What is Hyperinflation?

Hyperinflation

Inflation is the change in the amount of money that we must give to get in return the overall set of goods in the economy. The basket used to measure inflation must have a large number of goods and services in it. A few common measures of inflation are Consumer Price Index (CPI), CPIH (CPI including housing costs), CPIY (CPI measure excluding the impact of indirect taxes such as VAT and excise duty), CPI-CT (similar to CPIY, holds indirect taxes rates constant at the rate prevailing at the start of the year), Retail Price Index (RPI), RPIJ (RPI calculated using more internationally recognised geometric mean) and GDP deflator.

In the Long Run, we know that expected inflation meets the target inflation rate and there are no changes in the expected inflation rate once that is achieved. So, the target inflation rate has a positive one-on-one relationship with the nominal interest rate prevailing in the market (Fisher Equation). 

From the Quantity Theory of Money (MV = PY), where M is the quantity of money supply, V is the number of times money changes hands, PY being the nominal cost spent on goods, we can see that when inflation rises, price level rises and that leads to a rise in the nominal amount spent on the goods present in the market. To maintain equality, the fastest way to increase the total transactions is by increasing the money supply in the economy. This leads to a rise in money supply in the economy. 

So an increase in inflation leads to a rise in money supply in the economy. Thus, leading to a rise in the nominal interest rate (Taylor Rule) due to their one-to-one relationship. During this situation, people prefer to hoard a lot of cash and the Central Bank prints more cash to meet the demand for money. To increase the circulation of money, the Central Bank buys goods (rather than bonds and other assets) from the printed money. 

With the increase in money supply and even higher inflation level, prices skyrocket. This unprecedented fall in the purchasing power of a person due to an accelerated inflation rate is known as Hyperinflation. Sebastian Haffner in his book – Defying Hitler: A Memoir wrote, “On the thirty-first or first of the month my father would receive his monthly salary, on which we depended for our survival. Bank balances and securities had long since become worthless. What the salary was worth was difficult to estimate; its value changed from month to month. One month 100 million marks could be quite a substantial sum; a little while later 500 billion would be small change.”

Hyperinflation in Germany

Before the First World War, the global monetary system was based on the gold standard with most currencies fixed to gold. During the outbreak of the First World War, Germany came out of the global standard to increase its flexibility to fund the war. This led to the rise in the amount of paper currency from 2 billion marks in 1913 to 45 billion in 1919, unleashing inflation. The loss in the war led Germany to repay the loans it had acquired to fund the war and also pay reparation in billions of dollars.

The journey from inflation to hyperinflation gathered pace in 1921 when the price of food items rose by 50% on a monthly basis. Post 1922, prices were rising every few hours. Barter became a common form of exchange based on commodities like brass and fuel. A cinema ticket could be paid for with a lump of coal. There were stories of people ordering meals in restaurants and being charged more when the bill came.

During these years the currency collapsed as the mark’s supply rose exponentially. It fell from 7.4 per US dollar in November 1918 to approximately 2.5 trillion per US dollar on 15 November 1923 on the eve of currency reform.

Hyperinflation in Zimbabwe

The Zimbabwe government in the late 1990s introduced ESAP (Economic Structural Adjustment Programme) and  a series of land reforms which involved redistribution of land from the existing white farmers to black farmers. The little experience of the black farmers led to a fall in the agricultural yield. The economy experienced a sharp fall in output and this caused a collapse in bank lending. To fund the war in Congo, increase the salaries of the soldiers and officials, the bank started printing more money to increase the money supply. The short term benefits of money printing soon led to an increase in printing of money to finance government debt which caused inflation to rise further. Inflation meant bondholders saw a fall in the value of their bonds and so it was hard to sell future debt. The economy also experienced many shortages of goods.

Due to the decline in output, there were shortages of goods, which pushed prices up. Nominal demand was rising because people had more paper money. This combination of more money chasing fewer goods caused very rapid rises in price. Combined with printing more money and this shortage of actual goods, prices rose rapidly.

Ironically, the situation worsened once a price control was put in place. Price controls set the price for basic goods (the idea was to keep prices affordable and stop inflation). But, because the cost of production increased faster than prices, suppliers had little incentive to supply the goods. This made the shortage worse and the actual inflation worse. During the height of inflation from 2008 to 2009, it is assumed that Zimbabwe’s peak month of inflation is estimated at 79.6 billion percent per month, or 98% per day. Zimbabwe was the first country to experience hyperinflation in the 21st century and recorded the second worst inflation episode in history (after Hungary). In 2008, the ZWN was officially abandoned, and foreign currencies were adopted as legal tender.

Hyperinflation in Venezuela

Venezuela’s economy began to experience hyperinflation during the first year of Nicolás Maduro’s presidency. Potential causes of the hyperinflation include heavy money-printing and deficit spending. The inflation rate of Venezuela has been one of the highest in the world, going from 69% in 2014 to 800% in 2016 and from 4000% in 2017 to 1,700,000% in 2018. 

The growth in the BCV’s (Central Bank of Venezuela) money supply accelerated during the beginning of Maduro’s presidency, which increased price inflation in the country. The money supply of the bolívar fuerte in Venezuela increased 64% in 2014, three times faster than any other economy. Due to the rapidly decreasing value of the bolívar fuerte, Venezuelans jokingly called it “bolívar muerto” (“dead bolívar”). Another reason for the hyperinflation in Venezuela is the devaluation of the bolivar from 2010 to 2018 which resulted in the fall in the price of domestic currency against the US $. Since 2016, the overall inflation rate has increased to 53,798,500%. The current inflation rate, as of May 2020 is 2296%.

 

Advantages of Cryptocurrencies

We have seen that most of the hyperinflations that have occurred in the past was because of the government’s attempt to finance the budget deficit by over printing money. This shows us the fragility of fiat currencies. Because fiat money is not backed by any physical reserves and has no intrinsic value, its value is dependent on our good faith and credit in the economy. When excess currencies are in circulation we lose confidence in a piece of paper’s ability to retain value and money loses its value overnight. 

Today there is an excess US dollar supply beyond domestic needs. An oversupply of the world reserve currency could lead to an inflation level at a much larger scale. But the booming cryptocurrency scene could help in building an immune system that would not lead to hyperinflations in the future.

In the traditional world, banks hold only 10-15% of their deposits on a daily basis but earn interest on the remaining deposits that the Central Bank owns. Normal citizens on a regular basis do not know about the transactions happening between banks and how that could affect the value of the domestic currency. 

But with cryptocurrencies, there is no centralised entity to govern the money. The rules governing their supply are built into the code. Because the protocol and process is fully transparent, any average citizen can monitor and view the creation of money in real time. Cryptocurrencies eliminate the need to trust banks for fiat currencies.

The government or the Central Bank can come and intervene in the process of deciding the money supply but most cryptocurrencies are designed in a manner that limits their supply to a fixed number, for example, bitcoin supply is limited to 21 million bitcoins. This will lead to a more stable inflation rate as the supply of bitcoin reaches its limit. 

The mechanism of supply may differ for each cryptocurrency, but one thing they share in common is that the amount of cryptocurrencies in supply is completely predictable. This means that the producers of the economy will be able to project the real demand and supply of markets more accurately. For example, The amount of new bitcoin released with each mined block is called the “block reward.” The block reward is halved every 210,000 blocks or roughly every 4 years. In 2009, it was 50. In 2013, it was 25, in 2018 it was 12.5, and to 6.25 in May 2020.

 

Conclusion

Cryptocurrencies could replace fiat currency someday. In the meantime, it can be used during times of hyperinflation by leveraging it on a day to day basis. The stability in price of cryptocurrencies because of its transparent, trustless, immutable and decentralised nature allows us to make peer to peer payments, use it as a storage of personal wealth and send remittances (because of the low transaction cost and no loss in value due to hyperinflation or any financial crisis). The path is long but