I have lost enough games of Monopoly to understand that the money doesn’t really matter. I may cringe when I land on my opponent’s hotel on Park Place but I do so out of fear of losing the game, not that my net worth is materially dropping.
The game’s manufacturer, Parker Brothers, controls the supply of Monopoly money. Unfortunately, no one accepts it in exchange for actual goods, as they know Parker Brothers can just print more of it on colorful pieces of paper. The Monopoly money is only worth the paper on which it is printed.
The concept that government-issued money can be equally as worthless is hard to imagine. But for many around the world, worthless currency is a reality. The Zimbabwean dollar is perhaps the best example. At its peak, the country experienced daily inflation of 98 percent. That means the value of the Zimbabwean dollar is half of what it was about 25 hours ago. You can imagine how holding the currency can quickly deteriorate into a game of hot potato.
The Reserve Bank of Zimbabwe announced Feb. 2 that it would revalue the Zimbabwean dollar simply by knocking 12 zeros off the currency. Overnight, 1 trillion Zimbabwean dollars became 1 Zimbabwean dollar. Even after the redenomination, however, the currency continued to lose value. Finally, April 12, the government gave up and suspended the use of the currency. Today, Zimbabwean residents either barter or use other currencies when making transactions.
Some in the investment community believe many other nations around the world, including the United States, are headed on a path to inflation. The term “quantitative easing” has been thrown around almost daily on CNBC. It is simply a sophisticated way of saying, “printing money.” In practical terms, governments engage in quantitative easing by buying their own bonds using money they create out of thin air.
J. Kyle Bass, the managing partner at Hayman Capital, has called this recent trend, “the largest, global financial experiment in history.” In his most recent letter to investors, he goes on to explain, “Everywhere you turn, governments are running enormous fiscal deficits financed by printing money. The greatest risk of these policies is that the quantitative easing will persist until the value of the currency equals the actual costs of printing the currency (which is just slightly above zero).”
In his book “Monetary Regimes and Inflation: History, Economic and Political Relationships,” Economics Prof. Peter Bernholz compares the 12 largest episodes of hyperinflation during the 20th century. Each was caused by large public deficits financed by printing money. Bernholz’s key finding is that the tipping point for hyperinflation occurs when more than 40 percent of what the government spends is financed by borrowing or printing money. Current Office of Management and Budget projections imply that the United States will run deficits of 43 percent and 40 percent of total government expenditures in 2009 and 2010, respectively.
According to a September 2009 study entitled, “The Deficit Endgame,” the American Enterprise Institute for Public Policy Research, “The U.S. fiscal scenario will soon approximate the economic scenario for countries on the verge of a sovereign debt default.”
Some experts think the world’s second largest economy, the Japanese economy, is in even worse shape than that of the United States. In a recent speech, hedge fund manager David Einhorn, who famously predicted the collapse of Lehman Brothers, explained, “Japan appears even more vulnerable, because it is even more indebted and its poor demographics are a decade ahead of ours. Japan may already be past the point of no return … it is hard to see how Japan could avoid a government default or hyperinflationary currency death spiral.” The country’s debt is currently 1.9 times its GDP. By comparison, U.S. debt is estimated to be 0.9 times GDP for 2009.
The obvious question on many investors’ minds is what to do with dollars if their value will be inflated away in the next five to 10 years. Many are turning to hard assets, namely gold. As Einhorn said, gold has historically done well during the Great Depression and other times when the currency was debased.
Gold, he projected, should continue to “do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis.”
Einhorn is not alone. John Paulson, who made billions betting on the collapse of the U.S. housing market in 2007, is placing big bets on hard assets, including $4 billion in gold and gold miners. University alumnus Paul Tudor Jones, who manages about $11.6 billion, told investors in an Oct. 15 letter, “Gold appears to be cheap. In our view, gold’s value should increase as its scarcity relative to printed currencies increases.” Julian Robertson, who once ran the world’s largest hedge fund, Tiger Management Co., is similarly betting on inflation by buying curve caps that yield a profit if interest rates rise.
Thomas Jefferson also had strong view on the topic. In a letter to his Secretary of Treasury Albert Gallatin, he explained that central banks are “more dangerous to our liberties than standing armies.” He reasoned that the issuance of currency through inflation and deflation “will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.”
It seems that Mr. Jefferson’s dreary predications are gaining momentum in the investment community. I hope they don’t come to fruition – more Monopoly money won’t help me land on Boardwalk.
Rahul’s column runs biweekly Thursdays. He can be reached at r.gorawara@cavalierdaily.com.
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