What is Hyperinflation? How does it Work?

Hyperinflation is an episode where prices for goods and services rise rapidly over an extended length of time. Hyperinflation is the term used in economics to describe a scenario where all products and services see an unpredictable increase in rates over a specific period.

For instance, as per reports, the United States has been observing a rapid rise in the levels of hyperinflation, leading consumer rates to increase and reach almost 8% every year.

In other terms, hyperinflation is an increase that happens very quickly. When the cost of products and services increases by more than half every month, we experience hyperinflation. At that rate, a loaf of bread could have been priced differently in the morning and later in the day.

In this article, we will talk in detail about what is hyperinflation, how it occurs and the way it affects our lives.

What Is Hyperinflation?

An exponential, excessive, and unchecked increase in the general prices in a market is known as hyperinflation. While inflation measures how quickly prices rise for items and services, hyperinflation refers to inflation rising swiftly—typically by more than half per month.

Although it is rare in developed economies, hyperinflation has happened a number of times in countries like Germany, Hungary, Russia, China and Georgia.

Let’s explore a few consequences of hyperinflation.

• Hyperinflation can happen when any country’s central bank produces excessive money and scenarios exist that influence the production economy.

• As demand outpaces supply, hyperinflation could cause an increase in the rates of basics such as food and gasoline.

• Even though circumstances involving hyperinflation are usually uncommon, they could slip out of control once they start.

Causes of Hyperinflation

Now that we have talked about hyperinflation meaning, let us understand what causes it. Listed below are the causes of hyperinflation.

• Higher supply of money – The government typically prints a lot of money to the point where the currency’s value starts to decline to increase the quantity of currency. As more money is printed and the worth decreases, prices rise.
• Demand-pull inflation – Demand-pull inflation is the second cause of hyperinflation. When there is a gap in supply and demand for products or services, prices rise as a result.

This can happen due to increased government spending, a rise in exports, or rising consumer spending related to a robust economy.

• Cost-push inflation – Another factor that causes hyperinflation is cost-push inflation. Production factors like labour and natural resources start to increase in price due to cost-push inflation.

As a result, business owners frequently increase their prices to cover rising costs and still turn a profit. The business owners pass on the price increase to the customers because demand is unchanged, but production expenses are higher, which results in cost-push inflation.

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Effects of Hyperinflation

As the relative value of the nation’s currency falls from other currencies due to hyperinflation, it rapidly loses value on foreign exchange markets. This circumstance will compel holders of the domestic currency to decrease their holdings and convert to more secure foreign currencies.

People typically start investing in long-lasting goods like equipment, machinery, jewellery, etc., to prevent paying higher prices tomorrow due to hyperinflation. In prolonged hyperinflationary conditions, people will start to hoard perishable products.

This practice starts a brutal cycle where citizens of the country gain more goods as prices increase, which increases demand and drives up the prices even more. If hyperinflation continues unchecked, a significant economic breakdown almost always results.

The nation’s economy could shift to a barter economy due to severe hyperinflation, significantly impacting business trust. The banking system may also be destroyed if banks stop lending money.

Real-world examples of hyperinflation

Hyperinflation has been seen in various parts of the world throughout history. Some of them have been listed below.

1. Germany

Despite not being the worst, Weimar Germany’s hyperinflation is the most well-known instance. Germany suffered severe economic as well as political shocks after World War I, mainly due to the Treaty of Versailles terms that ended the conflict.

In accordance with the treaty’s terms, Germany had a duty to make restitution payments to the victorious nations through the Bank for International Settlements. Germany was practically unable to comply with the terms of these reparation payments, so the country failed to meet its responsibilities.

The Germans could not pay in their currency and were forced to exchange it at unfavourable rates for a “hard currency” that was appropriate. The rates worsened as they produced more money to make up the difference, and hyperinflation soon took hold.

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2. Zimbabwe

Zimbabwe is a more recent case of hyperinflation where, between 2007 and 2009, inflation exploded out of control at a nearly unfathomable rate. Political changes in Zimbabwe that resulted in the confiscation and redistribution of agricultural property, which in turn caused a flight of foreign capital, were the cause of the country’s hyperinflation.

Simultaneously, Zimbabwe suffered a terrible drought that, when combined with other economic factors, made a failed economy all but inevitable.

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3. Hungary

After World War II, Hungary witnessed the worst hyperinflation ever observed in 1946. Like in Germany, the need to pay for the recently ended war’s reparations led to hyperinflation in Hungary.

The government of Hungary released a brand-new currency for use in tax and postal payments because the Hungarian currency’s inflation was so out of hand. Even that special-use money had daily value announcements made by officials due to substantial variations.

By August 1946, the entire face value of all in-circulation Hungarian banknotes was equal to one-tenth of a US penny.

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4. Greece

Greece’s debt from World War II stems from its decision to print money to pay for expenses rather than tax its people. The German-Italian occupation ruined the country’s economy, which led to a decline in public confidence in the currency. As a result, the central bank started issuing gold-plated franc pieces, reducing currency demand.

Greece entered the international Bretton Woods system in 1953 to combat hyperinflation, which set exchange rates tying different currencies to the US dollar.

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How to Prepare for Hyperinflation?

Remembering hyperinflation is uncommon, specifically in developed countries where the central bank of the country concentrates on taking control over inflationary periods is vital. You can take steps to lessen the impact of low or high inflation on your assets, though.

You can reduce losses during inflation by having a balanced and diversified portfolio. Since the principal that has been invested in a TIPS adjusts with inflation, Treasury Inflation-Protected Securities (TIPS) can safeguard against increasing inflation.

You can also use mutual funds and exchange-traded funds that use inflation swaps to reduce the effect of inflation on your assets.

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Conclusion

In the case of hyperinflation, a country’s economic condition goes on a toll. If a nation finds itself in a position where it cannot afford to fulfil its obligations or faces challenges that limit its capacity to create goods and services, this is a cause for concern. Thus, hyperinflation is something that only happens sometimes; however, it holds the potential to cause grievous consequences.

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