Hyperinflation
In economics, hyperinflation is inflation which is "out of control", a condition in which prices increase rapidly as a currency loses its value. No precise definition of hyperinflation is universally accepted. One simplistic definition requires a monthly inflation rate of 50% or more. The definition used by most economists is "an inflationary cycle without any tendency toward equilibrium." A vicious circle is created in which more and more inflation is created with each iteration of the cycle. Although many factors can lead to hyperinflation, the direct cause is typically seen as an unchecked increase in the money supply.
Rates of inflation of several hundred percent per month are often seen. Extreme examples include Germany in the early 1920s when the rate of inflation hit 3.25 million percent per month; Greece in the mid-1940s with 8.55 billion percent per month; and Hungary during the same approximate time period at 4.19 quintillion percent per month. Other more moderate examples include Eastern European countries such as Ukraine in the period of economic transition in the early 1990s, in Latin American countries such as Bolivia and Peru in 1985 and 1988-1990, and in Brazil in the early 1990s.
In contrast to popular belief, hyperinflation did not directly lead to the Nazi takeover of Germany, as hyperinflation had ended several years before the Nazi rise to power. Some historians, however, argue that hyperinflation was an indirect cause in that it eliminated public trust in democratic institutions, thus paving the way for the Nazi takeover. If anything, the direct economic cause of the Nazi rise to power was the Great Depression, during which deflation and not hyperinflation was the primary issue.
Hyperinflation is generally associated with paper money because the means to increasing the money supply with paper money is the simplest: add more zeroes to the plates and print. Sometimes the paper of the worthless old currency has been used for printing the new currency on. It also is the most dramatic. The history of paper money is then, replete with episodes of hyperinflation, followed by a return to "hard money". Older economies would revert to gold or silver once inflation rendered a paper currency essentially worthless, or there would be "runs" on authorities issuing bank notes.
Unlike inflation, which some economists feel can be a justifiable policy choice, hyperinflation is always regarded as an evil - it effectively wipes out the purchasing power of savings held as paper assets of the country afflicted with it, distorts the economy in favor of extreme consumption and 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. Hyperinflation is met with drastic remedies, whether shock therapy of slashing government expenditures or altering the currency basis. An example of this later is placing the nation in question under a currency board as Ecuador has now in 2004, which allows the central bank to print only as much money as it has in foreign reserves. Hyperinflation is often the signs of a government in its death throes: as an example, the Kuomintang rule over Mainland China in the 1940's.
The aftermath of hyperinflation is equally complex, as hyperinflation has always been a traumatic experience for the area which suffers it, the next policy regime almost always enacts policies to prevent its recurrance. Often this means making the central bank very aggressive about maintaining price stability as is the case with the German Bundesbank, or the move to some hard basis of currency for example the gold standard or a currency board. Many governments have enacted extremely stiff wage and price controls in the wake of hyperinflation, which is, in effect, a form of forced savings: goods become unavailable, and hence people hoard cash, as was the case in the People's Republic of China under "Great Leap Forward" and "Cultural Revolution".
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2 Models of Hyperinflation 3 Hyperinflation and the currency 4 See also 5 External Links |
For a variety of reasons, governments have occasionally resorted to literally printing money to meet their expenses. In general, hyperinflation is associated with fiat money and/or debasement of currency, increasing the nominal amount of circulating medium. Episodes of hyperinflation produce staggering increases in price -- and bank notes denominated in millions, billions and trillions. The vicious cycle of borrowing to meet all expenses begins, and the monetary authority does not act to contain the cycle and may indeed accommodate it.
The root "fault" is a matter of more dispute. For both economists of the classical school as well as monetaristss, it is always the result of the monetary authority's irresponsibility (or stupidity), "running the printing presses." These critiques are often phrased in highly judgmental tones, as if there were other acceptable policy alternatives. For neo-liberal economists, hyperinflation is considered to be the result of a crisis of confidence, where the monetary base of the country flees, producing widespread fear that individuals will not be able to convert local currency to some more transportable form -- for example gold, or a internationally recognized hard currency such as the US Dollar. See below for more discussion.
Hyperinflation can also occur in the absence of a central monetary authority. For example, when there is debasement of the coinage -- where coins are consistently shaved of some of their silver and gold, increasing the circulating medium and reducing the value of the currency. The "shaved" specie is then often restruck into coins with lower weight of gold or silver. Another case is when there is "free banking" and banks are allowed to print their own notes without strong regulatory authority. These episodes are often brief, as there is then a run on banks, a panic, and a collapse in the money supply leading to a depression and deflation. An example of this is the "South Sea" Bubble under John Law.
One common cause of hyperinflation is warfare or civil war: governments needing to do whatever is necessary to continue fighting, since the alternative is defeat. They cannot cut outlays, because the main outlay is for armaments to fight the war itself. Further, a civil war may make it difficult to raise taxes or to collect the existing taxes. In normal times, a deficit is financed by borrowing, that is selling government bonds. But under conditions of war or civil 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 1939-1945 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.
In the United States, hyperinflation was seen during the Revolutionary War and during the Civil War, especially on the Confederate (losing) side. Many other cases of extreme social conflict encouraging hyperinflation can be seen, as in Germany after World War I and in Yugoslavia after the death of Marshall Tito.
In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of the specie which 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 which may become valueless, they want to spend them in preference to holding notes which will hold value. 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 occured during Napoleanic 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 merely very fast inflation, and has the same cause as all other inflation -- money-issuing bodies, central or otherwise -- produce currency to pay spiralling costs, often from lax fiscal policy, or the mounting costs of warfare. The increase in the money supply means, by supply and demand, that sellers will require more money for their products, because they see that there is more money chasing the same number of goods. The solution is for the central authority to stop printing money, and let the chips fall where they may. This typically corresponds to so-called "shock therapy" of slashing pensions, wages, and government outlays, and formed part of the Washingtion consensus of the 1990's.
Whatever the cause, hyperinflation is a dramatic increase in 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 the increasing the money stock, by which every 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.
That is, rapidly rising prices undermine money's role as a store of value, so that 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 rise endogenously as a result of the excessive increase in the money supply. At the point where ordinary purchases are affected by inflation pressures, hyperinflation is out of control, in the sense that ordinary policy mechanisms, such as increasing reserve requirements, raising interest rates or cutting government spending will all be responded to by shifting away from the rapidly dwindling currency 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] becomes common. Many of the people who hoard gold today expect hyperinflation, and are hedging against it by holding specie. There is, also, extensive capital flight or flight to a "hard" currency such as the U.S. dollar. These are sometimes met with capital controls, an idea which has swung from standard, to anathema, and back into semi-respectability. All of this constitutes an economy which 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 has been selling at a huge loss to quiet popular discontent, and the hyperinflation came to a halt almost immediately, since it could bring in hard currency by selling its oil abroad. The crisis of confidence ended, and people returned deposits to banks. The German hyperinflation of the 1920's 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. Though sometimes used, wage and price controls to control or prevent inflation, no episode of hyperinflation has been ended by the use of price controls alone, though they have sometimes been part of the mix of policies used to halt hyperinflation.
Inflation 1923-24: a woman feeds her tiled stove with money
As noted, 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 some interesting banknotes, including those denominated in amounts of 1,000,000,000 or more.
Some banknotes were stamped to indicate changes of denomination. This is because it would take too long to print new notes. By time the new notes would be printed, they would be obsolete (that is, they would be of too low a denomination to be useful).Root causes of hyperinflation
Models of Hyperinflation
Hyperinflation and the currency
One way to avoid the use of large numbers is by declaring a new unit of currency (so, instead of 10,000,000,000 Dollars, a bank might set 1 New Dollar = 1,000,000,000 old Dollars, so the new note would read "10 New Dollars".) While this does not lessen actual value of a currency, it is called revaluation.