Hyperinflation

What Is Hyperinflation?

Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.

Although hyperinflation is a rare event for developed economies, it has occurred many times throughout history in countries such as China, Germany, Russia, Hungary, and Argentina.

Understanding Hyperinflation

Hyperinflation occurs when prices have risen by more than 50% per month over a period of time. For comparison purposes, the U.S. inflation rate as measured by the Consumer Price Index (CPI) has averaged about 2% per year since 2011 according to the Bureau of Labor Statistics. The CPI is merely an index of the prices for a selected basket of goods and services. Hyperinflation causes consumers and businesses to need more money to buy products due to higher prices.

Whereas normal inflation is measured in terms of monthly price increases, hyperinflation is measured in terms of exponential daily increases that can approach 5% to 10% a day. Hyperinflation occurs when the inflation rate exceeds 50% for a period of a month.

Imagine the cost of food shopping going from $500 per week to $750 per week the next month, to $1,125 per week the next month, and so on. If wages aren't keeping pace with inflation in an economy, the standard of living for the people goes down because they can't afford to pay for their basic needs and cost of living expenses.

Hyperinflation can cause a number of consequences for an economy. People may hoard goods, including perishables such as food, because of rising prices, which, in turn, can create food supply shortages. When prices rise excessively, cash, or savings deposited in banks, decreases in value or becomes worthless since the money has far less purchasing power. Consumers' financial situation deteriorates and can lead to bankruptcy.

Also, people might not deposit their money in financial institutions, leading banks and lenders to go out of business. Tax revenues may also fall if consumers and businesses can't pay, which could result in governments failing to provide basic services.

Why Hyperinflation Occurs

Although hyperinflation can be triggered by a number of reasons, below are a few of the most common causes of hyperinflation.

Excessive Money Supply

Hyperinflation has occurred in times of severe economic turmoil and depression. A depression is a prolonged period of a contracting economy, meaning the growth rate is negative. A recession is typically a period of negative growth that occurs for more than two quarters or six months. A depression, on the other hand, can last years but also exhibits extremely high unemployment, company and personal bankruptcies, lower productive output, and less lending or available credit. The response to a depression is usually an increase in the money supply by the central bank. The extra money is designed to encourage banks to lend to consumers and businesses to create spending and investment.

However, if the increase in money supply is not supported by economic growth as measured by gross domestic product (GDP), the result can lead to hyperinflation. If GDP, which is a measure of the production of goods and services in an economy, isn't growing, businesses raise prices to boost profits and stay afloat. Since consumers have more money, they pay the higher prices, which leads to inflation. As the economy deteriorates further, companies charge more, consumers pay more, and the central bank prints more money — leading to a vicious cycle of hyperinflation.

Loss of Confidence in the Economy or Monetary System

In times of war, hyperinflation often occurs when there is a loss of confidence in a country's currency and the central bank's ability to maintain its currency's value in the aftermath. Companies selling goods within and outside the country demand a risk premium for accepting their currency by raising their prices. The result can lead to exponential price increases or hyperinflation.

If a government isn't managed properly, citizens can also lose confidence in the value of their country's currency. When the currency is perceived as having little or no value, people begin to hoard commodities and goods that have value. As prices begin to rise, basic goods — such as food and fuel — become scarce, sending prices in an upward spiral. In response, the government is forced to print even more money to try to stabilize prices and provide liquidity, which only exacerbates the problem.

Oftentimes, the lack of confidence is reflected in investment outflows leaving the country during times of economic turmoil and war. When these outflows occur, the country's currency value depreciates because investors are selling their country's investments in exchange for another country's investments. The central bank will often impose capital controls, which are bans on moving money out of the country.

Example of Hyperinflation

One of the more devastating and prolonged episodes of hyperinflation occurred in the former Yugoslavia in the 1990s. On the verge of national dissolution, the country had already been experiencing inflation at rates that exceeded 76% annually. In 1991, it was discovered that the leader of the then Serbian province, Slobodan Milosevic, had plundered the national treasury by having the Serbian central bank issue $1.4 billion of loans to his cronies.

The theft forced the government's central bank to print excessive amounts of money so it could take care of its financial obligations. Hyperinflation quickly enveloped the economy, erasing what was left of the country’s wealth, forcing its people into bartering for goods. The rate of inflation nearly doubled each day until it reached an unfathomable rate of 313 million percent a month. The central bank was forced to print more money just to keep the government running as the economy spiraled downward.

The government quickly took control of production and wages, which led to food shortages. Incomes dropped by more than 50%, and production crawled to a stop. Eventually, the government replaced its currency with the German mark, which helped to stabilize the economy.