I hope this doesn’t happen, but I don’t know if it can be avoided.  There is a lot of talk these days about how the bail out money is going to be spent, but not very much on how it is going to be financed.

santopoliti:

My Partner Todd Dagres wrote a pretty provocative blog post on Tech Crunch today. He has a big issue with how the bail out money is being spent and allowing managers who caused all these problems to continue with their ways.

I have a different issue with all that’s happening – and that’s hyper inflation. I recently had breakfast with a friend of mine who is (still) in the finance sector. He told me something very alarming: The fed is trying to control the yield curve by selling at the short end while buying at the long end.

Everyone is pretty much in cash right now after the melt down and buying the only thing that looks safe enough – treasuries. The demand is there so the government can borrow money at almost 0% interest rate. And they are borrwing as fast as they can, for all the bail out money.

Let’s play this out:

• For the next 12 months, dollar continues to be strong as the G7 economies deal with all the similar issues. Eventually the lending for the US dries up as the economy continues to get weaker.
• The demand for Treasuries at current terms star to slow significantly, supply demand takes over. The Fed’s only option is start increasing interest rates that reflects the risk and to spur demand.
• And it all happens very quickly, interest rates spiral up fast, weakening the dollar and devaluing the money we have in out wallets overnight.
• Our friend inflation comes back – it is now hyper inflation because until supply demand curve get to an equilibrium (and as the government needs to borrow more and more money) the spiral down continues in a jarring fashion.

I grew up in an hyper-inflationary environment in Turkey. Everything would be going great but as the trade inbalance grew the goverment would end up with no choice but devaluing the Lira overnight – time and again making the money in our pockets be worth less than the paper it was printed on. To give you an idea, when I was about 12 years old, when I started paying attention to these things: 1USD = 2.5 TL (Turkish Lira) which also happened to be my weekly allowance. When I graduated college 1 USD = 250,000 TL. So like most people in the country we had no money in the bank and kept whatever we had in cash (USD or German Franks) in our houses, litteraly under the mattress. You could transact anywhere, for example in the supermarket, in any currency, everybody carried calculators and the daily exchange rates with them and there was a premium to buying things in Turkish Lira – not fun.

The US economy is nothing like the Turkish economy – the manner we get there,  the severity is going to be very different but I am betting that we will get there including all the side effects like massive unemployment.