Steve Bain

What is Hyperinflation in Economics?

While there is no formal definition of Hyperinflation, it is characterized by a situation where the general level of prices in a country is rising so fast that its national currency is in danger of collapsing altogether.

The popular agreement on this at the current time is that a monthly inflation rate of 50% or more, as measured by the consumer price index (CPI), is the rate at which a very high inflation rate starts to be classed as hyperinflation. Note that this is 50% per month, which translates to an annual inflation rate of around 13,000% or so!

As insane as that sounds, there are plenty of examples from history of inflation rates way higher than this, with the most well known case occurring in Weimar Germany in 1923. The peak inflation rate at that time hit just under 30,000% in a single month, which meant that prices were rising by over 20% every single day!

As you can imagine, during a period of hyperinflation, anyone with savings or earnings that are not index-linked will quickly find that their money becomes worthless.

For some people, usually those who are politically connected, it creates perverse opportunities to enrich themselves at the expense of everyone else. To profit from this, the borrowers need a kind of 'inside information' i.e., they need to know that the government is about to print money and cause higher price inflation in future.

Typically, those 'in the know' arrange huge loans for themselves ahead of the inflation rate increase, all at a fixed interest rate. The borrowed money is then used to purchase something that will not be eroded by future inflation e.g., farmland, gold, foreign assets etc. The point is that, once inflation goes higher, the loan repayments will be eroded away to almost nothing.

In the opposite direction, those without any 'connected' friends i.e., the poor and middle-classes, are always hurt the most. Their savings and pensions get destroyed while their costs of living explode higher. Mass starvation is not uncommon during a hyperinflation, lawlessness is everywhere, and an unimaginable level of human suffering is guaranteed.

In hyperinflation, a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano. A prostitute in the family was better than an infant corpse; theft was preferable to starvation; warmth was finer than honour, clothing more essential than democracy, food more needed than freedom.

Adam Fergusson, 'When Money Dies'

This is somber stuff, but given the behavior of our governments and central bankers in recent decades we all need to be aware of the threat that is posed. The amount of money-printing that has occurred since 2008 is truly eye-watering, and what's worse is that our political elites seem blind to the dangers that it poses.

Speaking on an Irish talk show on October 28th 2022, Christine Lagarde (President of the European Central Bank) said that "inflation has come out of practically nothing", before going on to blame it all on Vladimir Putin and his invasion of Ukraine...

seemingly oblivious to the fact that inflation was already soaring well before the invasion began!

The real reason why inflation has soared higher is because our economies were forced into lockdown for a year, while our salaries were printed, meaning that more monetary units ended up chasing a declining supply of goods and services. Add to that the cost of production implications of sanctioning cheap Russian oil, the costs of funding the Ukraine War, and the global supply-chain squeeze following the lockdowns, and you quickly arrive at a situation where prices were bound to explode higher.

What Causes Hyperinflation?

The development of hyperinflation from a state of high inflation always stems from an uncontrolled increase in deficit spending, with money printing used to finance it.

For more details on what causes inflation in the first place, have a look at my article about What Causes Inflation, in this article I assume that a high state of inflation already exists.

An understanding of the development of stages leading up to hyperinflation is also useful, and for that you can see the following articles:

Budget deficits are difficult for weak governments to control, because spending cuts are usually unpopular with voters. It is all too easy for such governments to spend more money than they collect in tax receipts, and that leads to debt problems.

When inflation arises, it can add problems because governments collect taxes for the previous year. By the time it receives those taxes, inflation has eroded its purchasing power, meaning that the taxes collected are even more insufficient to fund the spending program.

The end result is always the same, the national debt grows until it becomes unmanageable. Once the point is reached whereby a country cannot service its debts without borrowing yet more money to do it, it becomes extremely vulnerable to international money flows.

Capital flight occurs when investors start to bail out of positions in the currency, and instead favor foreign assets. Interest rates will need to rise to attract new investors and deter capital from flowing out of the country. The problem there is that the existing debts are already unmanageable, and higher interest rates will only make them more so.

Capital controls may be resorted to, which make it illegal to move large amounts of money out of the country, but this will cause further loss of confidence in the currency. The exchange rate will likely plummet, meaning that the cost of imports will soar, thereby driving inflation even higher.

Unable to borrow sufficient funds to service its debts and cover its budget deficit, the government will likely issue yet more bonds (debt) and instruct its central bank to print the money needed to purchase those bonds. At this point a cycle of ever more printing is created until hyperinflation results, i.e. ever more monetary units chasing fewer and fewer goods as the economy collapses.

As the currency collapses, people start looking for alternatives like foreign currency (typically the US dollar), or they may resort to barter trades.

Anything can happen in these circumstances. At best the government will take the necessary action to stop the inflation (see next section), but it is perfectly possible that a civil war will break out, or some sort of revolution with the violent overthrow of the government. Dictators can replace elected politicians in these circumstances, and all manner of chaos and suffering can result.

How to Stop Hyperinflation

Firstly, it is important to realize that the way to stop hyperinflation might be completely different to how we might seek to stop inflation. This is not necessarily the case, and it is possible to defeat hyperinflation with tough action. The difference is that a deep and long lasting recession would be unavoidable, and for this reason it may be rejected by the people.

I've written a separate article about defeating mild to moderate inflation, and you can read that via the link:

Saving the Currency

Any hope of rescuing a currency once it deteriorates into hyperinflation will rely on sticking to a severely restricted amount of government spending, a reduction sufficient to balance the nation's books and eliminate the budget deficit.

This will mean making some tough decisions e.g. massively reducing welfare payments at a time of deep recession, or abandoning the state pension, or deep cutbacks to healthcare & education.

Typically the country will also default on its external debt obligations, making further borrowing impossible. If the government is prepared to enact these sorts of policies, then it may be able to bring inflation under control.

However, such policies will need the support of the people, without that support there may be an overthrow of the government and a resumption of inflationary policies.

Creating a New Currency

Once a state of hyperinflation exists, the existing currency may already be destroyed with no hope of being salvaged. The solution then would be to adopt a new currency and to do so in a way that prevents any repeat of past mistakes. To be credible, the monetary authorities need to be constrained so that they cannot print the new currency.

Typically, a country that adopts a new currency would peg that currency to the US dollar. The International Monetary Fund (IMF) would be called in and a loan arranged that would provide enough dollars to back up the new currency.

The loan may be contingent on giving management of the new currency to an outside agency that cannot be pressured by the profligate government into printing money. In addition, the IMF usually requires adoption of all manner of economic reforms.

In so doing, excess money-printing is impossible, a program of austerity is adopted, markets are opened up, government controls are removed, and the seeds of recovery are planted.

This sort of approach is immediately effective in stopping hyperinflation, but economic recovery will be slow and difficult. The damage caused by hyperinflation is permanent, and any country that survives it has a difficult road to recovery that will last for many years.

US Dollar Hyperinflation?

The question arises, given that the US dollar is the world's reserve currency and is the currency that other currencies are pegged to when seeking assistance from the IMF, about what would happen if the US dollar itself were to come under the threat of hyperinflation. A few years ago this might have seemed unthinkable, but all the major Western countries are now so severely indebted that the threat is real.

If the US dollar were to experience hyperinflation, a new international monetary system would be required. Without an obvious successor to the dollar in the form of an alternative currency, it is likely that some sort of commodity would be adopted as backing for international trade. Gold has served this purpose before, and would be a strong contender to do so again in such circumstances.

The consequences for the US would, of course, be dire. The loss of the reserve currency status would mean a huge loss of demand for dollars on international markets. As a result the exchange rate would deteriorate thereby making imported goods more expensive. Us influence across the globe would be lost, and all sorts of political consequences would manifest themselves.

In mid 2023 the likelihood of hyperinflation in the US might still seem remote, but all the hallmarks are present. Deficit spending is continuing at an unprecedented level, the national debt is far higher than at any other time in modern history, and the Federal Reserve is unable to raise interest rates above the rate of inflation without causing a financial crisis in the banking system.

Without a highly unlikely major technological advancement that could raise productivity levels sufficient to boost GDP high enough that paying down the debt is plausible, something is going to break. When it does it will require a deep recession and massive spending cutbacks to fix the economy.

A weak government that is fearful of losing its popularity with the voters might easily cower away from the necessary spending cutbacks, and in that case the US would be on the inevitable path to hyperinflation.

Sources:


Related Pages:

Show / Hide