Sunday, September 23, 2012

Hyperinflation or Default?

The big debate in libertarian circles regarding the economic future of the United States government managed economy is whether the future contains hyperinflation or if it contains default. The answer is really quite simple; the question cannot be answered. An economist cannot predict the actions of politicians, but can instead only tell what will be the result of decisions made by politicians. What path exactly the United States will follow when conditions worsen is a question that can be answered only by politicians.

The biggest question can only be answered by the Federal Reserve, which has a hybrid nature that is partly political and partly private. If the "Audit the Fed" bill passes, then the resulting audit will surely reveal facts that will not please the political class. Given that the only advocate of a sound currency is retiring from the congress, the result of an audit will instead result in tighter governmental controls over the Federal Reserve, which could ultimately end up in nationalization of the Federal Reserve.

This would be the solution favored by the other great opponents of the Federal Reserve, the Greenbackers. If the Federal Reserve is brought under greater governmental control it will result in a Federal Reserve that has no choice but to continue purchasing worthless government bonds and in that event the flood of worthless currency will indeed result in hyperinflation.

On the other hand, the Federal Reserve as it is currently structured is ultimately owned by the private banks that do not desire hyperinflation. If the Federal Reserve remains mostly independent of the government, the private banks could order the Federal Reserve to purchase no more bonds that it can sell on the market. As the federal budget remains unbalanced, with almost half of the revenue the result of borrowing that will result in the Federal Reserve refusing to purchase any more bonds from the government. That ends with a government default as the money to pay for more than can be sustained simply isn’t there anymore.

Both cases hinge on the decisions made in the legislative and executive branches of the federal government. Congress and the President are in full control of that decision, and thus no economist can actually predict what will happen.

In either case, though, there will be upheaval and social unrest. Again, there are many options but no economist can predict which will happen. Economists can only outline the different options and describe the resulting conditions of each.

In one scenario the unrest results in riots. There may be riots due to the banks being unable to process any more payments as an emergency measure. If the electronic payment network breaks down, most people do not have enough currency on hand to purchase more than a few trinkets or a few snacks. Currency riots would lead to food riots.

In another scenario, politicians actually act before the riots start by declaring martial law before the riots instead of after them. Strict controls barely contain the chaos, with political control breaking down farther away from the armed encampments of the cities.

In a third scenario the infrastructure grid in the country cannot sustain the delicate balance and this ultimately results in food shortages, which will result in even more desperate riots throughout the country as people flee the cities to find food.

Of course, in order to preempt those outcomes, the political class may decide that a war against an external enemy is necessary to distract the population. This would most likely result in a war against Iran If that happens, there will be both high inflation but not necessarily hyperinflation, as well as shortages and other hardships. There will be much more direct management of the economy, with people receiving their basic sustenance from the government.

That is also an unsustainable solution, but the additional bloodshed abroad may forestall the inevitable result of either hyperinflation or default for a short time. But as any economist can predict, the government cannot ignore reality forever.

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