The threat of hyperinflation in Europe

I interviewed GMO’s James Montier last week. Subscribers can read the full interview in the magazine on Friday, but there is one bit I couldn’t quite fit in – Montier’s views on hyperinflation. He isn’t much worried about it in most places (it rarely happens in “coherent and cohesive societies”), but the one place where he suggests there might be risk is in Europe.

Economists, he says, generally forget that “their subject is not economics, it is political economy”. Look at Europe and you can see that under economic rules it should have split already, but the politics of the eurozone mean that “economics is a slow burn force” there. That suggests that it could “trundle along for another decade” in a miserable state of low growth. It might then accept the need for fiscal transfers – that would help.

Quantitative easing (QE) wouldn’t be a bad thing either – it will at least stop bond yields in some countries crippling them. The problem is that while bond vigilantes are irrelevant in the UK, US and Japan (see the full interview for more on this) they are all too relevant in Europe, where there is still no real state-backed bond buyer of the last resort – and there is therefore real credit risk.

QE can change that and buy the Eurozone some time. What it can’t do, however, is solve its problems.

In the end there will be a break up, and then there could easily be hyperinflation. Look, says Montier to all previous breakups of monetary unions: the Russian Federation, the Hapsburg Empire, etc. “One of the underestimated costs of eurozone disintegration is hyperinflation.”

There’s more on the history of this here.