still need to pay them off partially after hyperinflation (source)
- Finally, remember that hyperinflation is game-over. So, from your flat in Berlin would have witnessed the rise of the Nazi party as well as the Soviet assault on Berlin and likely the Soviet occupation.
And, even if you just expect high… but not hyper-inflation, I found several research papers, linked in the description, ((papers on this: Neville et al. 2021 and Ang 2012 ).) that show that actually these traditional assets have a poorer track record than for example trend-following hedge funds or some specific commodities. So then it’s probably not very smart to get into debt for these investments
And, if you fear my Lebanon scenario for hyperinflation in the USA ….. the best way to protect yourself if probably just to get yourself and your money out of the country… just ask the Lebanese and Zimbabweans that have been lucky enough to have done that in time.
So, where does that leave EE’s video on hyperinflation? Well, in short, there is a tail risk of hyperinflation, but that the scenario will more likely be similar to the Lebanon scenario where consistent trade deficits and a loss of faith in the banking sector triggers an exchange rate collapse. On the other hand, there is no historical precedent for the scenario EE is proposing…
And since the case that EE made was barely grounded in economic theory and flat out contradicted by the data,
I think it would be better to think of EE here as standing for Entertaining Economics… or Extrapolating Economics… rather than Economics Explained…
That being said, if you are interested in why economists are genuinely fearful of a return of high inflation across the world, stay tuned for one of my next videos. And if you enjoyed this style of video, consider checking out my other response video, or my video on the fall of the Lebanese currency, and finally, if you appreciate the research, consider supporting me on Patreon or buying me a ‘coffee’ using the links in the description.
Other Sources:
- Hungarian hyperinflation: link
- Yuguslavia hyperinflation 1: link
- Yuguslavia hyperinflation 2: link
- Weimar hyperinflation: link
- Zimbabwe hyperinflation: link
- Zimbabwe hyperinflation 2: link
Data sources:
- Industrial production USA: FRED/IPB50002N
- CPI Lebanon: Bank of Lebanon
- CPI USA and House prices via QUANDL codes: RATEINF/CPI_USA, and YALE/NHPI
- CPI Japan and House prices via QUANDL codes: RATEINF/CPI_JPN
- Japan property prices: Bank of Japan
- Industrial production EU: QUANDL CODE: ECB/RTD_M_S0_Y_I_XCONS_X
- USA dollar index Yahoo Finance code: DXY
- China industrial production: Tradingeconomics