The pain of rising prices is well-known to investors and consumers alike. There are no places where increasing costs haven't been felt: the gas station, grocery shop, or even your Amazon cart.
We've witnessed worrying amounts of inflation since the coronavirus outbreak brought the globe to a stop and after Russia invaded Ukraine just as the economy was about to recover, especially in economies that are perceived to be immune to it.
This article will discuss hyperinflation from a practical and historical perspective and how to better prepare for it.
It is best to start by asking what hyperinflation is.
What is hyperinflation?
The term "hyperinflation" refers to a sudden, extraordinarily high increase in inflation of at least 50% each month or 14,000% annually.
When hyperinflation occurs, a cup of coffee may cost $5 on Monday and $10 on Friday. In severe circumstances, daily hyperinflation may surpass 200%.
Root Causes of Hyperinflation
Hyperinflation often results when several factors combine to create the worst-case situation. Corrupt regimes, shaky economies, and bad monetary policies are common elements. Natural occurrences like prolonged droughts that impair a nation's capacity to produce or feed itself can also impact hyperinflation.
Supply of money expanding.
When a central bank issues excessive amounts of money, it is one of the most frequent direct causes of hyperinflation. Historically, this happened when vulnerable countries had to finance wars or pay off huge debts.
As more money becomes accessible, the worth of each unit of new currency decreases, but prices increase. Consumers must spend more on the same goods and services as business earnings fall. The central bank may increase output further to keep up with rising prices, fuelling the cycle.
Demand-pull inflation
Hyperinflation occurs when demand abruptly and significantly exceeds supply. Prices increase when supplies become more limited. Demand-pull hyperinflation typically occurs after extreme events, such as wars or prolonged droughts, that result in significant supply shortages.
Psychology
Consumer psychology may fuel hyperinflation that is already out of control. Due to rising costs, consumers may be forced to stockpile necessities like food, toilet paper, or other in-demand commodities. Demand increases as products fly off the shelves, reducing supplies and creating a dangerous feedback loop.
What was the worst hyperinflation in history?
German hyperinflation in 1923 was among the worst ever recorded in modern history. It is most known for the severe devaluation of its currency and the failed measures to correct it.
Germany's Weimar Republic was then emerging from the devastating economic consequences of World War One. Banks printed four times as many paper bills as was typical throughout the war, and by 1923, they were creating astounding sums of their own paper money. The biggest coin ever made was worth 120 trillion Reichsmarks.
The only remedy available to the Weimar Republic was to print more money, which resulted in record-high hyperinflation levels because the country's economy was not sufficiently strong to find alternative solutions. As of October 1923, there were 400.3 trillion reichsmarks in circulation in Germany.
Scenes of normal life during this period revealed a collapsing society. Children used useless paper money as toys, people bought a loaf of bread and wheelbarrow full of Reichsmarks, and criminals snatched suitcases full of cash only to empty the paper money before taking the bag. Prices were growing so quickly that, according to reports, a guy who purchased a cup of coffee discovered the price had risen by the time it reached his table.
What caused hyperinflation in Germany?
The German government had increased the quantity of paper money it created throughout the war to pay soldiers and to buy weapons, ammunition, and other supplies instead of increasing taxes and running the risk of disturbing people.
Between 1914 and October 1923, taxes funded only roughly 15% of expenses. In the final ten days of October 1923, ordinary taxes barely covered 1% of costs.
When the war ended, more money was available for transactions than goods. Additionally, the French invaded the Ruhr (a German industrial area rich in coal and iron ore) after Germany refused to pay reparations to France.
The German people reacted by going on a nationwide strike to express their displeasure at the occupation. Almost little was produced during that strike. Thus, the few remaining commodities increased in value. Prices rose, and the mark made fewer purchases overall.
Due to the massive amount of German money in circulation and the dearth of products, necessities like milk and bread, which ordinarily cost a few marks, began to cost dozens of marks, hundreds of thousands, millions, and even more.
The Effects
Germans who had money in banks or depended on pensions or disability payments found themselves practically bankrupt due to inflation. Workers increasingly learned that they needed help to keep up with quickly rising prices despite salary increases.
What had been enough money to begin a secure retirement fund over months was no longer sufficient to purchase a piece of bread.
Who suffered from it?
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The value of the middle class's monetary savings was destroyed before their eyes, or "Mittelstand."
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The general population transfers wealth to the government, which issues the money.
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Lenders suffered losses while borrowers profited.
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Rent ceilings in Germany did not keep up with general price levels. Therefore, tenants benefited at the expense of property owners.
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The economy's efficiency weakened because individuals chose to barter.
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In contrast to paper money, which is constantly depreciating, people hang onto physical assets (such as commodities, gold, and land).
Value of German Currency, 1919–1923
Date Marks US Dollars
1918 4.2 1
1921 75 1
1922 400 1
January 1923 7,000 1
July 1923 160,000 1
August 1923 1,000,000 1
November 1, 1923 1,300,000,000 1
November 15, 1923 1,300,000,000,000 1
November 16, 1923 4,200,000,000,000 1
Lessons From the German Hyperinflation of 1921-1923
The German hyperinflation event is a prime example of a developed industrial economy giving in to the risks of currency depreciation promoted by incompetent central bankers.
Unfortunately, the truth is more complicated than that, especially when historical political and economic factors are considered.
As we shall see, that incident offers some significant lessons that may be used to assess the success of devaluing our currency in the twenty-first century.
Laying the Foundation
After World War I, the vast empires of Central Europe were gone, and the shattered nations that emerged from them had to adapt to a far more modest and unreliable operation.
After the Bolsheviks seized power in Russia, a new force emerged further to the East, audaciously declaring that it would not stop there. On the opposite side of the Atlantic, America proved it could gather the resources needed to win a significant global conflict and become a force reckoned with.
Since the once-powerful German troops were no longer a threat, Great Britain maintained its position as the leading superpower. Since it had security, its primary priority moving forward was economic, particularly as a defense against the escalating Bolshevik threat.
Germany emerged from the war with its industrial capacity substantially intact, leaving France vulnerable to a resurgent Germany. As a result, France's principal interests were political.
The British saw the two sides of Europe as separate, especially because the ongoing disputes of Eastern Europeans could once again draw the major Western powers into a regional conflict similar to 1914.
The French believed that the peace of Eastern Europe was a primary concern of Western European states and that Germany should never be allowed to reassert itself eastward. Britain thought Germany could be convinced to preserve the peace by making compromises, but France thought Germany could only be forced to do so.
Although it wasn't understood then, these opposing viewpoints would ultimately pave the way for Germany's hyperinflation episode.
German Reparations
Reparations for the war proved to be a major disagreement among Western European nations. The French, in particular, were profoundly dissatisfied with the outcomes of the Treaty of Versailles and actively sought retribution.
The beneficiaries claimed that only roughly 8 billion of the 20 billion marks in total that were intended to be handed out in the initial payments by May 1921 had been received. As a result, the victorious nations issued Germany various requests and deadlines, including the threat to occupy the Ruhr earlier that year.
After facing intense pressure, the Germans finally consented to issue bonds worth 132 billion marks as the total repayment payment. Eighty-two billion of these were put away and forgotten. In addition to a portion of German exports, the remaining 50 billion would be paid in yearly payments of 2 billion marks.
However, Germany would only be obligated to fulfill these obligations if two circumstances occurred: first, it had to have a fiscal surplus, which would give the government access to more money than what was necessary to meet its current obligations; and second, it had to have a positive balance of trade with other countries, which would allow it to amass enough gold or foreign currencies to pay the reparations.
Ultimately, neither of these circumstances materialized during the 1920s, so Germany could never make any reparations. Even though the true motivations for this strategy went beyond only reparations, money printing was the final result.
Inflation Breaks Out
The German government was exclusively to blame for failing to achieve a fiscal surplus because it failed to lower its spending, raise its citizens' living standards, or impose adequate taxes.
Germany's inability to achieve a good trade balance was partially the fault of its creditors. While the Germans made little to no attempt to reduce their foreign currency purchases, which would have similarly reduced their living level, they stubbornly refused to permit an open border for German goods because this would damage their industry.
Once more, the geopolitical leanings of the creditor in issue influenced how these failures were seen. The French thought they did not want to pay, while the British took them as evidence of Germany's incapacity to pay. In reality, both were accurate.
Due to its relatively higher per capita income levels as the decade passed, Germany could have created enough products and services to cover a sizable chunk of the reparations obligations if it had been permitted to export freely.
The German government chose to run consecutive budget deficits rather than enact severe tax hikes and spending reductions, or "austerity" in today's terminology. Central bank lending—the counterpart of our "quantitative easing"—is the source of finance.
So, rather than the reparations themselves, the German government's measures meant to get around them led to a major increase in inflation. In understanding the causes of the acceleration of inflation during that early period, it is sometimes overlooked how much the restriction on the free movement of German products to creditors' markets worsened the issue.
It did so more quickly. The par exchange rate of the German mark to the British pound was around 20, although it dropped from 305 in August 1921 to 1,020 by November of the same year.
The worst, though, was yet to come.
Germany Loses the Ruhr
Inflation's impacts were viewed quite unevenly throughout German society. It benefited those whose assets were real wealth, such as land or industrial facilities, by boosting the value of their holdings and eliminating their debts. As usual, the middle class suffered the most.
In July 1922, Germany sought to halt all monetary reparations payments for the following 30 months. The French maintained that the Germans had made no meaningful attempt to pay their obligations and that, as a result, such a moratorium would only be acceptable to them if it was accompanied by reasonable assurances, even though the British were ready to concede at least some of this.
The creditors had to seize control of numerous western German mines, factories, woods, and customs to obtain money to pay reparations. As a result, the Reparations Commission decided in January 1923 by a vote of 3 to 1 (Britain voted against France, Belgium, and Italy). Two days later, the Ruhr was taken over by the armed forces of the three countries.
The German economy greatly depended on this region. It produced 80% of the country's coal, iron, and steel, generating 70% of its freight traffic with only 10% of the population. Germany replied by calling a local general strike, stopping all reparations payments, and implementing a passive resistance strategy. To fund the strikes, extra paper money had to be manufactured.
By 1923, the region's output had been reduced to one-third of its capacity. By December 1923, the value of the German mark had nearly doubled, from 80,000 to the pound in January 1923 to 20 billion.
Another important factor to remember is that the collapse of Germany's currency was sealed by the reduction in its productive capacity, which was maintained by printing even more money.
Resolution
Resistance in the Ruhr region caused significant financial and economic pressure on Germany and psychological strain on the French and Belgians. The occupying nations did not get the due reparations while the German mark was being destroyed.
As a result, a settlement was achieved in which the Ruhr was evacuated, and Germany agreed to another reparations package (the Dawes package).
The British emerged as the winners in this incident, proving that the French could not effectively employ force without British consent. The years that followed would see significant geopolitical repercussions.
However, there were other winners as well. The radical political parties in Germany benefited from the consequent humiliation and annoyance experienced by significant portions of the populace. Within a decade, the most extreme among them would become the most powerful.
Lessons for Today
This episode highlights less evident but very significant aspects of the dynamics of money printing, particularly in how they interact with economic freedom and productive potential. High inflation rates may require plenty of paper credit, but more is needed today.
Ensuing gold outflows
In an open economy, inflation may appear as a steady price rise or a worsening trade balance. Regarding the latter, during the era of the gold standard, the ensuing gold outflows would act as a self-correcting process.
The central bank would then have to hike rates to reverse those outflows and reduce the domestic demand that first caused the imbalance.
These imbalances can last longer because we have monetary currencies now, which are influenced by differences in interest rates, inflation expectations, risk premiums, credit creation, and other factors. The nearly infinite manufacturing capacity is one significant advancement since the 1920s—the late 1970s.
Quick building of manufacturing capacity of money
Capitalism and globalization have made it feasible for business owners and, in certain crucial circumstances, central planners (think China) to quickly assemble manufacturing capacity anywhere in the world. Thus, supply may expand quickly to meet demand increases, reducing long-term market prices and consequences.
Through the free flow of money and products, global markets have grown extraordinarily effective at identifying and eliminating price advantage possibilities. As a result, Western economies have an essentially deflationary system, especially when combined with huge debt loads that might limit the sustainability of demand increases.
How to get ready in case of hyperinflation?
Although it may not seem like it, you should plan for hyperinflation as you would plan for retirement or a natural disaster. You need to safeguard yourself from both the likely and the unlikely.
Fortunately, there are a few things you can do to combat the hyperinflation crisis.
Hedging
An investment that retains value despite a currency's diminishing value is known as an inflation hedge. Common ways to hedge against inflation include investing in precious metals like gold or silver, purchasing real estate, or acquiring power sources, such as a generator or solar panels.
Because cryptocurrencies aren't affected by interest rates and inflation like traditional currencies, investors have recently turned to them as an inflation hedge.
Spending
Currency is meaningless when its value is lost. Spending money on needs is one of the smartest things you can do when you sense the threat of hyperinflation. Start with investments and buy non-perishables and canned, dry, and frozen products if the situation worsens.
