Are We Headed for Hyperinflation?

with Laurence Kotlikoff

Runaway inflation evokes some scary images: workers paid in wheelbarrows full of rapidly devaluing cash, astronomical prices for everyday goods, decimated savings and retirement accounts. Not to mention the threat of social instability and disorder that arises when governments fail to safeguard their citizens’ wellbeing. It’s the stuff of cautionary tales in economics and history classes.

With inflation now at a 30-year high in the US, some people are starting to worry that we may end up as the next lesson on the syllabus. Is our situation going to resemble that of Weimar Germany or Argentina? Will the current inflation rate initiate a cycle of money printing and rapid expenditure that will send the economy into a tailspin? Or will we get inflation under control before it does longterm damage?

Like everyone else, I’m looking for, if not reassurance, then at least some guidance on what the coming months and years may look like. So I turned to my good friend Larry Kotlikoff for a conversation about the conditions that can drive high inflation into hyperinflation, and what, if anything, we can do about it. Larry offers some much-needed clarity on these issues—I hope you enjoy the discussion.

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GLENN LOURY: Okay, well, one question is, is this a transitory blip or have we entered in a new or different era?

LARRY KOTLIKOFF: That’s also an interesting question, because part of, I think, what inflation's about is there being a mobile equilibrium, mobile past what the economy can take with respect to inflation. If everybody gets it into their mind that inflation is taking off, they get that expectation. Then if I’ve got a company, I’m going to start raising my prices because I know I gotta keep my workers and I gotta give them a higher raise. And then some other company sees me raising my prices and they raise their prices, and then say, “Well, I’ve got to keep up with them and they're trying to keep up.”

So it can become a self fulfilling-prophecy, you know, where people's expectations of more inflation or inflation accelerating take over. And if you look at the hyperinflations we had in the last century, we had 22 hyperinflations. Each of those countries had fiscal problems out the wazoo. Like the Weimar Republic, where people were being paid at lunchtime with wheelbarrows full of money. That you know for sure, that's the government printing money.

But even if you look at that hyperinflation, the price level rose at a much more rapid clip than the money was being printed. So let’s say the government’s, you know, just to give a very simple example, doubling the amount of money in the economy over the course of the week, but prices are going up not by a factor of two but by a factor of five. That’s because people are expecting prices to go up even faster and they're turning money into a hot potato. They don't want to pull the money, because by the end of the week, if they worry the prices are going crazy, and they say, “Gee, I don't want to hold this money. I'm gonna run to the store and use it.” So now we have faster money in the economy, [which] is really equivalent to more money, in our basic economic theory.

Let me share with the readers this famous formula: MV=PQ. Money times the velocity of money, the monetary stock times velocity, equals the price level times the quantity of goods that are being transacted. And you're just pointing out that a given monetary base can be more inflationary if people anticipate that tomorrow’s money will be worth less and rush out to spend today, which will increase the velocity with which money is being exchanged for goods.

It becomes a hot potato, and that's the V in that formula. So if M goes up by a certain percentage, but V is going up by a much bigger percentage than for given Y, which is the output, P can go up much more due to the V than due to the M increasing.

Now what's the evidence, to your mind, that this kind of expectations-driven self-fulfilling prophecy is playing out amongst us now?

Well, I don't know. I worry about this. I worry that people start forming expectations. Think about the Weimar Republic. Nobody knew during that hyperinflation exactly how much M was going up. So they had to form judgments about how much is M going up, and thus how fast should they run to the store to get rid of their money? How fast should they make V go up?

Or think about Argentina, which has had periods in recent decades where the government would be reporting information about how much money they were printing, which nobody believed. So it was like, there's no anchor. In that context, people could say, “Well, maybe the government’s tripling the money supply today, just overnight.” So people were setting prices in Argentina based on the exchange rate. The exchange rate was just being driven by expectations. So there’s no there there. There's no anchor. That's when things can come unleashed.

Am I naive to think that, whereas Weimar Germany or Argentina of more recent times might have had monetary policies which were not transparent, we here in the United States of America can see the books of the Federal Reserve and know exactly what the monetary policy of the government has been and therefore are not as much in the dark about how M is changing as people may have been in those examples you were citing?

This is where I wanted to get into this discussion with you. Because, you know, the MV=PY formula, that's the quantity theory that a lot of kids learn in introductory economics, a lot of your viewers. That's a static framework. But we live in an economy that's intertemporal, dynamic, going through time. So the government could print more money today, and let's say print a lot of money and buy a lot of airplanes for the Air Force, okay? And then five years from now, they could take in a lot of money with a big tax increase.

So just think about the amount of money out there in the economy, not at a point in time but kind of through time. So we might have a big increase now but a big decrease in the future. If people think, “Well, the Fed is going to be adjusting. Maybe they'll kind of overdo it this year, but in the future, they're going to underdo it.” So then through time, we're going to have a reasonable path of the money supply. Then you've got even more uncertainty about this whole process.

And what the Fed's up to is partly working with the treasury just to print money to buy lunch for the president. But part of what it's doing, which makes this very complicated to see what's going on from the debt, from the numbers—we can trust our government's numbers—is that the Fed is engaging in financial transactions. So let's say I'm the Federal Reserve chairman Jerome Powell, and I take a billion dollars and I buy some Tesla stock, just suppose, or some security or some Tesla bond. So I'm printing money. I'm buying this asset. So I'm printing, I don't know, a billion dollars of green pieces of paper, putting them out into the economy. We've got more money chasing the same amount of goods where you kind of think in the EC 101 concept, and I've taken back this asset.

So now the Fed has added to the money supply. But Powell can say, and everybody else can say or think, “Well, in three years, I’m going to take that Tesla stock or those Tesla bonds and sell them back into the market and take the money back out.” So the Fed's engaged in these portfolio transactions at the same time as just printing money for the president's lunch. And we can't really tell from the Fed's balance sheet because it's very complicated to understand. You really can't necessarily break it out, how much of this IS pure, you know, paying for the government's bills by printing money, because it might be doing some of that now, but less of it in the future. So it's a whole intertemporal path of policy.

But the one thing that you can be assured of is, if you have a projection of a path of fiscal policy taxes and and, outlays that don’t match up, which is our country’s situation, then you know that through time this path has gotta be one where there's a lot of printing of money to pay for the government's bills. I've been trying to point this out for decades now. I've written books called The Clash of Generations, The Coming Generational Storm. The fact that our longterm finances are leaving enormous bills for our kids. And when we have inflation, we get hurt.

You know, we just talked about the fact that somebody who's got a checking account or a pension lost 6% this year. Who’s getting helped? If we're getting hurt, the public's getting hurt, it’s the government that’s getting helped. This is really what's called the seigniorage tax, the So I inflation tax. So there's a strong tendency of countries that are broke, through time to try and rely on the seigniorage tax until they realize that all they’re doing is producing inflation. The economy gets used to high inflation, and that's very destructive to the economy, ultimately.