Inflation is a topic that we talk about and reference frequently (here, and here). You have heard us talk about healthy levels of inflation, and not so healthy levels. If there is modest steady inflation, most people seem to benefit. However, if inflation rises quickly and becomes uncontrollable (hyperinflation), it can do seemly irreparable damage.
This rapid uncontrollable increase in inflation is called hyperinflation. According to Investopedia, Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. Inflation is considered hyperinflation typically when it crosses the 50% per month threshold.
Although many may know what hyperinflation is, most believe that it is next to impossible to experience in a developed economy (for instance Canada). So what are some causes of hyperinflation? What are the effects of it? We also want to present some real-world examples of hyperinflation.
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What Causes Hyperinflation?
There are three widely agreed upon causes of hyperinflation: an increase in money supply, demand-pull inflation, and loss of confidence.
Let’s look at demand-pull inflation first. This occurs when demand outpaces supply. This can happen due to increased consumer spending in a rapidly growing economy, a sudden rise in exports, or more government spending. This is fairly straight forward. This is probably the least likely cause of hyperinflation if we were to see it.
Loss of Confidence
The loss of confidence in the Economy or the monetary system generally occurs in war times. However, this is something we could see. The loss of confidence is generally in the country’s currency or the central bank’s ability to maintain its currency’s value.
Companies selling goods within and outside the country demand a risk premium for accepting the currency by raising the prices. This can result in exponential price increases or hyperinflation.
This loss of confidence can also occur when citizens deem their government to be poorly managed. As confidence begins to dissipate, and the value of the currency with it, people begin to hoard commodities and goods. Prices then begin to rise as basics goods become more scarce. In response, the government is forced to print more money to stabilize prices and provide liquidity. In turn, exacerbating the problem.
Loss of confidence, at this point, is a more likely cause of hyperinflation than demand-pull inflation.
Increasing Money Supply
This is currently more of a concern than the other two potential causes. We talked about the effects of increasing the money supply in Helicopter Money to Increase Short-Term Inflation 2020?
If the increase in money supply is supported by growth in the economy, the effects aren’t as bad. However, when the increase in money supply is not supported by growth in the economy, that is where issues happen.
This imbalance in money supply compared to economic growth will lead to rising inflation. How? Well, if the amount of goods and services available stays constant, but consumers have access to more money, the price of those goods and services will increase.
COVID Relief Spending
The increase in money supply is not a secret. In the past year, it has seemed as though, those in charge of monetary and fiscal policy are touting how much money they have handed out and spent for the sake of COVID relief.
Based on a report by the government of Canada dated Sept 11, 2020, $25,617,000,000 has been spent in protecting health and safety. $214,255,000,000 has been paid in direct support measures. It has cost Canada $85,050,000,000 in tax liquidity support.
According to the 2019 Canada Federal Budget, the total revenue is projected at $338.8 billion. Well, the three figures listed in the preceding paragraph add up to $324.9 billion. That means that nearly 96% of all of Canada’s revenue has been spent on COVID tax liquidity support, direct support, and protecting health and safety.
Oh not to mention the $324.9 billion doesn’t include what they list as other liquidity support and capital relief. We also have to remember that just because your job might have evaporated or you’re just forced to stay home, it still costs money to run the country. Just because COVID is here doesn’t mean the expenses that Canada had previously magically disappear. Much of the COVID relief funds are in addition to what is normally on the federal budget.
If you think that copious amounts of federal debt are fine because the government is the one paying it back, you might be surprised. However, we don’t want to focus on debt, we want to focus on inflation, specifically hyperinflation.
Effects of Hyperinflation
Other than the obvious, prices increasing rapidly in a short amount of time, what effect does hyperinflation have?
First, hyperinflation can cause shortages in necessities. Everyone knows that tomorrow the necessity will cost significantly more than today, so people start hoarding goods. It starts with bigger items, but as hyperinflation persists, people start stockpiling perishable goods.
Second, people lose their stored up life savings as cash becomes worthless. The $10,000 you have saved will be worth much less in a month let alone 6 months. People will cash in their savings and spend it, so at least the money will be able to buy something today. Furthermore, if wages don’t keep pace with inflation, people will soon not be able to afford anything. This also puts the elderly and retired at risk because they do not have an active income.
Third, we talked about people withdrawing their savings, and this means that financial institutions could be in trouble. People pulling out their savings all at once can be quite detrimental to institutions structured on a fractional reserve banking system. In addition, what income people are generating, they won’t be saving because by tomorrow they will have lost significant purchasing power.
Fourth, the country’s ability to import goods deteriorates. As the value of the country’s currency plummets, buying goods from other countries becomes unbearably expensive. The exporting country will charge a risk premium because the payment received is in a hyperinflating currency from the importing country.
As import trade declines, more businesses are forced to close. With businesses closing, unemployment rises. This means that government tax revenues will also fall. As tax revenues fall, it becomes difficult for the government to provide basic services. Thus, governments print more money to pay the bills, in turn heightening the hyperinflation.
Who Benefits from Hyperinflation
There are only two benefactors of hyperinflation. The first is those who took out loans. As the dollar value falls so does the value of the debt. Essentially hyperinflation makes the debt worth less and less until it is virtually wiped out.
Secondly, exportation business stand to benefit. As their country’s currency devalues, it makes it cheaper for other countries to buy their products. In exchange, the exporter will receive the foreign currency of the importing company. The value of this foreign currency will continue to rise as the exporter’s domestic currency continues to devalue.
Examples of Hyperinflation
One of the most well-known examples specifically in the western world is the Weimar Republic in Germany. Through WWI, the number of German Marks in circulation increased fourfold. By the end of 1923, it had increased by billions of times.
By November of 1923, the German Reichsbank issued 92.8 Quintillion paper marks. The exchange went from 4 marks to 1 dollar down to 1 trillion marks to 1 dollar.
At first, the stimulus bolstered economic growth. However, not long after, the war ended the Germans were saddled with 132 billion marks in war reparations.
This caused production to collapse, leading to a shortage of goods, especially food. Due to how much money was in circulation the price of everyday goods doubled every 3.7 days. The inflation rate was 20.9% per day… PER DAY!
Venezuela is the most recent example of hyperinflation. Back in 2013 prices rose by 41%. Only five years later in 2018, prices rose by a staggering 65,000%. In 2017, the government increased its money supply by 14%. Now, Venezuela is promoting the “petro” cryptocurrency because they cannot even afford the cost of printing more money.
It got to a point where people were using eggs as a currency. One carton of eggs was worth 250,000 Bolivars, where, in 2017 it was worth 6,740.
This all occurred because price controls for food and medicine were implemented by former President Chavez. These prices were so low that it pushed domestic companies out of business. Thus, the government had to import everything. But in 2014 when oil prices crashed, it destroyed the revenues generated by the government-owned oil companies. The only option they were left with was printing money.
This is still something Venezuela is dealing with today. In early 2020, their annual inflation rate is still 15,000%. They also have a foreign debt of $100 billion, with seemingly no way to pay it back.
Between 2004-2009 Zimbabwe had hyperinflation worse than Germany. It started because the Government was printing money to pay for the war in the Congo. It was intensified due to droughts and farm confiscation which restricted food supply.
The inflation got so bad that it was 98% a day. Prices were doubling every 24 hours. It only ended when the country changed its main trade currency to the US dollar.
With the way governments are printing and spending money in response to Covid, and also locking down the economy, hyperinflation could become a possibility. We may not see hyperinflation in our lifetimes, but the stage is being set for a perfect storm. If governments continue to operate with seemingly reckless fiscal abandon, Canadians stand to lose a lot. The effects of hyperinflation can be felt for years after a currency has been stabilized. It seems we are currently living in a time when foresight is not admirable, and where we are just trying to survive for tomorrow. A place where we want to make necessary choices but not be subject to those eventual consequences. The choice to print and spend money with reckless abandon could have many adverse consequences for decades to come.
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