Inflation, Deflation, and Hyperinflation
What is hyperinflation?
The term “hyperinflation” conjures up doomsday images from history of people buying a loaf of bread with a wheelbarrow full of worthless cash. The breakdown of a market supersaturated with an unwanted currency that has lost all value is hyperinflation gone wild.
But the wild days and nights of hyperinflation are not all that rare. In fact, there have been three major examples of hyperinflation over the last 100 years: Weimar in Germany, Zimbabwe, and, more recently, Venezuela.
Could the U.S. be crippled by hyperinflation next? While most say no, some prominent thinkers believe U.S. hyperinflation is imminent.
What Is Hyperinflation?
What is hyperinflation? Hyperinflation is too much of a good thing—or something that was once good.
For starters, inflation signals an economy is doing well and growing. The Federal Reserve wants to ensure the U.S. economy is on sustainable ground, though. If inflation gets too high, the economy suffers. On the other hand, there’s deflation, which is bad because it means the economy is depressed. People don’t like to spend when the economy isn’t doing well.
Ultimately, inflation and deflation are important because they affect interest rates. Interest rates are a reflection of the state of the broader economy over time, comparing the price of purchasing something today relative to the price of purchasing something tomorrow.
When interest rates are high, your savings will be worth more tomorrow. When interest rates are low, like they are now, your savings are not going to be worth much tomorrow.
Hyperinflation comes as a result of deflation. Low interest rates, or even negative rates, force people to take their money out of the bank and stash it under the bed. To avoid deflation and kick-start the economy following consumers’ reactions to low interest rates, central banks adopt unconventional and, for the most part, unproven financial strategies to attempt to boost inflation, such as quantitative easing (QE). The Fed increases the money supply by buying bonds from the government.
This extra infusion of cash—or economic stimulus—makes its way into the economy since the artificially low interest rates that accompany it make it cheaper to borrow money. This is something many economists find repugnant…but, strangely, Wall Street welcomes with open arms.
What is hyperinflation’s impact? In the end, currency follows the same supply and demand dynamics of everything else. When the market is flooded with something, its value decreases. When it comes to a currency, it takes more money to buy something today than it did to buy the same thing yesterday.
Reckless fiscal policies like quantitative easing (which is entirely unproven) are a high-wire balancing act. Inflation happens when there is more money out there because the economy is expected to do better, people borrow, and there is more spending—as a result, the economy will grow.
If demand occurs too quickly, inflation will rise. By that I mean it will rise far too quickly. Hyperinflation happens when everyone realizes the money supply, which has been quietly growing, has less and less value. People basically lose trust in the currency and its purchasing power. People rush out to spend their money before it loses even more value. This causes prices to increase wildly.
With the value of the dollar rising daily, workers don’t want to wait two weeks to get paid. Businesses can’t afford to meet the cash flow. Eventually, there is a breakdown of the monetary system. The money created to initially kick-start the economy has flooded the market and become unstable—and useless. The money in your bank account, whether it’s $1.00 or $1.0 million, is worth nothing because of hyperinflation.
What do governments do in this scenario? Rinse and repeat. They try and stabilize the economy by adding more money to the equation.
What Is Hyperinflation’s Impact?
Hyperinflation is not as rare an occurrence as you might think. Over the last 100 years, there have been more than 50 examples of hyperinflation, most notably in China, Russia, Germany, Argentina, and Poland.
Could hyperinflation happen in the United States? Most economists don’t think so. But then again, most experts have a messianic complex when it comes to their understanding of the state of the U.S. economy and their trust in the Federal Reserve. These are probably the same “experts” who didn’t foresee the stock market crash in 1987 and said a similar catastrophic event was impossible. After all, we learn from our mistakes.
This doesn’t really explain the stock market crash in 2000 and 2008 or what’s been going on since the Federal Reserve initiated its first round of quantitative easing in late 2008. Keep in mind that hyperinflation is triggered by an excess of currency that has little to no value.
Why does the currency have no value? Because it isn’t backed by anything…save for the good word of the government. If a currency is backed by gold, there is a finite amount of currency that can be minted. If, however, the currency is not backed by anything, the central bank, or, in this case, the Federal Reserve, can print off as much as it likes with reckless abandon.
For a currency like the U.S. dollar to have any value, the underlying economy has to be trusted by those who use it. Because the greenback is a fiat currency, it isn’t backed by any physical reserves like silver or gold; it’s just paper. If people lose faith in the U.S. economy, the dollar becomes worthless.
When a country adopts a gold standard, the amount of currency it can issue is limited to the amount of gold it has on reserve. However, no country uses the gold standard anymore, so there is no limit to the amount of currency any country can print.
Basically, any country can now buy its way out of debt, which is what the U.S. is trying to do. As the country with the world’s reserve currency, it is able to get away with it—for now. If the U.S. dollar were still linked to gold, it wouldn’t be taking the U.S. down the fiscally irresponsible path it is today.
But I digress…
Hyperinflation in Germany
The most famous example of this concept is the example of hyperinflation in Germany during the Great Depression.
Wars are good for creating demand for a currency. When WWI began, Germany discarded the gold standard because it needed to print more money to finance the war. This left the reichsmark (Germany’s currency) without any intrinsic backing or value. (Source: “1923 Hyperinflation,” AlphaHistory.com, last accessed June 14, 2016.)
When the war ended, Germany agreed to pay reparations of around 226 billion gold marks; that’s upwards of $1.0 trillion today. That number was eventually lowered to 132 billion marks in 1921.
In 1921, Germany paid its first installment of two billion gold marks. Instead of using cold hard cash, Germany paid using materials like coal, iron, and wood.
In 1922, the country didn’t have enough money from taxes to make its second installment. France and Belgium didn’t believe Germany couldn’t afford to pay, so they invaded the Ruhr, German’s most important industrial area, taking over iron and steel factories, coalmines, and railways.
In early 1923, German workers went on a prolonged general strike against the occupation. The Weimar government subsidized the strike, printing off money and sending it to striking workers in hopes of stimulating the economy. (It does sound a little familiar, no? Except, I suppose, in the U.S., the bankers received the money.)
Flooding the market with money certainly had its downside, but the Weimar Republic knew it was just a temporary measure. The money continued to pour in and the economy stalled. Foreign investment left Germany and confidence in the country’s ability to cover its costs tanked.
Not many people were confident Germany could recover. The value of the mark was devalued and hyperinflation set in. Prices rose to match inflation and things got a little out of hand. In 1921, a U.S. dollar was worth about 50 marks. By the end of 1923, one U.S. dollar was worth 4.2 trillion marks. For a more practical example, in 1918, a loaf of bread was one quarter of a mark, but by November 1923, a loaf of bread cost 80 billion marks.
The Weimar government, unable to fix wages or prices, did what it did best: it printed more paper money in larger denominations and the cycle repeated itself.
If you were a pensioner on a fixed income, your pension was worthless. Those hardest hit were the middle class. Their earnings disappeared and unlike the wealthy, the middle class didn’t have the contacts to get food or land on which to plant food. In some cases, people were paid in gold. In other instances, Germans had to turn to bartering their heirlooms just to survive.
Hyperinflation in Zimbabwe
One of the most egregious examples of runaway prices was the incidence of hyperinflation in Zimbabwe just 10 short years ago.
After years of ruling the country as its prime minister, Robert Mugabe became the country’s first executive head of state in 1987, a position he has held onto ever since thanks to vote rigging, fear, and intimidation. How else can you explain one of the world’s most corrupt, violent leaders being re-elected in a so-called democratic election? (Source: “A Decade of Suffering in Zimbabwe,” Cato Institute, last accessed June 14, 2016.)
For good reason, the international community was wary of Mugabe’s economic and social policies and his human rights record. They refused to offer him more credit while calling in old loans. This created a situation where Zimbabwe had to come up with cold hard cash—fast!
Mugabe did this the best way he knew how (without inconveniencing himself that is). He printed off more money to pay off the country’s debts. He also doubled the wages of military officers to protect his thin skin and fragile ego. More money in a decimated economy translates into lost trust and worthless money—and one of the best examples of hyperinflation at its worst.
The country’s hyperinflation began in March 2007 and peaked in November 2008. By September, the country’s annual inflation rate was 471,000,000,000%. In November, the country recorded the second-highest inflation rate in history, 89.7-sextillion percent (I won’t overwhelm you with all those zeros, but note that a sextillion is equal to a one followed by 21 zeros).
That translates into an equivalent daily inflation rate of 98%, meaning prices doubled every 24.7 hours.
Note that the absolute worst case of hyperinflation occurred in Hungary in 1946, when prices doubled every 15 hours. (Source: “The Hanke-Krus Hyperinflation Table,” Cato Institute, last accessed June 14, 2016.)
The country resorted to making the U.S. dollar its currency, abandoning the Zimbabwean dollar and money that Mugabe no doubt has had squirreled away since taking power in the 1980s. That said, the country now uses a multi-currency system that also includes the British pound, South African rand, Chinese yuan, Australian dollar, Japanese yen, and Indian rupee.
Could hyperinflation happen here in the U.S.?
Of course it could.
Well, the U.S. is certainly following a similar trajectory of failed attempts to manipulate an economy into a state of hyperinflation.
Since 2008, when the Federal Reserve started its generous quantitative easing strategy to kick-start the economy, its balance sheet has ballooned from around $800 billion to more than $4.0 trillion.
Has it worked? Did the Fed kick-start the economy and save the free world?
Cheap money has made it easy to borrow money, but the banks have not been keen on lending that money out. And artificially low interest rates have decimated retirement savings, but it has propped up the stock market. Where else are income-starved investors to turn?
After eight years of intervention by the Federal Reserve, the U.S. economy is stalling. First-quarter gross domestic product (GDP) came in at a lame 0.8%. In the fourth quarter of 2015, GDP was 0.7%. That’s not exactly the kind of growth the Fed was hoping for. (Source: “Gross Domestic Product: First Quarter 2016 (Second Estimate),” Bureau of Economic Analysis, May 27, 2016.)
In May, U.S. employers added just 38,000 jobs to the payroll; the weakest pace since 2010. Unemployment dipped from five percent to 4.7%, but that’s because more people quit the labor force. The underemployment rate remains near 10%. (Source: “The Employment Situation – May 2016,” Bureau of Labor Statistics, June 3, 2016.)
Despite being near record levels, the S&P 500 is in an earnings recession. In the first quarter, the S&P 500 reported a blended earnings decline of 6.7%. This is the first time the index has reported four consecutive quarters of year-over-year declines in earnings since the financial crisis. (Source: “Earnings Insight,” FactSet, May 27, 2016.)
For the second quarter, the estimated earnings decline, for now, is 4.8%. If the S&P 500 reports a decline in earnings in the second quarter, it will mark the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since the third quarter of 2008 through the third quarter of 2009. (Source: “Earnings Insight,” FactSet, June 3, 2016.)
And more and more factors are suggesting the U.S. is heading for a recession. The economy is on the rocks, the outlook is bleak, the Fed has decimated retirement savings with artificially low interest rates, the stock market is being supported by desperate hope rather than earnings growth, and banks are tight-fisted with funds.
U.S. Hyperinflation Survival Guide
The U.S. has all the earmarks of a country headed toward hyperinflation. But the one thing helping the U.S. is its reserve currency status. It’s still the biggest economy in the world. Besides, even if the economy isn’t doing well, it’s doing better than most other developed economies.
As the reserve currency, the U.S. can deal with any country using its own currency. It can print money to buy whatever it wants and to pay off debt. It’s not that easy for every other country. If France wants to buy oil from Saudi Arabia, it does so with U.S. dollars. But France can only get its hands on greenbacks if it sells something of value to someone else.
It’s going to be pretty tough for the U.S. to enter hyperinflation territory with the printing presses in its corner. The world can never have enough U.S. dollars! Under the same circumstances, the U.S. could, if it was any other country, print itself into a corner and enter a period of hyperinflation.
However, chances are it will avoid it due to a number of technicalities. This is in spite of the Federal Reserve creating a lot of economic volatility, instability, and unpredictability. But it isn’t impossible. Any number of unexpected incidences (natural disasters, wars, prolonged recessions) could derail the U.S. economy and the U.S. dollar, resulting in a currency crisis like hyperinflation.
The Bottom Line on Hyperinflation
What is hyperinflation? And what is hyperinflation’s impact on the economy? Hopefully, you have a better idea how serious this can be now.
If the U.S. does enter a cycle of hyperinflation, where should investors turn? Most believe gold is the best thing to have during a period of hyperinflation and by all measures, it’s one of the better equities to hang onto. It will certainly do better than the greenback if hyperinflation kicks in. But then again, just about anything will be better than the greenback in a hyperinflation scenario.