Hyperinflation

Hyperinflation Definition – The word inflation is probably not new to you. Inflation is a general increase in prices of goods and services over a period of time.

Hyperinflation is a situation under which the inflation goes completely out of control. In such a situation concept of inflation starts becoming meaningless.

Although it is considered to be a rare event, in 20^th century the event has happened in 55 countries including major economies like China and Germany.

In this article, we look at Hyperinflation in detail –

• Types of Inflation
• When does Hyperinflation happen?
• How do one quantify whether it is normal inflation or hyperinflation?
• Yugoslavia Hyperinflation (1990s)
• Germany Hyperinflation (1920s)
• Zimbabwe Hyperinflation (2004-2009)
• What does Central Bank do to maintain inflation?
• How investors can avoid the hyperinflation trap?
• Conclusion

Types of Inflation

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If price rise is up to 3% a year, it is creeping, 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 as hyperinflation.

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When does Hyperinflation happen?

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• Hyperinflation happens when there is a significant decline in gross domestic product (GDP), however, the money supply is randomly increasing.
• This results in huge imbalance between the supply and demand in the economy. If the same is left unchecked for a while, the price of the currency starts following rapidly the prices of the goods starts rising substantially.
• It is often said that Hyperinflation is a man-made disaster. It often happens when there is a steep devaluation in the value of the currency and the citizens start losing confidence in it.
• In such a situation since people perceive that currency has no value, they start hoarding goods and commodities which actually has value. Since the demand for such goods start rising, prices also start rising rapidly. This also has a ripple effect, as the price starts rising rapidly, the basic commodities like fuel and food become scarce, which kicks on the second cycle of sky rocket prices of essential commodities.
• The third stage of the problem starts when in response to this rise, the government starts printing more money to stabilize prices and increase liquidity in the system. This only increases the problem.

 

How do one quantify whether it is normal inflation or hyperinflation?

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It has been seen that generally, normal inflation is measured  on monthly basis, hyperinflation is measured on a daily basis when the prices of goods start rising by 5 to 10 percent on the daily basis. Economically it has been said hyperinflation is a situation which occurs when the prices of the good increases by 50% over a period of one month.

History of Hyperinflation.

Below table shows the list of countries with History of Hyperinflation

source: goldonomics

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

Yugoslavia Hyperinflation (1990s)

• This is a case of prolonged and one of the most devastating hyperinflation ever. The country was on the verge of national dissolution, the former Yugoslavia was witnessing inflation rates which exceeded 75 percent annually.
• It was discovered that leaders of this Serbian nation plundered huge national treasury by issuing $1.5 billion to acquaintances. This forced the government to print an excessive amount of money so that they can meet their 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 quick 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 (1920s)

• Sometimes it has been seen that major money draining situations can also lead to Hyperinflation. This 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 the World War 1. The money circulation during World War 1 increased from 13 billion Deutschmarks in 1913 to 60 billion Deutschmarks in 1920.
• During the same period, the Sovereign debt of the country increased from 5 billion to 100 billion marks. Initially, it lowered the cost of exports and increased economic growth of the economy.
• As the war ended the country was also impacted with another 132 billion marks in war reparations. This lead 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, inflation rate per day was 20.9 percent.

Zimbabwe Hyperinflation (2004-2009)

• The most recent example of hyperinflation took place in African nation of Zimbabwe. This happened between 2004 and 2009.
• This also started with a war, the government printed huge money to fight the war of Congo. The situation on the supply side of goods was hit, due to impact of major droughts during the same period.
• In this case, Hyperinflation was worse than Germany as inflation rate stood at 98 percent a day and the prices on general were doubling every day.
• It ended post 2009 when people started accepting other currencies instead of Zimbabwean dollar.

Let’s look at a case study of hyperinflation in Zimbabwe. What were the causes of it and its impact on the economy of the country?

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

Hyperinflation in Zimbabwe began in the late 1990s, shortly after the confiscation of 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, it was difficult to measure Zimbabwe’s hyperinflation 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.

Some of the causes and effects of the same are shown below.

Causes

• Land reform program
• War funding
• Economic Mismanagement

Effects

• Persistently very high inflation
• Severe Unemployment
• Drop in life expectancy
• Severe food crisis
• Wide spread of diseases and high mortality rate

What does Central Bank do to maintain inflation?

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In modern day world, Central banks of the country are responsible to maintain inflation under control. The primary job of the Central bank is to control inflation under control. This is done through management of interest rate in the economy and controlling the money supply. Tightening the money supply helps in reduction of inflation, while increasing 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%, Fed will increase the Fed Funds rate (benchmark for interest rate in the economy). This will reduce the money supply in the system and hence lowering of inflation in the economy.

How Investors can avoid the Hyperinflation Trap

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Generally, Hyperinflation is a function of mismanagement and is a rare event. However, investor and readers are advised to be cautious about it.

Do not keep your money stagnant otherwise, inflation will eat away its value

• 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 it was earned.
• A lot of wealth is destroyed and poor are hurt the most in such a situation. This results in a huge imbalance between the supply and demand in the economy.
• If the same is left unchecked for a while, the price of the currency starts following rapidly the prices of the goods starts rising substantially.
• It is often said that Hyperinflation is a man-made disaster. It often happens when there is a steep devaluation in the value of the currency and the citizens start losing confidence in it. In such a situation since people perceive that currency has no value, they start hoarding goods and commodities which actually has value.
• If you 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 future. If you can’t think of where to invest your money, ask your parents or some elder person in the family for their guidance. Let it grow by gaining interest.
• But whatever you do, do not just lock your money up in your safe and keep it stagnant. If you do this, you will be losing money without even knowing it.
• The more money you keep stagnant the more money you will be losing.

Rate of returns on your investment should be higher than the rate of inflation

• When investing, you have to make sure that the rate of return on your investment is higher than the rate of inflation.

What is the rate of return on investment?

• The rate of return is how much you make on an investment.
• Suppose you invest Rs.100 in the market and over a year, you make Rs.110, then your rate of return is 10%.
• = (Latest price/Old price-1)*100
• = (110/100-1)*100 = 10%

What is the rate of Inflation?

• A general increase in prices is called inflation and the rate at which or how much the prices go up is called 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 rate of inflation is 10%, you should look for an investment avenue that will return at a rate more than 10%. So your money grows at a faster rate than the rate at which your money’s value or your purchasing power is going down. The situation goes completely haywire and people tend to lose confidence in the currency. This is when the final call of scrapping the currency is needed and the general solution has been to adopt a new currency of some other country. This tends to increase confidence and people stop buying commodities perceiving value in the same. Governments need to play a vital role in maintaining the confidence in the currency so that people don’t start hoarding up essential commodities.

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Conclusion

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

It often happens when there is a steep devaluation in the value of the currency and the citizens start losing confidence in it. In such a situation since people perceive that currency has no value, they start hoarding goods and commodities which actually has value. In modern day world, Central banks of the country is responsible to maintain inflation under control.

The primary job of the Central bank is to control inflation under control. Some of the government measures which can curb such disasters are like working on creating resources, have strong policies which can control the printing of money, proactive management by the Central bank of the country, not to print excessive for funding debt. If the rate of inflation is 10%, you should look for an investment avenue that will return at a rate more than 10%. So your money grows at a faster rate than the rate at which your money’s value or your purchasing power is going down. Investors should look for avenues by means of which they create returns which are higher than the inflation, this is the only time we are creating wealth. Investors are advised not to keep the money idle as money tends to lose value if kept idle.