Factors that Lead to Hyperinflations - Coursework Example

Hyperinflation Hyperinflation is the inflation, which is out of control. It is a situation where rapid price increase is associated with loss in currency value. In economics hyperinflation is associated with that rate where the monthly level of inflation exceeds 50 percent. However in common use we often associate hyperinflation with a much lower rate. Hyperinflation is an inflationary circle, which increases in a cumulative way and always moves far from the equilibrium. Causes of hyperinflation There is sufficient debate regarding the actual causes of hyperinflation. However, a somewhat general cause of hyperinflation may be described as follows – an unprecedented rise in money supply that is bereft of any growth in output or services creates a disparity between the demand and supply of money. This imbalance leads to a loss of confidence in the value of the money and finally, hyperinflation. The situation becomes such gruesome that any kind of legal tender laws, price controls, fail to return the confidence on the value of the paper money, which is without any intrinsic value to the consumer. If the government resorts to excessive printing of money and if it gets a friendly environment to foster inflation, hyperinflation keeps on sustaining and in a cumulative manner, erodes the economy day by day. The government in such case often fails to match the pace of its currency printing mechanism with that of the devaluating currency (the rate at which the currency is losing its value). (Hyperinflation: causes, cures”) The incident of hyperinflation is almost always associated with the paper form of money. This is because it is the simplest way to increase money supply. In most of the cases after experiencing hyperinflation, an economy reverts to hard money. An investigation into the basic causes of hyperinflation will offer more questions than answers. According to the monetarists and the classical economists, a hyperinflation is always led by irresponsible borrowing of money by the government in order to pay all of its expenses. The monetary and classical theory regarding the hyperinflation center on the untamed seignorage on behalf of the monetary authority and the gains they can reap off the inflation tax. The neo liberals, on the other hand, explain hyperinflation in terms of the confidence crisis. The neoliberal theory of hyperinflation is known as the quantity theory of hyperinflation. According to them loss of confidence of the mass on the capability of paper money to readily transform into hard currency like gold, silver or other form of precious metals initiate hyperinflation. The neoclassical economists defined the causes of hyperinflation in terms of deterioration of the monetary base. In a more elaborate way the neoclassical thinking regarding the hyperinflation may be explained as follows – the neoclassical opine that money has a storage value. During the time of hyperinflation, people lose confidence in holding the currency. On the other hand, the sellers demand high premiums to accept the currency, that is, suppose one unit of a good in normal time, sells at $5. In times of hyperinflation, the seller of the good will seek for more than $5, say $10. This is because the seller of the good will has to hold that money and he has already lost confidence in the store value of money. So he wants to minimize that risk by holding more amount of money. The inherent implication of this is that if $5 after a certain period becomes two and a half dollars, then in order to store a money value equal to $5, the seller must keep $10 with him. The neoclassical economic theory of hyperinflation can explain its initiation during the time of warfare, civil war or internal anarchy of a nation. In all these situations, the government puts all its effort to sustain the battle. Otherwise, it may face a defeat. The government cannot think of an expenditure cut as in these situations, the prime expenditure is expenditure on armaments. Moreover, during the time of a civil war, it might become impossible for the government to raise the tax. The government even fails to collect the existing tax revenues in an efficient manner. This puts huge pressure on the revenue side of the government budget. Furthermore, in normal times, when peace prevails, the deficit of the government budget is often financed through selling government bonds. However during wartimes, even this becomes quite difficult and the borrowing becomes too expensive to bear. In such cases, monetization of budget deficit is a common practice to follow suit. The central bank simply prints currencies and circulates the in the economy. It is not possible to provide any straightforward answer regarding the causes of hyperinflation, as it is multidimensional in approach. Even between loss of confidence and seignorage, which is the cause and what is the effect cannot be told without ambiguity. However, irrespective of their chronological order, one sets other into motion and both combined, leads to hyperinflation. Hyperinflation is often led by debasement of the coinage. The quality of metal used in the coin signifies the economic condition of a nation. A deteriorating economic condition is always associated with declining quality of the metal or presence of lesser amount of silver and gold in the coin. When the government strategically sheds the amount of silver and gold in the coin, the actual value o the currency gets reduced. Such debasement may lead to loss of the confidence of the people on the coin as well as on the government and that may initiate hyperinflation. However, such forms of hyperinflation are less commonly found. Apart from these, a hyperinflation may be initiated even in the absence of the central bank. In a regime of free banking if the government imposes a suspension on one bank regarding its convertibility, following any violation of compliance or law on behalf of the bank; it may initiate a panic among other banks, finally resulting in an entire collapse of the monetary system. Hyperinflation across the world Hyperinflation may be defined in the words of Cagan (1956) as, “hyperinflation as beginning in the month the rise in price exceeds 50 percent and as ending in the month before the monthly rise in prices drops below that amount and stays below for at least a year”(Cagan, 25). Instances of hyperinflation may be observed across several nations. (See Appendix 1) The most recent example can be drawn from the case of Zimbabwe where “hyperinflation is ravaging the purchasing power” (Zulu). The problems of inflation began n Zimbabwe from the time after it gained independence. The fall of the economy has devaleud the currency and this inturn caused may organizations to prefer the American dollar instead of ZD (Zimbabwe dollar). Zimbabwe mainly experienced the evils of hyperinflation the in current century. It reached 624 percent in early 2004 and 1730 percent within three years, in March 2007. The June figures, as officially released, stood at a staggering 7638 percent. The future predictions lie within the band of 3000 percent to 8000 percent. With a 6 percent economic contraction the price reached a good 26,470.8 percent high. The avergae rate of inflation in June 2007 was recorded at 1100 percent and the U.S. ambassador predicted it to rise to 1.5 million percent by the end of the year (“US says Zimbabwe change is afoot”). However the rate estimated by IMF was 115000 percent for december and 150000 percent for January 2008. The current circulaltion of notes reached $200000 and the crisis in fod, fuel and medicines continue. (Wines) According to Makochekanwa (2007), “Zimbabweans are getting stronger. Thirty years ago it took five people to carry fifty Zimbabwean dollars (Z$50)’s worth of groceries. Today a child can even carry five hundred thousand dollars (Z$50 x 104)’s worth of groceries.” (Makochekanwa, 2) Zimbabwe’s administration began to produce excess currency in order to finance the rise in salaries of soldiers and policemen (300 percent increase) and the 200 percent rise in salaries of other civil servants. However, the money was unplanned and not within the budget. New currency was issued in August 2006 by the government and civilians had to return old notes. However even this did not help control the inflation. Other legal measures included arrest of some executives of the companies of Zimbabwe and legal condemnation of inflation. The trend of hyperinflation shows a rising one from the late nineties till 2007 (see Appendix 2) According to a certain report, “Zimbabwe is facing a sharp decline in public expenditure on higher education, deteriorating teaching conditions, decaying educational facilities and infrastructure, perpetual student unrest, the erosion of university autonomy, a shortage of experienced and well-trained teaching staff, lack of academic freedoms, and an increasing rate of unemployment among the college graduates” (Kwidini, 1) Another case of hyperinflation may be found in Bolivia where the highest denimination was 1000 pesos before 11984 and reached 10 million pesos in 1985. (Weatherford, 194) The peso bolivano was pegged to the US dollars in 1987. the inflation occurred durign 1984 to 1986. Developed nations like Ukraine faced the rise in inflation rate between 1993 and 1995. During 1996 the hyperinflation rate turned into a 1400 percent per month. Till date Ukraine is known for its record of the maximum yearly inflation rate, which took place in 1993. The Weimar republic of Germany had the taste of hyperinflation during the early 1920s. The reason is often attributed to the high expenses in paying the war reparations, which were required under the treaty of Versailles. However history says that the German currency, mark, was not unstable in the year 1921, with respect to U.S. The London Ultimatum placed before Germany necessitated the nation to pay 2 billion gold marks and 26 percent value of the exports of Germany. (Guttmann, 21-25) This induced the devaluation of the Germany mark and eventually it reached a point when the value was one third of a cent by the end of the year. 132 billion gold marks were demanded in total and this exceeded the total German gold or the foreign exchange. The nation made an attempt to buy foreign exchange but the payment received was in the form of treasury bills and these commercial debts for Marks accelerated the devaluation process. Remedies for hyperinflation Reduction of money supply is the foremost requirement to tame the onrush of hyperinflation. However, a reduction in money supply might lead to failure of the government in order to meet its budgetary deficit. The degree of such failure can be reduced to a great extent if any government controls some of its expenditures. Countries like Germany, Hungary, china, Greek, Georgia, Bolivia, Angola and Taiwan, are there to speak on behalf of reduction in money supply as a successful policy towards control of hyperinflation. However, reduction in money supply has to be accompanied with stabilization program. Stabilization program provides the central bank greater level of autonomy in order to withdraw as a financier of government deficit through money printing. It has been observed that black market premium in foreign exchange market often is responsible for hyperinflation. In such cases there exists a positive difference between the black market foreign exchange rate and the officially announced exchange rate. Such kind of premium leads to expensive imported inputs and affects the inflation rate in an indirect way. Strict monitoring on behalf of the government in order to abolish the existence of such black marketers would be a great help in order to eradicate hyperinflation. Furthermore a country suffering from hyperinflation usually witnesses drying of foreign currency inflow and is left with only one option, export on which they can depend upon to unshackle themselves from hyperinflation. Boosting of exports will again be subject to a well-framed exchange rate policy. So a country suffering from hyperinflation needs to have such an exchange rate that in no case would discourage exports. If it does, it will only provide the black marketers a free field to put further pressure on the country’s economy. Certain studies have revealed that political rights have a long run influence on the price level of a country. So a country suffering from hyperinflation should consider improving its political environment from a multidimensional angle comprising international relations as well as internal governance. Furthermore, political stability and human rights are two factors that if restored to optimum will have significant positive effect in controlling the onrush of hyperinflation. References 1. Cagan, Philip (1956) ‘The Monetary Dynamics of Hyperinflation’ in Friedman M (ed) Studies in the Quantity Theory of Money: University of Chicago Press. 2. “Hyperinflation: causes, cures”, The Financial Gazette, 2003, retrieved on March 21, 2008 from: http://www.fingaz.co.zw/fingaz/2003/October/October2/1365.shtml 3. Kwidini, Tonderai, “Zimbabwe: Hyperinflation Wreaks Havoc On School Systems”, Global Information Network. New York: Jan 29, 2008.  Retrieved from ProQuest (March 20, 2008) 4. Makochekanwa, Albert, “A Dynamic Enquiry into the Causes of Hyperinflation in Zimbabwe”, University of Pretoria, Department of Economics Working Paper Series, July 2007. Retrieved on March 20, 2008 from: http://web.up.ac.za/UserFiles/WP_2007_10.pdf 5. “US says Zimbabwe change is afoot”, BBC News, June 2007, retrieved on March 20, 2008 from: http://news.bbc.co.uk/2/hi/africa/6229284.stm 6. Weatherford, Jack, The History of Money. Three Rivers Press, 1997 7. Wines, Michael, Caps on Prices Only Deepen Zimbabweans’ Misery, New York Times. 2007 8. Guttmann, William, The Great Inflation, Gordon & Cremonesi, London, 1975, pages 21-26 9. Zulu, Blessing, “Voa News: Monetary Doctor Steve Hanke Examines Zimbabwe Hyperinflation In New Book”. US Fed News Service, Including US State News. Washington, D.C.: Jan 17, 2008. Retrieved from ProQuest (March 20, 2008) Appendix 1: Instances of hyperinflation across nations: Country Year Ended Duration (Non of Months) Average Monthly Inflation rate (% age) Pre-World War II Austria 1922 11 47.1 Germany 1923 15 37.2 Poland 1924 13 81.1 Russia 1924 37 57 Hungary I 1924 28 46 Greece 1924 13 36.5 Hungary II 1924 12 2345 x 103 Post-World War II Taiwan 1949 17 30.7 China 1949 44 78 Bolivia 1985 18 48.1 Peru 1989 8 48.4 Yugoslavia 1989 4 50.9 Poland 1990 4 41.2 Brazil 1990 4 68.6 Argentina 1990 11 66 Ukraine 1993 12 1024 Georgia 1994 13 44.1 Zaire (DRC) 1994 16 66.5 (Makochekanwa, 10-11) Appendix 2: Read More