What Is Hyperinflation?
All economies experience some level of inflation, because the cost of goods increases as the purchasing power of the currency decreases, and the average price increases. There is generally a cooperative effort between the government and the financial institutions to ensure that inflation occurs in a smooth and gradual manner. Although inflation rates have as a rule accelerated at a steady rate, in many instances in history, inflation rates accelerated to such an unimaginable extent that the real value of a particular country's currency has been eroded in alarming proportions. This accelerated rate of inflation is commonly referred to as hyperinflation.
According to Philip Cagan, author of the book "The Monetary Dynamics of Hyperinflation," hyperinflation occurs when the prices of goods and services increase by more than 50% within the course of a month. We would be experiencing hyperinflation if, for instance, the price of a sack of rice increased from $10 to $15 in less than 30 days, and from $15 to $22.50 by the end of the following month. As a result, if this trend continues, in just six months, the price of the sack of rice will rise to $114, and in one year, the price could reach over $1,000.
The rate of hyperinflation rarely stays at 50%. These rates usually accelerate so quickly that they are able to drastically increase the prices of various goods and services within a single day or even within an hour. The rising prices lead to a decrease in consumer confidence and a decrease in the value of the country's currency. Ultimately, hyperinflation will have a ripple effect, resulting in an increase in unemployment rates, company closures, and decreases in tax revenues. Germany, Venezuela, and Zimbabwe are among the well-known countries that experienced hyperinflation episodes, but many other countries also experienced similar crises, including Hungary, Yugoslavia, Greece, and many others.
Hyperinflation in Germany
The Weimar Republic of Germany after World War I, as a result of hyperinflation, was one of the most famous examples of this phenomenon. During the war, Germany had borrowed massive amounts of money to finance the war effort, strongly believing that it would win the war and use reparations to repay its debts. Germany was not only unable to win the war, but it was also forced to pay billions of dollars in reparations as well.
In spite of divided opinions about what caused Germany's hyperinflation, it has been widely cited that the suspension of the gold standard, the war reparations, and the reckless issuance of paper money were some of the reasons. After the decision to suspend the gold standard at the beginning of the war, there was no correlation between the amount of money in circulation and the value of gold owned by the country. As a result of this controversial step, the German currency was devalued, forcing the Allies to insist that payments of reparations be paid in other currencies than the German paper mark. The German mark depreciated even more as a result of printed money and foreign currency purchases.
In the course of this episode, at some points the inflation rates were climbing at a rate of more than 20% per day. In fact, the value of the German currency had devalued so much that people started burning their paper money to keep their houses warm, as it was a lot cheaper than buying wood to do so.
Hyperinflation in Venezuela
In the 20th century, Venezuela was able to maintain a well-functioning economy because of its large oil reserves, but the 1980s oil glut and the economic mismanagement and corruption of the early 21st century gave rise to a serious socioeconomic and political crisis. This crisis started in 2010 and is now recognized as one of the worst crises in human history.
Venezuela has experienced a rapid increase in inflation rates during the past few years; from 69% in 2014 to 181% in 2015, inflation has risen rapidly. This period of hyperinflation started in 2016, with an inflation rate of over 800% by the end of that year, followed by over 4,000% in 2017 and over 2,600,000% in early 2019.
As part of the fight against hyperinflation, President Nicolás Maduro issued a new currency (sovereign bolivar) at a rate of 1/100,000 in order to replace the existing currency. In this case, 100,000 bolivares became one sovereign bolivar. However, the effectiveness of such an approach is definitely in question. The economist Steve Hanke has stated that cutting zeros is a cosmetic thing and that it has no real significance unless the economic policies are changed as well.
Hyperinflation in Zimbabwe
During the first few years following Zimbabwe's independence in 1980, the economy of the country was quite stable. In contrast, in 1991 the president of Zimbabwe, Robert Mugabe, enacted a program called ESAP (Economic Structural Adjustment Programme) that is regarded as one of the major reasons for Zimbabwe's economic collapse. Along with the ESAP, the rights granted by the authorities in land reforms resulted in a drastic drop in agricultural production, causing a severe financial and social crisis.
A number of indicators began to indicate the Zimbabwe dollar's instability in the late 1990s and hyperinflationary episodes began in the early 2000s. It is estimated that the annual inflation rates reached 624 percent in 2004, 1730 percent in 2006, and 231,150,888 percent in July 2008. A lack of data from the country's central bank resulted in the rates after July being calculated from theoretical estimates as there was no data available from the central bank.
It has recently been calculated by Professor Steve H. Hanke that Zimbabwe's hyperinflation topped out in November 2008, at an annual rate of 89.7 sextillion percent, which is equivalent to 79.6 billion percent per month, or 98% per day.
In the 21st century, Zimbabwe was the first country to experience hyperinflation, and more specifically, it was the second-worst episode of inflation in history (after Hungary). In 2008, the ZWN was officially abandoned, and foreign currencies became legally enforceable as a form of compensation.
The use of cryptocurrencies
Since Bitcoin and other cryptocurrencies are decentralized, their worth cannot be determined by governmental or financial institutions since they are not based on centralized systems. In addition to ensuring that new coins are issued in accordance with a predefined schedule, blockchain technology ensures that each unit of a cryptocurrency is unique and cannot be replicated or copied.
These are a few reasons why cryptocurrencies are becoming more and more popular - especially in countries like Venezuela, which is dealing with hyperinflation. There are similar occurrences in Zimbabwe, where payments using digital currencies (such as bitcoins and ether) have seen a dramatic increase in the last couple of years.
As a potential alternative to the traditional fiat currency system, authorities in some countries are seriously studying the possibilities and risks associated with a government-backed cryptocurrency. One of the first to do so is the Swedish central bank. Other notable examples include Singapore's central bank, the Bank of Canada, China's, and the Bank of the United States. Many central banks are experimenting with blockchain technology, but these systems will not necessarily result in a new paradigm for monetary policy since their cryptocurrencies are unlikely to possess a limited or fixed supply like Bitcoin.