Hyperinflation Is Really Bad

Let’s start off talking about regular old inflation.  They we’ll get in to hyperinflation and why it is a wealth killer.

Inflation is basically the rise in prices of products and services of an economy with a result in reduced value of the widely accepted currency in that economy. Although it may sound like a bad thing, inflation has economic benefits and is also a determinant in the health of an economy. In the case where the inflation rate goes parabolic and is very high the scenario is referred to as hyperinflation.

What is Hyperinflation?

The hyperinflation definition according to Wikipedia is monetary inflation that occurs when a country experiences very high rates of inflation. The situation is usually rapid and easily erodes the real value of the currency of the affected economy. As a result, people minimize their holdings of the local money greatly and then switch to holding foreign currencies that are rather stable. During hyperinflation, the general price rates within an economy increase rapidly as the local currency loses real value very fast.

Hyperinflation has happened in various countries across the globe in the 20th and 21st centuries and almost resulted in economic collapses. Examples include Hungary, Germany and Zimbabwe. Increase in prices of commodities rapidly erodes the purchasing power of people. This leads to uncertainty for business because of the difficulty in determining the future prices of goods and services. Another result is increased loan rates since financial institutions will have to compensate for the declined purchasing power and value for the money, which is usually going down every day. Again, the cost of doing business in such an economy is normally high thus discouraging foreign investors, which also slows economic growth.

A popular example is the Weimar Republic of Germany hyperinflation. The central bank was giving out 2 trillion banknotes. In fact, the highest value banknote to be issued was 100 trillion. During this time one US dollar was worth more than 4 trillion marks. Funny enough this is not the worst case, in the same century Hungary issued a banknote of 100 quintillion (One quintillion is same as 100,000 trillion!!!). In the recent past, Zimbabwe has also suffered a hyperinflation, which resulted to abandonment of the Zimbabwe Dollars. The political activities of the President of the country resulted in unbalanced economic activities.  The effects hit the economy in the early 2000 and progressed to inflation rates of up to 11,000 % by 2009.

How To Calculate Inflation Rate

The inflation rates are generally calculated using the Consumer Price Index, which is published every month by the Bureau of Labor Statistics. Currently, it is easy to determine the change in inflation rates since the information is readily available online. One can access the inflation rates of up to 1914. Normally, inflation is driven by the increase in money supply times. The logic is simple; the difference in time of money creation and supply creates a lag depending on the time taken. Thus having the money creation done in anticipation of growth reduces the rate of inflation even with fast economic growth. The Federal Reserve works to maintain inflation in the 2% rate but that is however not easily achieved because of the economic and political activities within and outside of the US.

The current inflation rate in the US has not been similar in the past. In Revolutionary war era, the inflation rate was slightly below 50%. This had happened after the Continental Congress ordered rapid printing of the continental currency, which in turn depreciated in value very fast. One of the key reasons for the depreciation in the value of the continental currency was counterfeiting by the British. It is claimed that the British advertised the counterfeits and sold them at the price of the printing paper. This was not the only case where Americans experienced high inflation rates. Another inflation era was in the 1860s during the US Civil war. The war had great impact on the dollar in very negative ways. During this time, the dollar depreciated every day the war continued to an extent it was worthless in the last days of war (in the year 1865). The inflation rates had hit the 40% mark.

The process of rising prices is protracted and not even noticeable when there is low inflation. It even requires studying past market prices to identify this kind of inflation. The case is not the same for hyperinflation. This is because of rapid and continuing increase in prices of goods and products. The inflation rate is usually crazy and moving so fast that the money supply can’t meet the economic requirement to maintain even little value for the local currency.

If economic hyperinflation occurs during an economic depression, the most probable cause is rapid increases in the money supply that cannot be supported by the GDP of a country. The imbalance created is so huge and results to rapid increase in prices of goods and services within a very short time. The situation gets worse if not rectified early and the local currency loses value with every hour. On the other hand, when hyperinflation occurs during the times of war, it is because of low confidence in the currency of the affected economy. People abandon the local currency for foreign currencies while investors shy off from such economies. These events force the sellers to demand a premium for risk in using the local currency, which further worsens the case.