Characteristics The main cause of hyperinflation is a massive imbalance between the
supply and demand of a certain currency or type of money, usually due to a complete loss of confidence in the currency similar to a
bank run. First, the enactment of
legal tender laws prevent discounting the value of
paper money vis-a vis gold, silver or a
hard currency, by forcing acceptance of a paper money which lacks intrinsic value. If the entity responsible for printing a currency then promotes excessive money printing, with other factors contributing a reinforcing effect, hyperinflation usually occurs. Often the body responsible for printing the currency cannot physically print paper currency faster than the rate at which it is devaluing, thus neutralising their attempts to stimulate the economy.
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, or even stamp old notes with new numbers. It also is the most dramatic so far with electronic money now posing the possibility of even faster "printing" and de-regulated capital markets allowing currency to "go global". There have been numerous episodes of hyperinflation, followed by a return to "hard money". Older economies would revert to
hard currency and
barter when the circulating medium became excessively devalued, generally following a "run" on the store of value.
Unlike inflation, which is widely considered to be normal in a healthy economy, hyperinflation is always regarded as destructive. It effectively wipes out the purchasing power of private and public savings, 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 by imposing a
shock therapy of slashing government expenditures or by altering the currency basis. An example of the latter is placing the nation in question under a
currency board as
Bosnia-Herzegovina had in 2005, which allows the central bank to print only as much money as it has in foreign reserves. Another example is
dollarization as
Ecuador officially initiated in September 2000 in response to a massive 75% loss of value of the Sucre currency in early January 2000.
Dollarization is the use of a foreign currency (not necessarily the U.S. dollar) as a national unit of currency.
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 recurrence. Often this means making the central bank very aggressive about maintaining price stability as is the case with the German
Bundesbank, or moving to some hard basis of currency such as 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 the "
Great Leap Forward" and "
Cultural Revolution".
For a variety of reasons, governments have occasionally resorted to printing money to meet their expenses. During hyperinflation, the monetary authority can't even do that as it becomes a net loss. Those holding government debt, directly or indirectly, have less buying power. Theories of hyperinflation generally look for a relationship between
seignorage and the
inflation tax. In both Cagan's model and the neo-classical models, a crucial point is when the increase in money supply or the drop in basic money stock makes it impossible for a government to improve its financial position. Thus when
fiat money is printed, government obligations that are not denominated in money increase in cost by more than the value of the money created.
From this, it might be wondered why any state would engage in actions that cause or continue hyperinflation. One reason is that often the alternative to hyperinflation is depression. In late 2001, the
Argentine peso collapsed in value. Rather than printing sufficient cash for the public to carry, which they feared would start a run on the banks, the government took the peso off its dollar peg. Many international economists predicted that they would have to get a new loan from the
IMF and impose shock therapy in order to avoid hyperinflation. Currency controls were imposed, tariffs were instituted, and the economy was allowed to fall into a severe recession during which unemployment hit 25%, homelessness and crime spiraled upwards, and the poverty rate peaked at over 50%.
The root cause is a matter of more dispute. In both
classical economics and
monetarism, it is always the result of the monetary authority irresponsibly borrowing money to pay all its expenses. These models focus on the unrestrained
seignorage of the monetary authority, and the gains from the
inflation tax. In
Neoliberalism, hyperinflation is considered to be the result of a crisis of confidence. 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, such as gold or an internationally recognized
hard currency. This is a quantity theory of hyper-inflation.
In neo-classical economic theory, hyperinflation is rooted in a deterioration of the
monetary base, that is the confidence that there is a store of value which the currency will be able to command later. In this model, the perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums. One example of this is during periods of warfare, civil war, or intense internal conflict of other kinds: governments need to do whatever is necessary to continue fighting, since the alternative is defeat. Expenses cannot be cut significantly since the main outlay is armaments. Further, a civil war may make it difficult to raise taxes or to collect existing taxes. While in peacetime the deficit is financed by selling bonds, during a 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
Himalaya, and then old currency was flown out to be destroyed.
Hyperinflation is regarded as a complex phenomenon and one explanation may not be applicable to all cases. However, in both of these models, whether loss of confidence comes first, or central bank
seignorage, the other phase is ignited. In the case of rapid expansion of the money supply, prices rise rapidly in response to the increased supply of money relative to the supply of goods and services, and in the case of loss of confidence, the monetary authority responds to the risk premiums it has to pay by "running the printing presses".
In the United States of America, hyperinflation was seen during the
Revolutionary War and during the
Civil War, especially on the
Confederate side. Many other cases of extreme social conflict encouraging hyperinflation can be seen, as in
Germany after
World War I,
Hungary at the end of
World War II and in
Yugoslavia in late 1980s just before break up of the country.
Less commonly, hyperinflation may occur when there is
debasement of the coinage — wherein 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. Historical examples include Ancient Rome, China during the Song Dynasty, and the United States beginning in 1933. When "token" coins begin circulating, it is possible for the minting authority to engage in fiat creation of currency.
Hyperinflation can also occur in the absence of a
central bank. One case is when there is "free banking" yet a government allows a bank to suspend
convertibility, often in violation of explicit or implicit promises and contracts. These episodes often cause a panicked run on other banks and a collapse in the available money supply, leading to a depression and deflation.
Root causes of hyperinflation The hyperinflation episode in the
Weimar Republic in the 1920s was not the first hyperinflation, nor was it the only one in early 1920s Europe. However, as the most prominent case following the emergence of economics as a science, it drew interest in a way that previous instances had not. Many of the surreal economic behaviors now associated with hyperinflation were first documented systematically in Germany: order-of-magnitude increases in prices and interest rates, redenomination of the currency, consumer flight from cash to hard assets, and the rapid expansion of industries that produced those assets.
It is sometimes argued that Germany had to inflate its currency to pay the war reparations required under the
Treaty of Versailles, but this is only part of the story. Reparations accounted for about one third of the German deficit from 1920 to 1923 (Costantino Bresciani-Turroni, The Economics of Inflation. London: George Allen & Unwin, 1937. p. 93). Nonetheless, the government found reparations a convenient scapegoat. Other scapegoats included bankers and speculators (particularly foreign). The inflation reached its peak by November 1923, but ended when a new currency (the
Rentenmark) was introduced. The government stated this new currency had a fixed value, and this was accepted.
Hyperinflation did not directly bring about the
Nazi takeover of Germany; the inflation ended with the introduction of the Rentenmark and the Weimar Republic continued for a decade afterward. The inflation did, however, raise doubts about the competence of
liberal institutions, especially amongst a middle class who had held cash savings and bonds. It also produced resentment of Germany's bankers and speculators, many of them
Jewish, whom the government and press blamed for the inflation.
The 1920s German inflation Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for money. Economists see both a rapid increase in the
money supply and an increase in the
velocity of money. Either one or both of these encourage inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly. The second theory is that there is first a radical increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation. In either model, the second effect then follows from the first — either too little confidence forcing an increase in the money supply, or too much money destroying confidence.
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 lose 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 occurred during Napoleonic 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 a
positive feedback cycle of rapid monetary expansion. It 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. When businesspeople perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency's value. The issuer must then accelerate its expansion to cover these prices, which pushes the currency value down even faster than before. According to this model the issuer cannot "win" and the only solution is to abruptly stop expanding the currency. Unfortunately, the end of expansion can cause a severe financial shock to those using the currency as expectations are suddenly adjusted. This policy, combined with reductions of pensions, wages, and government outlays, formed part of the
Washington consensus of the 1990s.
Whatever the cause, hyperinflation involves 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 increasing the money stock, by which ever 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 had been selling at a huge loss to quiet popular discontent, and the hyperinflation came to a halt almost immediately, since it was able to 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 1920s 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.
Models of hyperinflation 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.
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".) An example of this would be
Turkey's revaluation of the
Lira on
January 1,
2005, when the old
Turkish Lira (TRL) was converted to the
new Turkish Lira (YTL) at a rate of 1,000,000 old to 1 new Turkish Lira. While this does not lessen actual value of a currency, it is called
revaluation and also happens over time in countries with standard inflation levels. During hyperinflation, currency inflation happens so quickly that bills reach large numbers before revaluation.
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).
Metallic coins were rapid casualties of hyperinflation, as the scrap value of metal enormously exceeded the face value. Massive amounts of coinage were melted down, usually illicitly, and exported for hard currency.
Governments will often try to disguise the true rate of inflation through a variety of techniques. These can include the following:
None of these actions address the root causes of inflation, and in fact, if discovered, tend to further undermine trust in the currency, causing further increases in inflation. Price controls will generally result in
hoarding and extremely high demand for the controlled goods, resulting in shortages; additionally, supply may diminish as producers no longer find it sufficiently profitable to continue producing such goods, further exacerbating the problem.
By late 1923, the
Weimar Republic of Germany was issuing fifty-million Mark banknotes and postage stamps with a face value of fifty billion Mark. The highest value banknote issued by the Weimar government's Reichsbank had a face value of 100 billion Mark (100,000,000,000,000) {100 Trillion US/UK}.
[1]. One of the firms printing these notes submitted an invoice for the work to the Reichsbank for 32,776,899,763,734,490,417.05 (3.28×10%) for July, 1946, amounting to prices doubling every fifteen hours.
Outright lying as to official statistics such as money supply, inflation or reserves.
Suppression of publication of money supply statistics, or inflation indices.
Price and wage controls.
Forced savings schemes, designed to suck up excess liquidity. These savings schemes may be described as pensions schemes, emergency funds, war funds, or similar.
Adjusting the components of the
Consumer Price Index, to remove those items whose prices are rising the fastest.
Hyperinflation and the currency Angola went through the worst inflation from 1991 to 1995. In early 1991, the highest denomination was 50,000 kwanzas. By 1994, it was 500,000 kwanzas. In the 1995 currency reform, 1 kwanza reajustado was exchanged for 1,000 kwanzas. The highest denomination in 1995 was 5,000,000 kwanzas reajustados. In the 1999 currency reform, 1 new kwanza was exchanged for 1,000,000 kwanzas reajustados. The overall impact of hyperinflation: 1 new kwanza = 1,000,000,000 pre 1991 kwanzas.
Argentina went through steady inflation from 1975 to 1991. At the beginning of 1975, the highest denomination was 1,000 pesos. In late 1976, the highest denomination was 5,000 pesos. In early 1979, the highest denomination was 10,000 pesos. By the end of 1981, the highest denomination was 1,000,000 pesos. In the 1983 currency reform, 1 Peso Argentino was exchanged for 10,000 pesos. In the 1985 currency reform, 1 austral was exchanged for 1,000 pesos argentino. In the 1992 currency reform, 1 new peso was exchanged for 10,000 australes. The overall impact of hyperinflation: 1 new peso = 100,000,000,000 pre-1983 pesos.
Between 1921 and 1922, inflation in Austria reached 134%.
Belarus went through steady inflation from 1994 to 2002. In 1993, the highest denomination was 5,000 rublei. By 1999, it was 5,000,000 rublei. In the 2000 currency reform, the ruble was replaced by the new ruble at an exchange rate of 1 new ruble = 1,000 old rublei. The highest denomination in 2002 was 50,000 rublei, equal to 50,000,000 pre-2000 rublei.
Bolivia went through the worst inflation between 1984 and 1986. Before 1984, the highest denomination was 1,000 pesos bolivianos. By 1985, the highest denomination was 10 Million pesos bolivianos. In 1985, a Bolivian note for 1 million pesos was worth 55 cents in US dollars, one-thousandth of its exchange value of $5,000 less than three years previously. pre 1989 zaires.
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