Sunday, January 17, 2010

US Crosses the Bernholz Line -- Hyperinflation Early Warning Signal

Economic historian Peter Bernholz has identified that inflation starts to take on hyperinflationary characteristics some time after the deficits of a country as a share of government expenditure rise above a third and stay there for several years.

According to Bernholz, the great hyperinflations of France, Germany, Poland, Brazil, and Bolivia all occurred after deficits reached that magic percentage or higher (In Bolivia, it reached 91%). The United States crossed over the Bernholz line last year.

Japan is even deeper into the warning despite concerns of many that it has a deflation problem. Ambrose Evans-Pritchard writes:
2010 will prove to be the year that Japan flips from deflation to something very different: the beginnings of debt monetization by a terrified central bank that will ultimately spin out of control, perhaps crossing into hyperinflation by the middle of the decade...

Japan has been [above the Bernholz line]...almost continuously for the last eight years....Japan’s Bernholz index will rise above 50pc this year for the first time, meaning that it will have to borrow more from the bond markets than raises in tax revenue.
Clearly, crossing the Bernholz Line does not mean that hyperinflation is immediately around the corner. It's an early warning signal. What it does indicate is that a government is having trouble raising money outside of borrowing it. This results in tremendous supplies of new debt that the markets must absorb, pushing interest rates higher, and thus putting enormous pressure on a central bank to monetize the debt.

The specifics of how long after passing the Bernholz Line a hyperinflation kicks in varies greatly. But like a doctor, who detects in a patient the first signs of Alzheimer's, the prognosis is not good.


  1. Inflation is probably the most widely misunderstood economic concept. Keynesian economists, who run most governments these days, consider inflation "really high prices". Their response is typically to ignore it or demand price controls. Real inflation, however, is the expansion of the money supply beyond the rate of economic growth/GDP. Higher prices are really just a symptom, not the disease. In the US, we have tripled (and perhaps quadrupled) the money supply in the last 3 years-- there's your real inflation. In this scenario, every new dollar created decreases the value of those currently in circulation. It also decreases the 'real cost' of repaying our massive foreign debt. Eventually, the monopoly money will no longer be accepted by nations holding our debt and the entire house of cards will fall.

  2. Hmm...interesting. Robert, I believe you've stated that while the monetary base has greatly increased fairly recently, the money supply itself has not increased over the past year or so.

    Can't imagine a household would stay solvent for long if its expenses exceed income by a third.

  3. It's a great rule except when it doesn't work. They've been predicting this for Japan for years and still don't understand why it's not happening.

  4. it is only a matter of time. You can carry deficits but need them to invest in income producing activies. Unless there are assets to sell of, trouble is ahead. Only a matter of time. Historically, unless a nation takes the pain, along follow trade wars and military wars and signicant social upheaval. Time will tell.

  5. "They've been predicting this for Japan for years"

    True but when it comes to Japan, endless patience is everything. Anybody who has lived in Japan can testify that Japan is filled to the brim with examples of insane government largesse. And yes, the Japanese are lemmings and probably the most inflexible people I've ever met. I can't imagine any other country successfully surviving 20 years of similarly cheap credit while remaning in deflationary purgatory. But once savings finally start to go, even the Japanese will cease to be an exception.

  6. Using the ratio of deficit to expenditure is an important indicator, but I think there is better mathematical correlation to look at the relationship of hyperinflation and the ratio of debt to expenditure.
    (And even better to consider a relationship -one equation- between all three: debt, deficit and expenditure.)

    However, it is to late to bother with any of that now, the hyperinflation is coming as soon as the present short term deflation runs out of steam. The only useful math from now is how to calculate precious metal (mining companies) stock prices vs. the actual physical metal(s).

  7. I'm waiting for Japanese inflation. So are the Japanese. You need to rewrite this article.

  8. When China wants to cash in, America is going to cash out and that's when all hell breaks loose.