What is Hyperinflation?
A simple internet search images has thousands of examples of what could be shown to be hyperinflation. Usually, the results look to similar to this:
The mind conjures up further images: wheelbarrows of almost worthless cash being used to pay for a single loaf of bread, newly printed notes with almost an uncountable number of zeroes, that then immediately lose their value the next day, or pictures of food shortages and a return of a barter economy where goods are exchanged without the medium of a currency.
The dryer, more academic economist definition states that hyperinflation is: “rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.” (Investopedia)
Why is Hyperinflation so bad for economies?
At a basic level hyperinflation destroys the purchasing power of a currency within a country. In essence, goods become exponentially more expensive as the currency becomes continually, and significantly more devalued. At the economist definition of 50% per year we can look at an example. Bear in mind if wages remain constant, or not inflation linked, the standard of life of the population decreases as each month the monthly salary of a person or household becomes less able to afford goods and services.
In the imagined example below, we can see hyperinflation affecting a monthly budget of USD500 when the price of one loaf of bread rises 50% per month. From going to a very small part of the monthly budget, one single loaf of bread costs 17% of the monthly budget within one year. Now, if one imagines this happening to every single product within an economy it is clear how hyperinflation can destroy economies and also governments.
This is year 1:
|Bread||USD||Salary USD||% of Income|
But are the further consequences of this?
Business Investment Uncertainty
In such an environment business struggle to make hiring plans, investment decisions and procurement decisions. They simply do not know what the currency will be worth in a few months. Not only is the rise of the hyperinflation a problem, but also the volatility. The lack of stability means the currency can no longer be trusted.
Falling Living Standards – Political Fallout
As basic food stuffs and living costs become a significant proportion of household income political issues emerge. There may be protests, violence and anti-government campaigns which cause further uncertainty. Governments may have to print more money to meet these demand further fueling hyperinflation.
Self-fulfilling Demands for Wage Rise
As hyperinflation takes the costs of goods up, it also leads to pressure upwards on wages as employees can afford to buy less. This puts further pressure on businesses on their cost base, already struggling with pricing issues for an uncertain future.
“Real” Negative Interest Rates
As hyperinflation strikes, wealth accumulated loses it purchasing power. This creates a negative wealth affect, with people and firms seeing their savings evaporate in value, leading to less spending, more hoarding and further weakening the economy.
Once a country is in a hyperinflationary environment it takes a huge reputational hit. This is because of a country with hyperinflation usually descends into chaos as per the above reasons. Foreign investment disappears and trade declines. The cost of borrowing on foreign markets increases as investors demand a far higher (and usually prohibitive) premium to take account of the hyperinflation.
Now let’s look at year 2:
|Bread||USD||Salary USD||% of Income|
By the end of the second year one loaf of bread costs over 2000% of the monthly wage. At this point it is very unlikely international markets consider this currency as stable or reliable. Domestically this situation usually leads to revolution, famine, mass emigration or a combination of all three. Gold and other hard assets will usually be sought after.
What causes Hyperinflation?
While “demand” or “excess demand” is sometimes blamed for hyperinflation, the more likely scenario is the government or central bank increasingly the money supply in order to stimulate the economy by increasing the money supply. This money supply increase is also sometimes enacted to pay off debt or to pay for increased spending. If a government or central bank becomes dependent on such policy action then then inflation can easily turn into hyperinflation rather quickly.
There have been many examples of hyperinflation throughout history. In the upcoming lesson Hyperinflation II we will examine these examples. What is clear is however, is that this tendency for governments to expand the money supply goes back millennia. And that is exactly why Gold remains such a popular safe haven.