Finance

Hyperinflation Explained

A topic that everyone is talking about: hyperinflation. The United States is currently experiencing its highest rate of inflation in decades, and many of us, particularly younger generations, are getting a crash course in economics as prices rise. It's natural to question whether a hyperinflationary collapse will exacerbate the extremes of the future. Fortunately for us, there are certain historical and current parallels that can help us with forecasting and weathering the storm if it comes.

January 10, 2022

Hyperinflation Explained

A topic that everyone is talking about: hyperinflation. 

The United States is currently experiencing its highest rate of inflation in decades, and many of us, particularly younger generations, are getting a crash course in economics as prices rise.

It's natural to question whether a hyperinflationary collapse will exacerbate the extremes of the future.

It may be frightening for individuals who have never experienced hyperinflation. Fortunately for us, there are certain historical and current parallels that can help us with forecasting and weathering the storm if it comes.

You've undoubtedly recently purchased gas, groceries, a car, a home, or just about anything else and noticed that prices have risen significantly.

That's because inflation inched up to 8.6% in May, the largest annual gain in nearly four decades. Josh Bennett and Isaiah Douglass often speak about the failings with measuring inflation via CPI. For example, if inflation was measured the same way it was in the 1980’s (the last time we had major inflation) then our inflation rates are closer to 16%.

Source: Shadow Stats

Have you ever wondered why we are unable to print additional money to meet our demands?

We all know that the government prints money for the country, so it's understandable to question why it can't produce as much as it needs to meet the country's demands.

Here's why it won't work. 

If the government is allowed to print as much money as it wishes, hyperinflation will be the result. And that’s never good news.

Let us get to the heart of the matter and grasp the overall concept of the “why.”

So, to the question everyone is asking: What is Hyperinflation?

Hyperinflation can be easily confused with inflation, but they are not quite the same. 

- Inflation is defined as the rate at which the cost of products rises over time.

- Hyperinflation, on the other hand, refers to rapid, out-of-control price increases. 

For example, since hyperinflation occurs when prices rise by 50% in a month, this phenomenon equates to a daily increase of 5 to 10%. 

Yikes. You know, like when your kids have blue raspberry slushies and begin sprinting around your living room for a full hour? That’s it. Hyperinflation is just inflation on a sugar high.

How Do You Calculate the Rate of Inflation?

Source: Mint Life

In the formula, A would be the starting point in the Consumer Price Index for a specific good or service, which could either be a specific year or month. And B would be the current recording in the Consumer Price Index for this same good or service.

To use the formula:

- Subtract A from B to find out how much the price of that specific good or service has changed.

- Then divide the result by A (the starting price) which will leave you with a decimal number.

- Convert the decimal number into a percentage by multiplying it by 100. 

The result is the rate of inflation!

What Causes Hyperinflation?

An increase in a country's money supply and output constraints following a war or natural disaster are the most common causes of hyperinflation. It's not pretty, to be sure. 

Let's look at how each of these factors can result in hyperinflation.

1. Money Supply Increase (printing money)

The economy suffers from a negative growth rate during times of depression. As a result, governments frequently use the federal reserve to increase the money supply in order to encourage consumption and investment. This can endure for months or years, resulting in significant unemployment, personal and business bankruptcies, little to no production output, and lenders granting fewer loans.

For example, as the world battled with COVID-19, the Federal Reserve established regulations to address the pandemic's financial ramifications. The Federal Reserve declared in March 2020 that it will hold the federal funds rate between 0% to 0.25 percent. It also stated that it intends to buy at least $500 billion in Treasury securities over the following months.

The M1 money supply in the United States surpassed $4 trillion in February 2020. The M1 money supply had more than doubled by June 2020 as a result of the huge governmental response to COVID-19. By October 2021, the M1 money supply had surpassed $20 trillion.

2. Inflationary Demand-Pull

This occurs when the demand for items increases while the supply remains unchanged. If merchants are unable to keep up with demand, they may boost their prices. 

As a result, prices rise in order to keep up with demand. When there is a strong demand for commodities and the cost of purchasing them continues to rise, it creates the perfect storm for hyperinflation to emerge. As more exports are consumed by foreigners, rapid overseas expansion might likewise spark an increase in demand. Finally, when a government lowers taxes, it leaves households with more disposable money. As a result, consumer confidence rises, resulting in increased consumer spending. Demand-pull inflation can occur as companies pass on the higher cost of production to consumers to maintain their profit levels.

3. Loss of Confidence in an Economy

This is more common during a time of war. Conflicts can cause a country's currency to lose value, resulting in fiscal and economic collapse. Those that exchange products and services will raise their prices in order to acquire collateral for doing "risky commerce" using the local currency. If consumer confidence falls for any reason, people become less confident in their financial prospects and begin to spend less money; this, in turn, has an impact on businesses, as sales begin to fall. The economy will decelerate and may eventually enter a recession if consumer spending continues to fall and firms begin to cut down on production.

The Consumer Confidence Index (CCI), the most widely used quantitative measure of consumer confidence in the United States, is based on a monthly survey of 5,000 households performed by the Conference Board, an independent research organization. Businesses, the Federal Reserve, and investors all keep a careful eye on the CCI.

Effects of Hyperinflation

Hyperinflation affects consumer behavior at its most basic level. People pay more for products and services when prices rise, while also hoarding goods for later. Hoarding products generates shortages, which increases demand while also limiting supply and driving up prices.

As a result, cash loses its value and, as a result, a country's currency devalues. Domestic enterprises and importing services go out of business as the country's currency loses value in comparison to foreign currency, and unemployment rates rise.

The government's answer to hyperinflation is to print more money, but this just serves to speed up the rate of inflation. 

Only those who are in debt and unable to repay their loans gain from hyperinflation on a personal level. Export enterprises also benefit since moving items out of the nation becomes more economical.

Hyperinflation in Weimar Germany

The most well-known instance of hyperinflation occurred in Germany under the Weimar Republic in the 1920s. The number of German paper marks surged by a factor of four during World War I. It had risen by billions of times by the end of 1923. The German Reichsbank issued 92.8 quintillion paper marks from the commencement of the war until November 1923. The value of the mark fell from around four to the dollar one trillion to the dollar. Initially, the fiscal stimulus decreased export costs and boosted economic growth.

The Allies forced Germany to pay another 132 billion marks in war reparations when the war ended. The collapse in production resulted in a lack of supplies, particularly food. The price of ordinary commodities quadrupled every 3.7 days due to an excess of currency in circulation and a scarcity of goods. The daily rate of inflation was 20.9 percent. Farmers and others who produced commodities fared well, while the majority of people were either very poor or fled the nation.

Hyperinflation in Venezuela

Venezuela is the most recent example of hyperinflation. In 2013, prices increased by 41%, and by 2018, inflation had reached 65,000%.

The money supply was boosted by 14% by the government in 2017. Because the bolivar has lost nearly all of its value against the US dollar, it is promoting a new cryptocurrency called "Petro."   Unemployment reached over 20%, close to the percentage in the United States during the Great Depression.

How did this happen? Hugo Chávez, the former president of Venezuela, imposed price limits on food and medication. However, the regulated prices were so low that they drove domestic businesses out of business. The government retaliated by paying for imports. Oil prices dropped in 2014, reducing revenues for government-owned oil corporations. When the government's currency supply ran exhausted, it began printing more. 

Venezuela's foreign debt was estimated to be around $100 billion in 2016. In early 2020, the yearly inflation rate for consumer prices reached 2,300 percent. The country is facing a massive debt payback crisis as its economy continues to deteriorate. Venezuela's hyperinflation is expected to persist until late 2021.

Hyperinflation in Zimbabwe

Between 2004 and 2009, Zimbabwe faced hyperinflation. To fund the Congo conflict, the government minted money. Droughts and farm expropriation also hampered the availability of food and other locally produced commodities. As a result, hyperinflation was worse in the United States than it was in Germany. The daily rate of inflation was 98 percent, with prices doubling every 24 hours. 13 It came to an end when the country's currency was retired and replaced with a system that utilized a variety of foreign currencies, mostly the US dollar.

Hyperinflation in the United States

The United States only experienced hyperinflation once, during the Civil Fight, when the Confederate government produced money to fund the war.  The Consumer Price Index would be used to measure hyperinflation if it occurred again in the United States. The current inflation rate reveals that the United States isn't even close to hyperinflation (it's in the single digits).  In reality, slight inflation can be beneficial to economic growth, therefore inflation may be too low.

With monetary policy, the Federal Reserve prevents hyperinflation in the United States. The Fed's principal goal is to keep inflation under control while preventing a recession. It accomplishes this by tightening or loosening the money supply, or the quantity of money permitted to enter the market. The danger of inflation is reduced by tightening the money supply, whereas the risk of inflation is increased by loosening it.

The Federal Reserve's inflation target is 2% per year. This is the core inflation rate, which excludes the impact of volatile oil and gas prices. Those commodities fluctuate a lot depending on commodity trade. This has an impact on the cost of food transported across large distances by trucks. As a result, food prices are excluded from the core inflation rate by the CPI.

Are We Experiencing Hyperinflation?

No. Even with the current level of inflation, it would take a lot more to trigger hyperinflation. Remember that hyperinflation occurs when prices rise by 50% every month. And, despite the fact that it may appear that we've arrived, we haven't.

In 2022, food prices continued to climb at a rate of around 1% per month, while shelter prices rose at a rate of approximately 0.5 percent per month, and gas prices rose at a rate that was nowhere near 50%. Gas prices increased by 18% from February to March 2022. That's still a significant increase, but it's not 50%.

How to Combat Hyperinflation Before It Happens:

1. Evaluate Your Personal Budget

Examine your personal spending habits to see if there are any areas where you could save money. Refinancing loans, consolidating debts for reduced rates, and paying off debts are all options to consider. Investing in yourself through continuous education to improve your professional marketability can also lead to improved revenue from new business initiatives or supplemental income.

2. Explore Growing Assets

Invest in growing assets to protect your money. Use a diversified approach with a mix of assets instead of storing your money in a savings account. During inflationary eras, investments must grow to maintain their value, as they will not increase in value if retained in cash. Consider stocks, real estate, and other high-yielding investments.

3. Examine Your Investment Strategy

In times of rising inflation, it's a good idea to check in with an advisor to be sure you've got the right investment mix for your risk tolerance.

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