Sunday, August 29, 2010

The HyperInflation of Chile: Lessons for Us All

Given the current volatile situation in the United States, it is important to understand how other economies have moved through crisis economic times. I especially pay attention when someone tells me they have lived through a hyperinflation. The more you understand about hyperinflation, the more you will be prepared if hyperinflation should hit. Indeed, it may give you a major edge.

In an important article Gonzalo Lira explains the hyperinflation in Chile that occurred between 1970 and 1973:

Apart from what happened with the Weimar Republic in the 1920’s, advanced Western economies have no experience with hyperinflation. (I actually think that the high inflation that struck the dollar in the 1970’s, and which was successfully choked off by Paul Volcker, was in fact an incipient bout of commodity-driven hyperinflation—but that’s for some other time.) Though there were plenty of hyperinflationary events in the XIX century and before, after the Weimar experience, the advanced economies learned their lesson—and learned it so well, in fact, that it’s been forgotten.


However, my personal history gives me a slight edge in this discussion: During the period 1970–’73, Chile experienced hyperinflation, brought about by the failed and corrupt policies of Salvador Allende and his Popular Unity Government. Though I was too young to experience it first hand, my family and some of my older friends have vivid memories of the Allende period—vivid memories that are actually closer to nightmares.

The causes of Chile’s hyperinflation forty years ago were vastly different from what I believe will cause American hyperinflation now. But a slight detour through this history is useful to our current predicament.

To begin: In 1970, Salvador Allende was elected president by roughly a third of the population. The other two-thirds voted for the centrist Christian Democrat candidate, or for the center-right candidate in roughly equal measure. Allende’s election was a fluke.

He wasn’t a centrist, no matter what the current hagiography might claim: Allende was a hard-core Socialist, who headed a Hard Left coalition called the Unidad Popular—the Popular Unity (UP, pronounced “oo-peh”). This coalition—Socialists, Communists, and assorted Left parties—took over the administration of the country, and quickly implemented several “reforms”, which were designed to “put Chile on the road to Socialism”.

Land was expropriated—often by force—and given to the workers. Companies and mines were also nationalized, and also given to the workers. Of course, the farms, companies and mines which were stripped from their owners weren’t inefficient or ineptly run—on the contrary, Allende and his Unidad Popular thugs stole farms, companies and mines from precisely the “blood-thirsty Capitalists” who best treated their workers, and who were the most fair towards them.

Allende’s government also put UP-loyalists in management positions in those nationalized enterprises—a first step towards implementing a Leninist regime, whereby the UP would have “political control” over the means of production and distribution. From speeches and his actions, it’s clear that Allende wanted to implement a Maoist-Leninist regime, with himself as Supreme Leader.

One of the key policy initiative Allende carried out was wage and price controls. In order to appease and co-opt the workers, Allende’s regime simultaneously froze prices of basic goods and services, and augmented wages by decree.

At first, this measure worked like a charm: Workers had more money, but goods and services still had the same old low prices. So workers were happy with Allende: They went on a shopping spree—and rapidly emptied stores and warehouses of consumer goods and basic products. Allende and the UP Government then claimed it was right-wing, anti-Revolutionary “acaparadores”—hoarders—who were keeping consumer goods from the workers. Right.

Meanwhile, private companies—forced to raise worker wages while maintaining their same price structures—quickly went bankrupt: So then, of course, they were taken over by the Allende government, “in the name of the people”. Key industries were put on the State dole, as it were, and made to continue their operations at a loss, so as to satisfy internal demand. If there was a cash shortfall, the Allende government would simply print more escudos and give them to the now State-controlled companies, which would then pay the workers.

This is how hyperinflation started in Chile. Workers had plenty of cash in hand—but it was useless, because there were no goods to buy.

So Allende’s government quickly instituted the Juntas de Abastecimiento y Control de Precios (“Unions of Supply and Price Controls”, known as JAP). These were locally formed boards, composed of loyal Party members, who decided who in a given neighborhood received consumer products, and who did not. Naturally, other UP-loyalists had preference—these Allende backers received ration cards, with which to buy consumer goods and basic staples.

Of course, those people perceived as “unfriendly” to Allende and the UP Government either received insufficient rations for their families, or no rations at all, if they were vocally opposed to the Allende regime and its policies.

Very quickly, a black market in goods and staples arose. At first, these black markets accepted escudos. But with each passing month, more and more escudos were printed into circulation by the Allende government, until by late ’72, black marketeers were no longer accepting escudos. Their mantra became, “Sólo dólares”: Only dollars.

Hyperinflation had arrived in Chile. ..

But for sensible people, Apocalypse is a distraction—it’s not the main event. For sensible people who want to be prepared, Apocalypse represents opportunities.


A true story: In ’73, at the height of the Allende-created hyperinflation, an uncle of mine, who was then a college student, was offered an apartment in exchange for his car. That’s right—an apartment. He owned a crappy little Fiat 147—a POS if ever there was such a thing—but cars in Chile in the middle of that hyperinflation were so scarce, and considered so valuable, that he was offered an apartment in exchange. To this day, my uncle still tells the story—with deep regret, because he didn’t follow through on the offer: “That Fiat was in the junkyard by ’78, but that apartment still stands! And today it’s worth nearly a half a million dollars!” Actually, I think it’s worth a bit more than that.

Another true story: A banker friend of mine manages the assets of a fabulously wealthy 70-something gentleman, whom I'll call Alfredo. In 1973, Don Alfredo was a youngish man, just starting out, with a degree in engineering but no money—until he inherited US$3,000 from a deceased aunt. Alfredo realized that the $3,000 were in a sense worthless: He couldn’t buy anything with them, and it wasn’t enough for him to leave the country and start over someplace else. After all, even then, $3,000 was not that much money.

So he took those $3,000, went down to the stock exchange, and spent all of it on Chilean blue-chip companies: Mining companies, chemical companies, paper companies, and so on. The stock were selling for nothing—less than penny stock—because of the disastrous policies of the Allende government. His stock broker at the time told him not to buy stocks, as Allende’s government, it was thought, would soon nationalize these companies as well.

Alfredo ignored his broker, and went ahead with the stock purchases: He spent all of his $3,000 on buckets of near-worthless equities.

On September 11, 1973, the commanders in chief of the four branches of the Chilean military staged a coup d’état. Within a year, Alfredo’s stock had rebounded about ten-fold. Since then, they’ve multiplied several thousand-fold—yes: Several thousand-fold. Don Alfredo has lived off of that $3,000 investment ever since—it’s what made him a multi-millionare today.

He realized, of course, that either those blue-chip companies would be nationalized by Allende—in which case he would lose all his $3,000 inheritance, which really wouldn’t change his fortunes very much—or somehow a new normal would arrive in Chile. Since the $3,000 couldn’t buy him anything, he took a gamble—and won
Be sure to read the entire Lira piece, here. It is very important and he has great insights into how things may develop in the U.S.

The one note of caution I must add is that Lira looks beyond a coming crisis for America and expects things to return to a new better normal, as it did in Chile. This may or may not occur in the United States and may take years or decades if it does return to a new normal.The real point to keep in mind is that things could be very different for the economy, very soon. Learn as much you can about volatile economies, especially those that suffered under hyper inflation, so that you have some kind of edge if such a period hits the U.S.

One other point, during hyperinflations asset prices including stocks tend to go up. The drop in the stocks in Chile during the hyperinflation is likely the result of a great fear the companies were going to be nationalized.

7 comments:

  1. Wenzel,

    Don't forget to point out that Lira is confused into thinking inflation is rising prices and that it can be caused by the actions of money-users, rather than money-printers.

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  2. Ok, so we should conclude that an investment in hard assets -- blue chip stocks, real estate and precious metals -- will do us well during the (potential) round of high (hyper?) inflation which is coming to the US. Correct? Bill

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  3. What Lira neglects to mention is that the ensuing coup of 1973 brought into power Augusto Pinochet, one of the most ruthless far-right dictators of the 20th century. The brutality of his reign is well known in Chile and throughout South America; unfortunately in articles such as this it is completely ignored, with the justification being that the economy "rebounded" under Pinochet. There is much evidence to suggest that large corporations, both Chilean and foreign, played a significant role in undermining Allende's government and bringing Pinochet to power. One need only go to Chile today to uncover a different picture than that painted by Lira: Allende is regarded as something of a people's hero, while Pinochet is remembered as the head of a government which "disappeared" tens of thousands. Food for thought...

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  4. The story that Lira tells is far away from reality. It is easy to tell that Mr. Lira forms part of all these greedy people that brought Chile to such a horrible moment in its history "Pinochet's Holocaust Regime" .

    Lira forgot to tell that Pinochet DID NOT save the country from an economic downturn,instead he stole Chilean's money and put it in his foreign bank accounts, he killed people, and did terrible things to women and children.

    Salvador Allende has museums, avenues has been given his name, is remembered each year, he has statues all around the country.
    You should ask yourself, why does Pinochet have none of those ?

    Because he was the Hitler of Chilean history.

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  5. It is obvious to tell that Mr. Lira belongs to the high class society of Chile. The greedy people that preferred to see his fellows die instead of giving them a piece of bread.

    Lira forgot to tell that Pinochet stole Chilean's money and moved it to his own bank accounts, Lira forgot to tell that Pinochet killed and tortured women and children, Lira forgot to tell that Allende is remembered each year as Chile's best president, Allende has avenues with his name, and statues all over the country.

    Mr . Lira why does Pinochet have none of those?

    I guess because he was worst than Hitler or maybe because he did nothing for Chile and its economy.


    Go to Chile and see that what MR. Lira says is the version of the rich and greedy people that only represents less than 20% of the country.

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  6. Hahaha oh man what a good laugh I had reading this post. I can feel your right winged butt hurtness through the screen? If Allende screwed up the economy then why did your family move to wherever you are now when Pinochet took power? Because Pinochet screwed it up more and made the country a literal living hell. Before you go out and about spreading right winged fascist propaganda, do a little bit more research and open your mind. Pleb.

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  7. Hahaha oh man what a good laugh I had reading this post. I can feel your right winged butt hurtness through the screen? If Allende screwed up the economy then why did your family move to wherever you are now when Pinochet took power? Because Pinochet screwed it up more and made the country a literal living hell. Before you go out and about spreading right winged fascist propaganda, do a little bit more research and open your mind. Pleb.

    ReplyDelete