Tag Archive: Inflation

Does Fiat Money Always Fail? Usually.

A question came up about whether fiat money systems always fail. Some have made the argument that fiat systems don’t always fail and that something like a gold standard is worse.

I think those that make this point need to understand that a fiat money failing usually goes hand in hand with the government failing at the same time. In fact, hyper-inflation is the final gasp of most dying governments. Very few come out of the situation intact because the markets lose confidence and dump their currency to whatever sucker will pick it up.

Consider this, how many governments still exist today that existed 100 years ago out of hundreds of countries?

By my count, maybe six? U.S., Canada, Britain, New Zealand, Australia, Switzerland? Feel free to add any I missed in the comments. I’m not saying countries, I’m saying the governments over those countries and the money they issued. For instance, Germany today is not the same government it was 100 years ago obviously and the currency back then is worthless today. This is true for most countries on this planet.


In fact, the older a country gets, the more likely it is to have problems, not less. The U.S. is well over 200 years old. It is the outlier. It’s never good to be the outlier. So in terms of the dollar having serious problems, the odds of it happening go up each year, not down.

But the point is that when a government went away, often so did the currency they issued. No incoming government is likely to honor the debts and financial obligations of the old and will want to start anew. So in many cases where governments changed, chances are very high the money either became worthless, or lost a tremendous amount in value during the transition. It would be very unusual for a fiat money not to to experience either total or very deep loss when this happens.

What this means is if you’re playing the odds (and if you invest you are), then a catastrophic currency problem in one’s lifetime is actually quite high. Look at that number above about countries that have survived with intact governments the past 100 years and really think about it. It’s remarkable how unstable governments are in this world.

In fact, the older a country gets, the more likely it is to have problems, not less. The U.S. is well over 200 years old. It is the outlier. It’s never good to be the outlier. So in terms of the dollar having serious problems, the odds of it happening go up each year, not down.

I’m not being Chicken Little here, just looking at what history shows us so it’s best to be diversified.

I would argue that each year the dollar doesn’t have a problem is another year that it’s more likely to have problem going forward. I guess you’d call it a fiat currency paradox. At least, that’s what I’m calling it.

Just something to consider when someone says to you that fiat money is fine no matter what. It isn’t. It’s a good idea to hedge against the reality that fiat money won’t work forever and you don’t know when things could go wrong.

Argentina’s CPI Still Rigged – Brace for Impact

I am fond of using Argentina as the poster-child for incompetent and corrupt government management of an economy. They have destroyed their own economy so many times from inflation and collectivist policies that I’ve lost count.

I use their manipulation of their own Consumer Price Index (CPI) as a possible outcome of relying on Treasury Inflation Protected Securities (TIPS) in the U.S. to save you from high inflation:

TIPS Are a Bad Idea: Argentina’s CPI

As a follow-up to this very sad story that continues the cycle of impoverishing millions, I see this:

Argentine leader’s image falls as inflation soars

Annual inflation, clocked by private analysts at over 20 percent, was another worry voiced in the survey. The government fines economists who publish their inflation estimates, which tend to double or triple the official figures.

Again this is just something to consider about relying on the Consumer Price Index (which reflects overall inflation) and inflation indexed products that use it (like TIPS) to protect you in the event of an inflation emergency in the U.S.

Far from a conspiracy theory, I find the chances of the CPI being deliberately downplayed for political reasons to be a very real possibility regardless of where you live if high inflation comes for a visit.

Never buy inflation insurance from the government that is causing your inflation. I find it remarkable that this comment is even open for debate, but (sadly) it often is.

Never buy inflation insurance from the government that is causing your inflation. I find it remarkable that this comment is even open for debate, but (sadly) it often is.

Also I’ll just add that my usual skepticism of investing heavily in emerging markets still remains. I hope to visit Argentina one day as I hear it is quite beautiful, but I wouldn’t trust the government with a penny of my money. I hope you never do either.

Inflation and Business Intuition – Why TIPS Are Likely to Fail You

Treasury Inflation Protected Securities (TIPS) comes up repeatedly in conversation about inflation protection. In particular, many people claim they would be fine for future inflation in the U.S. and are the “perfect” inflation hedge according to some. Perfect? Really? Those sound like famous last words to me!

First, we’ll ignore that the “perfect” inflation hedge has recently auctioned 10 Year TIPS at a negative rate which will ensure loss in purchasing power.

Secondly TIPS, as has been discussed here before, have only been in the U.S. since 1997 and have never been through high inflation of the US dollar. So calling them a “perfect” hedge is a dangerous assumption considering they have not sustained any serious test (we’ve had disinflation/deflation since they were introduced and no serious inflation).

But I want to start talking more about business intuition and investing risk. This is because investing is not a hard science. Investing is a social science because we are dealing with human behavior at the individual level which amplifies into the millions of decisions the markets make each day about the price of things. I also want to talk about business intuition because I often see so many very dangerous investment assumptions being made using mathematical models with some pretty flimsy evidence. Just because you can express something in a formula does not mean it is correct.

Just because you can express something in a formula does not mean it is correct.

In particular about TIPS, let’s completely ignore the models of numbers showing how they move in a chart. Sure they may be useful for some things, but underlying TIPS are people and people can’t be modeled. In investing I find that understanding history is often just as important as any academic model you may encounter. So, let’s look just at the recent history of bad inflation in the US as a way to assess the extra spreadsheet risks that can affect investors. Extra spreadsheet risks are what I call the risks that a spreadsheet model will never show you. They are probably more colorfully called Black Swans. This is where some business intuition comes into play.

Looking at history, my intuition warns that TIPS would never function anything like a perfect inflation hedge. This is because TIPS are directly linked to the policy decisions that are normally the cause of high inflation. And these policy decisions behind inflation are almost always political in nature. So TIPS, through this process, are really tied to politics and all the nasty crud that entails.

Let’s review recent history of the 1970s to provide a possible framework on how TIPS could get pulled into a problem. Here is a short review:

1) President Nixon closes the gold window in 1971 defaulting on US obligations to foreign holders of dollars to exchange the currency for gold. This layers on the decision in 1933 by Franklin Roosevelt to confiscate the gold of Americans defaulting on that promise as well.

2) Nixon then implements price and wage controls in a futile effort to control inflation. At the same time, behind the scenes, there is some evidence he was putting pressure on then Fed Chairman Arthur Burns to keep a loose monetary policy to help him with his re-election bid.

Richard Nixon demanded and Arthur Burns supplied an expansionary monetary policy and a growing economy in the run-up to the 1972 election. – How Richard Nixon Pressured Arthur Burns – Burton A. Abrams

3) President Ford comes into office and decides to tackle the problem of high inflation not with addressing the actual problem of restricting the money supply, but with his Whip Inflation Now (WIN) program. It was complete with buttons and a bizarre plan for people to help stop inflation themselves by submitting in their comments to the governement about it. The plan was called “unbelievable stupidity” by then economic advisor Alan Greenspan when he first heard about it (as recounted in his book The Age of Turbulence).

4) President Carter came in and gave speeches, had commissions and other ineffective mechanisms while inflation hit double digits. The one good thing he did was bring in Fed Chairman Paul Volcker who knew the problem of inflation was only going to be solved by turning off the money supply, and not speeches.

5) By the time President Reagan came around, Volcker had kicked off a deliberate recession to slow down the growth of money and finally stop inflation. At the time of this action, prime interest rates had risen to over 20%. It was the closest the US had come to true hyper-inflation since the Civil War or perhaps the Continental Congress.

The bottom line is that policymakers let savers and investors languish for over a decade in the 1970s with nearly 50% loss in purchasing power and no real returns for stock and bond holders. They didn’t care about people that held dollars. If they did care about inflation and the dollar they wouldn’t have waited so long to fix what was obviously wrong. In fact, as shown above, there is evidence that politicians like Richard Nixon were using monetary policy for their own gains. Of course, the same kind of political pressure likely happens under any presidency.

And I know some people (and even eminent economists) are thinking: “They didn’t know back then what was causing the problem so you can’t blame them!”

My answer is: Of course I can blame them. But this defense (which I’ve heard in more elaborate form from some well-regarded economists) falls flat for two reasons:

1) They knew perfectly well what was causing the problem and choose to not do anything about it. So they were acting maliciously and irresponsibly during this period.

- or -

2) They didn’t know what was causing inflation, despite mountains of historical precedent on the subject, and are therefore incompetent.

So which is it? Were they malicious or just incompetent? Probably it was both. In either case do you really want to put all of your life savings under their domain? I don’t. But that’s exactly what relying on TIPS for inflation protection does. That’s the heart of the business intuition case for avoiding them. The people making the decisions likely can’t be trusted to act in your interest in regards to high inflation when it is a problem. This is not unique to the U.S., other countries where high inflation has been a problem react very similarly in terms of politics and misdirection.

So back to TIPS, the “perfect” inflation hedge…

Inflation is a political football. It involves finger pointing, blaming, and inaction until it finally gets so bad the markets force a solution one way (by punishing the currency) or another (by getting those responsible removed from office so the currency can regain strength under new leadership). But consider that TIPS are linked to the Consumer Price Index (CPI). The CPI is also controlled by the policymakers. That makes TIPS a political football by extension. Any debate on inflation is going to trickle down to anyone holding TIPS but they have no control over the situation.

Is there a mathematical model that can show this? No. Is there a bit of business intuition based on past history that should be used? Absolutely! We shouldn’t be naive about these risks.

Some may argue with me about this and call it a conspiracy and such. However, we are talking about inflation risks and assessing likely outcomes of high inflation if it returns to the U.S. for strategic investing and planning purposes. A likely outcome is, quite possibly, a variation of the theme that happened in the 1970s with respect to high inflation. That could very easily include misrepresentations of the CPI, policies enacted to impact inflation payments in other ways (a “windfall” tax, etc.) or other games during the crisis.

I don’t want my inflation protection to be a political negotiating point during a crisis. I’d rather be on the sidelines watching the game unfold and not an active participant, thank you very much. Any product relying on the CPI to provide inflation adjustment is just begging to be abused in this situation. Sorry to disappoint. We’re just theorizing here, but based on past actions it is something to seriously consider. My spider-sense just tingles too strongly when I think about TIPS saving me from high inflation.

My observation is that for low and steady inflation, stocks and bonds are perfectly fine and can keep up and give good real returns. But if inflation is very bad then these assets will fail and you better have some hard assets in your portfolio like gold and not TIPS to save you. Gold is immune from a lot of political inflation shenanigans that are likely to roast TIPS holders when they need that protection the most.