RealFin Capital Partners Hyperinflation What is Hyperinflation? When we hear the term “hyperinflation” we understand it to mean extremely high inflation, but without having lived through an episode of hyperinflation, it can be difficult to conceptualize. There is no fixed definition in economics to distinguish hyperinflation from extremely high inflation, but most agree that it is when inflation exceeds 50% per month. The chart below shows what the price of a loaf of bread, which, dependent on your gluten preferences, currently costs around R14 per loaf, would rise to under the minimum hyperinflation definition.
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Under a hyperinflationary scenario, in 12-months’ time, the R14 per loaf cost would jump to a pretty staggering R1 211 per loaf. From where we sit today, it is inconceivable to imagine paying over R1 000 for a loaf of bread, but hyperinflation is not a once off, isolated phenomena. Over the 20th and into the 21st century, there have been numerous cases of hyperinflation around the world.
Why does it occur? The most studied example of hyperinflation is that of Germany (The Weimar Republic) following World War I. Over a 16-month hyperinflationary period, prices rose by over 300% per month. Again, to get some sense of what an effective quadrupling of prices looks like – the R14 loaf of bread would cost just under R59 million 12-months later! It makes Atlantic seaboard property look like a steal at current prices. The German post-war hyperinflationary period occurred in part because of a change in money supply. Deutschmarks in circulation ballooned from 13 billion to 60 billion as the government “printed cash” to stimulate the post-war economy. This worked initially and there was some economic growth, but together with the war repatriations bill enforced on Germany by the Allies, production collapsed leading to a shortage of goods, food, in particular. Due to the massive amounts of cash in circulation, there was a total mismatch between the demand and supply of money in the economy. This mismatch completely eroded the purchasing power of money.
As a government increases the number of bank notes in circulation, prices begin to rise to match the money supply increase. The government then finds it cannot purchase the same amount of goods with its newly issued money because of the inflation it created, so it responds by increasing the money supply further. The feedback loop begins, more inflation leads to more money supply leads to more inflation and so on. While there are a number of economic theories that attempt to explain hyperinflation, there is a psychological element also at play. People lose faith in their currency as a medium of exchange. This means they start to reduce their cash balances and try to buy those assets which they believe will prove to be a better store of value. In hyperinflationary Germany, the price of “Gold Marks” skyrocketed as the populous tried desperately to preserve their wealth. Hyperinflation is a vicious circle and can lead to some unbelievable behaviors. In Germany, children were often given bank notes to play with as they were cheaper than toys. There is even an image of a woman fueling her stove with bank notes rather than using them to buy rapidly inflating coal.
Arts and Crafts with Bank Notes
Burning Notes cheaper than Burning Fuel
Getty Images
Getty Images
Modern Examples of Hyperinflation; While we understand the German bout of hyperinflation was precipitated by a world war and subsequent accelerating money supply, in non-post war scenarios, how does hyperinflation manifest itself? Zimbabwe experienced hyperinflation in 2008 and into 2009 following the destruction of its main source of foreign revenue through the confiscation of private farms collapsing the agricultural sector. The Zimbabwean government then ran out of money to pay civil servants and “loyalists” and resorted to simply printing the cash. Gideon Gono, the Reserve Bank of Zimbabwe governor at the time, said that “traditional economics do not fully apply in this country,” and stated that “I am going to print and sign the money…because we need money.” Inflation was so rampant, it was difficult to determine the actual rate, but during November of 2008, the peak of the hyperinflationary cycle, inflation was estimated to be 79,600,000,000% per month. The government printed ever increasingly ridiculous bank notes, and these Z$100 trillion notes now sell as novelty items on eBay for about $45. “Officially”, one US Dollar was equivalent to Z$2,621,984,228,675,650,147,435,579,309,984,228 – a number no politician could possibly announce. In 2009, the government scrapped the currency giving savers $1 for each 35 quadrillion (35,000,000,000,000,000) Zimbabwean dollars. Venezuela is currently following the Zimbabwe model. After a spree of financial largess in which very expansionary socialist policies were paid for with oil revenues which subsequently fell with a falling oil price, the government has resorted to printing money to pay its bills. Hugo Chávez who led Venezuela from 1998 until his death in 2013, expropriated businesses at will, sometimes on live TV for maximum impact, which destroyed the private sector and any associated business confidence. Nicolás Maduro, current president and Chávez’s hand-picked successor has continued his policies. Inflation reached an annual rate of 800% in December 2016 and together with the implementation of price controls, the economy has been decimated. The situation in Caracas, the capital, is particularly dire. Grocery-store shelves are empty, and the average Venezuelan has lost around 9 kilograms of body weight due to food shortages.
Could we experience hyperinflation in South Africa? Given that numerous countries, particularly in Latin America, have experienced the devastation of hyperinflation, why don’t governments know better? Without fail, hyperinflationary periods have been accompanied by rampant money supply growth – the government “printing money”. Apart from the post-war occurrences in which there is a clearly identifiable economic shock, other instances have seen a more gradual economic decline. No one shock event, but a series of economic missteps resulting in economic vulnerability. There is typically some sort of initial economic event – perhaps a widespread drought, or a massive increase in social spending to garner political favour, and these “extraordinary items” need to be paid for. If the government has insufficient funds from bond issuance or tax collections, there is a temptation to ask the Reserve Bank – the lender of last resort – to finance the bill. In this scenario, it is not that the mint printing presses are running at full steam, there is more of accounting anomaly in the electronic “creation of money” in the government’s Reserve Bank account. This works initially, the bill is paid and there is an illusion of economic growth. However, as the money enters the economy, there is more cash “chasing” the same goods and services which pushes up prices causing an inflationary response. The rise in inflation further constrains the government budget as debt issuance and servicing become more expensive and having tapped the Reserve Bank once, there is a real temptation to “do it again”. As people begin to recognize that the government is creating money to pay the bills, they lose faith in the ability of cash to preserve their wealth. By buying assets valued in hard currency, the currency weakens, inflation continues to rise and the hyperinflation spiral begins. So, could this happen in South Africa? It is highly improbable but not impossible. If government policies remain socialist in nature and expenses outrun government revenue, it is not inconceivable to think someone might have a “good, temporary fix” to preserve political power in the sort-term. However, provided the Reserve Bank remains independent, and our financial institutions remain robust, as our banks are, while we might suffer a harsh economic climate, the threat of hyperinflation in South Africa remains low.