Hyperinflation

What is Hyperinflation?

Hyperinflation is an extremely rapid and uncontrollable increase in the general price level of goods and services within an economy. It can have severe economic, social, and political consequences, as it erodes the purchasing power of money and can lead to a breakdown in economic stability.

Hyperinflation is an extreme economic condition defined by Economist Phillip Cagan, where the monthly inflation rate within an economy exceeds 50%. Under the purview of the International Accounting Standards Board, hyperinflationary circumstances are categorized under IAS 29.

Although the standard does not give an absolute inflation rate for classifying high inflation, it lays out a set of conditions that can be employed to determine the applicability of IAS 29.

The conditions outlined in IAS 29 are as follows:

1. When most individuals opt to safeguard their wealth by investing in non-financial assets or more stable foreign currencies to preserve their purchasing power, it becomes evident that hyperinflation is at play.
2. If the general public views monetary amounts as a comparatively stable foreign currency rather than the local currency and uses this foreign currency for price quotations, it signifies hyperinflation.
3. Even when credit transactions have brief periods, if sales and purchases conducted on credit are priced to account for the expected loss in purchasing power due to inflation, this points to hyperinflation.
4. A price index links interest rates, salaries, and costs and indicates hyperinflation.
5. When the cumulative inflation rate reaches or exceeds 100% over three years, it is a clear sign that hyperinflation is persisting.

Causes of Hyperinflation

Hyperinflation can stem from various causes. The following are some of the major factors that can trigger hyperinflation.

Excessive Money Printing

Printing of excessive money has been the most common trigger of hyperinflation throughout history.

Whether it was the Weimar Republic in Germany in the 1920s or Venezuela's current hyperinflation issue since 2013, hyperinflation appears to have occurred due to the government's excessive money creation policies.

When money is printed to pay for a non-productive policy that puts money straight into the hands of the public without any tangible gain in productivity, the money supply expands, but the economy's output remains static.

Since these non-productive policies typically do not contribute to increased economic output, the economy struggles to support the influx of additional currency.

Government Mismanagement

The government's poor handling of the economy can also trigger a high inflationary environment. If a government cannot manage its fiscal policies, it may be difficult to promote economic growth.

This is because governments fund the majority of infrastructure needed to attract private investment, and in most cases, private investment follows government investment.

This implies that if the government cannot supply this core support through income generated by taxes or other sources, it will most likely resort to money printing to cover the deficit produced by mismanagement, resulting in excessive inflation.

War and Conflicts

In the 21st century, every conflict or war interrupting the global supply chain has the potential to act as a catalyst for rising inflation. For example, the Russia-Ukraine war has resulted in a huge decline in global food and oil supply, causing inflationary pressure on global oil and wheat prices.

It is not necessary that only an all-out war can lead to a disruption in the supply chain. During the US-China trade conflicts, where two of the most powerful economies went to an out trade war, we saw the price of most goods and services rise due to these trade conflicts.

Natural Disasters

A severe natural disaster can disrupt supply and act as a trigger for high inflation.

For instance, if an island like Hawaii gets hit by a serious hurricane, destroying its ports and other critical infrastructures will create a situation where it cannot import goods for its economy. This will lead to a supply shock, ultimately leading to a high inflation rate.

Other Causes

Other than the above-mentioned factors that can trigger a high inflation situation, some factors that, if not addressed quickly in an economy, may cause inflation to rise.

These causes are:

• Foreign exchange rate fluctuation: If a country's exchange rate is volatile, it will be difficult for that country to import products from the international market, restricting its supply and causing prices to rise.
• Political instability: Suppose a country loses faith in its government. In that case, it will be harder to attract new capital investment, resulting in a drop in production capacity, leading to a drop in supply and an increase in the price of goods.
• Hoarding and speculation: If the market thinks that there will be a shortage of goods or the price of existing goods will rise, some distributors will start to hoard those goods, speculating that they can sell these at higher markups, and by creating this artificial shortage, they push the price higher.

Effect of Hyperinflation

When a high inflation situation is not controlled, it significantly negatively affects an economy. Some of its major effects are described below.

Loss of purchasing power

In a hyperinflationary environment, the daily erosion of a currency's purchasing power is significant. This happens because customers will need more money when prices rise to acquire the same goods and services.

Increased Unemployment

Private enterprises are cautious about investing in the economy since its future is uncertain during rising inflation. With this decline in investment, there is no new job creation in the economy, increasing the unemployment rate.

The government also imposes fiscal policy constraints, which limit its capacity to stimulate the economy. While there are no fresh investments to spur economic development, established enterprises may go bankrupt, increasing unemployment.

Capital and Brain Drain

As the economy becomes increasingly unstable and the currency depreciates rapidly, businesses and affluent individuals may withdraw their capital from the country. Similarly, skilled workers seek better opportunities in more stable environments abroad, leading to a "brain drain."

Loss of Trust in government and the currency

In a world that runs on trust, a situation where people's living standards erode leads to the erosion of that trust in the system. This makes a country more unstable and makes it harder to recover. 

Hyperinflation causes a country's economic climate to be so volatile that it undermines all investments and erodes all trust in the system. It starts a vicious cycle that worsens with time.

Examples of Hyperinflation 

One of the most severe types of inflation is hyperinflation. There have been several documented examples of countries suffering from significant inflation throughout history, and in most situations, it produces a hostile climate.

Below are the three most well-known examples of countries that had and are still facing this high and severe inflation.

Weimar Germany

Weimar Germany is one of the most famous examples of hyperinflation. After World War 1, Germany faced many problems. Its economy was in shambles, its production capabilities were reduced significantly, and it had to pay huge war reparations of 132 billion gold marks (equivalent to USD 33 billion at the time).

This created a perfect storm, and between 1921 and 1923, Germany experienced one of the most devastating hyperinflation episodes in history. In perspective, a loaf of bread that cost around 160 Marks in 1922 was priced at an astonishing 200,000,000,000 Marks by late 1923.

Germany tried to print their way out of their debts, but this led to a situation where managing the economy was getting difficult daily. The currency was so worthless that people were using it as wallpaper.

The price of almost every item was doubling every 3.7 days. The inflation peaked at 29,525% in November 1923.

Zimbabwe

Zimbabwe got its independence in 1980 with an exchange rate of 1 Zimbabwe dollar = 1.25 US dollars. As new governments came into power, they implemented land reforms, which failed and resulted in food shortages.

The rampant corruption in the government led to a decile in foreign investments, and the government also started to fund a war in Congo. MNCs started to hold goods and stopped imports to Zimbabwe.

With limited domestic productivity and scarcity of essential goods, the government resorted to printing money to cover its expenses.

Zimbabwe recorded some of the highest inflation rates between 2004 and 2009. Hyperinflation peaked in November 2008 at 79,600,000,000%, or a daily inflation rate of 98%. 

The government stopped reporting its inflation rate in 2008 and abandoned the Zimbabwe dollar as a legal tender in favor of other foreign currencies like the US dollar.

Venezuela

Venezuela is one of the most recent examples of hyperinflation. In 2014, Venezuela saw its inflation touching 69%, and by 2018, the IMF reported that the inflation reached 929,790% and is still experiencing hyperinflation.

The government implemented a price control policy on foods and medicines, bankrupting domestic producers, and the government had to use the oil revenue to import these necessary goods.

Still, that money ran out when the oil price fell in 2014. To pay for its obligations, the government resorted to printing money. Venezuela has one of the largest oil reserves in the world. Still, due to mismanagement of the government budgets and geo-political problems with the USA, inflation gripped the country hard. 

Researched and authored by Kunal Raj | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

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