Welcome to Finance and Fury, the Say What Wednesday Edition,
Where we answer your questions, today's question is from Sol Tau
Thanks for the Podcast and all the great info it provides. Could you explain what leads to hyperinflation and if there is any possibility of seeing that sort of scenario in Australia?
This is a great question – and one topic I was going to tackle in a few weeks in relation to the monetary reset to crypto – so I'll jump the gun and cover potential hyperinflation
First – What is hyperinflation? In economic terms - hyperinflation is very high or highly accelerating inflation rates Inflation is the measurement of the increase in prices of goods = CPI in measurement terms – basket of goods and how the costs to purchase them changes Central bankers try to use inflation to reduce the real value of the debt to give debtors some relief in the hope that they might spend more and help the economy get moving again Therefore – hyperinflation quickly erodes the real value of a currency – due to prices of a good increasing – reducing your purchase power unless wages increase at same or greater rate – Technically - Hyperinflation is when the prices of goods and services rise more than 50% a month. If you have $100 bill in your wallet – which could buy you 20 cage-free 12 pack of eggs at $5 each today You have another $100 bill and take it to buy eggs a month later – but the prices go up by 50% - now can only get 13 and 1/3rd egg cartons – reduction of about 33% of your purchase power If a good or service could cost one amount in the morning but be more expensive by the afternoon – how would you respond? You would buy more now? Or wait? Buy now – this creates shortages in stockpiles – leads to undersupply which further spikes price rises Hyperinflation massively increases uncertainty due to a rational behavioural response people make - but not accounted for in economic models – therefore – spending now rather than saving for the future is an ‘irrational behaviour’ Causes– number of different causes – but demand and supply come into it – but with some stress to the government budget, such as wars or their aftermath, socio-political upheavals (changes in governments – mostly socialism/communism), a collapse in aggregate supply or one in export prices, or other crises that make it difficult for the government to collect tax revenue – many different reasons – as it isn’t just one trigger that creates hyperinflation – requires a perfect storm of situations
Starts for a combination of reasons – but in most cases - step is when a country's government begins printing money to pay for its spending – increasing supply of money – decreases real value It is all about perception – well known example - Germany – Weimar Republic in Germany in the 1920s printed to pay off war debts – along with losing backing for supply of money in the form of gold in the WWI treaty But number of Deutschmarks in circulation went from 13 billion to 60 billion from 1913 to 1914 First time printed money to pay for WW1 – economy was strong and prepared before war But German government also printed government bonds - same effect as printing cash - so Germany's sovereign debt went from 5BN to 156BN DMs But from WW1 - 132 billion marks in war reparations – from taking away production capacity - lead to a shortage of goods, especially food. Because there was excess cash in circulation, and few goods, the price of everyday items doubled every 3.7 days. The inflation rate was 20.9% per day. Farmers and others who produced goods did well, but most people either lived in abject poverty or left the country. But today - Every government does this still - not to pay off war debts but fund spending – budget deficit is the term for the indirect way of funding this through bonds – which are purchased off the financial system which received an increase in their money supply from the Central Bank Modern day – I believe that once a country is cut off from the modern financial system – cant borrow/issue bonds for spending funding – so start printing as a response – not the only response they have though – they could always cut spending Theoretically - An increase in the money supply is one of the two causes of inflation – Monetarist theory – but after too much inflation - instead of tightening the money supply to stop inflation, the government keeps printing more – often out of perceived necessity Milton Friedman – “inflation is always and everywhere a monetary phenomenon” – may have been true back in his day – but not true today – pre-70s money was user demand-responsive = only grew through trade – more a country produced, more it could export – leading to monetary influx of funds – leading to companies being able to charge more – so prices went up creating inflation – with it – growth of the economy but only between a bandwidth of inflation Today – with Inflation being targeted and therefore manipulated from Central banks – it has become a function of behavioural psychology – the inflation trend is promised to us – and has been well delivered from the 70s all the way up until a few years ago – hard to get people to change their inflation expectations after the expectation and confirmation bias is there – but issue for central banks is it is very hard to raise inflation from under 1.8% to 2.5% through policy Anyone paying attention knows that Central Banks are trying to force inflation – i.e. the reduction in the real value of items valued in fiat currency – this for the financial system is something that can be profited off This leads to the other exacerbating causes – as behavioural is certainly one – monetary side to cover but quickly touch on behavioural – To make the most of your money – you would want to spend sooner and stockpile on the goods you can Petrol – before I left petrol was $1.3 and left with empty tank – got back less than a month and prices at $1.76 – if I had known would have filled up before leaving – but if inflation is almost guaranteed like in hyperinflation countries – I would have filled up and further reduced the supply even though I didn’t need to use it Inflation is part of a complex system – i.e. has non-linear developments – therefore can't simply be increased from 2% to 2.5% or 3% - instead, inflation hits a point it quickly spins out of control – jumps to 6%, then 9%, etc. The other is demand-pull inflation. It occurs when a surge in demand outstrips supply, sending prices higher. Cause people to hoard, creating a rapid rise in demand chasing too few goods. The hoarding may create shortages, aggravating the rate of inflation Modern Example – Venezuela – massive levels of price increases - Prices rose massively starting in 2013 with 41% In 2017, the government increased the money supply by 14% along with promoting a new cryptocurrency, the "petro," because the bolivar lost almost all its value against the U.S. dollar – due to USD increasing monetary supply – The International Monetary Fund projected prices to rise 13,000% in 2018 Can't afford the cost of printing new paper currency How did the people respond - began using eggs as currency. A carton of eggs was worth 250,000 bolivars compared to 6,740 bolivars in January 2017. Unemployment rose to 21%, similar to the U.S. rate during the Great Depression. How did Venezuela create such a mess?Former President Hugo Chávez had instituted price controls for food and medicine.
But mandated prices were so low it forced domestic companies out of business. In response, the government paid for imports. In 2014, oil prices plummeted. It eroded revenues to the government-owned oil companies. When the government ran out of cash, it started printing more. Rather than change its dangerous price and wage controls, President Nicolás Maduro is continuing unsustainable policies. As of 2019, Venezuela’s foreign debt is about $100 billion. Its inflation rate has hit 10,398% per annum. With the continued collapse of its economy, the country is facing a monumental problem of debt repayment. At this moment, it is the only country in the world suffering from true hyperinflation. Is it possible today? – Well, hard to say for certain, but it is a probability– Today’s environment is drastically different than it was in the late ’70s and early ‘80s when inflation was nearly out of control.
Today, disinflation is the primary challenge central banks face, not inflation.
Note - am not predicting it or saying it is an imminent likelihood – but if it were to kick off it would happen quickly - jumping from under 2% to 6%, 8%, 12% World is massively indebted – massive trick though – money technically isn’t in circulation (i.e. printed) – in the financial system or owned to other governments – essentially not in your hands to affect prices Since hyperinflation is visible as a monetary effect, models of hyperinflation focus on the demand for money. This is where Economists see both a rapid increase in the money supply and an increase in the velocity of money if the (monetary) inflating is not stopped. Historically – both of these have been a root cause of inflation or hyperinflation increase in the velocity of money - central to the crisis of confidence hyperinflation model - where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly Radical increase in the money supply in circulation - i.e the "monetary model" of hyperinflation Either of the previous may be the trigger – but the second effect is either loss of some confidence forcing an increase in the money supply – or a loss of all of it - destroying confidence Today’s markets depend on the artificially low-interest rates - Raising interest rates would devastatingly pop the asset bubbles in property and a lot of shares But the problems in the economy today are structural, not liquidity-related – Central banks trying to solve structural problems with liquidity solutions. That will never work, but it might destroy confidence in the fiat system (mainly USD) in the process CPI has remained low, despite the CBs efforts – begs the question of - where the inflation is – because trillions have been printed since – and Governments as massively in budget deficits (borrowing to fund expenses) But there has been inflation. It’s just been in assets like stocks, bonds, real estate, etc. The market’s back to record highs again, in case you haven’t heard. The bottom line is, we’ve seen asset price inflation, and lots of it, too. Trick to the system today – borrowed funds through debt instruments (bond) isn’t printing to fund spending – and the money never hits circulation – as the increase in monetary supply is from borrowings – put into hard assets (like shares or homes) Inflation today in the fiat system has only been seen to be experienced in the 3rd world buy those nations, not in the ‘financial system’ – bonds can always be issued to fund spending But QE, if it was put into circulation, may have triggered hyperinflation - massively increase the monetary supply – Inflation moves into financial markets measured by price increases – Xero is at a PE of between 4,500 to 6,000 – but people still are wanting to buy – not rational Also – the borrowings/government debts – USA went from $9trn 2007 to $24trn estimated this year in government Debt – when gained from QE programs – where Gov bonds are issued and bought using the Central Bank printed money – all to cover funding costs i.e. spending – backdoor way of printing money for spending – just not reflected in money supply in circulation – as it is tied up in the financial system/government's coffers Amount of money within the financial system growing at compounding 13% p.a., while money in circulation growing at 5% p.a. Potential Economic fallout - Banks and lenders go bankrupt since their loans lose value. They run out of cash as people stop making deposits. Hyperinflation sends the value of the currency plummeting in foreign exchange markets. The nation's importers go out of business as the cost of foreign goods skyrockets. Unemployment rises as companies fold. Government tax revenues fall, and it has trouble providing basic services. Historically – Governments make it worse - The government prints more money to pay its bills, worsening the hyperinflation Today –Supply issues - Think about Aus – We thankfully have a lot of goods locally produced – but not everything. So, shortages of goods are possible – especially fuel – 80% is refined in Singapore and shipped onto us –
Also - A sharp decrease in real tax revenue coupled with a strong need to maintain government spending, together with an inability or unwillingness to borrow, can lead a country into hyperinflation.
Australia – large Social spending – 40% to Centrelink payments – politicians don’t want to reduce as political suicide
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