Whaddya mean we dropped a zero from it?

September 9, 2007 10:03 PM

WhatIf Filter - What would happen if the dollar 3/4ths of it's value?

For all you economic MeFites out there?

I remember someone talking about this a long time ago, and he mentioned something about debt you hold being cheaper because things cost more, and (eventually) you might make more because of the change. Would this hold true? What other dire consequences would come about from such a thing happening? Additionally, would there be any bright spots in this, where if properly planned, you might actually come out better than you would otherwise?

posted by richter_x to work & money (10 comments total)

Not sure I get what you're saying, but I think you mean "What if we had serious inflation?", i.e., if the dollar were worth significantly less than it is right now. To simplify the discussion, let's say we had really crazy inflation like Germany before WW2 or Zimbabwe recently-- ever heard of people taking truckloads of cash to buy a loaf of bread? Imagine that.

So, in regard to debt, let's say you bought a house last year and owe $200,000 on the mortgage. You took out the mortgage when, for instance, Coca-Cola cost a dollar. But then in super-inflation world, Coke now costs $1000. So, theoretically, you should owe "200,000 Cokes" on your house but now you only owe "200 Cokes". Good for you, terrible for your bank. (Which eventually will probably be bad for you and all of us.)

So if you knew this were coming (and assuming hardly anyone else did), I guess the best way to plan ahead would be to take out loans and buy foreign currency. Loans, we've discussed, although if the crisis doesn't happen, you can wind up really bad off.

Foreign currency, in theory, would increase in value relative to the dollar -- so for example, today the UK's Pound Sterling is worth around $2; if hyperinflation happened, it might be worth $2000. Let's say you had 10 grand before the crisis. If you kept it in dollars, you'd still have $10,000 afterwards -- which would be worth much, much less than it used to be. BUT if you changed it into 5,000 pounds before the crisis, then you could reap the benefits afterwards as you exchange it back into $10 million. (Which is worth what $10,000 used to be, but since everyone else's American money is worth less, you're now comparatively much more well-off than you were before.)

Of course this is all very theoretical and doesn't play out as neatly in the real world.
posted by SuperNova at 10:16 PM on September 9, 2007

Oh, and about the debt -- the reason it works out in your favor is that your salary will probably correspondingly increase if there is really major inflation. It would have to -- would you still think it was worth getting up in the morning if you made 1/1000th what you do now? So while your salary will increase, your debt to the bank remains constant, and your house payment starts to look more like you're just buying an extra cup of coffee every month.
posted by SuperNova at 10:20 PM on September 9, 2007

The problem with your question is that it's an example of a "Static-line model":

They're using what's known as a static-line model, which is fancy economic speak for saying that it assumes that if you change one variable in a model, everything else will stay the same. But this is not true.

In this case, the problem is that there's no way to get a 25% devaluation of the dollar without all kinds of other things happening at the same time, and it's impossible to separate the consequences/results of such a devaluation from the consequences/results of all those other things.

For instance: a 25% devaluation of the dollar would massively shake up the economy. Employment in some areas would rise, while employment in other areas would drop.

Another problem is that once you're on that kind of path, it's tough to get back off it again. It wouldn't stop at 25%; it would keep going -- or at least, there would be a significant expectation by many here and around the world that it would keep going. That expectation has lots of consequences in its own right, going well beyond the immediate results of a 25% devaluation.

Finally, this: what would a 25% devaluation of the currency of the largest economy in the world do to all the other economies in the world? We're well into "it's impossible to say" territory here.
posted by Steven C. Den Beste at 10:37 PM on September 9, 2007

Price of gold goes through the roof. I make my living betting on this.

America would have a good opportunity to rebalance its gaping trade deficit with China, as Americans would be buying fewer goods- especially fewer goods from China. The Chinese would be the big losers in this scenario. As it stands right now, they hold a HUGE amount of US currency.

/looks up at the shit-covered fan
posted by solongxenon at 10:40 PM on September 9, 2007

Yes, what? Stay tuned.

This kind of situation is great for anyone who is in debt, holds equity (real estate, tangible assets, stock in viable companies, commodities like gold or oil), or who holds currencies that aren't inflating so fast. That's because these things are priced (and can be purchased) in dollars and as dollars become worth less the market assigns these things a higher worth in dollars.

It is better for wage payors (employers) and worse for wage receivers (salarymen), because employers generally have fixed contracts and can lag their wage payments behind inflation without too much protest.
posted by ikkyu2 at 10:42 PM on September 9, 2007

By the way, a different point: you didn't say how fast it would happen. There's a lot of difference between losing 25% over 14 years -- which is actually about the current inflation rate -- and losing 25% over a few months.

I can, at least, give you one rather catastrophic consequence of a very rapid inflation like that: war. Really serious world-wide economic dislocation of that kind has a very high chance of eventually leading to shooting and bombing.
posted by Steven C. Den Beste at 10:44 PM on September 9, 2007

when i was a wee lad, my daddy told me the following story:

once upon a time in germany, two brothers inherited a large, high-end wine collection in equal shares. one of the brothers was frugal and self-denying, he reasoned that it would be an extravagance to drink his share, so he sold it instead, and put the proceeds into prudent, conservative investments.

the other brother was a rakish, devil-may-care kind of hedonist, he reasoned that the sudden presence of all this fine wine in his basement was a sign from providence that he was intended to drink it and have a good time, and he did so.

this was during the weimar period in germany, between the two world wars. there was an epic hyperinflation, and...

the brother who drank his wine was able to sell the empty bottles for more money than the prudent brother got for his full bottles.
posted by bruce at 10:59 PM on September 9, 2007 [1 favorite]

If you want to know what would happen under moderately high inflation, look to the USA in the late 70's. Inflation was in the double digits. The Cost of Living Adjustment was invented. I remember my girlfriend bought a car in the early 80's and took an adjustable rate loan on it.
posted by faceonmars at 11:24 PM on September 9, 2007

the brother who drank his wine was able to sell the empty bottles for more money than the prudent brother got for his full bottles.

...the best thing would have been to keep the wine in the cellar - it would probably have kept its value quite well.

In inflation, there would also be an important distributional effect. Inflation tends to hit the poor more than the rich.
posted by TrashyRambo at 4:29 AM on September 10, 2007

Here's a recent article from bankrate.com about the effect of inflation on you.
posted by ikkyu2 at 11:29 AM on September 10, 2007