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Hyperinflation

Updated on April 4, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Hyperinflation?

Hyperinflation is merely an accelerated level of inflation that tends to quickly destroy the actual value of the local currency since there is a rise in the cost of all products and services, and it causes people to lower their holdings in that particular currency as they opt to participate in foreign currencies that are relatively more stable.

Hyperinflation

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The prices of products rise considerably and the entire process happens very rapidly. This might happen due to uncontrolled currency in circulation in the economy or too much demand for goods and services, thereby increasing prices.

Key Takeaways

  • Hyperinflation is an extreme level of inflation that results in a rapid decrease in the value of the local currency.
  • This occurs due to a significant increase in all goods and services prices. As a consequence, people tend to reduce their holdings in the affected currency and seek more stable foreign currencies.
  • Hyperinflation can be categorized into three types: creeping, galloping, and walking, depending on the speed and severity of the inflationary surge.
  • Hyperinflation can have severe consequences for an economy. It destroys wealth, adversely affects people with low incomes, and creates imbalances between supply and demand.

Hyperinflation Explained

Hyperinflation is the process in which the prices of goods and services in the economy rise to such an extent that the localor the domestic currency lose its value very rapidly . It has a devastating effect in the country because the prices rise within days or even hours. It becomes extremely hard for people to hold money because due to high price, even buying very less quantity of anything need lot of money. The result is also rise in money circulation, which further leads to inflation. The people loses faith in the government who are responsible in managing the country because the entire system takes a plunge.

The price rise does not happen overnight. If we analyse the steps, it is seen that if is up to 3% a year, it is creeping, a 3% to 10% rate is known as walking, and more than 10% is known as galloping. When the rate of inflation is unusual or too high (say 50%), it’s termed Hyperinflation. Thus, if the government does not take the necessary steps to control the situation when it is at least in the galloping stage, then it soon crosses the limit.  However, it is quite a rare phenomenon.

Overall, inflation is a very important concept that the country’s central bank intends to manage. However, mismanagement and a wrong turn of policy can make it a bomb in the form of Hyperinflation. It can ruin the economy, and people feel worse as part of the process. In countries with hyperinflation ,a lot of wealth is destroyed, and the poor are hurt the most in such a situation. It results in a huge imbalance between the supply and demand in the economy. If the same is left unchecked for a while, the currency’s price starts following the prices of the goods rapidly rising substantially. It is often said that Hyperinflation is a man-made disaster.

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Hyperinflation Explained in Video

 

Causes

Hyperinflation is a situation under which inflation goes completely out of control. Although it is considered a rare event, in the 20th century, the event has happened in 55 countries, including major economies like China and Germany. In such a situation, the concept of inflation starts becoming meaningless.

Hyperinflation happens when there is a significant decline in the gross domestic product (GDP). However, the money supply is randomly increasing.

It results in a huge imbalance between the supply and demand in the economy. If the same is left unchecked for a while, the currency’s price starts following the prices of the goods starts rising substantially.

It is often said that Hyperinflation is an unnatural disaster. It often happens when there is a steep devaluation in the currency‘s value, and the citizens start losing confidence.

In such a situation, , in countries with hyperinflation people perceive that currency has no value, they start hoarding goods and commodities with value. Since the demand for such goods starts rising, prices also rise rapidly. It also has a ripple effect. As the price rises rapidly, basic commodities like fuel and food become scarce, which kicks on the second cycle of skyrocketing prices of essential commodities.

The third stage of the problem starts when the government starts printing more money to stabilize prices and increase liquidity in the system in response to this rise. This only increases the problem.

Signs

The signs of this kind of situation is not very difficult to identify. It has been seen that generally, normal inflation is measured monthly. So, economically it has been said. But hyperinflation is measured daily when the prices of goods start rising by 5 to 10 percent daily. Hyperinflation is a situation that occurs when the prices of goods increase by 50% over one month. Therefore when the rate of inflation is measures, the actual situation comes to light.

History Of Hyperinflation

The below table shows the list of countries with a hyperinflation history.

History of Hyperinflation

source: goldonomics

Let us now write a few examples in detail to understand the flow and impact of Hyperinflation.

Yugoslavia Hyperinflation (the 1990s)

It is a case of prolonged and one of the most devastating Hyperinflation ever. The former Yugoslavia was witnessing inflation rates that exceeded 75 percent annually. The country was on the verge of national dissolution.

It was discovered that leaders of this Serbian nation plundered huge national treasury by issuing $1.5 billion to acquaintances. It forced the government to print excessive money to meet its financial obligations.

Hyperinflation quickly engulfed the whole economy, erasing all wealth and leading people to move into a barter system. The prices of goods doubled each day until the inflation level reached 300 million percent every month.

The Government then took some temporary measures where the production ultimately stopped, and they replaced the currency with the German mark, which finally helped them stabilize the economy. In modern-day economics, this has been one of the worst-case of Hyperinflation.

Germany Hyperinflation (the 1920s)

Sometimes, it has been seen that major money-draining situations can also lead to Hyperinflation. It is the case of Germany in the 1920s.

Reeling from the impact of World War 1, the country printed money to pay for the costs of World War 1. World War 1 increased from 13 billion Deutschmarks in 1913 to 60 billion Deutschmarks in 1920.

Sovereign debt increased from 5 billion to 100 billion marks during the same period. Initially, it lowered the cost of exports and increased the economy’s economic growth.

Another 132 billion marks also impacted the country in war reparations as the war ended. It led to a collapse in production and a huge shortage of goods.

The major impact was seen in essential goods like food. Since the cash in circulation was high and goods available were in shortage, the price of everyday items started doubling every 3.7 days.

As per estimates, the inflation rate per day was 20.9 percent.

Zimbabwe Hyperinflation (2004-2009)

The most recent example of hyperinflation history, took place in the African nation of Zimbabwe. It happened between 2004 and 2009.

It also started with war, and the government printed huge amounts of money to fight the war of Congo. The supply side of goods was hit due to the impact of major droughts during the same period.

In this case, Hyperinflation was worse than in Germany as the inflation rate stood at 98 percent a day, and the prices, in general, doubled every day. It ended post-2009 when people started accepting other currencies instead of Zimbabwean dollars.

Hyperinflation is characterized by the general increase in goods and services price levels at a very high rate, say 50% a month.

Hyperinflation in Zimbabwe began in the late 1990s, shortly after confiscating private farms from landowners. It came towards the end of Zimbabwean involvement in the Second Congo War. During the height of inflation from 2008 to 2009, surviving hyperinflation was difficult because the government of Zimbabwe stopped filing official inflation statistics. However, Zimbabwe’s peak month of inflation is estimated at 79.6 billion percent in mid-November 2008.

Effects

Let us look at the effects of this kind of inflation in the economy.

Persistently very high inflation – This is the worst part of the entire process, where the price rise is beyond control and currency totally loses its value. People rush to buy goods, further spending their money and adding to the inflationary situation.

Severe Unemployment – Due to mismanagement in the economy and exorbitant price rise, the government is not able to concentrate on the development of the country. This leads to severe loss of jobs and lack of employment, further adding to the chaos and dissatisfaction. Citizens no longer have any faith in the government.  

Drop-in life expectancy – This is a side effect of the negative situation because due to price rise, the basic necessities like food and medicines also crosses the normal price limit, which leads to loss of lives which could otherwise have been saved.

Severe food crisis – Food shortage is a dangerous situation that results from this inflationary effect. This happens because the food becomes unaffordable and is available to only the ones who can pay the extremely high price for them.      

Widespread diseases and a high mortality rate – Again as a side effect, due to proper food, shelter, hygienic conditions and medicines, there is a rapid spread of disease and lack of medicines add to the situation, resulting in untimely death.

Solution

In the modern-day world preparing for hyperinflation is necessary. The country’s central banks are responsible for maintaining inflation under control. The primary job of the Central bank is to control inflation . It is done by managing interest rates in the economy and controlling the money supply.

Tightening the money supply helps reduce inflation while increasing the money supply is coupled with increasing inflation. The United States Fed has the target inflation rate of 2% for the economy.

If the Inflation rate in the economy moves above 2%, the Fed will increase the Fed Funds rate (a benchmark for the interest rate in the economy). It will reduce the money supply in the system and lower inflation in the economy and help in surviving hyperinflation.

How To Avoid?

Generally, Hyperinflation is a function of mismanagement and is a rare event. However, investors and readers are advised to be cautious about it preparing for hyperinflation is necessary.

Do Not Keep Money Stagnant

A penny saved is a penny earned. But thanks to inflation, over time, the value of the penny saved could be much less than when earned.

A lot of wealth is destroyed, and the poor are hurt the most in such a situation. Moreover, it results in a huge imbalance between the supply and demand in the economy.

If the same is left unchecked for a while, the currency’s price starts following the prices of the goods rapidly rising substantially.

It is often said that Hyperinflation is a man-made disaster. It often happens when there is a steep devaluation in the currency‘s value, and the citizens start losing confidence. In such a situation, since people perceive that currency has no value, they start hoarding goods and commodities with value.

If we save money by just putting it aside at home, it will lose value over time. So, always invest money to beat inflation and get some handsome returns in the future. If we can’t think of where to invest the money, we ask parents or some elderly person in the family for their guidance. Then, let it grow by gaining interest.

But whatever we do, do not just lock money up in the safe and keep it stagnant. If we do this, we will be losing money without even knowing it.

The more money is kept stagnant, the more money we will be losing.

Aim For Higher Returns

When investing, wehave to make sure that the rate of return on investment is higher than the inflation rate.

What is the rate of return on investment?

The rate of return is how much we make on an investment.

Suppose we invest Rs.100 in the market and over a year, and make Rs.110, then the rate of return is 10%.

= (Latest price/Old price-1)*100·      

= (110/100-1)*100 = 10%

A general increase in prices is called inflation, and the rate at which or how much the prices go up is called the rate of inflation.

If the price of chocolate is Rs. 80, then after a year with a 4% rate of inflation, the price will go up to (Rs. 80 x 1.04) = 83.2

If the inflation rate is 10%, we should look for an investment avenue that will return at a rate of more than 10%. So the money grows at a faster rate than the rate at which the money’s value or the purchasing power is going down. The situation goes completely haywire, and people tend to lose confidence in the currency. When the final call of scrapping the currency is needed, the general solution has been to adopt a new currency of some other country. It tends to increase confidence, and people stop buying commodities perceiving value. Governments need to play a vital role in maintaining confidence in the currency so that people don’t hoard essential commodities.

Frequently Asked Questions (FAQs)

1. How does hyperinflation affect savings and investments in an economy?

Hyperinflation severely impacts savings and investments in an economy. As prices skyrocket, the value of savings erodes rapidly, leading to a loss of purchasing power for individuals and businesses. Traditional safe-haven assets like cash become virtually worthless, causing investors to seek alternative ways to preserve wealth, such as investing in tangible assets like real estate or precious metals.

2. Can hyperinflation lead to social and political instability?

Yes, hyperinflation can indeed lead to social and political instability. The dramatic price increase causes significant hardships for the general population, leading to protests, strikes, and civil unrest. Governments may struggle to maintain order, and political leaders may face increased pressure or lose public confidence. This instability can potentially lead to political upheaval or even regime change.

3. How does hyperinflation affect international trade and foreign investments in the affected country?

Hyperinflation can have detrimental effects on international trade and foreign investments in the affected country. Foreign investors may lose confidence and pull out their investments as the currency rapidly depreciates, leading to capital flight. International trade can be disrupted as the country’s export competitiveness diminishes while import costs soar. This can result in trade imbalances, reduced foreign investment inflows, and strained economic relations with trading partners.

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