In the present world economic debacle everyone appears to advocate that we have to fund a recovery by throwing money we don't have at the problem. The only way we may be able to do this is by printing more money. I have wondered (although I have not so far blogged on the subject) whether this will inevitably lead to severe inflation down the line. It was interesting to come across a blog on the Financial Times that more or less addressed the same subject all be it more eloquently than I could do so.

Morgan Stanley’s Jocahcim Fels and Spyros Andreopoulos looked at the possibility of hyperinflation hitting the western shores of the UK, Europe and the US. They said one stark lesson from the ongoing financial and economic crisis is that so-called black swans — large-impact, hard-to-predict and seemingly rare events — can occur more frequently than generally believed. With policymakers around the world throwing massive conventional and unconventional monetary and fiscal stimuli at their economies they thought it is worth exploring the black swan event of very high inflation or even hyperinflation.

The risk of hyperinflation cannot be dismissed very easily any longer. The classification of hyperinflation is an episode where the inflation rate exceeds 50 per cent per month. In history this has occurred in the 1920s in Austria, Germany, Hungary, Poland and Russia. In 1923, for example, Germany experienced a 3.25m per cent inflation rate in a single month. Since the 1950s hyperinflation has been experienced in Argentina, Bolivia, Brazil, Peru, Ukraine and Zimbabwe.

The root cause of hyperinflation is excessive money supply growth, usually caused by governments instructing their central banks to help finance expenditures through rapid money creation. It could possibly happen in Europe or the US under certain conditions.

Firstly, the rapid expansion of the monetary base by the Federal Reserve, The European Central Bank and the Bank of England would have to continue and feed into a more rapid and sustained expansion of money in the hands of the general public. Secondly, governments would have to face difficulties financing their bailout packages and funding their debt. Lastly, public confidence in the government’s ability to service debt without resorting to the printing press would have to disappear, as well as the government’s actual ability to withstand the pressure to do so in the first place.

And while all of the above is an extreme scenario the pundits Fels and Andreopoulus concluded that given the size of the current and prospective economic and financial problems, and given the size of the monetary and fiscal stimulus that central banks and governments are throwing at these problems, investors would be well advised not to ignore this tail risk, especially as markets are priced for the opposite outcome of lasting deflation in the next several years. Put differently, they believe that buying some insurance against the black swan event of high inflation or even hyperinflation makes sense and is relatively cheap currently. They add that when hyperinflation occurred in the eastern block countries towards the end of the communist era, most citizens hedged via significant purchases of black-market US dollars, the US dollar becoming the effective proxy store of value. This time round, that would not be an option.

My own view is that there may of course be an upside in hyperinflation. Given the vast amounts that need to be borrowed now the effect of high inflation might be to minimise in relative terms the cost of the present borrowings. But I do not have an answer and what is really worrying is that neither does anyone else.