Thursday, January 26, 2012

Hyperinflation and Misinformation: Two Debilitating Diseases

Hyperinflation sounds like some serious medical condition, and, in fact, it does describe a particular illness.  But, it is also an economic condition, and that’s what I want to discuss here.

Hyperinflation, or very high inflation when prices increase rapidly while currency declines in value, is largely a twentieth-century phenomenon.  The threshold for determining when hyperinflation exists is somewhat arbitrary, but economists generally use it when the inflation rate exceeds fifty percent. 
The most widely studied case hyperinflation is that which occurred in Germany after World War I.  The inflation rate in November 1923 was 322 percent.  While historically this is perhaps the best known case of hyperinflation, in Hungary, after World War II, prices rose more than 19,000 percent per month, or 19 percent in a single day.  In October 1923, German prices rose at a rate of 41 percent per day.  In July 1946, prices in Hungary rose more than 300 percent per day.

What are the causes of hyperinflation?  There is, unfortunately, no single factor, no matter how severe, that can explain sustained, continuously rapid growth in prices; not war, not destruction of resources, not the actions of external actors.  It does, however, occur when the monetary and fiscal authorities of a country issue on a regular basis large quantities of money to pay for government expenditures.  This extremely rapid growth of paper money, when not backed with increased industrial output, is a pernicious form of taxation, with the government benefiting at the expense of those who are forced to hold currency that has no value.

Hyperinflation tends to be a self-perpetuating condition.  When a government decides to fund its expenditures by issuing money and the rate of inflation increases, it will soon discover that it can no longer buy as much, and if it responds by printing more money, it begins the cycle – or, perhaps a better description is ‘decline’ into spiraling hyperinflation.  How, one might ask, does a government end hyperinflation?  Economists are divided on the answer to this.  Some believe that it takes a credible commitment on the part of government to stop the proliferation of paper money, while others believe that it is also necessary to take steps to balance the government’s budget.  Whichever side of the argument you support, what is clear is that the responsibility to end hyperinflation falls squarely in the lap of the government.

A firm commitment by government to restore public confidence in its monetary and fiscal policies, and an adoption of policies that drive people toward monetary rather than barter transactions, is absolutely essential.  People have to have their faith in money restored to the point where they are willing to hold money rather than spending it as quickly as possible.  Sometimes, as in the case of hyperinflation in Zimbabwe, the cure hurts in the early phase of application almost as much as the disease, but if the policies are held to firmly, the situation can be reversed.

Inflation in Zimbabwe at independence in 1980 was 7%, and until 1999 fluctuated, rising to nearly 50% on several occasions, but never qualifying as hyperinflation.  In 1999, the rate was 59.9%, jumping to over 100% in 2001, and finally surpassing 11 million percent until the local currency was abandoned in favor of a multi-currency regime in 2009 (primarily the US Dollar and the South African Rand).  Some of the measures the government took included declaring inflation illegal, with CEOs subject to arrest for changing prices.  Needless to say, price freezes and arrests did nothing to halt hyperinflation; instead, goods disappeared from the shelves of stores, and many people were forced to illegally use foreign currency.

One often hears that it was U.S. and European sanctions that caused, or at least aggravated hyperinflation.  There is, however, never any data presented to support such a claim, and only those uninitiated in economic matters actually subscribe to such a claim.  Sanctions, or other external policies of other governments, did not control government expenditures or determine the volume of currency being printed, nor did they have a role in government actions that dismantled the economy’s productive agricultural sector or cause declines in mining and manufacturing.  What doesn’t get mentioned when this claim is proffered is that, instead of facing its responsibility and adopting rational monetary and fiscal policies, the government continued to spend and print money.

Hyperinflation is a disease that sometimes can’t be prevented, but failure to accept responsibility can certainly aggravate it.  There are no simple answers to such phenomena, and efforts to shift the blame externally do nothing to correct the deficiency.  When hyperinflation is compounded by misinformation, though, one thing is sure; the people of a country are the ones who suffer.