It is difficult to say exactly when hyperinflation will hit a currency. However, I am convinced that the danger level is so high for most fiat money that it is worthwhile for everyone to increase their understanding of hyperinflation. This article presents 10 frequently asked questions or objections about hyperinflation with answers.
This version of the original article, written by Vincent Cate, has been edited here by munKNEE.com for length (…) and clarity ([ ]) to provide a fast & easy read. Visit our Facebook page for all the latest – and best – financial articles! Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.
The statements or questions below are in bold and my responses follow.
1. How is hyperinflation defined?
The International Accounting Standard of IAS 29 says there is hyperinflation when “the cumulative inflation rate over three years approaches, or exceeds, 100%.” This works out to 26% per year….
Note that hyperinflation is not defined in terms of the money supply alone, since the velocity of money and GNP are also key factors in the price level during hyperinflation. Hyperinflation is a process, a positive feedback loop, that once entered is very hard to get out of. This process can go on for years.
2. Is there a real chance the U.S. dollar could get hyperinflation?
Hyperinflation happens when government debt is over 80% of GNP and the deficit is over 40% of government spending (Bernholz did a study of 29 cases of hyperinflation and looked at the circumstances that lead up to them and found that the best predictor of hyperinflation were these numbers for debt and deficit.). The U.S. is at or near these numbers, so the danger of hyperinflation is real.
What happens is that the more the central bank prints money and buys bonds the less other people want to hold bonds – but the less other people hold bonds, the more the central bank has to buy them so the government has enough money to spend. You get a positive feedback loop or death spiral.
3. Has hyperinflation ever happened in America?
… There was hyperinflation during the Revolutionary War (remember, “not worth a Continental”?) and in the South during the Civil War. I also think that if the U.S. had not made it illegal to own gold in 1933 that the Fed would have gone bankrupt because they did not have enough gold to back all of the notes they had issued, and that paper money would have become worthless then too.
Hyperinflation is more common than most people realize. The time periods from the Revolutionary War hyperinflation, to the Civil War hyperinflation, to the 1930s currency crisis, to now, are all similar. To me this looks like some major currency crisis cycle is about due.
4. What is the math for hyperinflation?
The math for hyperinflation starts with the equation of exchange and with one transformation you get:
P = M * V / Q
Where the variables are:
P = Price level
M = Money supply
V = Velocity of money, how many times money turns over in a year
Q = Real GNP
In hyperinflation the money supply is going up, the velocity of money is going up, and the real GNP is going down, all at the same time. It is a triple whammy that drives prices up really fast.
5. What comes first, hyperinflation or money printing?
…Hyperinflation is really a positive feedback loop. It is a circle, a death spiral. To argue about what comes first in hyperinflation is a bit like arguing which came first, the chicken or the egg.
6. Why can’t you stop hyperinflation by just having the central bank stop monetizing debt?
It seems obvious that if you just have the central bank stop buying government debt the hyperinflation would stop. The problem, [however,] is that the government needs money to operate and is spending far more than what it gets in taxes and has debt around the size of the GNP. The deficit is so large that cutting government or increasing taxes enough is not possible.
The only way the government can keep in operation, when other people stop buying their bonds or even rolling over their bonds, is if the central bank steps in so the government always makes sure the central bank steps in. This may take changing laws or replacing people at the central bank, or just ignoring laws, but the government will get the money or it is bankrupt.
7. Could the Fed cause hyperinflation on its own?
[No!] It is always the combination of the government spending far more than it gets in taxes and the central bank printing money and buying government debt (monetizing debt). When they are in this situation they can not borrow more, except from the central bank under their control so they get the central bank to make money and “loan” it to them.
When the reality is [that] the only way they can pay back that “loan” from the central bank is by first getting another “loan” from the central bank you are probably headed for hyperinflation.
8. Isn’t hyperinflation a political event and not a monetary event?
The root cause of hyperinflation is politicians spending far more than they get in taxes. In this sense hyperinflation is a political problem. However, I think Milton Friedman was right when he said “inflation is always and everywhere a monetary phenomenon”….[and I believe that] to think otherwise…is not only wrong but dangerous. This wrong idea keeps people from understanding what is really going on.
For example, Modern Monetary Theory (MMT), as it stands, does not explain hyperinflation. They do not see any tipping point, positive feedback loop, sudden risk, or danger of inflation getting out of control. They think that you could always just make a bit less money if inflation got too high. Instead of admitting the problem with the theory (lots of experimental evidence of inflation getting out of control) they just say hyperinflation is a political event not a monetary event. This is like science with a bit of magical thinking – just wrong.
9. In a hyperinflation scenario would the U.S. dollar fall relative to other currencies?
Other countries have all sorts of problems too, so the U.S. dollar may not drop against those other currencies.
Hyperinflation is not really about exchange rates. If the Pound, Yen, Euro, and Dollar were all getting 26% inflation the exchange rates could stay the same but we would still have hyperinflation.
10. Can hyperinflation happen to the USD – the world’s reserve currency?
It is only since 1971 that the world has had a fiat currency as a world reserve currency. In the past it was always gold or silver or a currency convertible to gold or silver. It is not possible to get hyperinflation when using gold and silver.
Hyperinflation happens to fiat currencies [so, yes, hyperinflation can happen to the U.S. dollar].
While fiat money is created out of thin air, no alchemy yet can make gold out of nothing so, while any paper money always has some risk of becoming worthless, the same is not true for gold and silver so, when fiat money is at risk of failing, the “hard money”, gold and silver, seems to do well.
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Hyperinflation is not an unusual phenomenon. 33 countries have experienced hyperinflation over the last 100 years of which no less than 22 have experienced it in the past 25 years and 4 in the past 10 years. The United States is one of the few countries to have experienced two currency collapses during its history (1812-1814 and 1861-1865). Could it happen again?
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Editor’s Note: The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.