Hyperinflation

A World History

He Liping

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351361880
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Since 1970s when the world was experiencing an "age of inflation", a great volume of academic research about hyperinflation has been conducted. However, it is also true that parrot-like superficial talks abound, without questioning the economic, political and social foundations existing underneath the economic phenomenon.

Based on research results of contemporary economists, media reports and historical works, this book will be the most comprehensive narrative of all major events of hyperinflation worldwide from the turn of the first millennium to the mid-2010s. Firstly, it gives a brief illustration of the basic concepts of hyperinflation, starting with the definitions and price measurement. Then it traces and analyzes all major episodes of hyperinflation that occurred over the past two thousand years or so, from the earliest incidence to the four tidal waves in the 20th century, and to the three latest episodes in the 21st century. Using basic concepts in modern finance such as indexation and dollarization, this book explains why hyperinflation in some countries could explode into astronomical levels, while rhythms of hyperinflation in the 20th century world are in resonance of megatrends in world economy and politics. Finally, this book underscores the importance of policy making, institutional building and international relations in the process of hyperinflation and stabilization.

Scholars and students studying money and finance, economic history, international finance and economics will be attracted by this book.

1
Introduction

Basic concepts of hyperinflation

“Natura non facit saltum.” (Nature does nothing in jumps)

An axiom cited by Alfred Marshall in his Principles of Economics, 1890

“Nature abhors a vacuum.”

Aristotle

Inflation as an economic and monetary phenomenon usually refers to a rising trend in general prices in a country over a period of time. Hyperinflation is an unusual type of inflation wherein general price rises reach such unusually high levels that the currency tends to become no longer able to perform its normal functions in part or wholly. Monetary conditions in the economy have therefore rapidly become enormously aberrant. The causes of hyperinflation may be easily confused with those of inflation, but they are distinctively different. As a type of financial crisis, hyperinflation can lead to economic collapse, and a stabilization program is necessary following an outbreak of hyperinflation. Correcting policy, building institutions in sensible ways, and having access to international resources are the most important elements of a successful stabilization program.

What is hyperinflation?

Inflation has been common worldwide from past to present, but hyperinflation has not. Over the course of history, the known incidence of hyperinflation is not high. From the late eighteenth century to the 2000s, 56 episodes of hyperinflation involving nearly 40 countries or political regimes have been recorded, based on a “monthly” definition of hyperinflation,¹ and 16 countries have witnessed at least one hyperinflationary incidence between 1800 and 2008,² according to an “annual” definition of hyperinflation.

Three quantitative criteria of hyperinflation

The first quantitative definition of hyperinflation is that a general price level increases 50 percent or more from one month to the next. And, the second is that a general price level climbs at least 500 percent year on year. The two definitions of hyperinflation are not directly comparable; there is no way to say which is greater. Of course, in a year when the monthly inflation rate is 50 percent every month, the annual inflation rate will be nearly 13,000 percent – corresponding to an almost 130-fold increase in prices – far greater than the annual criterion of 500 percent. In reality, however, hardly any country would see such an inflation rate sustained over a long period. In other words, an economy experiencing a monthly rate of 50 percent for one month or a few months may end up with an annual rate below 500 percent for the year. Or, an annual rate of 500 percent may be accompanied by a monthly rate of at least 50 percent for one or more months during that year.

The monthly definition was first suggested by American economist Phillip Cagan in a research paper published in 1956 on hyperinflations in five countries during the interwar period: Austria, Germany, Hungary, Poland, and Russia.³ In light of his systematic analysis, the term “hyperinflation” became popular in academia. Before then, many phrases were used to describe high inflation – including “very high inflation,” “severe inflation,” “rapid inflation,” “acute inflation,” “gallop inflation,” “runaway inflation,” “explosive inflation,” and “extreme inflation” – and some are still in use to a certain extent. A concise, mathematically rigorous definition facilitates accurate analysis and also discards many other “unimpressive” cases of inflation, both past and present.

In the history of hyperinflation, Hungary holds the all-time world records, measured on both monthly and annual bases. In 1946, her consumer prices rose 4.19 × 10¹⁶ percent month on month in July and climbed at an annual rate of 9.63 × 10²⁶ percent that year.⁴

Some economists suggest a much lower criterion for hyperinflation or “very high inflation”: an annual rise of 100 percent in general prices.⁵ This does not mean, however, that economists disagree on the criterion of hyperinflation. Rather, different quantitative thresholds serve as a reminder that other circumstances may be used to determine whether a country has encountered hyperinflation. For instance, in today’s world, when single-digit inflation is the norm, any country that has double-digit inflation would be regarded as having “very high inflation.” In ancient times, when people’s incomes were considerably low by contemporary standards, and their daily necessities relied on market supplies, a 10 percent monthly rise or 50 percent annual rise in prices would harm people’s living standards tremendously, often leading to malnutrition and even starvation. Such situations should be taken into account when studying high inflation or hyperinflation.

Measurement of inflation and hyperinflation

The study of hyperinflation requires appropriate price indicators, a number of which are widely used nowadays in routine macroeconomic research.

Consumer price index (CPI): a general price index consisting of a basket of consumer goods and services.

Producer price index (PPI): a general price index consisting of a basket of producer goods, mainly industrial products, as they are delivered to others.

Retail price index (RPI): like CPI, a measurement of prices of a basket of consumer goods and services, with the information collected from a large number of retailers. In earlier times, RPI mainly covered goods.

Wholesale price index (WPI): a measurement of prices of a basket of merchandise that is frequently traded in a country’s wholesale markets.

All these price indexes are compiled with similar statistical methodologies and can be fairly used for historical comparison purposes.

Influenced by the rise of labor movements during the first half of the twentieth century, many countries started to compile and publish a cost of living index (CLI). While CPI and CLI are basically the same, the two may differ in the weights they assign to individual categories or items in the basket of consumer goods and services.

In recent decades, many countries have also published price indexes such as Core CPI and GDP deflator. Core CPI excludes food and fuels, which conventional CPI⁶ includes, mainly because prices of food and fuels tend to be more vulnerable than others to short-term shocks. Without these two, Core CPI may show relatively stable movement over time or mostly reflect the effects of economic activity within a country. GDP deflator – an implicit price deflator for gross domestic product – is a comprehensive measure of price changes in both the production and consumption sectors of an economy. Its scope is much wider than those of CPI, PPI, RPI, or WPI. Usually the information of GDP deflator is published on quarterly base, so that it has a lower frequency than many other price indexes.

Sometimes, when no price index information is available, other indicators may serve equally well for gauging inflation or possible hyperinflation. Interest rates and exchange rates are such indicators. In theory, interest rates and exchange rates change quickly and accordingly when price inflation is happening, because participants in credit markets or foreign exchange markets should be able to properly adjust their use of money based upon observed and anticipated price changes. Even if price index information is available, interest rates or exchange rates can be used either to confirm the occurrence of hyperinflation or to reveal its impacts in the economy.

Usually when hyperinflation takes place, the domestic credit and foreign exchange markets of the country concerned are in chaos. Consequently, black markets for credit and foreign exchange typically emerge, and people tend to rely on interest rate and exchange rate information derived from these unofficial markets as it reflects actual market transactions.

In absence of all of the above-mentioned price indexes and interest and exchange rates, inflation or hyperinflation may be gauged by reference to the prices of single commodities. In Asia, price information about rice provides a good example in this regard.

Collecting price information is time-consuming and costly. As a result, compiling and publishing price information on a regular basis and in a transparent way is a public service provided by government. Yet, in reality, governments from time to time attempt to distort price information for short-term political gain. The Economist, the weekly periodical based in London, once suspended the inclusion of the Argentine CPI in its regular tabulation of the latest international macroeconomic data on suspicion of the Argentine government’s manipulation of the information.⁷ Scrutiny is always needed with regard to the reliability of price information.

A qualitative definition of hyperinflation

From past to present, money performs three basic functions in an economy:

• A unit of account – values of any commodity in a society are expressed and measured in a unit of currency, therefore transactions and trade can take place in accordance with the principle of equal exchange.
• A medium of exchange – money is used as a means of payment for anything else in a society, and it saves the cost of transactions which use non-monetary means of exchange, such as in the case of barter.
• A store of value – money can be saved by its holders for future use, as long as its value (purchasing power) does not fall over time. The purchasing power of money is the total quantity or quantities of goods and services that a fixed amount of money can buy. As such, the purchasing power of money depends on given prices of goods and services and their changes over time. How much money people save – to what extent money is used as a store of value – is thus affected by price inflation as well as by other factors including income, wealth, and degree of uncertainty about the future.
• By law, a form of money can become legal tender in a country, to be used in settlement of debts and obligations between members of the society. If the money is sound, its role as legal tender should have no problems. But if the money becomes unsound, even the law cannot stop people from discarding it.

A practical definition of sound money is money that can perform all of its three basic functions at the same time. Correspondingly, unsound money is money that can no longer properly fulfill some of its functions, primarily because of serious inflation. During periods of inflation, the purchasing power of money tends to decline. When no possibility exists in the domestic monetary system for money holders to offset the diminishing effect of rising inflation on purchasing power, they tend to seek alternative ways of saving, whether foreign currency, commodities, or something else.

A qualitative definition of hyperinflation, therefore, is loss of the function of money as a store of value. When this happens and domestic money holders begin to seek alternative assets or forms of money, asset substitution or currency substitution occurs. In these circumstances, domestic money may continue to perform its functions as a unit of account and a medium of exchange. But, hyperinflation can lead to an outcome where people even abandon the use of national currency in domestic transactions, i.e., the money loses its other two functions as well. Economists nowadays refer to this situation as “dollarization” – the widespread use of foreign money in domestic transactions. When the situation is not recognized by the government concerned, it is de facto dollarization. And when a government formally endorses a foreign currency as legal tender in its jurisdiction, it is de jure dollarization. Partial dollarization means that domestic and foreign currencies coexist in domestic transactions, and this most probably suggests that the domestic money has lost its function as a store of value.

What causes hyperinflation?

The causes of hyperinflation are easily confused with those of inflation. With regard to the latter, the following are often regarded as necessary candidate factors:

• Shortages: Excess demand caused by either a demand or supply shock such as a sudden drop in output due to a natural disaster;
• Balance of payments shocks: For example, a sudden rise in international oil prices (terms of trade shock); overvaluation of domestic currency leading to deterioration of the currency account balance; or unsustainable accumulation of foreign debt;
• Government budget deficit: Such as a sudden loss of revenue or an irresistible increase in fiscal spending;
• Expansionary monetary policy: Monetary authorities in a country adopt a policy of continually increasing money supply and pushing down interest rates in real terms;
• Paper currency system: Governments with paper money systems are constantly tempted to resort to an inflationary policy to finance budgetary needs as and when necessary or desirable.

Modern periods of inflation have been closely related to these factors. When inflation occurs in a country over a period of time, people can often identify at least one of the five factors. Clearly, though, these factors are not sufficient conditions for inflation, not to mention hyperinflation. In a paper currency system, for instance, deflation can occur as much as inflation. In the 2010s, many governments around the world run budget deficits, yet their national economies barely see any significant inflation. For hyperinflation to arise, something else must be in effect. Often before a period of hyperinflation, an economy has already experienced substantial inflation, which the government has already attempted to contain through certain policy measures. Hyperinflation very rarely occurs all of a sudden, without any early warning signs. Rather, hyperinflation usually results from previous inflation that has eventually escalated to an astronomical level.

Therefore, hyperinflation has its own causes, distinctively different from those of “ordinary” inflation, the following three of which are the most relevant:

• Policy failure in an inflation stabilization process;
• Institutional deficiency that causes the public to lose trust in the government and confidence in a stabilization process; and
• International i...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Contents
• List of figures
• List of tables
• Foreword
• Preface
• Acknowledgements
• 1 Introduction: basic concepts of hyperinflation
• 2 Monetary adventures before the twentieth century
• 3 The first wave of hyperinflation in the twentieth century: Germany, Russia, and CEE countries in the 1920s
• 4 The Second World War and the upsurge of hyperinflation in the 1940s
• 5 War finance and its aftermath: China in the 1940s
• 6 Hyperinflation in an “age of inflation”
• 7 A wave of hyperinflation in transition economies
• 8 World trend outliers: Zimbabwe and Venezuela in the twenty-first century
• 9 Conclusion
• References
• Index