What is Hyperinflation?
All economies experience some level of inflation, which occurs when the average price of goods increases, as the purchasing power of that currency decreases. Usually, governments and financial institutions work together to ensure inflation occurs at a smooth and gradual rate. However, there have been many instances in history where inflation rates have accelerated at such an unprecedented degree that it caused the real value of that country's currency to be diminished in alarming proportions. This accelerated rate of inflation is what we call hyperinflation.
In his book, "The Monetary Dynamics of Hyperinflation," economist Philip Cagan states that hyperinflation periods begin when the price of goods and services increases by more than 50% within one month. For example, if the price of a sack of rice increases from $10 to $15 in less than 30 days, and from $15 to $22.50 by the end of the following month, we would have hyperinflation. And if this trend continues, the price for the sack of rice could rise to $114 in six months, and over $1,000 in one year.
Rarely does the rate of hyperinflation remain stagnant at 50%. In most cases, these rates accelerate so rapidly that the price of various goods and services can increase drastically within one single day or even hours. As a consequence of rising prices, consumer confidence declines and the value of the country's currency decreases. Eventually, hyperinflation causes a ripple effect leading to company closures, increased unemployment rates, and decreased tax revenue. Well-known hyperinflation episodes occurred in Germany, Venezuela, and Zimbabwe, but many other countries experienced similar crisis, including Hungary, Yugoslavia, Greece, and many more.
Hyperinflation in Germany
One of the most famous examples of hyperinflation took place in the Weimar Republic of Germany after the First World War. Germany had borrowed massive amounts of money to fund the war effort, fully believing they would win the war and use reparations from the Allies to repay these debts. Not only did Germany not win the war, but they were required to pay billions of dollars in reparations.
Despite the debate about the causes of Germany’s hyperinflation, some commonly cited causes include the suspension of the gold standard, the war reparations, and the reckless issuance of paper money. The decision to suspend the gold standard at the beginning of the war meant that the amount of money in circulation bore no relation to the value of gold the country owned. This controversial step led to the devaluation of the German currency, which forced the Allies to demand reparations be paid in any currency other than the German paper mark. Germany responded by printing massive amounts of its own money to purchase foreign currency, causing the value of the German mark to depreciate even more.
At some points during this episode, inflation rates were increasing at a pace of more than 20% per day. German currency became so worthless that some citizens burned the paper money to keep their houses warm, as it was cheaper than buying wood.
Hyperinflation in Venezuela
Thanks to its large oil reserves, Venezuela maintained a healthy economy during the 20th century, but the 1980s oil glut followed by economic mismanagement and corruption of early 21st century gave rise to a strong socioeconomic and political crisis. The crisis started in 2010 and is now among the worst in human history.
Inflation rates in Venezuela increased rapidly, raising from an annual rate of 69% in 2014 to 181% in 2015. The period of hyperinflation started in 2016, marked by 800% inflation by the end of the year, followed by 4,000% in 2017 and over 2,600,000% in early 2019.
In 2018, president Nicolás Maduro announced that a new currency (sovereign bolivar) would be issued in order to fight the hyperinflation, replacing the existing bolivar at a rate of 1/100,000. Thus, 100,000 bolivares became 1 sovereign bolivar. However, the efficacy of such an approach is highly questionable. Economist Steve Hanke stated that cutting zeros is “a cosmetic thing” and “means nothing unless you change economic policy.”
Hyperinflation in Zimbabwe
After the independence of the country in 1980, Zimbabwe’s economy was quite stable during its early years. However, the government of President Robert Mugabe initiated a program in 1991 called ESAP (Economic Structural Adjustment Programme) that is deemed as a major cause of Zimbabwe’s economic collapse. Along with ESAP, land reforms performed by authorities resulted in a drastic drop in food production, leading to a big financial and social crisis.
The Zimbabwe dollar (ZWN) started to present signals of instability in the late 1990s, and hyperinflationary episodes began in the early 2000s. Annual inflation rates reached 624% in 2004, 1,730% in 2006, and 231,150,888% on July 2008. Due to the lack of data provided by the country’s central bank, the rates after July were based on theoretical estimates.
According to Professor Steve H. Hanke’s calculations, Zimbabwe’s hyperinflation reached a peak in November 2008, at an annual rate of 89.7 sextillion percent, which is equivalent to 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.
The use of cryptocurrencies
Since Bitcoin and other cryptocurrencies are not based on centralized systems, their worth cannot be determined by governmental or financial institutions. Blockchain technology ensures that the issuance of new coins follows a predefined schedule and that each unit is unique and immune to duplication.
These are some of the reasons why cryptocurrencies are becoming increasingly popular - especially in countries that are dealing with hyperinflation, such as Venezuela. Similar occurrences can be seen in Zimbabwe, where digital currencies peer-to-peer payments have seen a dramatic rise.
In some countries, authorities are seriously studying the possibilities and risks associated with the introduction of a government-backed cryptocurrency, as a potential alternative to the traditional fiat currency system. The central bank of Sweden is among the first. Other notable examples include the central banks of Singapore, Canada, China, and the US. Although many central banks are experimenting with blockchains, these systems won't necessarily create a new paradigm in terms of monetary policy as their cryptocurrencies are unlikely to have a limited or fixed supply like Bitcoin.
Although instances of hyperinflation might seem few and far between, it’s clear that a relatively short period of political or social unrest can quickly lead to the devaluation of traditional currencies. Lower demand for the sole export of a country can also be a driving cause. Once the currency devalues, prices shoot up very quickly, eventually creating a vicious cycle. Several governments have tried to counter this problem by printing more money, but this tactic alone has proven to be useless and only served to further decrease the overall currency value. It is interesting to note that as trust in traditional currency falls, faith in cryptocurrency tends to rise. This might have powerful implications for the future of how money is viewed and dealt with globally.