Don't Fear Hyperinflation

Many of my clients worry that today's easy money will eventually have devastating inflationary consequences. Are they right? As a world-class nonexpert on hyperinflation, I decided I needed to hit the books. After boning up, my short answer is no — but with some caveats.

First, there is a lot of irresponsible talk that easy money and large deficits will inevitably lead to hyperinflation. Glenn Beck has been predicting hyperinflation since 2008, saying he has more faith in a piece of paper towel than in the U.S. dollar. Every ultraconservative Web site I look at thrives on apocalyptic ads predicting the dollar's demise, which would certainly lead to higher commodity prices and would likely fuel more general inflation.

In The Little Book of the Shrinking Dollar, author Addison Wiggin makes the preposterous claim that "every paper currency in the history of civilization has eventually lost its entire value." As one studies hyperinflation theory, alas, one has to wade through a lot of raw sewage like this.

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Mainstream worrywarts. But not everyone banging the hyperinflation drum is a crackpot. Famed hedge fund managers Nassim Taleb and John Paulson have established funds that would benefit from hyperinflation. Baupost Group's Seth Klarman, one of the best investors ever, thinks hyperinflation in the U.S. is a possibility. In 2010, he told Jason Zweig of the Wall Street Journal, "I worry now that a new element has been introduced into the game, which is, in effect, Will the dollars we make be worth anything?…It's not clear that any currency is actually all that trustworthy." Klarman's solution: Buy gold, gold-mining stocks and long-term options that will appreciate as interest rates surge.

Although Klarman thinks hyperinflation is unlikely, he warns against complacency. That's because he thinks government figures dramatically understate the inflation rate. Moreover, he reminds investors that things can go south in a hurry.

My biggest complaint about the hyper­inflationists is that many ignore history. Printing a lot of money does not by itself produce hyperinflation, as James Montier points out in an outstanding paper, "Hyperinflations, Hysteria, and False Memories," that he wrote for money manager GMO. If running the government printing press in the wee hours were the whole problem, we'd see hyperinflation all the time—and we don't. It takes an enormous shock to trigger runaway inflation, such as a war or a general economic collapse.

Worst cases. Many people think the worst hyperinflation of the 20th century occurred in Germany's Weimar Republic after World War I. They're wrong. It actually occurred in Hungary after World War II, when prices rose at the equivalent of 207% per day in July 1946, when inflation was at its peak. The problem? The war destroyed half of Hungary's industrial capacity and damaged almost all of the rest. In addition, the Russians extracted huge war reparations. The second-worst hyperinflation in modern times occurred in Zimbabwe after a disastrous drought and ill-conceived land reform. Inflation raged at 98% a day in mid November 2008, and the world was introduced to its first $100 trillion bill.

Well, if it takes a shock and not merely printing money to produce hyperinflation, what could cause it today? The breakup of the euro zone would be the most likely culprit, speculates Montier. Star U.K. hedge fund manager Hugh Hendry says hyperinflation could result from a European disaster that would trigger deflation first and then hyperinflation as politicians tried to cure the deflation.

Am I petrified? No, but my research did lead me to ask a question: Why don't I own any gold? Pretty soon I think I will.

Columnist Andrew Feinberg manages a New York City–based hedge fund called CJA Partners.