© James Cumes
From "America's Suicidal Statecraft: The Self-destruction of a Superpower" (2006)
Hyperinflations – inflations in which the monthly rate exceeds, let us say, 50% or thereabouts - are largely a twentieth-century phenomenon. The most widely studied hyperinflation occurred in Germany after World War I. From August 1922 to November 1923, prices increased at an average monthly rate of 322%. On average, prices quadrupled each month during the sixteen months of hyperinflation.
While the German hyperinflation is better known, a much larger hyperinflation occurred in Hungary after World War II. Between August 1945 and July 1946 the general level of prices rose at the rate of over 19,000 percent per month, or 19 percent per day.
Even these very large numbers understate the rates of inflation experienced during the worst days of the hyperinflations. In October 1923, German prices rose at the rate of 41 percent per day; and in July 1946, Hungarian prices more than tripled each day.
What causes hyperinflations? No one-time shock, no matter how severe, can explain sustained - that is, long and continuously rapid - price growth. The world wars themselves did not cause the hyperinflations in Germany and Hungary. The destruction of resources during the wars can explain why prices in Germany and Hungary would be higher after the wars than before; but the wars themselves cannot explain why prices rose continuously at rapid rates during the long periods of the hyperinflations.
The key is that hyperinflations are usually caused by extremely rapid growth in the supply of "paper" money. They occur most characteristically when the monetary and fiscal authorities continue to issue large quantities of paper money, on a regular basis, to pay for an extraordinary and continuing volume of government expenditures. In hyperinflations, prices typically grow more rapidly than the money stock because people attempt to lower the amount of purchasing power they keep in the form of the swiftly devaluing money. Instead, they try to hold more of their wealth in the form of almost any kind of physical commodities, such items as gold and silver if they are available but almost anything else that has some intrinsic value if precious metals and the like are ruled out. As they buy these commodities not only for daily use but as a store of value, prices are forced up ever higher and inflation consequently accelerates ever more rapidly.
Hyperinflations tend to be self-perpetuating. Suppose a government is committed to financing its expenditures by issuing money and begins by raising the money stock by 10 percent a month. Soon the rate of inflation will increase, say, to 10 percent a month. The government can no longer buy as much with the money it is issuing and is likely to respond by expanding money growth even further. So the hyperinflation cycle is well under way. There will be a continuing tug-of-war between the public and the government. The public will try to spend the money it receives quickly in order to avoid what is, in effect, an inflation tax; the government will respond to higher inflation with still higher rates of paper-currency issue.
Hyperinflations end when governments make a credible commitment to halt the rapid growth in the stock of money. By this token, the German hyperinflation ended in late 1923, with the creation of a new unit of currency. The German Government promised that the new currency could be converted on demand into a bond having a certain value in gold, with the implied promise that the rapid uncontrolled issue of paper money would cease.
An alternative view held by some economists is that not just monetary reform, but also fiscal reform, is needed to end a hyperinflation. According to this view a successful reform entails two credible commitments on the part of government. The first is to halt the rapid proliferation of paper money. The second is to bring the government's budget into balance. This second commitment is necessary for a successful reform because it removes, or at least lessens, the government's incentive to resort to inflationary taxation. Proponents of this second view argue that the German reform of 1923 was successful because it created an independent central bank that could refuse to monetize the government deficit and because it included provisions for higher taxes and lower government expenditures.
Hyperinflations reallocate wealth. They transfer wealth from the general public, which holds money, to the government, which issues money. They also cause borrowers to gain at the expense of lenders in cases where loan contracts on fixed terms enter into force before the worst phases of the inflation. Commitments to repay those loans in real terms simply vanish in a few hours or days of hyperinflationary impact. Businesses that hold stores of raw materials and commodities gain at the expense of the general public. In Germany, tenants gained at the expense of property owners because rent ceilings did not keep pace with the general level of prices. One view is that, by destroying so much of the wealth of Germany's established classes, the hyperinflation cleared the way for the Nazis to win political power. Certainly, it created such economic and social turmoil that radical political outcomes of some kind could reasonably have been predicted.
Hyperinflation tends to drive the economy away from monetary transactions toward the clumsiness and inefficiency of barter. People hold money in as small quantities, for as short a time as possible. In a normal modern economy, major and fundamental efficiencies are derived from using money in exchange. However, during hyperinflations, people prefer to be paid in commodities in order to avoid what might be regarded as an inflation tax. If they are paid in money, they spend that money as quickly as possible. In Germany workers were paid twice a day and would shop at midday to avoid further depreciation of their earnings in the afternoon. Hyperinflation is a wasteful game of "hot potato" where individuals use up valuable resources trying to avoid holding on to paper money.
The hyperinflations that took place in Germany in 1923, in Hungary in 1945-46 and in several Latin-American countries – Argentina, Brazil, Peru, Bolivia, Chile and Uruguay – in the last thirty years seem to have provided the models for the monetarist theories of the 1970s and 1980s, some elements of which continue to be applied today. Monetarism postulated that inflation or hyperinflation was caused by excessive issue of paper or fiat money. Consequently, it was the money supply that must be carefully monitored and controlled if inflation were to be cured and avoided. However, excessive issue of paper dollars was not the cause of the inflation and stagflation that occurred in the United States after 1969 and that then spread to other highly industrialised countries. The dollar continued to be regarded as a respected reserve currency and several of the Latin-American countries used "dollarisation" to create a confidence-building "new currency" to manage their hyperinflations.
Although there had been, during the 1960s, huge expenditures on defence, the Vietnam War, space and external aid, as well as social welfare under Johnson's Great Society concept, United States inflation in July 1969 was modest. On a base of 100 for 1982-84, prices had lifted from around 31 in the earlier 1960s to a level of around 35 to 36 for 1969.
After 1969, the higher inflation – which never remotely approached hyperinflation if we define it as around 50% a month – came not from excessive government spending, large budget deficits or extraordinary printing of fiat money. It came instead from a reduction in production, especially industrial production, while consumer spending stayed high. So the inflation and stagflation of the 1970s and 1980s did not qualify for the remedies applied to correct a hyperinflation of the kind of that in Germany in 1923. What was called for was not a new currency which would have the confidence of users at home and abroad. Rather what was needed was a new stimulus to fixed-capital investment, which would enhance productivity and increase production. That would lift supply to match or exceed the level of aggregate demand originating in the private and public sectors combined. However, instead of doing this, a succession of United States Administrations, plus the Federal Reserve Board, did exactly the opposite. They persisted in fighting inflation by raising interest rates and thus providing additional disincentives to investment and increases in production - or increases in "supply" - that would have solved inflation by raising supply to the level of aggregate demand. From the early 1980s onwards, they also cut taxes in ways that further exaggerated disequilibria arising from excess consumption and inadequate production.
The "solution" came eventually when supply became available from outside the United States domestic economy. At that point, inflation was shifted from increases in domestic prices to deficits in the balances of trade and payments. However, that brought a whole new set of economic, political and strategic problems which we will deal with in due course. It also failed to solve the problem of inflation for goods and services which could not be "supplied from outside." Specifically, items supplied in such broad categories as education and health continued to be subject to intense inflationary pressures which were often not adequately identified in such official inflationary statistics as the Consumer Price Index (CPI).
Here we will just note that the shift in inflation to trade deficits and the accumulation of massive budget deficits over the years have brought us to a situation in 2006 in which a hyperinflation is a real and could conceivably be a near-term prospect. John Williams, a statistician and analyst who paints a more realistic picture of the American economy, especially contrasted with the official statistics, wrote in February 2006 that, if and when the value of the dollar falls dramatically under the weight of an avalanche of debt –
"You're going to see a lot of dumping of U.S. securities, particularly Treasuries. To absorb them, you're going to see a sharp spike in rates or the Fed will step in and provide liquidity to the market and buy them. My betting is, especially with [Fed Chairman] Mr. Bernanke, who is a student of what happened in the Great Depression, now in charge, that he has some ideas about what is going to happen here. If you look at what happened in the banking collapse in the early '30s, it's widely believed now that the Fed made a mistake in not pumping liquidity into the system. They let the money supply collapse as the banking system collapsed and that tended to accelerate the deflation and the depression; made the depression deeper than it perhaps had to be. So going forward here, if we have a circumstance where that mistake could be made again, the effort likely will be in the other direction, to provide liquidity to the system. You're not going to see banks fail. You're not going to see large financial institutions fail. The Fed will back the system with every dollar that it can print. But of course all that would go on top of what is already an uncontrolled federal deficit. The end result, when it does all come together, will be something akin to a hyperinflation, but at the same time you'll have also a very depressed economy. So there'll be an inflationary recession, which I think we're already beginning to get into, that possibly could evolve into a hyperinflationary depression, as much as I really hate to use that term. I am an optimist at heart. I'm not a perennial bear… (N)o one has mistaken me for a perennial bull for awhile, but if there's any way of getting around this—and I'm looking for ways for it to happen—I just don't see it. I mean, if we can accept for a moment my premise that there's no way of curing the fiscal problem shy of a bankruptcy—and that there's no way the government is going to renege on its debt—I'm sure it'll do what has been politically expedient in the past: You rev up the printing presses and pay off the debt with the money that you print—even as that money becomes worthless. The thing is, with the dollar, we are dealing with the world's reserve currency. So we are talking about a global crisis of unprecedented proportions, probably one that would lead to the collapse of the current currency system. You'd probably have to have an international conference to reconstitute the global currency system and somehow build confidence in the public that the new system will work and that it's stable, so that we are not put in the same position as the poor people of Germany, after WWI, because that is the type of hyperinflation that could evolve here. So the cures will have to be remarkable. They will have to convince people that things have changed. As crazy as it sounds, I think the only thing they will be able to do is to go back on some kind of gold standard."