Hyperinflation—Calamity Or Opportunity?

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 Strategic Intelligence, recently published an article entitled “Buffet Takes a Page From the ‘Inflation King’s’ Playbook”. 

In that article Rickards compares the apparent investing strategy of today’s Warren Buffet—one of the two or three most successful investors of our time—to that of Hugo Stinnes—the wealthiest investor and industrialist in Germany during the 1920s.

According to Rickards,

“Both Stinnes and Buffet were ultra-wealthy investors whose opinions were eagerly sought on important political matters, who exercised powerful behind the-scenes influence, and who seemed to make all the right moves when it came to playing markets.”

Stinnes achieved much of his spectacular wealth by accurately anticipating the Weimar Republic’s hyperinflation of 1922-1923 and investing accordingly.  Based on his seemingly miraculous success, Stinnes was dubbed Germany’s “Inflation King”.

•  Rickards notes that Warren Buffet’s current investing strategy seems practically identical to that which Stinnes used in the early 1920s.  Buffet has been selling off his investments in corporations (like Proctor & Gamble or Johnson & Johnson) that depend on consumer spending and buying “hard assets” like railroads.  Apparently, Mr. Buffet believes that consumers may soon be too impoverished to spend and consume much more.

Richards infers that, just as Stinnes anticipated German hyperinflation in the 1920s, Buffet’s investment strategy implies that Buffet must also be anticipating an imminent episode of hyperinflation—but this time, for the fiat dollar.

Rickards:

“To understand Stinnes’ wealth, recall that from 1922-1923, Germany suffered the worst hyperinflation experienced by a major industrial economy in modern times. The exchange rate between the German paper currency, the reichsmark, and the dollar went from 208-to-1 in early 1921 to 4.2 trillion-to-1 in late 1923.  At that point, the reichsmark became worthless and was swept down sewers as litter.

“Yet Stinnes was not wiped out during this hyperinflation. Why was that?”

Rickards didn’t describe Stinnes as an “Horatio Alger story”.  Stinnes was not a poor boy who made good.  Stinnes had advantages:  he was born into a fairly prosperous German family that had interests in coal mining; at age 20, Stinnes started his own business in competition to his father; when his father died, Stinnes inherited his family’s business, bought his own coal mines, and diversified into shipping, buying cargo lines and even a prominent newspaper.

Nevertheless, Stinnes was much more than a rich kid who got lucky.  Stinnes was smart enough to perceive that hyperinflation was coming to Germany.  More importantly, Stinnes had the courage to act on his perceptions.

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•  The world has always had plenty of people who are smart enough to perceive what’s going to happen. But the world has only a few who have the courage to act on their perceptions.  Most of us tend to be members of a “herd” who would rather do what everyone else is doing, say what everyone else is saying and believe what everyone else is believing, than risk acting on whichever of our own perceptions run contrary to those of the “herd”.

That’s why it’s so hard to follow the fundamental rule of successful investing:  Buy low and sell high.  If you would “buy low,” you must buy when all the rest of the “herd” is selling, dismissing the particular investment vehicle you’re attracted to as trash, and regarding anyone who “buys” as a fool.  Most of us would rather stick with the herd than “buy low” and risk being labeled a fool.

Similarly, most of us would rather stick with the herd and keep buying and holding an investment vehicle that’s rising than “sell high” (when all the rest of the herd is buying) and risk being labeled a fool.

As a result, we don’t go broke simply because we lack knowledge or intelligence.  Knowledge and intelligence are important, but we go broke (or at least fail to prosper) because we lack the courage to act based on our own, independent perceptions.

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•  Hugo Stinnes didn’t suffer from that disability. He had the courage to act on his own perceptions.

Stinnes undoubtedly anticipated the Weimar hyperinflation of A.D. 1922-1923.  He therefore borrowed vast sums of currency denominated in fiat reichsmarks and used those funds to purchase “hard assets” like coal mines and barges to haul coal.  When the hyperinflation hit, Stinnes was able to repay his debts with vastly cheaper fiat reichsmarks. 

Hyperinflation wiped out Stinnes’ debts—as well as those of every other German debtor.

However, while his debts were wiped out by hyperinflation, the prices of Stinnes’ “hard assets” (coal, steel, shipping vessels, etc.) rose dramatically, and retained their value.

Implication:  If you were sure, really sure, that hyperinflation was imminent, you’d be wise to borrow all you could before the hyperinflation hit and invest in “hard assets” like coal, steel, shipping vessels and gold and silver.

•  Rickards:

“It didn’t matter what happened to the German currency – a hard asset [something other than paper debt-instruments] is still a hard asset and does not go away even if the currency goes to zero.”

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If you’ve invested in hard assets prior to hyperinflation, the prices of those hard assets will at least rise enough to preserve their value during hyperinflation.  On the other hand, all “soft assets” (debt-instruments whose prices were fixed on paper and denominated in the hyperinflating, fiat currency) would tend to be destroyed.

“Stinnes’ international holdings also served him well because they produced profits in hard currencies, not worthless reichsmarks. Some of these profits were kept offshore in the form of gold held in Swiss vaults.  That way, he could escape both hyperinflation and German taxation.

“Not only was Stinnes not harmed by the Weimar hyperinflation, but his empire prospered. . . .  When Germany returned to a new gold-backed currency, Stinnes was one of the richest men in the world, while the German middle classes were destroyed.”

•  Stinnes’ spectacular wealth hinged on six points:

1) Stinnes had sufficient education to understand the nature of money.  I.e., he understood the difference between intrinsically-worthless, fiat reichsmarks and gold or gold-backed money.  He understood that the inevitable fate of fiat reichsmarks would be hyperinflation and fiat currency death.

2) Stinnes had sufficient intelligence to objectively perceive an imminent period of hyperinflation.

3) Stinnes had sufficient courage to trust and act on his own perceptions.

4) Stinnes borrowed German fiat currency before the hyperinflation began.  I.e., Stinnes knew that once the hyperinflation began, his debts would be virtually destroyed.

5) Stinnes invested his borrowed currency in “hard assets” whose value would not be destroyed by hyperinflation.  And,

6) Stinnes repaid all of his debts with hyperinflated (and therefore worthless) fiat reichsmarks.  He borrowed reichsmarks when they were 200 to the US dollar, and repaid his debts when (thanks to hyperinflation) the reichsmarks were valued at 4 trillion to the dollar.

Implication:  If you were sure that hyperinflation was coming, and you had a good idea of when it would arrive, you’d do well to borrow all you could to purchase all the hard assets you could find.

″  But, what, exactly, is hyperinflation?

It’s the inevitable fate of fiat currencies.

It’s not mere mathematics or the result of some fixed economics formula.  Hyper-inflation is an expression of the public’s loss of confidence in their national currency.

As people lose confidence in their currency, they don’t simply quit the currency, but they do demand more and more of it to pay for tangible goods and services.

For example, I might sell you a pound of steak today for $10.  Next month, I might demand $20, and the month after that I might demand $50.  I haven’t (yet) lost all confidence in the value/purchasing-power of the fiat dollar, but rising prices are evidence that I’m in the process of losing more and more or my former confidence in the fiat currency.

Eventually, I’ll demand so much hyperinflating currency to pay for a steak, that you might offer to pay me with a lamp for my desk, or perhaps a chair.  I will eventually prefer to take something tangible in payment for my steak because I’ll know that if I accept fiat currency, its current purchasing power will decline quickly and significantly over the next weeks, days or even hours.  At the point, some significant percentage of people will insist on bartering tangible goods for tangible goods, and the fiat currency will fail and be discarded.

Chaos will follow.  Those members of the “herd” who had held their wealth in the form of paper-debt instruments will be wiped out.

Stinnes must’ve understood the nature of money and realized that Germany’s fiat reichsmark was doomed to die in an explosion of hyperinflation.  He had to know that the German people would inevitably lose confidence in the reichsmark and it would collapse into worthlessness.  He invested accordingly and became rich.

•  Rickards:

“ Interestingly, today Warren Buffett is using the same techniques as Stinnes used almost a century ago.  It appears that Buffett has studied Stinnes carefully and is preparing for the same calamity (or opportunity) that Stinnes saw: hyperinflation.

If it’s true that Warren Buffet—one of the greatest investors of all time—is currently investing based on his expectation that hyperinflation is imminent, then it’s reasonable that you and I should do the same.

“Buffett purchased major transportation assets in 2009 in the form of the Burlington Northern Santa Fe railroad.  This railroad consists of hard assets in the form of rights of way, adjacent mining rights, rail, and rolling stock. The railroad makes money moving hard assets, such as ore and grains.

“Buffett next purchased huge oil and natural gas assets in Canada in the form of Suncor.  Buffett can now move his Suncor oil on his Burlington Northern railroad in exactly the same way that Stinnes moved his coal on his own ships in 1923.

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Over the last couple of years, Warren Buffett’s holding company, Berkshire Hathaway, reduced its exposure to American stocks that rely on consumer spending.

For example, over a two-year period, Buffett’s holding company reportedly sold off 96.8% of its holdings in Johnson & Johnson, 99.7% of its holdings in Kraft Foods Group, and 11.5% of his holdings in Procter & Gamble.  Apparently, Buffet suspects that consumers will soon go broke and be unable to buy.

But, surprisingly,

“A huge part of Buffett’s portfolio is [now] in financial stocks—particularly in banks and insurance companies—that are highly leveraged borrowers.

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Q:  Why would Buffet seek out financial stocks that are “highly leveraged” (deeply indebted)?

A:  Because—if hyperinflation is imminent—today’s “highly leveraged borrowers” should be able to repay their debts with worthless fiat dollars and thereby legally “rob” their creditors.  I.e., deeply indebted people and businesses will be suddenly freed from their debt bondage by hyperinflation.

If we enter an era of hyperinflation, the value of all debts and debt-instruments will be dramatically reduced or even destroyed.  Hyperinflation is almost miraculous for debtors but catastrophic for creditors

All of which raises several more questions and answers:

Who’s the world’s biggest debtor? The US government.

Therefore, who might stand to gain the most from a dose of US dollar hyperinflation? The US government.

Who might lose the most from a dose of US dollar hyperinflation? All lenders who are now holders of US Bonds, or other paper debt-instruments denominated in fiat dollars. Both domestic and foreign (even Chinese) creditors would suffer significant financial losses as their US bonds and US dollar-denominated debt-instruments suffered hyperinflation.

Domestic and even global chaos might ensue if the fiat dollar were subjected to hyperinflation—but even so, is it conceivable that the US government would want to cause or allow hyperinflation in order to eliminate much of the National Debt?

The answers to the first three questions are obvious. The answer to the fourth question is more subjective.

We know that our government wants to cause inflation.  Could the US government also want to cause or allow hyperinflation?  The answer is, at least, “maybe”.

Clearly, being the world’s greatest debtor, the US government has a powerful, vested interest in causing hyperinflation.

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•  Rickards concludes:

 “If hyperinflation were to slam the U.S. today, Buffett’s results would be the same as Stinnes’. His hard assets would explode in value, his debts would be eliminated, and he would be in a position to buy out bankrupt competitors.   Of course, the middle classes [a/k/a the “herd”] in the U.S. would be wiped out, just as they were in Weimar Germany.

“Perhaps Buffett sees the same hyperinflation in our future. It’s not too late for you to take some of the same precautions as Stinnes and Buffett.”

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The fate of virtually all fiat currencies is death by hyperinflation.  Sooner or later, the fiat dollar will fall to hyperinflation.

Although the timing can’t be known, Jim Rickards says Warren Buffet and several other super-wealthy investors are acting as if they believe hyperinflation is imminent.

It would be in the interest of every overly-indebted government on earth (from Greece, to Japan, to the EU, to the United States) to allow or cause a hyperinflationary “currency reset” in order to wipe out their national debts.

Imminent hyperinflation is at least probable—perhaps within the next six to twenty-four months.

If so, that gives all of us a window of opportunity—time to act—before hyperinflation begins.

If you believe hyperinflation is imminent, you should ignore the conventional wisdom of the herd and determine to act courageously and independently.  You should move as much of your wealth as possible from paper debt-instruments into “hard assets” like steel, transportation, railroads, silver and gold.