I recently wrote a post comparing Detroit with Washington DC. I said that many people make a mistake in assuming there are absolutely no limits to the Fed and its ability to create money. In reality, there is a limit and that is hyperinflation. I have also written several times in the past that I think the Fed is likely to stop short of hyperinflation, as the Fed members would simply be ruining themselves and their control over the economy.
In response to my post, I received the following comment:
“Hyperinflation is not something that central banks or governments decide to do. It is a market response to excessive debt and deficit and a central bank monetizing government debt.”
First, definitions are important. I like to distinguish between monetary inflation and price inflation. This comment is assuming that hyperinflation is simply referring to prices, which is fine, but I just want it to be clear. Inflation can be defined as an increase in the money supply. The definition of inflation was changed to mean rising prices, which is actually a result of inflation. This definition change was implemented by the establishment so that monetary policy would not be strictly to blame for rising prices.
But let’s assume the comment is referring to prices. The comment says that “hyperinflation is not something that central banks or governments decide to do.” While it is technically consumers and market participants who bid up prices, it really is the central bank or government deciding it by creating massive amounts of money out of thin air. The market is simply reacting to the situation that has been dealt.
The second sentence says that “it is a market response to excess debt and deficit(s) and a central bank monetizing government debt.” The second sentence is just about contradicting the first. Let’s just shorten and simplify the two sentences and we have the following: “Hyperinflation is not something that central banks decide to do. It is a market response to a central bank monetizing government debt.” This is correct on a technicality at most. It is obviously the central bank’s monetizing of debt that is causing the rising prices. Therefore, the Fed or any other central bank can typically stop hyperinflation simply by ceasing to monetize more debt.
As I have written in the past, it is technically possible to have hyperinflation (in regards to runaway prices) without having a massive increase in the money supply. Velocity could pick up just based on the expectations that there would be massive monetary inflation in the future. It is even technically possible for a currency to lose most or all of its value simply based on the mood of the market. If everyone in America read some literature on fiat currencies and gold and turned into libertarians overnight, it is possible that everyone could simply turn away from the dollar and start using gold and silver or some other medium of exchange. But the likelihood of this happening without massive monetary inflation is extremely remote.
I have never heard of a hyperinflation situation where the central bank or government was not creating massive amounts of new money out of thin air. So to say that hyperinflation is not something central banks and governments decide to do is extremely misleading at best. The Fed, or any other central bank, can decide to stop monetizing debt and buying assets. It can completely stop its monetary inflation. This would be a decision to avoid hyperinflation.
One last thing I would like to point out is that the national debt and deficit do not cause hyperinflation. There is a correlation because the debt will often grow more when more debt is monetized. Or perhaps it could be said the other way around that there will be more monetization with the growth of debt. But just because the debt is over $16 trillion, it doesn’t mean that the Fed has to keep buying debt. It can stop inflating and tell Congress to figure it out. Congress would be forced to scale back its spending. So while high debts and deficits may be a predictor of hyperinflation to a certain extent, it is not a direct cause. It is still the decision of the central bank to monetize more debt.
In conclusion, I think it is important to know that both the supply and the demand of money will affect prices. But if the Fed does not want a situation of hyperinflation, it can avoid this simply by stopping its monetary inflation. There may be some point of no return, but I highly doubt we are close to that point yet. The Fed could simply stop its policy of monetary inflation right now and we will likely avoid hyperinflation.