18 Scary Things You Didn't Know About Inflation and Hyperinflation

It’s Inflation Week at Len Penzo dot Com. Follow me over the next several days as I explore the multiple facets and facts about this insidious scourge, the probability of its resurgence, its potential impacts on us, and strategies for protecting yourself and your personal finances. Hey, it’s not as fun as Shark Week at the Discovery Channel, but it’s almost as scary!

In my previous post, I discussed why there is little doubt that high inflation will eventually strike the United States. The real questions facing us now are 1) when will it strike; and, 2) will it be severe inflation like that experienced in the mid 1970s, or will it be a more sinister bout of hyperinflation?

What can we expect if the world loses faith in the US dollar and hyperinflation were to take hold? To help you make sense of it all, here is a primer:

1. Inflation occurs when the supply of money exceeds the rate of economic growth. Or, as economist Milton Freidman eloquently stated, inflation results when too much money chases too few goods.

2. Inflation weakens the function of money as a storage of value. Because of this, inflation increases the opportunity cost of holding cash balances. If you were to sell a bushel of wheat for a single gold coin, you expect to be able to receive a bushel of wheat in return for that same gold coin some time later. However, the effects of inflation result in the inability of that gold coin to purchase the same bushel of wheat at some time in the future.

3. Between 1913 and 2006 the average rate of inflation in the United States was 3.45%. At that rate, prices double every 21 years.

4. Inflation isn’t all bad: A low rate of inflation is preferred by economists as it reduces the severity of economic recessions. To maintain currency stability, most nations try to maintain an annual inflation rate of between 2% to 5%.

5. The alternative to inflation is deflation. Economists consider deflation to be a less favorable alternative because it results in a loss of demand by consumers and widespread unemployment. The last major bout of deflation in the United States occurred during The Great Depression which saw a peak unemployment rate of 25%.

6. Confidence in any currency is directly related to the currency’s ability to hold that value. During times of hyperinflation, confidence wanes to dangerous levels and bartering becomes the favored means of conducting financial transactions in order to get rid of excess cash before it is devalued further.

7. With hyperinflation, real estate and gold replace cash as the favored means of wealth storage. The use of consumer goods as an alternate, but inferior, method of wealth storage creates widespread shortages.

8. Zimbabwe Rhodesia offers one of the most recent case studies of hyperinflation. During the month of March 2007 the inflation rate was 1730%. To put it another way, a loaf of bread that cost $2 on March 1st, cost $36.60 on the first day of April.

9. By November 2008, the annual inflation rate in Zimbabwe was 89.7 sextillion percent. That’s 89.7 followed by 20 zeros. At that rate, prices were doubling every 24 hours.

10. To keep up with inflation, the Zimbabwe treasury was forced to print bills with denominations as high as one hundred trillion dollars. For an excellent pictorial presentation of life in Zimbabwe with their astronomically denominated currency, check out this link.

11. Zimbabwe, however, doesn’t hold the record for largest bank note denomination ever to be placed into circulation. That dubious honor belongs to Hungary, which printed a 100 quintillion pengo note when it suffered from hyperinflation back in 1946. For the record, when written in long form “100 quintillion” looks like this: 100,000,000,000,000,000,000.

12. Zimbabwe and Hungary aren’t the only countries to suffer from hyperinflation. Many other countries have experienced hyperinflation throughout history. One of the most studied and famous examples is the hyperinflation that struck the German Weimar Republic shortly after World War I.

13. In the period immediately prior to World War I, the German Mark was trading at a value of roughly five Marks to the dollar. To finance the war, Germany fired up their printing presses and abandoned the gold backing of its currency. After the war was over Germany’s war debt, coupled with the reparations they were required to pay, resulted in hyperinflation that eventually saw the exchange rate reach one trillion Marks to the dollar.

14. The frightening implications of the catastrophic effects of hyperinflation on retirement and other savings accounts is illustrated in this excerpt from Paper Money by Adam Smith (the pen name for George J.W. Goodman): “My father was a lawyer,” says Walter Levy, an internationally known German-born oil consultant in New York, “and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20-year policy, and when it came due, he cashed it in and bought a single loaf of bread.”

15. During the height of the Weimar Republic hyperinflation crisis, consumers found it cheaper to burn the currency than to use it to buy firewood. As prices soared higher with each passing day, life became more surreal. Here’s another excerpt from Goodman: Menus in cafes could not be revised quickly enough. A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. “If you want to save money,” he was told, “and you want two cups of coffee, you should order them both at the same time.”

16. Profiles in Cowardice: Hyperinflation takes time to manifest itself, and usually takes root only because the affected nation’s leaders suffer from a lack of the political courage required to solve the problem. To temper high inflation, anti-inflationary measures that are painful to the populace must be enacted. Unfortunately, as the resulting discontent rises, leaders usually end up reverting to the original policies that led to the hyperinflation in the first place.

17. Once hyperinflation sets in, it becomes difficult if not impossible to rein it in by simply increasing interest rates. Potential solutions include freezing government spending, raising taxes, stopping the printing of money, lifting price controls, tying the currency to on-hand gold reserves, and/or eliminating wage hikes that just inflame the inflationary spiral. Unfortunately, these options result in increased rates of unemployment and/or sharp declines in living standards.

18. Another effective way to stop hyperinflation is to simply abandon the affected domestic currency and permanently replace it with a sound foreign currency. It is highly unlikely, however, that this option would ever be taken by a major power such as the United States or the European Union.

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