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Hyperinflation: Money Out of Control

What It Is | Causes and Examples | Effects

What Causes Inflation: Too Much Money

Inflation is caused by an imbalance between the money supply and the goods and services in an economy and/or when confidence in the currency is eroded. At any given moment the economy contains a certain number of goods and services. This can be considered the true wealth of the system. Adam Smith in his book, "Wealth of Nations" pointed out that the pots and pans produced by the foundries of Great Britain constituted the wealth of the nation. He said that wealth was not the gold in the treasury nor the money in people's pockets. This is because money, per se, is only a useful commodity. It is a medium for exchange.

Inflated Dollar Image

It is an immutable economic law that the price of a good or service is the result of two factors, supply and demand. How supply and demand inter-relate determines the price. As the money supply increases proportionally to the goods and services, each unit of money becomes worth less. The decrease in value of money means that it takes more of it to buy things. That is, the price of things goes up. This is what we call inflation. To look at it from the perspective of the individual, the more money a person has, the more that person is willing to pay. When masses of people have more money, they increase the demand for goods and services. In effect: the value of each dollar drops.

Another way to view it is to see that all the money in an economy will buy all the goods and services. Making more dollars will not make more goods and services. It will only mean the same total of goods and services will be equivalent to more dollars.

Thus, any increase in the amount of money in the system relative to the goods and services within the system creates inflation. This is primarily caused by the printing of more money than what is needed to facilitate exchange within an economy. Inflation can also be caused by fewer goods and services being made available. Perhaps the most insidious factor is spending by the government on goods and services that are not productive within the economy. It is easy to see that an expansion of the bureaucracy, for example, increases the number of people within the economy who are not adding to the wealth of the nation. They are paid for by drawing capital out of the economy via taxation, which decreases production.

Hyperinflation: Way Too Much Money

Hyperinflation is inflation on steroids. It is considered by many economists to be an inflation rate of 50% or more per month. However, individuals experiencing extreme inflation of over ten percent per year have been known to apply the term. The most severe periods of hyperinflation occurred in Germany and Hungary between World War I and World War II. Germany's inflation peaked in 1923 when it became so severe that a wheelbarrow full of money would not buy a newspaper, and people spent money as quickly as they could in order to preserve as much value as possible. Goods were bartered because it became easier than actually using money. At the worst point one trillion marks were equivalent to one dollar.1

Hyperinflation is nearly always caused by governments spending far beyond their ability to tax, coupled with an inevitable loss of confidence in the currency. The reparation payments imposed on Germany as punishment for losing World War II coupled with the necessity for maintaining governmental services proved too much for the Weimar (German) government. Money was borrowed to the limit, and when lack of confidence in the government would not allow it to borrow, it simply printed the money to pay its bills.2

Though not as severe as Germany in the early 1920s, very high inflation has occurred in the United States. During the American Civil War the currency of the Confederacy began at roughly equivalent to the Union "greenback". By the end of the war, U.S. currency was worth more than 100 times C.S.A. currency. This was largely due to the fact that the South had no manufacturing base, and the blockade precluded trade of the one saleable commodity of that economy, cotton.3

The Library of Economics and Liberty explains it:

Hyperinflations are caused by extremely rapid growth in the supply of “paper” money. They occur when the monetary and fiscal authorities of a nation regularly issue large quantities of money to pay for a large stream of government expenditures. In effect, inflation is a form of taxation in which the government gains at the expense of those who hold money while its value is declining. Hyperinflations are very large taxation schemes.

Effects of Inflation

It is easy to see that inflation is, in fact, a transfer of wealth from individuals to whatever entity has the power to print money. If we think of the money supply as a giant pie, by printing money, the government's share of the money supply grows in proportion to that of individuals. Thus, the government has more, while individuals have less. Inflation has the effect of destroying the value of savings. (In Weimar Germany retirements were wiped out. People who had saved all their lives were suddenly cast out of their homes.) Those who have borrowed money pay back their loans in dollars worth less than the ones that were borrowed. Thus, governments actually have an incentive to cause inflation as they can effectively reduce debt by paying it back in inflated dollars.

It has long been the policy of the U.S. as well as many advanced economies to foster a mild inflation (below 3%). It is thought that this is good for the economy (because it helps borrowers expand industry) and is seen as advantageous to the government's financial situation. Yet, ultimately, inflation destroys confidence in the money supply, destroys savings, and erodes retirements. Excessive inflation and hyperinflation can even cause unrest within civil societies because it creates instability.

More on Economics

  1. Essay On German Hyperinflation
  2. Definition of Hyperinflation
  3. History of the American People, by Paul Johnson (Chapter on Civil War)

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