Hyperinflation – Still More Than a Monetary Phenomenon

One of the bigger myths in the world of economics and finance remains the cause of hyperinflation.  As I’ve highlighted many times over the years, hyperinflation is more than just a monetary phenomenon (and misunderstanding this led to many incorrect hyperinflation predictions in the USA in recent years).  In fact, the monetary explosion is almost always the result of some other rare or extreme exogenous factor.  My original conclusions on this found that hyperinflations tended to occur around the follow events:

  • Collapse in production.
  • Rampant government corruption.
  • Loss of a war.
  • Regime change or regime collapse.
  • Ceding of monetary sovereignty generally via a pegged currency or foreign denominated debt.

These events usually lead to a collapse in the tax system or expansion in deficits that appear like the cause of the hyperinflation when the reality is that the debt increase is always the result of some rare or extreme exogenous event.  And let’s be clear – when we say “rare” we mean really rare.  As in wars that destroy countries, regime changes that shift entire countries, corruption that destroys an economy, ceding of monetary sovereignty in the use of a currency peg or foreign debts, or a collapse in production.

Anyhow, it was kind of nice to see a paper by the Cato Institute noting that hyperinflations tend to “arise under extreme conditions” as opposed to the usual “money printing” conclusion:

“Hyperinflation is an economic malady that arises under extreme conditions: war,
political mismanagement, and the transition from a command to market-based economy –
to name a few. In each of these circumstances, there are barriers to the recording and
publication of reliable inflation statistics. As we discovered over the course of our
investigation, overcoming these barriers was an arduous and painstaking process. In light
of this, it is little wonder that no one has been able to fully and accurately document
every case of hyperinflation.”

It’s nice to see that some people are beginning to connect the dots and make earnest attempts to understand why hyperinflation didn’t happen in the USA.  Of course, if you don’t understand the basic operational realities of the monetary system then you likely can’t even begin to piece together the dynamics behind the recent lack of hyperinflation in the USA so if you’re bored on a Friday you might want to peruse this document first.  


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • yo

    It would be nice if all the misinformed malcontents who predicted deflation from the financial deleveraging were now exposed for the charlatans that they are.

    Not holding my breath.

  • Robert K

    Hello Cullen:
    I am going to argue against the thesis you present, because I would be interested to hear
    your reaction to the scenario I am about to propose. Before doing so, I would suggest
    that the fact that many past hyperinflations have coincided with the set of 5 events you
    list does not mean that a hyperinflation must be exclusively caused by them.
    Correlation does not prove causation, but I agree that, when you find it, you should try to figure out if there are possible causal mechanisms at work.

    I contend that a hyperinflation of the US dollar has already occurred, but due to an
    unique set of circumstances never before present in world history, it has not shown
    up as the skyrocketing prices for most consumer goods which we generally associate with the onset of the disease. The lesser of these mechanisms I will mention first,
    followed by the more important one.

    The distribution of wealth within society is such that the vast amount of excess dollars
    within the system come to reside under the control of a very small sector of the
    population, among which are large corporations. These dollars find their way into
    a vast array of paper assets, representing both debt and equity claims, but which are
    not counted in traditional inflation calculations. They are in fact the “heat sink” or
    “pressure release valve” which keeps the excess dollars out of the “tangible assets”
    arena where supposed “real inflation” is measured. So long as losses are not allowed
    to materialize in these assets, this game can continue a long time.

    The unique event in world history to which I referred is that, never, prior to 1945 has
    the entire world been dominated by a single national currency, as is still the case today
    with the US dollar. Consider the following little thought experiment:

    Imagine a currency which is the “legal tender” within a nation consisting of only 4%
    of the world’s population, but which for a particular set of reasons related to the
    outcome of a pair of great, devastating wars (I and II) has acquired the status of a
    global reserve currency, or second currency, for the entire world population. These
    countries have their own fiat currencies of course, which they use in day to day
    transactional exchanges, and in which they store some savings, depending on the
    quality of their currency management, but for surplus savings, particularly between
    nations, this currency, the US$, is most used. And, it is guaranteed (until 1971) to
    be convertible to gold at a fixed price. (a very bad idea, by the way, but it lent
    credibility early in the game)
    Imagine also that a few VERY IMPORTANT products essential to modern life, of
    which the most important is petroleum, but including corn, wheat, coal, iron ore etc
    were all priced and traded in this currency, and were allowed to be SETTLED in it. Thus
    everyone needed the currency, and held it for just such purposes. The result of this
    set of facts is that the US$ became the world’s “second money”, the money for today’s
    7 billion population, not just the US 315 million. Because of this, the inflation policy
    of the dollar issuer is spread not just among its citizens, but across the entire world,
    dampening the price effects at home. And where are these surplus $ stored? Why,
    they are lent right back to the US government, in the form of treasury securities, so
    hey, no problem. No inflation here, it’s all being shock absorbed by the securities
    of the issuer. What could possible go wrong here?
    Now, consider what might be the consequences if the holders of these securities
    ever came to the conclusion that they “don’t really mean anything” because they
    can never be converted, in the nation where they retain “legal tender” status, into
    anything of value “at anything like present prices”. That would give a whole new
    meaning to the term “blowback”, wouldn’t it? Do you see evidence of this emerging
    awareness on the part of dollar holders around the globe today? I do. I would be
    interested to hear your thoughts on this. Cheers!

  • Bond Vigilante

    Hyper-Inflation occurs when a government resorts to literally printing money in order to fund their expenses. And it can resort to printing money when a government is unable to issue new debt.

    And that happens when:
    1. Production collapses.
    2. Collapsing taxrevenues as a result of falling/collapsing production.
    3. a country is involved in a war (which is extremely expensive).
    4. a regime change and the new regime won’t recognize the old debts.
    5. There’s massive corruption. This disables a government to make tough choices needed for structural reforms.

    All these conditions apply to the US today. So, I won’t rule out Hyper-Inflation in the near future for the US as well.

  • Alberto

    Hyperinflation in the US and other (west block) countries is extremely unlikely and I’m not worried about it. The real fact is financial repression via mild inflation (about 4%) more or less hidden by the fact that’s computed on a basket of goods set by the goverment itself AND persistent low interest rate (I believe 10y will be lower than 2% and 30y lower than 3% for at least a generation). Market can’t do nothing about it and bond vigilantes will shot at the moon. Gold and a few equities are the only possible long term investments.

  • Robert Rice

    Inflation is really very simple. Businesses are the price change mechanism, and unless they have motivation related to increasing (or at least sustaining) profits, prices don’t change. There are any number of reasons to give a business the motivation to increase prices, but ultimately it’s about the maintenance or increase of profits. With that written, let’s focus on your thought experiment:

    It is certainly true if the entire world decides to come to the U.S. with their U.S. currency to dump their dollars for real assets by buying American made products for fear they won’t each be able to buy products simultaneously at existing prices, the massive influx of demand will likely give businesses the motivation to raise prices at a harmful rate. But the chances of that are less than nil if international consumers can get the products for less elsewhere with those same dollars. And not only this, but it isn’t really foreign consumers holding dollars, it’s foreign governments and corporations. While those entities can also consume, I don’t think it escapes them their financial holdings consist of paper or electrical current within transistors, not of real assets. Hence, I don’t see this eureka hyperinflation scenario you propose as realistic.

    Now, you might argue that other countries wouldn’t be willing to accept those dollars in your scenario, only the U.S., and so competition wouldn’t function as a preventative factor as I argued a moment ago. Even in the extremely unlikely event your doomsday scenario began to take shape, the U.S. could always implement an international sales tax, mitigating foreign demand. This would be great–the government wouldn’t have to print and thereby freak out the paranoid, stuck in the currency user paradigm folks. They could tax this spending heavily and use it to fund projected spending while perhaps even reducing debt. Frankly, if putting people to work is our concern, a large influx of foreign demand would be advantageous.

    Hyperinflation is the boogie man in the closet that doesn’t exist. In the land of fairy tales, we have ghosts, goblins, the boogie man, God (aka sky fairies), and hyperinflation, although the latter at least has the possibility of existence. Nevertheless, it’s all a lot of superstitious paranoia. Harmful levels of inflation wouldn’t be hard to identify, nor the reasons leading to it, nor the prevention or elimination thereof. There are scenarios, shocks as Cullen coined it, that could be problematic, but I don’t find your scenario even remotely likely as one of them.

  • Robert Rice

    Hogwash. Money creation is not inherently inflationary. Money creation has to lead to certain outcomes first before any substantive level of inflation takes hold:

    Step 1: Money creation.
    Step 2: Money creation must then cause an increase in consumer incomes.
    Step 3: Increased consumer incomes must then result in increased spending/demand.
    Step 4: Demand then needs to reach such high and sustained levels, aggregate business confidence elevates to a point where a general, consensus belief arises that price increases will lead to sustained or increased profits.

    Money creation is like drinking water; in moderation, it is healthy and needed for a thirsty body; in excess, it can kill you. The current economic environment of rampant unemployment, under-production, and thirst for demand literally implores us to create money to fund our spending in an effort to increase consumer incomes. This can come from stimulus checks, infrastructure retooling jobs, R&D, how about even government programs implemented to encourage the mental and emotional health of the society? It will be stimulative, job-creative, and otherwise an antidote to the poison. All we have to do is not be foolish and print to excess. That shouldn’t be too difficult for us.

  • REN

    Almost all hyperinflations in history are caused by debts denominated in another currency. That includes the Weimar inflation, as well as South America. I’m not sure about Zimbabwe/Rhodesia. The Weimar inflation was partially solved when the FED lent cheap credit to Wall Street, so Germany could take out credit loans. This gave them dollars to pay England and France, who then paid back the U.S. government for inter-ally debts. In effect, money came out of wall street banks, paid Germany, then went to England/France, and vectored back to the U.S. Government. Dollars came out of one pocket in the U.S. and then went into another, while loading the Germans with debt. (Yet, further proof that two sources of money in an economy is dangerous.)

    This cheap FED credit ultimately led to a bubble economy in the U.S. culminating in the 1928 depression.

  • http://www.pragcap.com Cullen Roche

    Zimbabwe is the closest to a traditional case of hyperinflation that we often hear described by people. But even this was a case of rare events. They had 85% unemployment and then decided to hand over their one major export industry to a group of unskilled farmers. So when the farming industry collapsed the whole economy basically collapsed. And when you don’t have a production base for the money the tax receipts collapse, the govt spends and the money supply explodes. It’s part govt incompetence, part production collapse.

  • REN

    Here’s my inflation boogie man that keeps me awake at night. I wonder how far off base I am? I could have the line of causation wrong, at least I hope so.

    BRICS system grows, allowing moves away from dollar as reserve. Dollar’s exchange value falls as it is no longer chosen for international transactions (lower demand for dollars).

    The FED cannot prop up dollars exchange value by creating more dollars to purchase dollars. The FED can buy Treasury debt keeping bond prices from falling. In order to buy overseas dollars we would need foreign currencies, but that is out since we have a structural trade deficit. Perhaps OPEC chooses to not price in dollars, hastening the exchange rate problem.

    In order to forestall the exchange rate collapse, the FED does currency swaps. But, the exchange rate problem persists due to the large amount of dollars, and foreign central banks give up.

    The value of the dollar continues to fall, so ultimately bond prices cannot stay high. Also, imports rise in price, which shows up as higher inflation. People don’t want to hold onto bonds paying negative rates during inflation, so they start to exit bonds.

    As interest rates are forced up by the exchange rate problem, the TBTF banks are exposed due to their derivative position. Most derivatives are interest rate swaps, and the bankers make money when interest rates are low. When interest rates go high, TBTF bankers are on the hook for their very high leveraged positions, such as 30:1 in some cases.

    The FED creates money in order to bail out TBTF banks, causing a large amount of money to enter the money supply. FED money is vectored from the Banks to municipalities and others holding the derivative contract. This causes more inflation due to more dollars thus raising interest rates, causing FED to print more for derivative payments, creating a hyperinflation feedback loop. The exchange rate problem gets worse, accelerating the feedback loop.

    I hope I’m wrong, but this scenario is not in the history books.