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Hyperinflation is a serious form of inflation, namely the widespread increase in the prices of goods and services. What distinguishes hyperinflation from inflation is its pace and causes. Hyperinflation is sometimes defined as inflation of more than 50 percent per monthcompared to typical inflation in a developed country of 1 to 4 percent annual. The result of hyperinflation resembles the classic images of consumers carrying cartloads of cash to buy groceries in 1920s Germany.
Here’s the cause of hyperinflation, its signs, and what you can do to protect yourself.
What causes hyperinflation?
Inflation can be caused by a variety of factors – including increased money supply, too much demand, reduced supply, rising input prices and price increases – and it is normal for some inflation to occur as an economy grows. But the conditions for hyperinflation are more specific:
- A country has significant debt, especially debt denominated in foreign currencies.
- The country’s productive capacity is being compromised in some way, which hurts both the government’s ability to collect tax revenue and the country’s exchange rate.
- The cost of foreign debt is rising (due to a falling exchange rate), and the government cannot collect enough taxes to cover its expenses and cannot borrow to make up the difference, perhaps due to a crisis of confidence among political or political parties . economic chaos.
- The government starts printing money to pay its bills, the exchange rate collapses and the debt spirals out of control.
A vicious circle reinforces the process. As the value of money falls, the government must print more to keep up with spending, leading to even higher inflation – and ultimately hyperinflation. Consumers realize that their money will be worth more if they spend it now instead of saving it for later, further driving up inflation.
What are the signs of impending hyperinflation?
Economists and financial experts recognize several signs of impending hyperinflation.
Rapid rise in inflation: Economists consider inflation above 5 percent to be high. If this rate exceeds 50 percent per month, it is called hyperinflation. A rapid escalation in inflation, especially without corresponding real economic growth, can be a warning sign of hyperinflation.
Loss of confidence in government institutions: When the public loses confidence in the government’s ability to manage economic and financial crises, including confidence in the country’s currency, hyperinflation may be on the horizon. It is important to consider the loss of confidence of foreigners in a country, especially foreign investors, who might otherwise lend to the country. Their reluctance to at least borrow money is contributing to accelerating hyperinflation.
Increasing debts: Rising debt levels help put pressure on the government by creating a further source of financial pressure. It can be particularly tricky if the debt is denominated in a foreign currency, as any fall in the exchange rate makes it more expensive to repay.
Collapsing exchange rate: Another part of the equation for hyperinflation is a gradually falling and then collapsing exchange rate as international investors lose confidence in the country. The collapsing exchange rate makes foreign currency debt unaffordable.
Inability of a government to borrow: If the government is unable to borrow, especially in its own currency, it may have no other solution than to print money to pay its bills.
Rapid increase in money supply: If the money supply grows rapidly without being supported by an increase in real growth, this can lead to hyperinflation. This scenario often occurs when governments print money excessively. A recent example of rampant money printing and hyperinflation is Venezuela.
How does hyperinflation differ from high inflation and stagflation?
Although all three terms – hyperinflation, high inflation and stagflation – indicate negative economic conditions, they differ in impact and frequency. For example, high inflation can make it difficult to afford daily necessities, but the cycle is relatively easier to break than hyperinflation.
- Hyperinflation is an extreme state of inflation resulting from severe currency devaluation, skyrocketing debt, loss of confidence in the country, and government money printing.
- High inflation is less serious, but also causes price increases. High inflation can generally be curbed by reducing the money supply through higher interest rates or by reducing aggregate demand.
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Stagflation combines high inflation with stagnant economic growth and high unemployment, marking an unhealthy economic scenario.
How does hyperinflation affect the economy and individuals?
At the macro level, hyperinflation can seriously hinder a country’s ability to meet its financial obligations or produce goods and services. The price of goods is skyrocketing, making it difficult for consumers to afford basic necessities and for businesses to make profits. Meanwhile, prices can change so quickly that it becomes difficult to plan and operate. The exchange rate plummets, making the country’s products cheap to foreigners, and making foreign goods or raw materials prohibitively expensive to import.
On an individual level, it also becomes unaffordable to buy anything produced outside the country, and citizens only have to buy locally made products. Ultimately, citizens’ living standards will be destroyed, resulting in widespread poverty.
How can hyperinflation be controlled or stopped?
Controlling or stopping hyperinflation requires a multi-faceted strategy. Overall, the country needs to wipe the slate clean and create a new and credible foundation for financial transactions.
One of the first steps to recover from hyperinflation is to introduce a new currency. That currency could be a new version of the existing currency, a credible foreign currency such as the US dollar or a peg of the currency to another benchmark such as gold.
The use of a foreign currency or other measure prevents the government from printing money, thus keeping spending in check. This approach also helps restore the government’s credibility as a prudent lender, and can convince foreign investors to lend money to the country.
If the government introduces a new currency, it must be a credible alternative to the existing currency, which means that the potential users of the currency must believe that the government will not simply do the same as with the old currency. Making a new currency work often requires the creation of a new government that can make credible promises to foreign investors.
After a credible new currency is in place, the country can begin the process of rebuilding its living standards using the productive resources at its disposal.
What actions can the Federal Reserve take to prevent hyperinflation?
In the US, the Federal Reserve plays a crucial role in keeping prices stable, and the disastrous economic consequences of hyperinflation are one reason for that. Officials view a small amount of inflation as a hallmark of a sustainable and productive economy, with 2 percent typically being the Goldilocks, a “not too hot, not too cold” rate.
The Fed controls inflation in a number of important ways:
- Adjust interest: To slow inflation, the Fed can raise its key interest rate, which directly leverages the borrowing costs consumers pay to finance cars, homes or things with a credit card. It is thought that higher interest rates will depress demand and consumer spending, and ultimately reduce the availability of credit in the economy as financial firms lend less money.
- Regulating the money supply: To suck out the amount of money sitting around in the economy, the Fed can reduce banks’ reserves.
- Building confidence in US monetary policy: By talking tough on inflation and creating a pattern where words are backed by action, the central bank can help investors and consumers maintain their faith in U.S. price stability — an expectation that often becomes reality.
- Taking actions that preserve jobs: Keeping the U.S. economy productive can stimulate growth and ensure that Americans have a stable income that can be taxed with government revenue.
While the Fed can help the US avoid hyperinflation through monetary policy, the government can pursue fiscal policies that thwart central bank policy. For example, the government can spend much more than it takes in and then refuse to raise taxes (perhaps because of political impasse) or cut spending. Such continued stalemate could ultimately lead to a loss of confidence in U.S. financial institutions and counter the Fed’s anti-inflation policies.
How can you protect yourself against hyperinflation?
Individuals can adopt different strategies to safeguard their finances during hyperinflation. At their core, these strategies are based on investing money safely in stable foreign economic regimes, because a key aspect of hyperinflation is a rapid devaluation of the domestic currency.
- Buying foreign shares: Buying shares in productive foreign companies keeps your capital working and generating income.
- Buying foreign real estate: Foreign real estate in a stable area can retain value regardless of what happens in the hyperinflationary environment. Publicly traded real estate investment trusts (REITs) that hold assets abroad are a quick way to protect money from a hyperinflationary environment.
- Buy gold: Gold can act as a store of value and a kind of international currency, and it can be one of the fastest ways to quickly link your capital to a source of value outside your country. It’s easy to buy a gold ETF that tracks the price of gold, but bullion is a much less attractive way to do this.
In short, those with investable assets should try to get them out of the rapidly depreciating currency as quickly as possible so that they retain as much value as possible.
In short
Hyperinflation can quickly erode the value of a country’s currency and lead to unaffordable prices for daily necessities. But it’s important to understand that it takes a specific set of circumstances and a long path of missteps for a country to make this drastic mistake.
