When Money Becomes Worthless
by Martin Hutchinson October 12, 2009
The Financial Times last Tuesday noted a disturbing new trend – hedge fund and other investors are increasingly seeking to invest in physical commodities themselves, rather than in futures. Given the excess of global liquidity, this is not entirely surprising. It does, however, raise an ominous possibility of a supply shortage in one or more commodities, caused by investor demand that exceeds available mine output and inventory. That could potentially produce a collapse in economic activity similar to that from the 1837-41 and 1929-33 liquidity busts, but with the opposite cause.
in addition to the hedge funds, there are other huge pools of money available for deployment in commodities markets. For example China and Japan each have around $2 trillion of foreign exchange reserves, while Saudi Arabia and the Gulf states have comparable sized pools of liquid assets available for investment. Since the available inventory of commodities is a fraction of their annual production, we could potentially end up with an extreme case of too much money chasing too few goods.
Disruptions of commodity flows of this kind can potentially cause both hyperinflation and a major recession. In a gross liquidity surplus, in which investment capital disrupts commodity trade flows, inflation rather than deflation results, probably very rapid inflation rather than the moderate 5% to 10% inflation we became used to in the 1970s. That inflation still further increases demand for commodities, worsening the problem. Businesses unable to obtain raw materials close their doors, workers' real incomes decline sharply (even when they keep their jobs) and Gross Domestic Product declines similarly to the deflationary case.
We have never experienced a global hyperinflation, In hyperinflationary periods citizens of Argentina have starved, even though the country is one of the world's greatest food producers. However, globally we have experienced nothing worse than the moderate worldwide inflation of the 1970s, which money is unable to purchase goods, so it becomes worthless.
The cost of avoiding this disaster appears to be steadily increasing. Once articles start appearing in the Financial Times about investors choosing to buy physical commodities rather than futures, many more such investors will be drawn into this activity. A moderate tightening of monetary policy that might well have deflected the forces of hyperinflation if it had been instituted several months ago may well prove ineffectual at this stage.
Given the predilections of today's policymakers, it is unfortunately unlikely that they will tighten monetary policy sufficiently to break the commodity flight,
the Financial Time's story itself and the gold price breakthrough have significantly increased the size of the hike in interest rates necessary to halt the flight to commodities.
Time is short, and the probability of disaster is rising
Read the whole article-every word, and start thinking what you can do to prepare for whichever way this thing goes. 
