Inflation, but not Hyperinflation, is on the Horizon

Inflation, but not Hyperinflation, is on the Horizon. By BullionVault.

Hyperinflation is qualitatively different to inflation. During inflation, prices are going up. They may even be going up a lot (for example, inflation in Britain in the 1970s went as high as 26%).

But in hyperinflation, the speed of the increase in prices is so extreme that measuring it is almost irrelevant. … It’s the collapse of an economy and its currency, rather than simply a tough period. …

I think that most of us would agree that there’s a difference between 1970s Britain and 1920s Weimar Germany or 2000s Zimbabwe or 2010s Venezuela.

Inflation is a tough period, but hyperinflation is when the currency dies. The difference is vital:

Hyperinflation is not the result of money printing alone. In fact, it’s more correct to say that rampant money printing is a side effect of the conditions that give rise to hyperinflation.

Three factors cause a hyperinflation. First, a substantial reduction in the supply of goods and services:

You need a huge supply shock – in other words, there needs to be a sharp reduction in the productive capacity of the economy. That means there is not as much “stuff” to go round, so that demand outstrips supply, which is inflationary.

You can see this in all the big famous hyperinflations, and also in the less well-known ones. In Weimar Germany, the supply shock was World War I (hyperinflation often arises in the aftermath of war). In Zimbabwe, the supply shock was the destruction of agricultural production through cronyism and mismanagement. …

Wheelbarrow of money in 1920s Germany

Off to buy bread and milk in 1922, in Berlin

Second, the economy needs to be repaying debt in goods or hard currency:

A country needs to have a lot of obligations that need to be paid in a foreign currency -– possibly debt that is denominated in an overseas currency (often US Dollars, or in the olden days, gold), or simply a need to make payments abroad that the country’s productive capacity can’t easily accommodate.

This makes it impossible for a country to simply print money to get rid of its obligations, and it encourages money to flee the country, which in turn leads to pressure to print even more, which drives down the value of the currency, and so on.

Again, if you look at historical hyperinflations, all of them involve countries or regimes with large overseas obligations. In Weimar Germany, it was reparations, denominated in gold. In Zimbabwe, the big issue was that the government made such a mess of the economy that it had to import food (which had to be paid for in US Dollars).

Making it simpler, “good” money flows out of the country while the “bad” money stacks up at home (eventually in wheelbarrows). …

Third, you need the push-pull of price increases and wages growth:

You need a vicious circle to drive prices up and sustain them at the extraordinary levels seen in a hyperinflation. This “transmission mechanism” comes in the form of rising wages.

Prices soar, workers can’t pay for goods, so they demand and get pay rises, which drives up prices further, and so on. You tend to get price and wage controls imposed at this point but obviously they don’t work, because “black market” rates take over. …

Without those factors, money printing will only get you inflation:

Put very simply, the economy is no longer able to produce enough to both service its debts and meet the needs of the population. The remaining productive capacity goes on meeting the most important obligations while the other needs are met with increasingly worthless IOUs.

It’s like having a big mortgage, then losing your job. You keep paying the mortgage so you have a roof over your head, but start handing out IOUs to pay the rest of your bills. Clearly, this couldn’t happen in real life, but if it did, it wouldn’t take long before all your other creditors were demanding “real” money.

So this is why the idea that printing money = hyperinflation is flawed.

At the moment, those second and third factors don’t exist in the West, so we’re not going to get hyperinflation anytime soon. While we have a shocking drop in both supply and demand due to the lockdowns, presumably both will pick up again as the lockdowns are rolled back.

South America has had a long experience with hyperinflations. They say that one day there is high but manageable inflation, but suddenly there is a change in psychology — and within a few days or maybe a week, everyone suddenly knows to spend their money as fast as possible, before it loses too much value. Once it gets to that stage, the currency never recovers.

Several tens of trillions of US dollars or equivalents have been brought into existence by central banks, to pay for the lockdowns. Compare that to the world’s supply of money, which is roughly equal to total debt (because modern money is essentially IOUs) — currently about US$ 270 trillion. This is literally an inflation, of the money supply.

After the lockdowns end, there will be substantially more money chasing the same amount of goods and services. This will likely result in increases in consumer prices and in wages.