Sunday, January 27, 2013

Surprising Facts about inflation

I recently read a comment where the writer challenged the curious to "bing" or look up the term "Weimar Inflation", some of what I discovered was surprising. Germany had come out of the first World War with most of its industrial power intact, the speed at which inflation suddenly destroyed the currency dovetails with some of my thoughts on currency trading today. It is possible that inflation "could stem from the lack of faith in a currency, or all currencies, rather than from a lack of available goods". It was amazing how quickly inflation took root in Germany during the 1920s, we must consider how fast it could happen now that we live in an age of instant communication.

The German currency was relatively stable at about 60 Marks per US Dollar during the first half of 1921. But the demands in May 1921 for reparations in gold or foreign currency to be paid in annual installments of 2 billion gold-marks plus 26 percent of the value of Germany's exports was crushing. The first payment was paid when due in June 1921. That was the beginning of an increasingly rapid devaluation of the Mark which fell by November 1921 to approx. 330 Marks per US Dollar. The total reparations demanded was 132 billion gold-marks which were far more than the total German gold and foreign exchange.

In August 1921, Germany began to buy foreign currency with Marks, this increased the decline, the lower the mark sank in international markets, the more marks were required to buy the foreign currency demanded by the Reparations Commission. During the first half of 1922, the Mark stabilized at about 320 Marks per Dollar because of international reparations conferences, including one organized by U.S. investment banker J. P. Morgan. After these meetings produced no workable solution, the inflation shifted to hyperinflation and the Mark fell to 8000 Marks per Dollar by December 1922. The cost of living index increased more than 15 times in just six months.

In the world today people have developed a "false' belief in financial security because of "controlled"  inflation. When people look at how much more they are earning now than in the past they realize that if they go into debt it will be easier to pay it off with inflated income.  For decades people have been given pay raises to keep up with inflation meaning the vast majority of pay raises have nothing to do with either a person's work or performance. Many people essentially perform the same functions for 30 years; however, their pay grows much greater as time move on.

The best definition or rule about inflation, its effect on the economy, and on savings came to me so long ago that I do not even recall who presented it to me. It goes like this, "Inflation is a thief that robs those who are improperly invested, and gives the money to those improperly invested."  This would, of course, be referring to those who had the foresight to positioned their investments for its emergence. The same can be said about deflation, it mimics in reverse the process, also acting as a way to transfer wealth between parties. The problem is to time and recognize the approach of these two strong economic forces.

The mindset of investors and of the "money people" often shifts into overdrive when opportunities for speculation arise. The distortion caused by easy money from Federal Reserve policy coupled with political and social compassion for affordable housing, medical care, has obvious implications as debt and promises continue to rise. Most agree the Central Banks are not in a position to tighten the money supply at this time. Remember, so many of the things we invest in are merely promises and such, hard assets are rare. A word of caution, while hyperinflation does not occur that often when it hits, and the speed at which it hits is a game changer.

On November 18th of last year, I posed the following question, What Is Something Worth?;

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