With inflation soaring all over the world there is a risk even the Western world could end up with hyperinflation. We are still far from that, but if anybody had told me a year ago that Holland would have 17% year-over-year inflation right now I wouldn’t have taken them serious. Hyperinflation is a lot more than 17% of course, the definition that’s mostly used is 50% inflation on a month-to-month basis. If that happens the economy doesn’t function anymore and many people will lose everything they have. Companies will go bankrupt and there will be large social unrest. I decided to look a bit deeper into what happens when there is hyperinflation and how you can protect yourself against it.
Debt to GDP ratio as a predictor of hyperinflation
Generally hyperinflation only occurs in countries with a debt to GDP ratio of over 120%, that number seems to be a significant turning point. As a rule of thumb a ratio of over 130% is considered the death zone for countries. However, this rule of thumb seems to be more valid for second- or third-world countries than for first world ones. For example, Japan has had a ratio of over 130% for many years and is now approaching 250% and still gets away with it, although it hurts its currency. The US is now close to 130%, but because the USD is still the leading global currency people won’t as easily lose trust in it. In Europe a number of countries are close to or above 130% as well, most notably Italy with 150%. Because the EU is a monetary union Italy can still get away with it, but it will be harder and harder for them to borrow money, which may force to EU to eventually issue joint debt to bail out countries like Italy.
So we are not there yet in the Western world and we will hopefully never get there, but it’s still good to consider what might happen in case hyperinflation should hit. There are some good books about the subject, among others When Money Dies. That book focuses on Weimar Germany in the period after World War I, after Germany took itself off the gold standard (like the USD did in 1971) to finance WWI. After Germany lost the war it was forced to make reparation payments that eventually led to hyperinflation. Because the book describes a period about 100 years ago it’s not very applicable to the current situation, but it shows you how quickly things can go wrong and how almost everyone is affected by it. A good example of how hyperinflation in Germany affected everyone I found here:
“My father was a lawyer,” says Walter Levy, an internationally known German-born oil consultant in New York, “and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20-year policy, and when it came due, he cashed it in and bought a single loaf of bread.”
Argentina and Zimbabwe
Other countries that have faced hyperinflation more recently include Argentina and Zimbabwe, and what happened (and happens) there could be a good lesson for us in how to mitigate the worst problems. I recently had a conversation with someone in Zimbabwe who told me that banks still provide mortgages there. He keeps on remortgaging his properties and even after 20 years of hyperinflation banks let him do that, despite the fact that they know they will lose real value on these loans. He said the main reasons they do that is because it’s their business to carry on, because of relationships, because of the fees they earn, and that because of regulatory reasons they don’t have many other options.
Of course nominal interest rates are very high, but in the end inflation is always much higher so you are almost guaranteed to make a profit as long as you have cash flow. For example, the person who remortgages now pays 200% on some loans. That’s painful when there are no devaluations for a while if the Central Bank is trying to tighten, but in the end it always breaks with printing more money, because the country simply can’t avoid that.
The situation in Argentina is different, at least for real estate loans. Almost all property deals are done for cash in Argentina, without a mortgage. The reason is that Argentines do not trust their banks. So savings from the private sector barely enter the banking system: if people don’t put their money in the banks for saving, then the bank doesn’t have any money to lend. Many people therefore rent, because they can’t buy property without savings. Also many sellers only want USD and that’s hard to get because of currency controls.
Rental yields in 2014 were 7-8% per year, but went down to 2% in 2019. Because not many people were buying, sellers decided to rent out and are happy with that. In 2019 there were only 30,000 housing transactions in Buenos Aires (a metropolis of 15 million people), mainly because most transactions are in USD and people are not allowed to change more than $10K worth of pesos per month.
Hyperinflation and mortgages
If hyperinflation would hit the Western world existing mortgages would not be affected, and would be easier to pay back over time (assuming your wages would rise with inflation, an effect which is always delayed during times of high inflation). Of course this assumes that you have a fixed mortgage rate, if your rate is variable you will be in big trouble and you might be forced to sell your house, most likely in a market without many buyers, because nobody can afford mortgages at inflated rates. The big lesson is to have a fixed mortgage once hyperinflation hits.
If you are a landlord hyperinflation will be a major problem, because you generally can’t increase rent as much as you like (rent control) or only once a year. If there are any repairs those may be much more costly than the rent you receive. Governments will likely intervene as well, to avoid that most renters will become homeless because they can’t afford the higher rents. Of course property is still a good store of value, so landlords may just suck it up because it’s better than cash that evaporates in front of your eyes.
Hyperinflation and companies
High inflation changes the fundamental nature of business operations. For companies, instead of focusing on production, cash management becomes extremely important. One lesson from Argentina is that you should not keep your cash in the bank but invest it in other currencies. Companies in Argentina put their cash abroad in USD if they had that opportunity. In the end many companies can only survive by speculating in the currencies and commodities markets. However, business that are highly leveraged are doomed to fail because interest rates will go up extremely fast. One interesting thing is that companies often wait to sell their products. Stockpiling large inventories to sell later at higher prices is better than to try to sell them right away.
Alternatives for the USD
Now, if the USD would hyperinflate most likely all fiat currencies will be doomed, so there are no other currencies left to put your cash into. I think that is when Bitcoin will come to the rescue: it is not a fiat currency, so you don’t need to trust it (nor a government). In times of hyperinflation the price of Bitcoin could literally go to millions of dollars very quickly, but of course those millions would have a lot less purchasing power than they currently have.
Hyperinflation and the stock market
How about the stock market? Generally stock markets are very resilient and are a good way to survive hyperinflation. As someone told me recently, the rich use stock markets to move money, so these markets generally will do well. That might be true if you look at what happened in countries with hyperinflation over the past decade, but the question is what would happen to stock markets if the USD collapses. That is an unprecedented event and the effect could be a total collapse of the financial system, including the stock markets.
When stock markets fail the winners will be owners of real assets. Those go up in value and can be sold at hyperinflated prices if needed. This can be anything from watches to pianos (they were bought as a store of value in Weimar Germany), and from real estate to diamonds. However, the best real assets will likely be commodities like silver and gold, and of course Bitcoin. It’s simply much easier to sell some gold, silver or Bitcoin to buy food, than to sell a piano. Most real assets can be good stores of value, but they are simply less liquid, less divisible, and more fungible than precious commodities and especially Bitcoin.
My conclusion after reading a lot on this topic is quite simple: if hyperinflation hits Western world outside the USD zone, get into USD to hedge yourself. If the USD gets hit by hyperinflation all bets are off and the whole financial system could fall apart. In that case make sure you own liquid real assets, preferably gold, silver or Bitcoin.
Will this happen? Most likely not, but it is also certainly not impossible. I believe governments will try to inflate their debts away with inflation rates in the double digit percentages per year. That might work until people realize that in the end they are paying for it, because their savings and money lose a lot of value every year. In that case we may get a monetary reset, which aims to restore faith in the currency by chopping off zeros from all prices and will that reduce government debts in the same way. That might work for the currency, but it will lead to financial devastation for many people. Also in that case the best way to survive the crisis is to own real assets.
I am not trying to sound fatalistic, but these are real risks in today’s world. The current global financial situation is getting out of hand and Central Banks have lost control. Something’s gotta give, but we don’t know yet what. So, as I have said several times before on this blog, please make sure you are prepared for an uncertain financial future. Hedge your bets when you can still do so.
Good summary. In general, with the dense population nowadays, if hyperinflation would become a reality, it will lead to total chaos. People will fight for access to basics, like food.
Thanks Marc for this very good article. I heard that some people went completely out of stocks and moved to crypto/commodities. What do you suggest % how to balance best your portfolio.
Great opinions Marc! Can you make a post about main cryptocurrencies situation and their current low prices?
It’s hard to believe that the USD will be the last strong currency given the state the country is in.
Marc, why don’t you invest most of your spare money in gold? That feels like a sure bet.
This is the moment that Gold should be shining, but it did not. In a high inflation environment Gold should have gone up a lot, but it actually went down over the past 2 years, so it’s not even a good store of value anymore.