It isn't only gold bugs and fringe theorists who are talking about the possibility of hyperinflation in the United States and other Western countries.
Some of the most respected minds in investment management are doing so, too.
The road to hyperinflation is via hyperdeflation, Hugh Hendry of Eclectica Asset Management said in a recent interview with Barron's.
Hendry, who has about $700 million of assets under management, said that if something were to go wrong with the global economy, governments would be forced to print more money to stave off the threat of deflation, and that would lead to hyperinflation.
His main fear is that China's economy will crash and contract by 5 percent or 10 percent in a year. Hendry believes the bloated public sector in China has created a huge bubble, one that may burst if the Chinese central bank tightens monetary policy. And the bank may have to do that if China continues to struggle with already-high inflation.
In Europe, the debt crisis could end in disaster -- precipitated, for example, by Italy's bond market collapsing or Greece's exiting the euro. Hendry believes that if one of these disaster-catalyst situations, or another, materializes, the Federal Reserve could end up printing trillions of dollars and gold may soar to $5,000 an ounce.
But Hendry predicts economic problems and deflation will happen first, so he has bought credit-default swaps on Japanese companies. Those bets would pay off big if the companies went bankrupt, Barron's noted.
Clearly, they can and do go bust, Hendry said. I'm buying the CDS on investment-grade Japanese corporations because of the overpricing anomaly.
Loss Of Faith In The Pound
Jonathan Ruffer of London-based Ruffer LLP, which manages about $19 billion, has repeatedly warned In recent media appearances about high inflation in the U.K. His reasoning, though, could also be applied to other Western countries.
Ruffer's premise is that the British economy can't generate enough real growth to pay off its enormous debt. The government's only choice, therefore, is to print money. But if does that, Britons may begin to lose faith in their currency, the pound.
And if that happens, people will choose to spend money as it comes in, rather than saving, which will only accelerate inflation, Ruffer told the Yorkshire Post.
When high inflation hit, the U.K. government couldn't raise interest rates because doing so would make its interest-payment burden nearly unbearable.
Ruffer doesn't think modern Britain will suffer the kind of hyperinflation seen in Germany's Weimar Republic of the 1920s. Instead, it will likely endure either a slow-burn, five-year slide in the value of money or a couple of crisis years of extreme and painful inflation, he told Risk.net.
The asset manager recommends investing in inflation-linked bonds, although he acknowledged that they have already become expensive because many people are worried about inflation.
Put Options On Long-Term Treasurys
In mid-2010, Seth Klarman of Baupost Group, which manages about $24 billion, said worries about U.S. government borrowing and money-printing made him fear inflation, the Wall Street Journal reported.
He therefore resorted to buying out-of-the-money put options on long-term U.S. government bonds -- bets that long-term interest rates will eventually rise sharply. Klarman told the Journal in 2010 that he was using the options to buy cheap insurance in case rates go into double digits.
His options will expire, worthless, if long-term interest rates rise to only 6 percent or 7 percent, rack up big gains if rates increase by 10 percent and make 50 or 100 times the initial investment if rates climb above 20 percent, Reuters reported.
Baupost's most recent quarterly filing with the U.S. Securities and Exchange Commission shows holdings in Allied Nevada Gold Corp. (AMEX: ANV) and NovaGold Resources Inc. (AMEX: NG), two gold-mining stocks used as hedges against inflation.