Appearance
9.8 — Inflation and the Great Hyperinflations
In 1922 a US dollar bought about 190 German marks. By November 1923 it bought 4.2 trillion.
Contemporary accounts describe workers being paid twice a day and their wives meeting them at the factory gate to run and spend it before the afternoon price rise. Restaurants stopped printing menus. People burned banknotes because they were cheaper than firewood, and papered walls with them.
And a man who had borrowed to buy a house in 1920 could repay the whole mortgage in 1923 with the price of a postage stamp.
That last fact is what makes hyperinflation politically explosive, and Chapter 11.6 is downstream of it.
What inflation is
A sustained rise in the general price level, which is the same thing as a fall in the purchasing power of money.
It is not the same as a rise in one price. If tomatoes get expensive because the crop failed, that is a relative price change carrying information — it tells people to use fewer tomatoes and grow more. Inflation is when everything rises together, which carries no information and only degrades the unit of measurement.
How it is measured. A basket of goods a typical household buys, weighted by how much they spend on each, priced repeatedly. The Indian consumer price index gives food and beverages a weight of around 46 percent, against roughly 15 percent in the United States — which is why Indian headline inflation moves with the monsoon and why the Reserve Bank also watches core inflation, which strips out food and fuel.
Every index has known biases. Substitution bias — when beef gets expensive people buy chicken, and a fixed basket does not notice. Quality bias — a phone costing the same as five years ago is a far better phone, which is a real price fall the index struggles to capture. New goods enter the basket late. The consensus is that standard indices overstate true inflation modestly, which matters because pensions and wages are indexed to them.
The three ways it starts
Distinguishing them matters, because the remedies differ and applying the wrong one does damage.
Demand-pull. Total spending exceeds what the economy can produce at current prices. Too much money chasing too few goods. The remedy is to reduce demand: higher interest rates, tighter budgets.
Cost-push. Input costs rise — oil, wages, imported goods — and producers pass them on. The 1970s oil shocks are the standard case. The remedy is awkward: raising interest rates to fight a supply shock suppresses the whole economy to offset a shortage in one part of it, and doing nothing risks the increase becoming embedded.
Expectations. This is the mechanism that turns a temporary rise into a persistent one. If people expect 8 percent inflation, workers demand 8 percent wage rises, firms set prices 8 percent higher, and lenders demand 8 percent more interest. The expectation produces the outcome.
Which is why central bank credibility is the central asset (Chapter 9.7). A central bank everyone believes will act does not have to act as hard.
Why hyperinflation is a different thing
The conventional definition is inflation above 50 percent per month, which compounds to roughly 13,000 percent a year.
And every single case in history has the same cause. A government whose spending vastly exceeds its revenue, which cannot borrow because nobody will lend to it, and which therefore has the central bank create money to pay its bills (Chapter 9.7's monetisation).
That is it. There is no case of hyperinflation from any other mechanism.
The dynamic that makes it explosive is the flight from money. As people realise money is losing value fast, they spend it immediately. The speed at which money circulates rises. Money circulating faster has the same effect as more money, so prices rise faster, so people spend faster still. The government needs to print more each week just to buy the same goods, and the loop closes.
And the tax system collapses, because taxes are assessed on last quarter's income and paid in money worth a fraction of what it was — the Olivera-Tanzi effect — which widens the deficit that started it.
The cases
Germany, 1921–23
The cause was not primarily reparations, and the popular account gets this wrong.
Germany had financed the First World War almost entirely by borrowing rather than taxation, on the assumption of winning and imposing indemnities on the losers (Chapter 11.4). It lost, and was left with an enormous domestic debt and a destroyed tax base.
The Versailles reparations added an obligation payable in gold or foreign currency, which required buying foreign exchange with marks, which pushed the mark down.
The trigger was the Ruhr occupation of January 1923. France and Belgium occupied Germany's industrial heartland over a missed reparations delivery. The German government called for passive resistance and paid the striking workers — by printing money — while the region's output, and therefore the tax revenue, stopped.
The end came in November 1923 with a currency reform. The Rentenmark was introduced, notionally backed by a mortgage on German land and property, at one Rentenmark to a trillion old marks. The central bank stopped discounting government paper. It worked within days, which demonstrates the general rule: hyperinflation ends when the printing stops and people believe it has stopped.
The political consequences are the reason this episode matters so much. The middle class — people holding savings, bonds, insurance policies and pensions in marks — was wiped out. People with debts or real assets did well. A society's savers were destroyed and its debtors rewarded, arbitrarily, in eighteen months.
Hitler's Beer Hall Putsch was in November 1923, at the peak. It failed, and the constituency it later mobilised was created that year. The German horror of inflation, which shaped the Bundesbank, the design of the European Central Bank and German policy in the eurozone crisis, is a direct inheritance from 1923.
Hungary, 1945–46 — the record
The worst hyperinflation ever recorded. At its peak, prices doubled roughly every 15 hours.
The context: a country devastated by war, with its industry destroyed, occupied, and paying reparations to the Soviet Union.
The largest denomination note ever issued anywhere was Hungarian: 100 quintillion pengő — a one followed by twenty zeros. A higher note was printed and never issued.
It ended in August 1946 with a new currency, the forint, which is still in use.
Zimbabwe, 2007–09
Peak monthly inflation is estimated at around 80 billion percent.
The causes: land reform from 2000 that redistributed commercial farms in a manner that collapsed agricultural output; the loss of export earnings; spending on a war in the Democratic Republic of Congo and on unbudgeted payments to war veterans; and financing all of it by printing.
A 100 trillion Zimbabwe dollar note was issued in 2009. It ended when Zimbabwe abandoned its own currency and adopted the US dollar and other foreign currencies — the most complete admission of monetary failure available.
Venezuela, 2016–
Oil revenue was around 95 percent of export earnings. When the oil price collapsed in 2014, spending was not reduced; price controls and expropriations destroyed domestic production, and the deficit was monetised. Inflation reached rates estimated in the millions of percent. Several million people emigrated.
It is the resource curse of Chapter 1.12 running to its conclusion.
And the ancient cases
Rome. The silver content of the denarius fell from around 90 percent under Augustus to a few percent by the mid-third century (Chapter 5.4). Diocletian's price edict of 301 CE fixed maximum prices for hundreds of goods with death as the penalty, and failed completely — goods disappeared from legal markets. It is the first well-documented failure of price controls and the mechanism has not changed.
China. The world's first paper money produced the world's first paper-money inflation under the Song and again under the Yuan (Chapter 7.9).
And India's own experience is modest by comparison and real. The highest post-independence inflation was around 28 percent in 1974–75, driven by the oil shock, drought and a monetised deficit, and it contributed materially to the political crisis that produced the Emergency (Chapter 6.27).
Why deflation is worse
A point Chapter 9.7 raised and that deserves its own statement, because the intuition runs the other way.
Falling prices sound good and they are dangerous.
Debt becomes heavier in real terms. A loan fixed in rupees is harder to repay when everything you sell is falling in price. Irving Fisher's debt-deflation theory describes the spiral: debtors sell assets to repay, which pushes prices down further, which makes the debt heavier still.
Spending is postponed, because anything you buy will be cheaper next month, which reduces demand, which lowers prices further.
And wages are sticky downward. People will accept a real pay cut through inflation and resist a nominal cut fiercely. In deflation, employers who cannot cut wages cut jobs instead.
Japan's experience after 1990 is the standing modern case: two decades of near-zero inflation and periodic deflation, with weak nominal growth and a debt burden that would not shrink.
Where this shows up in your life
Your salary needs to rise by the inflation rate to stand still. A 6 percent increment with 6 percent inflation is not a raise.
Your savings in a bank account are losing value unless the interest exceeds inflation after tax.
And the political point is the one worth carrying. Inflation is a tax that nobody votes for and it falls hardest on people who hold cash and fixed incomes — the elderly, the poor and the salaried — while benefiting borrowers, including the government, which is the largest borrower of all.
Which is why a government always has an incentive to permit a little more of it than it says, and why the institutional arrangements of Chapter 9.7 exist, and why they are always under pressure.
What the next page covers
Between 1929 and 1933, world industrial output fell by roughly a third and unemployment in the United States reached a quarter of the workforce. Chapter 9.9 covers the Great Depression — what caused it, why the standard remedies made it worse, what the gold standard had to do with it, what Keynes actually argued, how different countries escaped it, and why it is the single most consequential economic event of the twentieth century, including for the political catastrophes that followed.