Wednesday, January 7, 2009

Can you say 'Hyperinflation'?

Excerpts from Wikipedia’s article on Hyperinflation: 
http://en.wikipedia.org/wiki/Hyperinflation

1. Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for money. Economists see both a rapid increase in the money supply and an increase in the velocity of money. Either one or both of these encourage inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly.

The second theory is that there is first a radical increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation.

In either model, the second effect then follows from the first — either too little confidence forcing an increase in the money supply, or too much money destroying confidence.

2. “Governments will often try to disguise the true rate of inflation through a variety of techniques. These can include the following:

* Outright lying in official statistics such as money supply, inflation or reserves. 
* Suppression of publication of money supply statistics, or inflation indices. 
* Price and wage controls. 
* Forced savings schemes, designed to suck up excess liquidity. These savings schemes may be described as pensions schemes, emergency funds, war funds, or something similar. 
* Adjusting the components of the Consumer price index, to remove those items whose prices are rising the fastest.

None of these actions address the root causes of inflation, and in fact, if discovered, tend to further undermine trust in the currency”

3. In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of the specie which back a currency, removes the belief that the authority issuing the money will remain solvent — whether a bank or a government. Because people do not want to hold notes that may become valueless, they want to spend them in preference to holding notes that will lose value. Sellers, realizing that there is a higher risk for the currency, demand a greater and greater premium over the original value.

Under this model, the method of ending hyperinflation is to change the backing of the currency — often by issuing a completely new one. War is one commonly cited cause of crisis of confidence, particularly losing in a war, as occurred during Napoleonic Vienna, and capital flight, sometimes because of "contagion" is another. In this view, the increase in the circulating medium is the result of the government attempting to buy time without coming to terms with the root cause of the lack of confidence itself.

4. Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for money. Economists see both a rapid increase in the money supply and an increase in the velocity of money. Either one or both of these encourage inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly. The second theory is that there is first a radical increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation. In either model, the second effect then follows from the first — either too little confidence forcing an increase in the money supply, or too much money destroying confidence.

In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of the specie which back a currency, removes the belief that the authority issuing the money will remain solvent — whether a bank or a government. Because people do not want to hold notes that may become valueless, they want to spend them in preference to holding notes that will lose value. Sellers, realizing that there is a higher risk for the currency, demand a greater and greater premium over the original value. Under this model, the method of ending hyperinflation is to change the backing of the currency — often by issuing a completely new one. War is one commonly cited cause of crisis of confidence, particularly losing in a war, as occurred during Napoleonic Vienna, and capital flight, sometimes because of "contagion" is another. In this view, the increase in the circulating medium is the result of the government attempting to buy time without coming to terms with the root cause of the lack of confidence itself.

In the monetary model, hyperinflation is a positive feedback cycle of rapid monetary expansion. It has the same cause as all other inflation: money-issuing bodies, central or otherwise, produce currency to pay spiraling costs, often from lax fiscal policy, or the mounting costs of warfare. When businesspeople perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency’s value. The issuer must then accelerate its expansion to cover these prices, which pushes the currency value down even faster than before. According to this model the issuer cannot "win" and the only solution is to abruptly stop expanding the currency. Unfortunately, the end of expansion can cause a severe financial shock to those using the currency as expectations are suddenly adjusted. This policy, combined with reductions of pensions, wages, and government outlays, formed part of the Washington consensus of the 1990s.

Whatever the cause, hyperinflation involves both the supply and velocity of money. Which comes first is a matter of debate, and there may be no universal story that applies to all cases. But once the hyperinflation is established, the pattern of increasing the money stock, by whichever agencies are allowed to do so, is universal. Because this practice increases the supply of currency without any matching increase in demand for it, the price of the currency, that is the exchange rate, naturally falls relative to other currencies. Inflation becomes hyperinflation when the increase in money supply turns specific areas of pricing power into a general frenzy of spending quickly before money becomes worthless. The purchasing power of the currency drops so rapidly that holding cash for even a day is an unacceptable loss of purchasing power. As a result, no one holds currency, which increases the velocity of money, and worsens the crisis.

That is, rapidly rising prices undermine money’s role as a store of value, so that people try to spend it on real goods or services as quickly as possible. Thus, the monetary model predicts that the velocity of money will rise endogenously as a result of the excessive increase in the money supply. At the point when ordinary purchases are affected by inflation pressures, hyperinflation is out of control, in the sense that ordinary policy mechanisms, such as increasing reserve requirements, raising interest rates or cutting government spending will all be responded to by shifting away from the rapidly dwindling currency and towards other means of exchange.

During a period of hyperinflation, bank runs, and loans for 24-hour periods, switching to alternate currencies, the return to use of gold or silver or even barter becomes common. Many of the people who hoard gold today expect hyperinflation, and are hedging against it by holding specie. There may also be extensive capital flight or flight to a "hard" currency such as the U.S. dollar. This is sometimes met with capital controls, an idea which has swung from standard, to anathema, and back into semi-respectability. All of this constitutes an economy, which is operating in an "abnormal" way, which may lead to decreases in real production. If so, that intensifies the hyperinflation, since it means that the amount of goods in "too much money chasing too few goods" formulation is also reduced. This is also part of the vicious circle of hyperinflation.

Once the vicious circle of hyperinflation has been ignited, dramatic policy means are almost always required; simply raising interest rates is insufficient. Bolivia, for example, underwent a period of hyperinflation in 1985, where prices increased 12,000% in the space of less than a year. The government raised the price of gasoline, which it had been selling at a huge loss to quiet popular discontent, and the hyperinflation came to a halt almost immediately, since it was able to bring in hard currency by selling its oil abroad. The crisis of confidence ended, and people returned deposits to banks. The German hyperinflation of the 1920s was ended by producing a currency based on assets loaned against by banks, called the Rentenmark. Hyperinflation often ends when a civil conflict ends with one side winning. Although wage and price controls are sometimes used to control or prevent inflation, no episode of hyperinflation has been ended by the use of price controls alone. However, wage and price controls have sometimes been part of the mix of policies used to halt hyperinflation.

Hyperinflation and the currency

In times of hyperinflation, gold is a store of value whose value cannot be printed out of existence.

As noted, in countries experiencing hyperinflation, the central bank often prints money in larger and larger denominations as the smaller denomination notes become worthless. This can result in the production of some interesting banknotes, including those denominated in amounts of 1,000,000,000 or more.

* By late 1923, the Weimar Republic of Germany was issuing fifty-million Mark banknotes and postage stamps with a face value of fifty billion Mark. The highest value banknote issued by the Weimar government’s Reichsbank had a face value of 100 trillion Mark (100,000,000,000,000; 100 billion on the long scale).[6] [7]. One of the firms printing these notes submitted an invoice for the work to the Reichsbank for 32,776,899,763,734,490,417.05 (3.28×1019, or 33 quintillion) Marks.[8]

* The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion pengő (100,000,000,000,000,000,000, or 1020; 100 trillion on the long scale). image (There was even a banknote worth 10 times more, i.e. 1021 pengő, printed, but not issued image.) The banknotes however didn’t depict the number, making the 500,000,000,000 Yugoslav dinar banknote the world’s leader when it comes to depicted zeros on banknotes.

* The Z$100 billion agro cheque, issued in Zimbabwe on July 21, 2008, shares the record for depicted zeroes (11) with the 500 billion Yugoslav dinar banknote.

* The Post-WWII hyperinflation of Hungary holds the record for the most extreme monthly inflation rate ever — 41,900,000,000,000,000% (4.19 × 1016%) for July, 1946, amounting to prices doubling every thirteen and one half hours.

One way to avoid the use of large numbers is by declaring a new unit of currency (an example being, instead of 10,000,000,000 Dollars, a bank might set 1 new dollar = 1,000,000,000 old dollars, so the new note would read "10 new dollars".) An example of this would be Turkey’s revaluation of the Lira on January 1, 2005, when the old Turkish lira (TRL) was converted to the New Turkish lira (YTL) at a rate of 1,000,000 old to 1 new Turkish Lira. While this does not lessen the actual value of a currency, it is called redenomination or revaluation and also happens over time in countries with standard inflation levels. During hyperinflation, currency inflation happens so quickly that bills reach large numbers before revaluation.

Some banknotes were stamped to indicate changes of denomination. This is because it would take too long to print new notes. By time the new notes would be printed, they would be obsolete (that is, they would be of too low a denomination to be useful).

Metallic coins were rapid casualties of hyperinflation, as the scrap value of metal enormously exceeded the face value. Massive amounts of coinage were melted down, usually illicitly, and exported for hard currency.

Governments will often try to disguise the true rate of inflation through a variety of techniques. These can include the following:

* Outright lying in official statistics such as money supply, inflation or reserves. 
* Suppression of publication of money supply statistics, or inflation indices. 
* Price and wage controls. 
* Forced savings schemes, designed to suck up excess liquidity. These savings schemes may be described as pensions schemes, emergency funds, war funds, or something similar. 
* Adjusting the components of the Consumer price index, to remove those items whose prices are rising the fastest.

None of these actions address the root causes of inflation, and in fact, if discovered, tend to further undermine trust in the currency, causing further increases in inflation. Price controls will generally result in hoarding and extremely high demand for the controlled goods, resulting in shortages and disruptions of the supply chain. Products available to consumers may diminish or disappear as businesses no longer find it sufficiently profitable (or may be operating at a loss) to continue producing and/or distributing such goods, further exacerbating the problem.

More…

No comments: