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24 – Hyperinflation

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24 - Hyperinflation

 

 

Hyperinflation is a fascinating economic phenomenon that is one area of economics that makes studying entertaining and interesting.  In this article we will take a broad look at what hyperinflation is and finish off with a couple really interesting examples.

 

In this Article:

  •         Hyperinflation Basics
  •         What does Hyperinflation do?
  •         Hyperinflation and Depressions
  •         Hyperinflation and Wars
  •         Hyperinflation in Post-War Germany Example
  •         Hyperinflation in Zimbabwe Example
  •         Hyperinflation Wrap up

 

Hyperinflation Basics

In its most basic form hyperinflation is an extremely rapid or out of control rate of inflation within an economy.

There is no exact percentage rate of increase in inflation that tells us when hyperinflation is happening.  Rather, hyperinflation is a situation where the price increases for goods and services are so out of control that the concept of inflation becomes meaningless.  There is just no way for the nation’s citizens buying power to keep up and afford to buy the essential goods and services that they once could before hyperinflation set in.

Although hyperinflation is considered a rare event, it has occurred more than 50 times in the 20th century in countries such as China, Germany, Russia, Venezuela, Zimbabwe, Hungary, the former Yugoslavia, and Argentina to name a few.

 

What does Hyperinflation do?

If hyperinflation is left unchecked it will cause the prices of goods and services to increase at extreme and unsustainable rates.  To make things worse, hyperinflation causes the local currency to rapidly lose its value against other countries.

At the same time, the nation’s citizen’s experience massively decreasing purchasing power.  When purchasing power falls too quickly it causes poverty to increase really fast for the people who do not have excess financial means.  Basically, the people who are most at risk and live paycheck to paycheck (a huge percentage of people in most developed economies) suffer the most because they can’t buy anything they need to survive.

Hyperinflation tends to cause extreme political instability.  In fact, it could have been the political instability that caused the hyperinflation to happen in the first place.

Money will tend to flow out of any country that is showing signs of hyperinflation as wealthy people and businesses flee and attempt to preserve their wealth any way that they can.  This mass exodus of money out of the country only contributes to further devalue the local currency.

 

Hyperinflation and Depressions

When associated with depressions, hyperinflation often occurs when there is a significant increase in the money supply that cannot be supported by the natural growth in gross domestic product or GDP.  For example, if GDP is only 2% but the growth of money in the economy is 300% per month then there is just no way that this disparity can go on for long.

300% per month increase in the money supply may seem like a huge percentage but once hyperinflation sets in there is typically no way out and the numbers can get much much larger than that.

This results in a huge imbalance in the amount of supply of money that is simply too much for the demand that the money of the economy naturally has.  There is just way too much supply of money than demand can naturally overcome. And because the value of the money is plunging there are not many things a central bank can do to entice investors back into the economy.  

 

Hyperinflation and Wars

When associated with wars, hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath.  Because of this lack of confidence, sellers demand a higher risk premium to hold onto the local currency.

The central bank will then have to raise interest rates to compensate investors for holding onto their local currency.  Remember that one of the key mandates of any central bank is to maintain a stable currency and sometimes they will have to entice outside investment with higher rates of interest.

However, remember that central banks raise interest rates to slow an economy down.  If they are raising interest rates in an environment where the economy is in horrible shape this really tells us that they are very desperate and that the end of their currency may be near.  Hyperinflation only sets into economies that are in a lot of trouble so raising interest rates only adds more pressures to the nations businesses and citizens.

Within a short period of time, the average price level of goods and services can increase exponentially resulting in hyperinflation.

 

Hyperinflation in Post-War Germany Example

One of the best-known examples of hyperinflation is that of Weimar Germany.  This certainly is not the worst case of hyperinflation but given Germany’s high profile on the world stage it is one worth taking a look at.

In the period following the World War I, Germany suffered severe economic and political shocks, resulting in large part from the terms of the Treaty of Versailles that ended the war.  The treaty required payment of reparations by the Germans through the Bank for International Settlements (BIS for short) for the damage caused by the war to the victorious countries.

For all you history buffs out there, check out this video and article on History.com.  It’s pretty fascinating to see how this Treaty of Versailles worked and the ultimate outcome of the treaty.  Spoiler alert, this sparks the rise of Hitler and actually caused WWII.

https://www.history.com/topics/world-war-i/treaty-of-versailles

The terms of these reparation payments made it practically impossible for Germany to meet the obligations and the country failed to make the payments to the BIS.

Germany was prohibited from making payments in their own currency and had no choice but to trade it for an acceptable "hard currency" at very unfavorable rates.  This forced Germany to print more and more money to make up the difference. By doing this it caused the interest rates they were paying to go sky high and this in turn caused hyperinflation to quickly set in.

At its height, hyperinflation in Weimar Germany reached rates of more than 30,000% per month, causing prices of essential goods and services to double every few days!!  Can you imagine that? Wow!

You can see from these historic photos depicting Germans burning cash to keep warm and cook food because it was less expensive than using the cash to buy wood or other materials they could burn.

 

Hyperinflation in Zimbabwe Example

A more recent example of hyperinflation happened in Zimbabwe.  From 2007 to 2009, inflation spiraled out of control at an almost unimaginable rate.

Zimbabwe's hyperinflation was a result of terrible political changes that led to the seizure and redistribution of agricultural and farming land.  This doesn’t take into account the murder of untold amounts of people and unprecedented corruption.

One thing that investors hate more than anything is uncertainties and instability in both politics and the local currency.  This caused foreign investors to pack up their capital and head for the safety of other countries.

At the same time, Zimbabwe suffered a one of their worst droughts on record which only added to the economic problems the country was facing.  Zimbabwe's leaders attempted to solve the problems by printing more and more money and the country quickly descended into hyperinflation that at its peak exceeded 79 billion% per month.  Spelled out differently for you…..that is 79,000,000,000% per month!

WTF??  That is absolutely crazy but true!!  Now, Zimbabwe is a fraction of the size of Germany but wow is this ever an example of hyperinflation and its full effects.

You can see how bad hyperinflation got by looking at this 100 trillion dollar bank note which at the time wouldn’t even come close to buying a tank of gas!

 

Hyperinflation Wrap up

As currency traders we need to be acutely aware of any signs that inflation is getting too high or potentially out of control in the currencies that we are trading.

Throughout your career you will see a central bank take decisive action to stop this situation from occurring.  Now, it’s not likely that we will see an example of hyperinflation in the G8 currencies that we will mostly be trading but you never know.  This makes it worth understanding what this all means. And you never know when there may be an opportunity to trade an exotic currency that is experiencing this situation sometime in the future.

Doing a simple Google search will yield many interesting examples of times when excessive inflation threatened to cause problems for certain countries.  But, as you can see from just 2 examples it’s obvious that central banks will work bloody hard at controlling inflation because things can get really bad quickly if inflation is allowed to get out of control.

 

Up Next:

Wow, nothing like having a trillion dollars and still not being able to afford bubble gum!  Up next we will round up our learning of economic cycles by talking about how these cycles keep central banks busy.

 


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