Hyperinflation Essay Example

presentation currency. IAS 21 provides for translations of foreign currencies into the presentation currency.

IAS 29 establishes special accounting rules for use in hyperinflationary environments, and lists four factors which can trigger application of these rules:

1. The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain purchasing power.

2. The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that foreign currency.

3.Sales and purchases on credit take place at prices that are increased by an amount that will compensate for the expected loss of purchasing power during the credit period, even if the period is short.

4. Interest rates, wages and prices are linked to a price index and the cumulative inflation rate over three years approaches, or exceeds, 100%. Root causes of hyperinflation By definition, hyperinflation is a rapid increase in Nominal GDP (the Money Supply multiplied by the velocity of money) without a corresponding increase in real output (see Equation of exchange).

This is often caused by decisions on the part of the central bank to increase the money supply much more than markets had previously expected, often when money is printed to finance government spending. This results in a fall in the demand for money relative to its supply, which in an extreme case can grow into a complete loss of confidence in the money, similar to a bank run. This loss of confidence causes a rapid increase in velocity of spending which causes a corresponding rapid increase in prices. For example, once inflation has become established, sellers try to hedge against it by

increasing prices.

This leads to further waves of price increases. Hyperinflation will continue as long as the entity responsible for increasing bank credit and/or printing currency continues to promote excessive money creation. In severe cases, legal tender laws and price controls to prevent discounting the value of paper money relative to hard currency or commodities can fail to force acceptance of the rapidly increasing money supply which lacks intrinsic value, in which case hyperinflation usually continues until the currency is abandoned entirely.

Hyperinflation is generally associated with paper money, which can easily be used to increase the money supply: add more zeros to the plates and print, or even stamp old notes with new numbers. Historically, there have been numerous episodes of hyperinflation in various countries followed by a return to "hard money". Older economies would revert to hard currency and barter when the circulating medium became excessively devalued, generally following a "run" on the store of value.

Hyperinflation effectively wipes out the purchasing power of private and public savings, distorts the economy in favour of extreme consumption and hoarding of real assets, causes the monetary base, whether specie or hard currency, to flee the country, and makes the afflicted area anathema to investment. Hyperinflation is met with drastic remedies, such as imposing the shock therapy of slashing government expenditures or altering the currency basis. One form this may take is dollarization, the use of a foreign currency (not necessarily the U. S. dollar) as a national unit of currency.

An example was dollarization in Ecuador, initiated in September 2000 in response to a 75% loss of value of the Ecuadorian Sucre in early 2000. The aftermath of hyperinflation is equally complex. As hyperinflation has always been a traumatic experience for the area which suffers it, the next policy regime almost always

enacts policies to prevent its recurrence. Often this means making the central bank very aggressive about maintaining price stability, as was the case with the German Bundesbank or moving to some hard basis of currency such as a currency board.

Many governments have enacted extremely stiff wage and price controls in the wake of hyperinflation but this does not prevent further inflating of the money supply by its central bank, and always leads to widespread shortages of consumer goods if the controls are rigidly enforced. As it allows a government to devalue their spending and displace (or avoid) a tax increase, governments have sometimes resorted to excessively loose monetary policy to meet their expenses. Inflation is effectively a regressive consumption tax, but less overt than levied taxes and therefore harder to understand by ordinary citizens.

Inflation can obscure quantitative assessments of the true cost of living, as published price indices only look at data in retrospect, so may increase only months or years later. Monetary inflation can become hyperinflation if monetary authorities fail to fund increasing government expenses from taxes, government debt, cost cutting, or by other means, because either ? during the time between recording or levying taxable transactions and collecting the taxes due, the value of the taxes collected falls in real value to a small fraction of the original taxes receivable; or ? overnment debt issues fail to find buyers except at very deep discounts; or ? a combination of the above. Theories of hyperinflation generally look for a relationship between seignior age and the inflation tax. In both Cagan's model and the neo-classical models, a tipping point occurs when the increase in money supply or the drop in the monetary base makes it impossible for a

government to improve its financial position. Thus when fiat money is printed, government obligations that are not denominated in money increase in cost by more than the value of the money created.

From this, it might be wondered why any rational government would engage in actions that cause or continue hyperinflation. One reason for such actions is that often the alternative to hyperinflation is either depression or military defeat. The root cause is a matter of more disputes. In both classical economics and monetarism, it is always the result of the monetary authority irresponsibly borrowing money to pay all its expenses. These models focus on the unrestrained seignior age of the monetary authority, and the gains from the inflation tax.

In Neoliberalism, hyperinflation is considered to be the result of a crisis of confidence. The monetary base of the country flees, producing widespread fear that individuals will not be able to convert local currency to some more transportable form, such as gold or an internationally recognized hard currency. This is a quantity theory of hyperinflation. In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base that is the confidence that there is a store of value which the currency will be able to command later.

In this model, the perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums. One example of this is during periods of warfare, civil war, or intense internal conflict of other kinds: governments need to do whatever is necessary to continue fighting, since the alternative is defeat. Expenses cannot be cut significantly since the main outlay is armaments.

Further, a civil war may make it difficult to raise taxes or to collect existing taxes.

While in peacetime the deficit is financed by selling bonds, during a war it is typically difficult and expensive to borrow, especially if the war is going poorly for the government in question. The banking authorities, whether central or not, "monetize" the deficit, printing money to pay for the government's efforts to survive. The hyperinflation under the Chinese Nationalists from 1939 to 1945 is a classic example of a government printing money to pay civil war costs. By the end, currency was flown in over the Himalayas, and then old currency was flown out to be destroyed.

Hyperinflation is regarded as a complex phenomenon and one explanation may not be applicable to all cases. However, in both of these models, whether loss of confidence comes first, or central bank seignior age, the other phase is ignited. In the case of rapid expansion of the money supply, prices rise rapidly in response to the increased supply of money relative to the supply of goods and services, and in the case of loss of confidence, the monetary authority responds to the risk premiums it has to pay by "running the printing presses. " Nevertheless the immense acceleration process that occurs during yperinflation (such as during the German hyperinflation of 1922/23) still remains unclear and unpredictable. The transformation of an inflationary development into the hyperinflation has to be identified as a very complex phenomenon, which could be a further advanced research avenue of the complexity economics in conjunction with research areas like mass hysteria, bandwagon effect, social brain and mirror neurons. Less commonly, inflation may occur when there is debasement of the coinage:

wherein are consistently shaved of some of their silver and gold, increasing the circulating medium and reducing the value of the currency.

The "shaved" specie is then often re struck into coins with lower weight of gold or silver. Historical examples include Ancient Rome, China during the Song Dynasty, and the US beginning in 1933. When "token" coins begin circulating, it is possible for the minting authority to engage in fiat creation of currency. Much attention on hyperinflation naturally centres on the effect on savers whose investment become worthless. Academic economists seem not to have devoted much study on the (positive) effect on debtors.

This may be due to the widespread perception that consistently saving a portion of one's income in monetary investments such as bonds or interest-bearing accounts is almost always a wise policy, and usually beneficial to the society of the savers. By contrast, incurring large or long-term debts (though sometimes unavoidable) is viewed as often resulting from irresponsibility or self-indulgence. Interest rate changes often cannot keep up with hyperinflation or even high inflation, certainly with contractually fixed interest rates. For example, in the 1970s in the United Kingdom inflation reached 25% per annum, yet interest rates did not rise above 15% – and then only briefly – and many fixed interest rate loans existed). Contractually there is often no bar to a debtor clearing his long term debt with "hyperinflated-cash" nor could a lender simply somehow suspend the loan. "Early redemption penalties" were (and still are) often based on a penalty of x months of interest/payment; again no real bar to paying off what had been a large loan. In interwar Germany, for example, much private and

corporate debt was effectively wiped out; certainly for hose holding fixed interest rate loans. Hyperinflation and the currency 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 two-trillion 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 million million). At the height of the inflation, one US dollar was worth 4 trillion German marks. 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. ? The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion pengo (100,000,000,000,000,000,000, or 1020; 100 million million million). There was even a banknote worth 10 times more, i. e. 1021 pengo, printed, but not issued. ) The banknotes however did not depict the numbers, "hundred million b. -pengo" ("hundred million trillion pengo") and "one milliard b. -pengo" were spelled out instead. This makes the 100,000,000,000,000 Zimbabwean dollar banknotes the note with the greatest number of zeros shown. ? The Post-World War II hyperinflation of Hungary held the record for the most extreme monthly inflation rate ever — 41,900,000,000,000,000% (4. 19 ? 1016% or 41. quadrillion percent) for July, 1946, amounting to prices doubling every 15. 3 hours. By comparison, recent figures (as of 14 November

2008) estimate Zimbabwe's annual inflation rate at 89. 7sextillion (1021) percent, which corresponds to a monthly rate of 5473%, and a doubling time of about five days. In figures, that is 89,700,000,000,000,000,000,000%. 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 1 January 2005, when the old Turkish lira (TRL) was converted to the New Turkish lira (TRY) 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 the time new notes were 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. None of these actions addresses the root causes of inflation and they, if discovered, tend to further undermine trust in the currency, causing further increases in inflation.

Price controls will generally result in shortages and hoarding and extremely

high demand for the controlled goods, resulting in disruptions of supply chains. 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 at the legal prices, further exacerbating the shortages. Examples of hyperinflation Argentina Argentina went through steady inflation from 1975 to 1991. At the beginning of 1975, the highest denomination was 1,000 pesos.

In late 1976, the highest denomination was 5,000 pesos. In early 1979, the highest denomination was 10,000 pesos. By the end of 1981, the highest denomination was 1,000,000 pesos. In the 1983 currency reform, 1 Peso argentino was exchanged for 10,000 pesos. In the 1985 currency reform, 1 austral was exchanged for 1,000 pesos argentinos. In the 1992 currency reform, 1 new peso was exchanged for 10,000 australes. The overall impact of hyperinflation: 1 (1992) peso = 100,000,000,000 pre-1983 pesos. Zimbabwe  The 100 trillion Zimbabwean dollar banknote (1014 dollars), equal to 1027 pre-2006 dollars

Hyperinflation in Zimbabwe was one of the few instances that resulted in the abandonment of the local currency. At independence in 1980, the Zimbabwe dollar (ZWD) was worth about USD 1. 25. Afterwards, however, rampant inflation and the collapse of the economy severely devalued the currency. Inflation was steady before Robert Mugabe in 1998 began a program of land reforms that primarily focused on taking land from white farmers and redistributing those properties and assets to black farmers, which sent food production and revenues from export of food plummeting.

The result was that to pay its expenditures Mugabe’s government and Gideon Gono’s Reserve Bank printed more and more notes with higher face values. Hyperinflation began early in the

twenty-first century, reaching 624% in 2004. It fell back to low triple digits before surging to a new high of 1,730% in 2006. The Reserve Bank of Zimbabwe revalued on 1 August 2006 at a ratio of 1 000 ZWD to each second dollar (ZWN), but year-to-year inflation rose by June 2007 to 11,000% (versus an earlier estimate of 9,000%). Larger denominations were progressively issued: 1. May: banknotes or "bearer cheques" for the value of ZWN 100 million and ZWN 250 million. 2. 15 May: new bearer cheques with a value of ZWN 500 million (then equivalent to about USD 2. 50). 3. 20 May: a new series of notes (“agro cheques”) in denominations of $5 billion, $25 billion and $50 billion. 4. 21 July: “agro cheque” for $100 billion. Inflation by 16 July officially surged to 2,200,000% with some analysts estimating figures surpassing 9,000,000 percent. As of 22 July 2008 the value of the ZWN fell to approximately 688 billion per 1 USD, or 688 trillion pre-August 2006 Zimbabwean dollars. Date of |Currency |Value | |redenomination |code | | |1 Aug 2006 |ZWN |1 000 ZWD | |1 Aug 2008 |ZWR |1010 ZWN | | | |= 1013 ZWD | |2 Feb 2009 |ZWL |1012 ZWR | | | |= 1022 ZWN | | | |= 1025 ZWD |

On 1 August 2008, the Zimbabwe dollar was redenominated at the ratio of 1010 ZWN to each third dollar (ZWR). On 19 August 2008, official figures announced for June estimated the inflation over 11,250,000%. Zimbabwe's annual inflation was 231,000,000% in July (prices doubling every 17. 3 days). For periods after July 2008, no official inflation statistics were released. Prof. Steve H. Hanke overcame the problem by

estimating inflation rates after July 2008 and publishing the Hanke Hyperinflation Index for Zimbabwe. Prof. Hanke’s HHIZ measure indicated that the inflation peaked at an annual rate of 89. sextillion percent (89,700,000,000,000,000,000,000%) in mid-November 2008. The peak monthly rate was 79. 6 billion percent, which is equivalent to a 98% daily rate, or around 7?? 10108 percent yearly rate. At that rate, prices were doubling every 24. 7 hours. Note that many of these figures should be considered mostly theoretic, since the hyperinflation did not proceed at that rate a whole year. At its November 2008 peak, Zimbabwe's rate of inflation approached, but failed to surpass, Hungary's July 1946 world record.

On 2 February 2009, the dollar was redenominated for the fourth time at the ratio of 1012 ZWR to 1 ZWL, only three weeks after the $100 trillion banknote was issued on 16 January, but hyperinflation waned by then as official inflation rates in USD were announced and foreign transactions were legalised, and on 12 April the dollar was abandoned in favour of using only foreign currencies. The overall impact of hyperinflation was 1 ZWL = 1025 ZWD. Worst hyperinflations in world history |Highest monthly inflation rates in history |

Country |Currency name |Month with highest inflation rate |Highest monthly inflation rate |Equivalent daily inflation rate |Time required for prices to double | |Hungary |Hungarian pengo |July 1946 |4. 19 ? 1016 % |207. 19% |15 hours | |Zimbabwe |Zimbabwe dollar |November 2008 |7. 96 ? 1010 % |98. 01% |24. 7 hours | |Yugoslavia |Yugoslav dinar |January 1994 |3. 13 ? 108 % |64. 63% |1. 4 days | |Germany |German Papiermark |October 1923 |29,500% |20. 87% |3. 7 days | |Greece |Greek drachma

|October 1944 |13,800% |17. 84% |4. 3 days | |Taiwan (Republic of China) |Old Taiwan dollar |May 1949 |2,178% |10. 98% |6. 7 days | |