Inflation and Democracy: Warnings From History


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According to macro analyst Octavio Costa, the United States (and, for that matter, most of the world) are facing three macro extremes simultaneously: The debt problem of the post-World War II era of the 1940s; the highly inflationary environment of the 1970s; and Bubble equity valuations, as in the 1990s, before the dotcom bubble.

Each of these problems would be formidable in isolation. That we are facing them simultaneously significantly limits the room for maneuver for central bankers and economic planners.

Ray Dalio, a macro investor and founder of a leading U.S. hedge fund Bridgewater Associates, believes we are in the final phases of an 80-year economic down cycle, the aforementioned trifecta being fairly typical symptoms. The stresses induced by these difficulties lead to polarization and civil strife. He believes there is a 30% chance of a civil war type event in the United States over the next five years as the down cycle reaches new lows. 

In a recent interview, Charlie Munger, a close associate of investor Warren Buffet stated that inflation is the graveyard of democracies, contributing to the collapse of multiple countries and civilizations, from the Roman Empire to the Weimar Republic. Inflation eats away at savings, reduces purchasing power, leading to dissatisfaction and civil strife.

Munger’s scenario is that the U.S. dollar will inflate to become effectively worthless within 100 years, which may threaten the very foundations of democracy in the States and elsewhere.

My own view is that given the current macro situation, the dilution of the U.S. dollar may be much faster.

Increased Sensitivity

The currency has effectively lost 97% of its value since “temporarily” coming off the gold standard in 1971. The U.S. Fed is already widely regarded as responding late to the threat of inflation, perhaps even losing control of the situation, yet is prevented from raising interest rates dramatically because of uncertainties surrounding Ukraine, COVID, and global debt levels (at 360% of Global GDP), that increases sensitivity to interest rate hikes.

Labor markets are tight, and inflation is becoming embedded in expectations, meaning that it will be stubborn to combat, possibly even with a tendency to accelerate. Given the background, what are the options for the Fed? And what are the options for investors?

The Fed has no good options. The trifecta, caused by years of poor fiscal and monetary governance, has diminished room for maneuver. If the Fed were to apply the monetary brakes (in other words, dramatically raise interest rates) in a fragile and decelerating economy, with record debt levels and global uncertainties, a major recession or depression would be the result. Taking inflation back to 2% would require raising interest rates to levels that would completely throttle the economy. 

In today’s circumstances, just preventing an acceleration of inflation would already be a not bad result. The inflation would have a monumental societal cost on retirees and savers in general but perhaps falls short of Weimar inflation levels that destroyed the pre-World War II democracy. Allowing negative real interest rates for five to seven years would have the enormous benefit of allowing the world to inflate away its debt (assuming profligate spending is stopped), as in the late 1940s.

As for investors, I believe gold to be the best hedge. Bitcoin is highly correlated to the Nasdaq, and inversely to the volatility or risk index (VIX); it does not provide the type of counter-cyclical hedge offered by gold. 

Follow the Gold

It is not an accident that central banks the world over hold vast amounts of gold. The Deutsche Bundesbank, the German central bank, has recently stated that it would not rule out the revaluation of gold to deal with high debt levels.

Other than gold, resource and mining shares also provide a hedge. Global resource companies (excluding energy) represent a mere 2.5% of the worldwide value of all publicly listed equities. As the world wakes up to the threat of inflation and seeks refuge in tangibles, there will be a rotation into commodities and mining shares. In my opinion, this process has barely begun.

There is an increasing sense that, as we reach the bottom of this 80-year cycle, there will be increasing turbulence that will result in an economic reset. The head of the IMF has warned of such.

It is too early to predict what will happen in the reset, but it could involve the U.S. dollar losing its currency reserve status, changes in the Bretton Wood organizations (the International Monetary Fund, the World Bank, and so on) and a more pivotal role for gold, as fiat currencies strive to regain credibility. Above all, moving into the first more positive phase of the next debt cycle will require excellence in leadership. 

Disclaimer: This article is for educational purposes only. It should not be construed as investment advice. Investors should perform their own due diligence and consult their financial advisors.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (, a Central European corporate finance firm. He is a former World Banker, author of Business Exit Planning (, and a previous president of the American Chamber of Commerce in Hungary.

This article was first published in the Budapest Business Journal print issue of February 25, 2022.

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