History never repeats, but sure does rhyme (English, 2022-09-14)

The inflation numbers came in rather high this month in Sweden, at 9% YoY. The KPIF is a lagging indicator, which means that inflation is higher! Apparently, we share this inflationary development with the rest of the West, as our economies have been up until quite recently, tightly connected. In Germany, the CPI reading in August was about 8%.

Inflation is a monetary phenomenon, apparently. I recall a time when people wondered what would happen to all those US dollars that had been printed to finance world trade and domestic American consumption. After all, the USD has been the world reserve currency for quite some time. Would they come back to haunt the US? It was a relevant question, or fear, since the USD, along with the Euro, was backing a whole host of currencies in Europe. Especially China’s motives were interesting, as it had assets of some 3 trillion USDs in the US financial system.

It seems that now we have the answer. The dollars, completely virtual and stored as digitial numbers, were not spent — Chinese did not find anything worth spending them on, having been blocked from making strategic acquisitions in the US — but held as a token of trust in the US system, while the Chinese built up their domestic productive capabilities. Along with the development of their national industries, they adopted gold as money, and now gold is used in transactions across the whole of Asia (including oil rich Saudi Arabia). The latest country to adopt gold has been Russia.

A gold coin with a nominal value of 10 Russian ruble,

minted in August, constituting a legal tender.

So, how high can CPI, or PPI for that matter, go? The simple answer is that the sky is the limit. In order to understand how this can materialise, we will have to look at some fundamental conditions that are now in place.

Until that particular point in time when Western states choose to adopt gold, we will live in economies that inflate, and if we are not careful, possibly even hyper inflate. In Sweden, this was actually a warning professed by Kerstin Hessius (former Riksbank director) some two years ago, as the Corona lock downs hit worldwide, even though she did not make any reference to gold. At the same time, the President of the European Commission von der Leyen announced that member states could borrow as much money as they saw fit, effectively rendering the Maastricht treaty void. (I wonder whether history, in hindsight obviously, will deem that speech by von der Leyen during the spring of 2020 to mark the very end of the EU?)

Locking down economies, while debt financing consumption, is a bad combination for price stability in itself. Now, when one adds the burden of turning former friends into enemies, as Germany has with Russia, it becomes even more costly to obtain energy. Also, make no mistake about the state of energy availability, there is a lot of energy around.

Source: BP Statistical Review 2022

However, the energy is going to Asia, where the marginal propensity for energy consumption is the highest, and possibly resold at a markup to the EU. Without energy, basic industries will have a hard time operating, and households will have trouble heating their homes. The response in the EU seems to favour the artificial alleviation of energy scarcity by printing money, further still. Imports will become even more expensive, forcing citizens to choose between “heat or eat”.

Source: BP Statistical Review 2022

I suppose its tragic to see that history rhymes, because Germany has actually been in this situation once before. During the early days of the Weimar inflation, Rudolf Havenstein decided to print Paper Marks in order to safeguard the purchasing power of German households. He died in 1923, and along with him, the hyperinflationary policy. The situation today is perhaps not as dire, but still carries some resemblance.  But if politicians abstain from pursuing the Havenstein policy, what will happen then? Well, policy rates will have to be raised. There is a simple logic to it as well. If the price of energy is expected to increase by some 50%, we are looking at policy rates that have to be higher than this rate of increase.

Why? If rates are not raised, suddenly a business logic prevails in which speculators can buy energy on credit, warehouse it, and exit later at a higher price. The psychology coupled with available credit will drive prices higher. No, rates will have to go up, and at these levels it implies total collapse of indebted economies, like the Swedish one. But this is only the case if we abstain from the Havenstein course of action. 

Speaking of Havenstein, he only pursued it because Germany had no gold. Towards the end of the hyperinflation, Hjalmar Schacht took the reigns and construed, in consultation with Norman Montague, his English counterpart, a rentenmark backed by forrest (yes, wood, that is). That’s one way to go, but I can’t recall what the exchange rate was, nor figure out what implies in the case of Sweden, or the EU. But I do recall that it wasn’t very credible.