Meaghie Champion: Caution: inflation ahead

Western governments have borrowed extraordinary sums to get through COVID-19. There may be only one way out, and it's bad news for your savings

He warned people before the 2008 subprime mortgage fiasco and recession.

He's trying to warn us now.

Remember Michael Burry from the movie, The Big Short, about the 2008 financial crisis? In the movie, Burry was the one played by Christian Bale.

When almost everyone thought the housing market was doing great, Burry figured out that it was about to collapse and made a huge, multi-million dollar investment bet that he was right about that. His "short" investment ended up making a $700 million profit.

So when Burry has something to say about financial markets and the economy, we should listen. One would think.

Recently, he posted this tweet:

"People say I didn't warn last time. I did, but no one listened. So I warn this time. And still, no one listens. But I will have proof I warned."

The warning: Inflation is coming.

He later deleted his tweets about inflation and posted this explanation of why:

"Tweeting and getting in the news lately apparently has caused the SEC to pay us a visit. Lovely. #nomoretweets https://t.co/6t3v8Tc7LF

— Cassandra (@michaeljburry) March 18, 2021"

He has since deleted his entire Twitter account.

Is there some reason that the U.S. Securities Exchange Commission doesn't like him tweeting warnings about inflation? Well, I'm taking that as even more of an indicator that people should pay attention. Our governments are running up extraordinary debts in response to COVID-19, prompting fears that our profligate ways will inevitably devalue our currencies, driving up the price of everything we purchase. Meanwhile, an emerging school of economic thought called Modern Monetary Theory is championing the idea that wild deficit spending actually doesn’t much matter, as long as governments impose measures like tax increases and jobs guarantees to counter-act the inflationary effects of, essentially, printing money to service government programs.

Now, we ordinarily have inflation all the time. That means prices on various goods and services go up on a regular basis, normally measured quarterly and annually. So the prices at the store go up a by about two or three per cent per year. So what?

Well, sometimes, it's a lot more than that. Take what is happening in Venezuela, for example. Their annual inflation rate is about 2,665 per cent. To make that relatable: If we had that much inflation for a year, a 4-litre jug of milk would go from $5 to $133. A $2 can of soup would go up to about $50. Gasoline would cost about $40 per litre. If filling up your car costs $50 now, that much inflation would drive the price of a fill up to over $1,300.

That's not the worst it can get. In 2019, the annual inflation rate in Venezuela hit 350,000 per cent. At that rate, the prices double every month.

In an inflationary period, people who own homes with large mortgages would find that their houses have become worth many millions while the mortgages stayed the same. People who own businesses can increase their prices to try to keep up with inflation. The rest are out of luck.

One of the nastiest things about inflation is that those who have worked hard, saved money, and parked it in things that are considered safe like cash, chequing accounts, savings accounts and government bonds will be financially destroyed. Meanwhile, those who ran up debts and have no savings will be rewarded as their debts evaporate. Those who have the closest connection to the government and its pet banks will be in a position to profit immensely. Some of these people will be recipients of the increased government spending. Others will benefit by getting a pile of newly created money in the form of bank loans that they pay back later when the value of that debt has evaporated due to high inflation.

So, could it happen here?

Canada's money supply increased by more than 18 per cent last year. Normally, it's more like five per cent. According to Bloomberg, Canada’s central bank was purchasing $4-billion worth of government bonds every week — and is acquiring so much government debt that the bank’s Governor, Tiff Macklem, has warned that “market functioning could get distorted” if we don’t pull back.

In the U.S., the situation is even more dramatic, with the money supply increasing by 26 per cent. No wonder; their budget deficit of $3.3 trillion is about half their total spending. Already this is happening. About half of all borrowing by the U.S. Treasury is from the Federal Reserve, which just issues new money and lends it to the government.

The U.S. has another big problem that we don’t have.

People in the rest of the world are holding huge amounts of U.S. money. The best estimates are that there is more U.S. currency in the rest of the world than inside the U.S. Perhaps as much as a trillion dollars in cash. Foreign central banks are holding about $7 trillion more. There’s a lot more held by other foreign banks. If the U.S. dollar drops a lot in value, the rest of the world may want to cash in dollars for other currencies. Last year, the value of the U.S. dollar dropped by 7 per cent compared to other currencies.

If all those dollars abroad come flooding back in, that alone could massively increase money supply, which could set off an inflationary spiral. U.S. Nobel prize winning economist Paul Samuelson predicted in 2005 that something like this could happen someday.

It may seem as though the U.S. economy is large enough to absorb huge amounts of new money without a major problem. That's true. When the U.S. essentially printed money to escape the 2008 economic crisis, we did not see hyper-inflation. A hundred billion dollars of new money would be just a blip to the U.S. economy. Trillions upon trillions of new dollars is something else entirely. The numbers matter.

There is that much coming. There is a $3.3-trillion budget deficit. $7.7 trillion in existing debt that has to be refinanced over coming decades — likely at higher interest rates — and also with newly created money. And that's without any massive new spending initiatives. President Biden has announced $2 trillion in new spending initiatives; in short, the U.S. does not show any indication of constraining spending or deficits at all for the foreseeable future.

Peter Bernholz, a German economist, conducted a study on hyperinflation. He found that at least 25 out of 29 episodes of hyperinflation that he studied were caused by governments covering budget deficits by issuing more money. Right now, the U.S. has an enormous budget deficit equal to half their spending and half the deficit is being covered by creating new money. That is the recipe for hyperinflation.

It’s possible that these more dour economists are entirely off the mark. Modern Monetary Theory — an emerging school of thought — has presented ideas around spending and deficits that fundamentally reframes how governments might approach carrying ambitious new spending programs. In short, MMT is the increasingly popular theory that governments can simply print cash to finance deficits, as long as they account for the inflationary effects. This connection between money supply and inflation is currently one of the most hotly debated topics in modern economics. So far, the economies of most wealthy nations have proven remarkably resilient to hyperinflation in the face of major international crises, which suggests that the MMT folks may have it right.

Or maybe not.

Perhaps we’ve just been lucky so far, and this luck has given us the sense that we’re invulnerable to the kinds of paper-money catastrophes that have rocked nations like Venezuela. The coming months may tell us whether or not that faith is well founded, or if it is not.

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