Inflation Hyperinflation the Contemporaneous Society

Inflation

Hyperinflation

The contemporaneous society is facing one of the most crucial crises ever -- the internationalized economic crisis. It emerged within the United States real estate sector, to gradually expand to the totality of American industries, as well as the majority of the global regions. The manifestation of the crisis has been complex and dramatic. Banking institutions faced weakened liquidities. The economic agents lost customers and business; were forced to cut costs and even ended up filling for protection under the bankruptcy act. People lost their jobs and became unable to pay their debts.

The average individuals, with a limited knowledge of economic mechanisms, dramatized this crisis. It is indeed a severe situation, but it is a natural process of the economy, which goes through the natural stages of boom, slowdown, recession and eventually recovery. And these stages are not only theoretical concepts, but they have been proven by history, with relevant examples being constituted by the 1997 Asian crisis, the 2001 economic crisis in the United States or the Great Depression of 1929-1933.

Aside from economic stages, the history offers other valuable lessons, such as the risks countries face regarding inflation. Today, concerns are raised that hyperinflation would be impacting the United States. The theory is based on the current deflation, and the inability of the government -- despite its efforts -- to transform the stimulus package in the solution to increase consumer spending. It is possible for deflation to further intensify and lead to the devaluing of the dollar, the lowering of prices, the loss of employment and so on. The loss of trust in the currency could as such lead to hyperinflation (Lira, 2010).

This current endeavor strives to identify the manifestations and affects of hyperinflation in other circumstances, in order to constitute a starting point in the understanding of the lessons in economic history. It is as such first necessary to reveal the meaning of hyperinflation, and then present its affects in other countries. The endeavor comes to an end with a section on concluding remarks, which restates the most important findings of the project.

2. Understanding hyperinflation

At an initial level, it would seem rather intriguing that in times of deflation, the risk of hyperinflation is real. But this is however the case due to a crucial element -- the loss of trust in the national currency. In order to understand this, it is necessary to make the distinction between inflation and hyperinflation. In times of deflation, inflation is indeed less likely to occur. Hyperinflation is however possible.

Inflation and hyperinflation are similar concepts with similar manifestations, in the meaning that they enhance the circulation of liquidities, but the real value of the money is decreased. In the case of inflation however, the situation is generated in times of economic boom, when people have increased amounts of money they want to spend, and when the demand for the products and services is higher than the offer. This subsequently leads to higher retail prices.

In the case of hyperinflation nevertheless, people are looking to spend money on products and services in order to escape from the instable and continually devaluing currency. Investments in various assets are as such more likely to maintain their value. Gonzalo Lira explains:

"Hyperinflation is the loss of faith in the currency. Prices rise in a hyperinflationary environment just like in an inflationary environment, but they rise not because people want more money for their labor or for commodities, but because people are trying to get out of the currency. it's not that they want more money -- they want less of the currency: So they will pay anything for a good which is not the currency."

Investopedia, a financial website under the patronage of Forbes, argues that hyperinflation represents an accentuated increase in prices, throughout a situation which is too complex and too rapidly developing for it to be called simply inflation. The editors at the website explain that hyperinflation is likely to occur in times of economic crisis, when the federal authorities pour massive liquidities into the market, but when these liquidities are not supported by real gross domestic products and national output. In such a situation, prices will increase as trust in the national currency decreases.

As it has been mentioned, hyperinflation is generally assimilated with a situation in which inflation has been outpaced. This virtually means that a limit has to be imposed as to where inflation ends and where hyperinflation begins. According to Michael K. Salemi, the trash hold is flexible and established by the economists in charge, based on several situation specifics. At an overall level, it is assumed that hyperinflation commences when the monthly inflation rate is higher than 50 per cent. For example, if on the 1st of January of year 1, a product were to retail at a normal price of $1, on the 1st of January the following year, it would retail at $130.

Peter D. Schiff and Andrew J. Schiff (2010) argue that inflation and hyperinflation are mechanisms of transferring wealth through changing roles of debts and savings. In both cases, the savings of the population lose value, but so to the debts. This specifically means that the savings are lost, whereas the debts are devalued, and as such easy to pay. An exception is however constituted when the savings are not in currency, but in material assets, such as buildings for instance, as these would regain their value once the hyperinflation is overcome.

3. Historic manifestations of hyperinflation

The most commonly cited case of hyperinflation is that which occurred in Germany in early 1920s, but other countries hale also fallen victim to the devaluation of their national currencies. In all cases, the hyperinflation was created by the federal institutions, in the aftermath of a nationally challenging event. In the case of Germany for instance, hyperinflation was created to help pay the country's debts in the aftermath of World War One. Peter D. Schiff and Andrew J. Schiff (2010) reveal that hyperinflation

"[H]as happened many times before: France in the 1790s, the Confederate States of America in the 1860s, Germany in the 1920s, Hungary in the 1940s, Argentina and Brazil in the 1970s and 1980s, and Zimbabwe today. In all of these instances, the circumstances which led up to the hyperinflation, and the economic devastation that followed, were remarkably similar. The countries satisfied staggering debt by wiping out the value of their currencies. As a result, their own populations were thrown into abject poverty."

3.1. Hyperinflation in France

During the 1790s decade, France was in dire need of financial resources to fund its army and salvage the revolution. This objective was achieved with the aid of the printing machine, which was exhaustively used to create money to finance the army, as well as feed the population. In future fights for domination of the European continent, France's hyperinflation prevented the country from winning its battles.

France's hyperinflation commenced in 1789, when the French Assemblee decreed the issuance of 400 million assignats -- livres of note -- and used the properties confiscated from the Church to secure them. During the fall of that year, another 800 million notes were issued -- this time without any coverage, as well as without any interest. A limitation of 1.2 billion was imposed, but it was neglected during 1790 and 1791, when another 1.2 billion notes were approved.

The affects of the situation were multiple, with the general result of the population becoming poorer. At a particular level, the following implications were obvious:

The prices of all commodities increased

The wages of the population also increased, but at a slow rate, significantly lower than the rate of price increases

The prices were regulated by laws and limits were imposed on how high they could go

The national output decreased to a point at which food sufficiency was no longer insured

The government implemented rationing in order to ensure that all people had access to minimum food supplies

People became skeptical about the assignats and were no longer wiling to use them

The government imposed punishments of twenty years in prison for those sold their notes at discount, and also a death penalty for those who differentiated between the notes and precious metals (gold and silver).

During the following years, the social and economic problems continued, and the government strived to resolve them by printing more money. By 1975, the number of assignats in circulation reached 15 billion.

"When the total reached 40 billion livres the printing plates for assignats were publically destroyed. A new type of note, called a mandat, was issued, but within two years these also lost 97% of their value. The printing plates for mandats were also publically destroyed. In 1797 both assignats and mandats were repudiated and a new monetary system based upon gold was instituted" (San Jose University).

The case of France provided a cautionary tale for governments in other European countries, which became more responsible in their use of the printing machine. The states in the Old Continent ensured stable economies and lack of inflation, but the lesson was short-lived. It as such only lasted up until the 1920s, when Germany used printed money to finance its war losses (Palairet, 2000).

3.2. Hyperinflation in Germany

The case of hyperinflation in Germany is the most common one offered as example, yet, it is not the most dramatic hyperinflation episode in economic history. The hyperinflations in Hungary or Zimbabwe are more dramatic, but Germany constituted the first important hyperinflation and has since then captured the attention of the economists (Full Wiki).

It is generally stated that Germany created hyperinflation to pay for its war reparations, as demanded under the Treaty of Versailles. Other opinions however argue that hyperinflation commenced before the war, with the federal decision to use debt to finance the war, rather than increase taxation. The underlying logic was that the country would win the war and would force the losers to pay for its costs. When the country nevertheless lost, it was faced not only with its own debt, but also with the need to pay reparations for other states as well.

Germany refused to pay the reparations, as it perceived them as unfair. As a result, France and other allied countries occupied the industrial region of Ruhr, which severely impacted the country's economic stability -- they for instance became unable to collect taxes on imports. The German authorities resorted to the printer, as a solution to creating more money. The affects of this decision integrate the following:

Massive devaluation of the mark (the German national currency at the time; it was eventually replaced with the euro) in relationship to other foreign currencies

The costs of imported products increased and the population's access to the commodities decrease

The prices increased and they not only generated problems for the population, but also made it difficult for the government to operate

The trajectory of the German hyperinflation is revealed in the graph below:

Source: Mayer, 2008

The initial reaction of the German population to the incremental prices was that of spending less money and focusing instead on saving it. In time however, the people realized that the situation was not only a matter of higher prices, but a more severe problem of devaluation of the national currency. Upon this realization, they strived to transform the marks they still had in more stable assets. This reaction led to a situation in which price controls could not be effective. Just like in any case of hyperinflation, the German situation generated both winners as well as losers. The winners were represented by those who had debts, and who found it easy to pay them. The losers on the other hand were represented by those who saw their savings reduced to zero, the people who were rich before the war (and before the hyperinflation), and were now struggling to make it through the day (San Jose University).

3.3. Zimbabwe

Today, Zimbabwe is an international concern with its high inflation rate. It is nevertheless difficult to estimate when the situation occurred or when it first arose. During the 1990s decade, inflation in the African country fell in the double digit zone, fluctuating between 18 per cent and 58 per cent. It is generally estimated that the inflation transformed into hyperinflation during late 1999, when the International Monetary Fund suspended its aid of the country. They argued that the country had no restriction on how to spend the financial resources, but this was counter-argued with the ongoing conflicts with Congo, which required impressive financial resources.

The decision of the IMF was followed by the decision of foreign investors to leave the country. Zimbabwe's firms were quickly left without resources and demands, and the national output dropped significantly. Prices soared and the country was prohibited from using IMF funds to alleviate the poverty in the country. In 2003, its voting rights in the IMF were suspended as the country had failed to adequately collaborate with the institution. By that time, inflation had reached 365 per cent. By the end of 2007, the inflation rate had reached 10,000 per cent. The affects of the crisis included:

Massive increase in prices, with the subsequent limitation of access to the commodities

A myriad of socio-economic problems, associated with poverty, unemployment and restricted access to basic commodities

The decision of President Robert Mugabe to force economic agents to slice prices in half

The inability of economic agents to operate in circumstances in which their operational costs were higher than the limited price imposed

The bankruptcy of economic agents and the takeover from mobs, which came to rule the distribution of bread, cornmeal, sugar and other basic commodities, which could no longer be found on shelves

Governmental decision to declare inflation illegal and the imposition of punishments on those who raised prices

The punishment of 4,000 business people for violation of price caps.

By 2008, inflation has soared to 150,000 per cent, generating more instability for Zimbabwe. This situation leads to political turmoil, but also the deepening of the socio-economic problems. People from the African country have fled and are now sending their families food from abroad -- this constitutes the sole survival mechanisms for several families. Additionally, the general health of the population is decreasing as the doctors reveal more diseases associated with poverty (Allen, 2009).