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Finance and capital markets
Course: Finance and capital markets > Unit 3
Lesson 2: Inflation scenariosHyperinflation
Basic of hyperinflation. Weimar Germany, Hungarian Pengo and Zimbabwean Dollar. Created by Sal Khan.
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How does Mr Bernanke intend to withdraw the excess money supply from the system once he determines the economy has recovered sufficiently?
(23 votes)
In normal times when the Fed senses that inflationary pressures are growing they start to unwind their balance sheet by selling assets and shrinking the money supply. Usually they have shorter dated securities and very safe debt that's not subject to lots of market volatility, and they can "return" them back to the market for the price they paid more or less. Thereby ensuring that all the excess money they injected to the market which is causing inflation can be cleaned up.
However, this time with QE1 and QE2 the Fed put on its balance sheet longer dated treasury's which could have wild interest rate swings, in addition, they also purchased MBS and other junk which we don't even know the real value of them, or if they even have any value. Plus, the purchases was in trillions of dollars which is much more than the fed usually keeps on its balance sheets.
When inflationary pressures start growing, really you could already take out the word "when" by now, the Fed most probably won't be able to rein in the excess money it injected into the market, for the assets on their balance sheet won't be worth what they paid for it and will have to sell at steep discounts. In other words they won't have the necessary tools to stop inflation which would be devastating to the already fragile economy.(32 votes)
- How is hyperinflation stopped or corrected?(22 votes)
We did in Brazil, and it at was quite an amazing experience. In a very simplistic way of explaining, we were used to think in US dollars, so the governament created a "fake " money during some months. Everybody got used to that, and then, during a weekend, they asked eveybody to go to the bank and change their money, and suddenly, all the crazy inflation ( we had 2% a day) disapeared. Of course was not that simple, but worked as magic. It was in 1994, and I still remember the feeling of having a money with REAL value for the first time in my life.(36 votes)
- I didn't understand why "printing like mad" will directly cause prices to rise right away. Is it because goods and services sellers sense that the currency is worth less, or is it because the comodities they import to produce the goods they sell are getting more expensive due to currency exchange ratios? Imagine if it were a closed-to-foreign trade country, why the prices needed to rise instantly if the goods were all coming from inside of the country?(19 votes)
There are a few reasons. The first is basic economics. There are more dollars(supply) with no change in demand(before actual hyperinflation). When hyperinflation is in progress, people don't want dollars(they want bread or gold or whatever) which decreases the demand for them. This causes supply to go up and demand down, both make the dollar worth less. The dollar is also supposed to be a represent a portion of GDP(fixed to gold before the move to fiat). As more dollars are printed, they each represent a smaller portion of GDP. This makes each dollar worth less and each commodity more. There is usually some lag when dealing with inflation. Look in the Banking and Money; and Economics section for more information.(12 votes)
- At0:37why would a government "print like mad"? Sal mentions that they would do this if they have "no other way of getting revenue", but knowing the danger of this approach why would they even attempt it? Wouldn't it be safer to cut taxes, or encourage foreign investment?(9 votes)
- In the long run it would be better if the government cut spending in half but for next week or next month it always seems better to just print. Politicians don't have the long range view that we would like them to. The other thing is that they don't really know the danger. Japan has been increasing their money supply by about 1.6% every 10 days since April. I don't mean 1.6% annual rate, I mean 1.6% every 10 days. Japan is spending twice what it gets in taxes. The vast majority of the politicians, and in fact people all over, are clueless about how dangerous this is.(8 votes)
Why would excessive printing lead to immediate rise in prices? (I know it's been asked before, but I'd like a simpler, more structured answer.)(2 votes)
Think of it this way. If the government suddenly decided to send a million dollars to every person in the country, causing every person to try to go out and buy a sports car, then there would not be enough sports cars to go around. The logical thing for the sports car manufacturer to do would be to increase prices.
This can be shown with a simple supply/demand graph. If the government prints more money, that would cause a major increase in demand for goods and services. Since this increase in demand is not accompanied by any similar increase in supply, the price must rise. In fact, if anything, supply will actually decrease, because the suppliers have to pay more for raw materials as well.
This is all because money has absolutely no intrinsic value. It only has value because we believe it does, but if you were stuck on a desert island, money would be absolutely worthless. Hypothetically, if everyone started to believe that money had no value, then it wouldn't have value. Everyone would refuse to accept other people's money as payment, and so there would be no use to having money in a bank, because you could never spend it.(19 votes)
- So in the case of hyperinflation, it is reasonable to predict that an economy would regress back to bartering?(6 votes)
- Yes, an economy can go back to traditional bartering ways if a depression was bad enough. If the dollar is completely worthless, what else are you going to use to acquire goods and food? You either have to perform a service or trade other goods.(4 votes)
- How long does the inflation rate have to be above 50% for it to be considered a period of Hyperinflation? or is it just as soon as it goes above 50% it is automatically hyperinflation?(3 votes)
- There is no exact definition. The 50% comes from one of the first studies ever done on hyperinflation. But if a country had just below 50% inflation, it's hard to argue that it's anything other then hyperinflation. For example, Iran recently had 40% monthly inflation.
More importantly, international financial reporting standards (IFRS) does not put an exact number on what defines hyperinflation. They define it when the local population keeps most of their assets in non-monetary assets, or a stable foreign currency and local transactions take place in a stable foreign currency. The exact % of inflation is open to interpretation.(6 votes)
How does a country recover from hyperinflation ?? What happens to the money ie One Trillion worth of single notes circulated in the market ??(2 votes)
If you think about the causes of hyperinflation (overprinting money, decreased confidence in the currency, hoarding, stagflation), you can see ways to recover from it.
First, the central bank needs to stop printing currency. As demonstrated in the video, doing so only feeds the cycle and drives inflation higher. Sometimes, a country will replace its currency (as Brazil did with the Real and Mexico did with the nuevo peso) or peg the currency against a stable one. Most importantly, confidence in the country's currency must be restored. Get people to stop hoarding goods and restore confidence in your currency, and the recovery from hyperinflation will take place.
As for getting rid of ridiculous notes (like a one trillion dollar bill), the government will often buy them back at a fixed exchange rate for a new currency (e.g., one million old dollars for 1 new one) or for a stable foreign currency (e.g., one million old dollars for 1 US dollar). Escaping hyperinflation might require foreign aid, and if foreign governments are able to provide their [stable] currencies, it gives the central bank of the affected country the funds necessary to do this.(5 votes)
- I have always been under the assumption that hyperinflation was caused by a loss of faith in the currency. While increases in money supply leads to inflation, doubts about the quality of the money supply leads to higher prices which ends up in hyperinflation. In the video, Sal says that it was "governments going wild with printing money" that leads to hyperinflation. What is the starting point of hyperinflation, do governments print money that cause prices to increase or do prices increase that causes the government to print more money?(3 votes)
It is a bit of both. Generally, the first step is having large debts and/or little income (say taxes). The government has to pay the police, military, government workers, etc., but they don't have the physical currency, so they print more. The people lose their faith in the currency and buy hard goods, increasing the velocity of money flow, like in an earlier video. Then the cycle repeats.
Another cause is extreme negative supply shocks, such as after a war or natural disaster.(3 votes)
- I'm not sure, if my question wasn't answeared yet, but wouldn't it be better if central banks didn't mess with money supply? What are the cons of Austrian School?(3 votes)
The longest period of US history without a central bank is 1836 - 1913. However, the Union did issue paper money without a central bank during the Civil War (as did the Continental Congress during the Revolutionary War). Without a central bank, shocks to the money supply caused several panic-induced liquidity crises in 19th century US. A central bank capable of smoothing out the shocks to the money supply is required to prevent unnecessary panic-induced liquidity crises.(2 votes)
0:37Video transcript
We now know a little bit
about inflation and deflation. And now I want to introduce
you to hyperinflation. And as the word implies,
it's inflation gone wild. How hyperinflation,
or at least the cases that we've seen in modern times,
how they've happened is you have some type of a
government just going wild with the printing press. They're just printing
a ton of money. So the general cycle
is they print money, they print like mad,
usually because they don't have any other
way of getting revenue. They print like mad. That leads to prices going up. And then because
prices go up, they have to print more
in order for them to be able to get the
same goods and services or pay the government
workers what they wanted to pay the government workers,
or pay the soldiers what they wanted to pay the soldiers. This by itself would probably
drive the hyperinflation in and of itself. But on top of this, we're used
to thinking high inflation is 5% or 10%, but you
could imagine what happens when inflation
is 5% or 10% per hour. Because then
there's no incentive to be actually holding currency. Every second that
you hold currency it becomes worth less
and less and less. And so what happens in a
scenario like this is people want to hoard hard assets. So if the price of bread
is going up by the minute or by the hour, or
the price of shoes are going up by the
minute or by the hour, the increase in prices is going
to make people hoard things. Hoarding goes through the roof. And you can imagine if
hoarding goes through the roof, if the shoe seller doesn't
want to sell his shoes anymore, or he wants the hold
them a little bit longer, then the supply of shoes
are going to go down, and the prices are going
to go up even higher. So hoarding leads
even to higher prices. When people go to
the bread market, and there's five loaves of
bread, they buy all of them. And then the next
person can't buy any because they know that
the price of bread is going through the roof. So it just keeps
getting worse and worse. And it's all started
by the government just going nuts with
the printing press. Now, the three most
famous examples of this happening--
probably the most famous one is what happened
in Weimar Germany after World War I. They had
huge reparations to pay. That's what the
Weimar government would have argued
was their main cause. But they just printed
money like crazy. Some people said
that they were almost trying to destroy the economy
so that they wouldn't have to pay reparations for what
they did in World War I. But this just gives you a
sense of how crazy it was. Here's the end of World
War I. And they just printed money like mad. And isn't the rate of inflation. This is how much it was
relative to a gold mark. So this is one gold
mark over here. So only after about 2 and a
half years it was over tenfold. And this is a logarithmic scale. Each slash year, this
is a factor of 10. So after by the
end of 1923, you're looking at-- This is what? Not 100,000, not a
million, not a billion. This is a trillion. It had gone up a trillion fold
in the span of one, two, three, four, five, six years. The other famous
examples of this, Zimbabwe from 1980 until 2009. Once again, printing
money like mad. And some of their productive
capacity went away. This right here is a 100
trillion Zimbabwe dollar. And this shows you
the Zimbabwean dollar relative to the US dollar. And once again, is
a logarithmic scale. This is 10 to the 30th power. And then the largest or the
most extreme hyperinflation ever was Hungary
after World War II. And this right here
is a 10 million pengo note, just to give
you an idea of what people were carrying around
in their pockets.