In economics, hyperinflation is very
high and typically accelerating inflation. It quickly erodes the real value of
the local currency, as the prices of all goods increase. This causes people to
minimize their holdings in that currency as they usually switch to more stable
foreign currencies, often the US Dollar. Prices typically remain stable in
terms of other relatively stable currencies.
Unlike low inflation, where the process
of rising prices is protracted and not generally noticeable except by studying
past market prices, hyperinflation sees a rapid and continuing increase in
nominal prices, the nominal cost of goods, and in the supply of money.
Typically, however, the general price level rises even more rapidly than the
money supply as people try ridding themselves of the devaluing currency as
quickly as possible. As this happens, the real stock of money (i.e., the amount
of circulating money divided by the price level) decreases considerably.
Hyperinflation is often associated with some stress to the
government budget, such as wars or their aftermath, sociopolitical upheavals, a
collapse in aggregate supply or one in export prices, or other crises that make
it difficult for the government to collect tax revenue. A sharp decrease
in real tax revenue coupled with a strong need to maintain government spending,
together with an inability or unwillingness to borrow, can lead a country into
hyperinflation.
Causes
While there can be a number of causes of
high inflation, most hyperinflations have been caused by government budget
deficits financed by money creation. Peter Bernholz analysed 29 hyperinflations
(following Cagan's definition) and concludes that at least 25 of them have been
caused in this way. A necessary condition for hyperinflation is the use of
paper money, instead of gold or silver coins. Most hyperinflations in history,
with some exceptions, such as the French hyperinflation of 1789-1796, occurred after
the use of fiat currency became widespread in the late 19th century. The French
hyperinflation took place after the introduction of a non-convertible paper
currency, the assignats.
Money
supply
Hyperinflation occurs when there is a
continuing (and often accelerating) rapid increase in the amount of money that
is not supported by a corresponding growth in the output of goods and services.
The increases in price that result from
the rapid money creation creates a vicious circle, requiring ever growing
amounts of new money creation to fund government deficits. Hence both monetary
inflation and price inflation proceed at a rapid pace. Such rapidly increasing
prices cause widespread unwillingness of the local population to hold the local
currency as it rapidly loses its buying power. Instead they quickly spend any
money they receive, which increases the velocity of money flow; this in turn
causes further acceleration in prices. This means that the increase in the
price level is greater than that of the money supply. The real stock of money,
M/P, decreases. Here M refers to the money stock and P to the price level.
This results in an imbalance between the
supply and demand for the money (including currency and bank deposits), causing
rapid inflation. Very high inflation rates can result in a loss of confidence
in the currency, similar to a bank run. Usually, the excessive money supply
growth results from the government being either unable or unwilling to fully
finance the government budget through taxation or borrowing, and instead it
finances the government budget deficit through the printing of money.
Governments have sometimes resorted to
excessively loose monetary policy, as it allows a government to devalue its
debts and reduce (or avoid) a tax increase. Monetary inflation is effectively a
flat tax on creditors that also redistributes proportionally to private
debtors. Distributional effects of monetary inflation are complex and vary
based on the situation, with some models finding regressive effects but other
empirical studies progressive effects. As a form of tax, it is less overt than
levied taxes and is therefore harder to understand by ordinary citizens.
Inflation can obscure quantitative assessments of the true cost of living, as
published price indices only look at data in retrospect, so may increase only
months later. Monetary inflation can become hyperinflation if monetary
authorities fail to fund increasing government expenses from taxes, government
debt, cost cutting, or by other means, because either
during
the time between recording or levying taxable transactions and collecting the
taxes due, the value of the taxes collected falls in real value to a small
fraction of the original taxes receivable; or
· government
debt issues fail to find buyers except at very deep discounts; or
· a
combination of the above.
Theories of hyperinflation generally
look for a relationship between seigniorage and the inflation tax. In both
Cagan's model and the neo-classical models, a tipping point occurs when the
increase in money supply or the drop in the monetary base makes it impossible
for a government to improve its financial position. Thus when fiat money is
printed, government obligations that are not denominated in money increase in
cost by more than the value of the money created.
From this, it might be wondered why any
rational government would engage in actions that cause or continue hyperinflation.
One reason for such actions is that often the alternative to hyperinflation is
either depression or military defeat. The root cause is a matter of more
dispute. In both classical economics and monetarism, it is always the result of
the monetary authority irresponsibly borrowing money to pay all its expenses.
These models focus on the unrestrained seigniorage of the monetary authority,
and the gains from the inflation tax.
In neo-classical economic theory,
hyperinflation is rooted in a deterioration of the monetary base, that is the
confidence that there is a store of value that the currency will be able to
command later. In this model, the perceived risk of holding currency rises
dramatically, and sellers demand increasingly high premiums to accept the
currency. This in turn leads to a greater fear that the currency will collapse,
causing even higher premiums. One example of this is during periods of warfare,
civil war, or intense internal conflict of other kinds: governments need to do
whatever is necessary to continue fighting, since the alternative is defeat.
Expenses cannot be cut significantly since the main outlay is armaments.
Further, a civil war may make it difficult to raise taxes or to collect
existing taxes. While in peacetime the deficit is financed by selling bonds,
during a war it is typically difficult and expensive to borrow, especially if
the war is going poorly for the government in question. The banking
authorities, whether central or not, "monetize" the deficit, printing
money to pay for the government's efforts to survive. The hyperinflation under
the Chinese Nationalists from 1939 to 1945 is a classic example of a government
printing money to pay civil war costs. By the end, currency was flown in over
the Himalayas, and then old currency was flown out to be destroyed.
Hyperinflation is a complex phenomenon
and one explanation may not be applicable to all cases. In both of these
models, however, whether loss of confidence comes first, or central bank
seigniorage, the other phase is ignited. In the case of rapid expansion of the
money supply, prices rise rapidly in response to the increased supply of money
relative to the supply of goods and services, and in the case of loss of
confidence, the monetary authority responds to the risk premiums it has to pay
by "running the printing presses."
Nevertheless, the immense acceleration
process that occurs during hyperinflation (such as during the German
hyperinflation of 1922/23) still remains unclear and unpredictable. The
transformation of an inflationary development into the hyperinflation has to be
identified as a very complex phenomenon, which could be a further advanced
research avenue of the complexity economics in conjunction with research areas
like mass hysteria, bandwagon effect, social brain, and mirror neurons.
Supply
Shocks
A number of hyperinflations were caused
by some sort of extreme negative supply shock, often but not always associated
with wars, the breakdown of the communist system or natural disasters.
Models
Since hyperinflation is visible as a
monetary effect, models of hyperinflation center on the demand for money.
Economists see both a rapid increase in the money supply and an increase in the
velocity of money if the (monetary) inflating is not stopped. Either one, or
both of these together are the root causes of inflation and hyperinflation. A
dramatic increase in the velocity of money as the cause of hyperinflation is
central to the "crisis of confidence" model of hyperinflation, where
the risk premium that sellers demand for the paper currency over the nominal
value grows rapidly. The second theory is that there is first a radical
increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation. In either model, the second
effect then follows from the first—either too little confidence forcing an
increase in the money supply, or too much money destroying confidence.
In the confidence model, some event, or
series of events, such as defeats in battle, or a run on stocks of the specie
that back a currency, removes the belief that the authority issuing the money
will remain solvent—whether a bank or a government. Because people do not want
to hold notes that may become valueless, they want to spend them. Sellers,
realizing that there is a higher risk for the currency, demand a greater and
greater premium over the original value. Under this model, the method of ending
hyperinflation is to change the backing of the currency, often by issuing a
completely new one. War is one commonly cited cause of crisis of confidence,
particularly losing in a war, as occurred during Napoleonic Vienna, and capital
flight, sometimes because of "contagion" is another. In this view,
the increase in the circulating medium is the result of the government
attempting to buy time without coming to terms with the root cause of the lack
of confidence itself.
In the monetary model, hyperinflation is
a positive feedback cycle of rapid monetary expansion. It has the same cause as
all other inflation: money-issuing bodies, central or otherwise, produce
currency to pay spiraling costs, often from lax fiscal policy, or the mounting
costs of warfare. When business people perceive that the issuer is committed to
a policy of rapid currency expansion, they mark up prices to cover the expected
decay in the currency's value. The issuer must then accelerate its expansion to
cover these prices, which pushes the currency value down even faster than
before. According to this model the issuer cannot "win" and the only
solution is to abruptly stop expanding the currency. Unfortunately, the end of
expansion can cause a severe financial shock to those using the currency as
expectations are suddenly adjusted. This policy, combined with reductions of pensions,
wages, and government outlays, formed part of the Washington consensus of the
1990s.
Whatever the cause, hyperinflation
involves both the supply and velocity of money. Which comes first is a matter
of debate, and there may be no universal story that applies to all cases. But
once the hyperinflation is established, the pattern of increasing the money
stock, by whichever agencies are allowed to do so, is universal. Because this
practice increases the supply of currency without any matching increase in demand
for it, the price of the currency, that is the exchange rate, naturally falls
relative to other currencies. Inflation becomes hyperinflation when the
increase in money supply turns specific areas of pricing power into a general
frenzy of spending quickly before money becomes worthless. The purchasing power
of the currency drops so rapidly that holding cash for even a day is an
unacceptable loss of purchasing power. As a result, no one holds currency,
which increases the velocity of money, and worsens the crisis.
Because rapidly rising prices undermine
the role of money as a store of value, people try to spend it on real goods or
services as quickly as possible. Thus, the monetary model predicts that the
velocity of money will increase as a result of an excessive increase in the
money supply. At the point when money velocity and prices rapidly accelerate in
a vicious circle, hyperinflation is out of control, because ordinary policy
mechanisms, such as increasing reserve requirements, raising interest rates, or
cutting government spending will be ineffective and be responded to by shifting
away from the rapidly devalued money and towards other means of exchange.
During a period of hyperinflation, bank
runs, loans for 24-hour periods, switching to alternate currencies, the return
to use of gold or silver or even barter become common. Many of the people who
hoard gold today expect hyperinflation, and are hedging against it by holding
specie. There may also be extensive capital flight or flight to a "hard"
currency such as the US dollar. This is sometimes met with capital controls, an
idea that has swung from standard, to anathema, and back into
semi-respectability. All of this constitutes an economy that is operating in an
"abnormal" way, which may lead to decreases in real production. If
so, that intensifies the hyperinflation, since it means that the amount of
goods in "too much money chasing too few goods" formulation is also
reduced. This is also part of the vicious circle of hyperinflation.
Once the vicious circle of
hyperinflation has been ignited, dramatic policy means are almost always
required. Simply raising interest rates is insufficient. Bolivia, for example,
underwent a period of hyperinflation in 1985, where prices increased 12,000% in
the space of less than a year. The government raised the price of gasoline,
which it had been selling at a huge loss to quiet popular discontent, and the
hyperinflation came to a halt almost immediately, since it was able to bring in
hard currency by selling its oil abroad. The crisis of confidence ended, and
people returned deposits to banks. The German hyperinflation (1919–November
1923) was ended by producing a currency based on assets loaned against by
banks, called the Rentenmark. Hyperinflation often ends when a civil conflict
ends with one side winning.
Although wage and price controls are
sometimes used to control or prevent inflation, no episode of hyperinflation
has been ended by the use of price controls alone, because price controls that
force merchants to sell at prices far below their restocking costs result in
shortages that cause prices to rise still further.
Nobel prize winner Milton Friedman said
"We economists don't know much, but we do know how to create a shortage.
If you want to create a shortage of tomatoes, for example, just pass a law that
retailers can't sell tomatoes for more than two cents per pound. Instantly
you'll have a tomato shortage. It's the same with oil or gas.”
Effects
Hyperinflation effectively wipes out the
purchasing power of private and public savings; distorts the economy in favor
of the hoarding of real assets; causes the monetary base, whether specie or
hard currency, to flee the country; and makes the afflicted area anathema to investment.
One of the most important
characteristics of hyperinflation is the accelerating substitution of the
inflating money by stable money—gold and silver in former times, then
relatively stable foreign currencies after the breakdown of the gold or silver
standards (Thiers' Law). If inflation is high enough, government regulations
like heavy penalties and fines, often combined with exchange controls, cannot
prevent this currency substitution. As a consequence, the inflating currency is
usually heavily undervalued compared to stable foreign money in terms of
purchasing power parity. So foreigners can live cheaply and buy at low prices
in the countries hit by high inflation. It follows that governments that do not
succeed in engineering a successful currency reform in time must finally
legalize the stable foreign currencies (or, formerly, gold and silver) that
threaten to fully substitute the inflating money. Otherwise, their tax
revenues, including the inflation tax, will approach zero. The last episode of
hyperinflation in which this process could be observed was in Zimbabwe in the
first decade of the 21st century. In this case, the local money was mainly
driven out by the US dollar and the South African rand.
Enactment of price controls to prevent
discounting the value of paper money relative to gold, silver, hard currency,
or other commodities fail to force acceptance of a paper money that lacks
intrinsic value. If the entity responsible for printing a currency promotes
excessive money printing, with other factors contributing a reinforcing effect,
hyperinflation usually continues. Hyperinflation is generally associated with
paper money, which can easily be used to increase the money supply: add more
zeros to the plates and print, or even stamp old notes with new numbers.
Historically, there have been numerous episodes of hyperinflation in various
countries followed by a return to "hard money". Older economies would
revert to hard currency and barter when the circulating medium became
excessively devalued, generally following a "run" on the store of
value.
Much attention on hyperinflation centers
on the effect on savers whose investments become worthless. Interest rate
changes often cannot keep up with hyperinflation or even high inflation,
certainly with contractually fixed interest rates. For example, in the 1970s in
the United Kingdom inflation reached 25% per annum, yet interest rates did not
rise above 15%—and then only briefly—and many fixed interest rate loans
existed. Contractually, there is often no bar to a debtor clearing his long
term debt with "hyperinflated cash", nor could a lender simply
somehow suspend the loan. Contractual "early redemption penalties"
were (and still are) often based on a penalty of n months of interest/payment;
again no real bar to paying off what had been a large loan. In interwar
Germany, for example, much private and corporate debt was effectively wiped
out—certainly for those holding fixed interest rate loans.
Ludwig von Mises used the term
"crack-up boom" (German: Katastrophenhausse) to describe the economic
consequences of an unmitigated increasing in the base-money supply. As more and
more money is provided, interest rates decline towards zero. Realizing that
fiat money is losing value, investors will try to place money in assets such as
real estate, stocks, even art; as these appear to represent "real"
value. Asset prices are thus becoming inflated. This potentially spiraling
process will ultimately lead to the collapse of the monetary system. The
Cantillon effect says that those institutions that receive the new money first
are the beneficiaries of the policy.
Aftermath
Hyperinflation is ended by drastic
remedies, such as imposing the shock therapy of slashing government
expenditures or altering the currency basis. One form this may take is
dollarization, the use of a foreign currency (not necessarily the U.S. dollar)
as a national unit of currency. An example was dollarization in Ecuador,
initiated in September 2000 in response to a 75% loss of value of the
Ecuadorian sucre in early 2000. But usually the "dollarization" takes
place in spite of all efforts of the government to prevent it by exchange
controls, heavy fines and penalties. The government has thus to try to engineer
a successful currency reform stabilizing the value of the money. If it does not
succeed with this reform the substitution of the inflating by stable money goes
on. Thus it is not surprising that there have been at least seven historical
cases in which the good (foreign) money did fully drive out the use of the
inflating currency. In the end the government had to legalize the former, for
otherwise its revenues would have fallen to zero.
Hyperinflation has always been a
traumatic experience for the people who suffer it, and the next political
regime almost always enacts policies to try to prevent its recurrence. Often
this means making the central bank very aggressive about maintaining price
stability, as was the case with the German Bundesbank, or moving to some hard
basis of currency, such as a currency board. Many governments have enacted
extremely stiff wage and price controls in the wake of hyperinflation, but this
does not prevent further inflation of the money supply by the central bank, and
always leads to widespread shortages of consumer goods if the controls are
rigidly enforced.
Currency
In countries experiencing
hyperinflation, the central bank often prints money in larger and larger
denominations as the smaller denomination notes become worthless. This can
result in the production of unusually large demoninations of banknotes,
including those denominated in amounts of 1,000,000,000 or more.
By late 1923, the Weimar Republic of
Germany was issuing two-trillion mark banknotes and postage stamps with a face
value of fifty billion marks. The highest value banknote issued by the Weimar
government's Reichsbank had a face value of 100 trillion marks (1014;
100,000,000,000,000; 100 million million). At the height of the inflation, one
US dollar was worth 4 trillion German marks. One of the firms printing these
notes submitted an invoice for the work to the Reichsbank for
32,776,899,763,734,490,417.05 (3.28 × 1019, or 33 quintillion) marks.
The largest denomination banknote ever
officially issued for circulation was in 1946 by the Hungarian National Bank
for the amount of 100 quintillion pengő (100,000,000,000,000,000,000, or 1020;
100 million million million) image. (A banknote worth 10 times as much, 1021 (1
sextillion) pengő, was printed but not issued image.) The banknotes did not
show the numbers in full: "hundred million b.-pengő" ("hundred
million trillion pengő") and "one milliard b.-pengő" were
spelled out instead. This makes the 100,000,000,000,000 Zimbabwean dollar
banknotes the note with the greatest number of zeros shown.
The Post-World War II hyperinflation of
Hungary held the record for the most extreme monthly inflation rate ever –
41,900,000,000,000,000% (4.19 × 1016% or 41.9 quadrillion percent) for July
1946, amounting to prices doubling every 15.3 hours. By comparison, recent
figures (as of 14 November 2008) estimate Zimbabwe's annual inflation rate at
89.7 sextillion (1021) percent. The highest monthly inflation rate of that
period was 79.6 billion percent, and a doubling time of 24.7 hours. In figures,
that is 79,600,000,000%.
One way to avoid the use of large
numbers is by declaring a new unit of currency. (As an example, instead of
10,000,000,000 dollars, a central bank might set 1 new dollar = 1,000,000,000
old dollars, so the new note would read "10 new dollars".) A recent
example of this is Turkey's revaluation of the Lira on 1 January 2005, when the
old Turkish lira (TRL) was converted to the New Turkish lira (TRY) at a rate of
1,000,000 old to 1 new Turkish Lira. While this does not lessen the actual
value of a currency, it is called redenomination or revaluation and also
occasionally happens in countries with lower inflation rates. During
hyperinflation, currency inflation happens so quickly that bills reach large
numbers before revaluation.
Some banknotes were stamped to indicate
changes of denomination, as it would have taken too long to print new notes. By
the time new notes were printed, they would be obsolete (that is, they would be
of too low a denomination to be useful).
Metallic coins were rapid casualties of
hyperinflation, as the scrap value of metal enormously exceeded its face value.
Massive amounts of coinage were melted down, usually illicitly, and exported
for hard currency.
Governments will often try to disguise
the true rate of inflation through a variety of techniques. None of these
actions addresses the root causes of inflation; and if discovered, they tend to
further undermine trust in the currency, causing further increases in
inflation. Price controls will generally result in shortages and hoarding and
extremely high demand for the controlled goods, causing disruptions of supply
chains. Products available to consumers may diminish or disappear as businesses
no longer find it economic to continue producing and/or distributing such goods
at the legal prices, further exacerbating the shortages.
There are also issues with computerized
money-handling systems. In Zimbabwe, during the hyperinflation of the Zimbabwe
dollar, many automated teller machines and payment card machines struggled with
arithmetic overflow errors as customers required many billions and trillions of
dollars at one time.
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