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Current time:0:00Total duration:11:43

When the functions of money break down: Hyperinflation

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Video transcript

so in the last video I was talking about various functions of money you know the first was that it's a medium of exchange if you want to trade for things typically you give someone money and they give you the thing rather than trying to barter trading apples for oranges or horses for legal services or things like this the second is that it's a store of value if you hold on to your money its value isn't just going to evaporate whereas if you hold on to you know a bunch of apples as they rot and degrade away they're no longer valuable and the third is that it's a unit of value it's a way that we assign a number to items to say how valuable is this you know that something that's a hundred dollars is about twice as valuable as something that's fifty dollars and having this sort of number system for value makes it a lot easier to compare different goods and what I want to do in this video is talk about a circumstance where these functions of money break down and what I'm thinking of is the case of hyperinflation hyper inflation now inflation means that prices are increasing so if you you know look at a the price of a carton of milk and let's say it's one dollar one day it would be if it increases later on so maybe it's a dollar twenty cents and if the prices of all goods as a whole in the economy tend to be increasing you know it's not just milk is getting rarer or something like that it's it's called inflation and hyperinflation is basically a case where this is just happening really really quickly so Sal has some videos talking about inflation itself and the root causes and I'm not going to go into that here in this case all you need to know is the idea that prices increase really really quickly and just to give give an example there's been lots throughout history and this isn't necessarily the starkest example but it'll be interesting to us in terms of what the ultimate solution was Brazil in the 1980s and early 1990s so 1980s and a little bit into the early 1990s was undergoing very fast inflation and to give a feel for the kind of rates we're talking about at its peak it was around 80 percent eighty percent per month and what this means is that every month the prices of general Goods you know a carton of milk or a chair or the price of land things like that would generally get multiplied by a factor of 1.8 now if you compound this over a full year and every month it's increasing by 1.8 so you multiply it in twelve different times this is actually an increase by more than a factor of a thousand so that would mean if you have something that costs a hundred dollars one day it's going to cost after a year if inflation increases at this rate a hundred thousand dollars so the annual inflation rate the percentage per year would actually be one hundred thousand percent per year now there have been inflation rates in history faster than this but this is still really insane and just to get our minds around what it might feel like to be in an economy like this let's just imagine a super simplified economy where you have only four different people so we'll have four different people here and let's say I don't know let's name these guys like person a person B person C and person D I guess I give should you give person D some eyes and let's say it's the case that the way that this economy works is that a buys all of his things from B so a will give B maybe let's say it was $50 a month for all of his things and B in response gives a things and then B she buys all of her things from C and she pays that same amount she takes the full $50 that she earned and she gets various things that she needs in life from C and then similarly C buys all of his things from D and let's say just for simplicity that it's the same amount and then D buys all of her things from a and this is obviously way oversimplified as an economy but I do think it gives a good feel for kind of the cyclic nature of things that one person's income is another person's expenses so now let's say that you're in a hyperinflationary circumstance where you have this you know 80% increase per month something that cost $100 one day a month later is going to cost $180 if you were say person a and you knew the prices of things are going to increase you might in anticipation raise your prices as you're selling things to D you might raise your prices and say well actually today I think I'm going to charge you fifty one dollars because things are getting more expensive so I want to earn more and then deed in response says geez now I have to pay more so I'm going to have to charge my customer C a little bit more as well and I'm going to charge him 51 and then C says I'm going to have to charge my customer more as well in order to make ends meet and everybody kind of has to increase their prices to keep up and when the next day rolls around you know no one wants to be the last one to increase their prices so maybe this time bee says Oh yesterday I had prices increase on me and I was earning less but then I had to spend more so today I'm going to make sure that I'm not the last one so I'm going to increase my prices and I'm going to increase them maybe she says 53 just to be sure and then a noticing the prices have increased has to keep up as well so he needs to do this and of course the cycle continues everyone in order to make ends meet has to increase their prices so this circumstance where you're changing your prices in anticipation of future change is what distinguishes hyperinflation in kind of a qualitative sense from regular inflation you know I think there's a quote that I really like I think it's by Napoleon and it's a quantity sometimes has a quality all of its own and that's definitely the case with hyperinflation because ordinary inflation ordinary inflation like let's say that which the United States dollar is undergoing around these days typically ends up being around 1 to 3 percent it depends but 1 to 3 percent per year so obviously this is dramatically less than you know a hundred thousand percent per year but the idea is that hyperinflation isn't just that it's a much bigger number it's that there's a psychological difference in the society where people are starting to anticipate changes and change their prices accordingly and this is how things spiral out of control this is how you get insane numbers like 80 percent per month now why am I talking about this right this is about functions of money why am i talking about hyperinflation well let's take a look at these functions of money and kind of analyze whether or not they still apply in a hyper inflationary economy now medium of exchange money is still being used as a medium of exchange people are still buying things using the national currency so that one stays intact store value however this one clearly breaks down because if you're holding on let's say you have a hundred dollars in savings today and then you know that things are increasing by a hundred thousand percent per year it's going to be 1,000 times less valuable after a year so most certainly it is no longer a store of value and you could argue by the way that even in an ordinary inflation circumstance money doesn't quite serve this function as a store of value because even if prices are increasing only very slowly every year it's still the case that you know a dollar that you hold on to you know you're not investing it or collecting interest rate slowly degrades over time so you argue that even in an ordinary circumstance store value doesn't quite apply due to inflation but let's consider this third this third function of money unit of value if you're living in this hyper inflationary circumstance the numbers that you're seeing no longer really correspond to value right if you had something that originally was $50 of value and then after a year it's $50,000 you're not thinking of the value of that thing in terms of the national currency and often throughout history people start thinking of the value of various items in terms of another nation's currency so if your own currency all of the numbers are fluctuating very rapidly and they're increasing very rapidly you look for a more stable number just so if you want to know hey how much should a carton of milk cost rather than thinking in your own nation's currency maybe say oh it's analogous to you know 1.5 British pounds or something that seems a little bit more stable so this unit of value property no longer applies in the case of hyperinflation and notice that that's distinct that is something different between hyperinflation and regular inflation because even in let's say the United States these days even though prices slowly increase we still think about the value of things in terms of the US dollar this still serves as our our unit of value so that's one of the core distinctions and I think that's that's actually very important for you know what distinguishes hyperinflation from inflation in a qualitative sense now why did I choose to think about Brazil's hyperinflation as opposed to a lot of other ones like post-world War one Germany or is it Bob way or places where you've had even faster rates of hyperinflation and basically because there was a really interesting way that they went about solving it now any solution has to address the underlying causes of inflation and this video isn't necessarily about those so there's going to be things associated with making sure that the government is still fiscally responsible and balancing budgets and things like that but a different component that needs to be addressed is that money is no longer serving as a unit of value so one really interesting thing that Brazil did in the early 1990s is they introduced a fake currency that they called the u rv4 unit of real value or really it was in the really it's the portuguese words for these I think unidade of the Lord I don't really know Portuguese but the initials are the same you are V and what they started doing is saying okay everybody continue paying in the national currency which the time was the the crucero I'm probably pronouncing that wrong but Crusader oh so they're still paying for everything in terms of their crucero that's serving as the medium of exchange but what they did is they said every time that you're pricing something please list your price is not only in terms of the crucero so I guess in this case I've written dollars but let's say let's pretend that says 53 crucero 51 crucero things like that and in addition to listing it there please also list the price in terms of units of real value which in this case might have been like 50 because everything started off being 50 and they loosely pegged this fake currency that's just made-up number to the US dollar so over time even though the price in terms of cruzeiro's was increasing it might be 53 cruzeiro's and then 55 and everyone's paying more and more in terms of cruzeiro's the unit of real value would stay the same because it had no reason to increase it's just a made-up number that you're pegging on things just to keep straight how valuable things actually are so what they're basically doing is they just they said currency our current money is not serving this function as a unit of value so let's just make up a new thing that does so at this time the crucero was still serving the function as a medium of exchange you know nothing was really storing the function of cert store value except for hard goods like land and then this made-up number was serving the function as a unit of value and over time as people started getting used to the idea that you go out to buy milk and you you know that it's going to be lets say one unit of real value and then you just have to look up okay how many how many cruzeiro's corresponds to a unit of real value today people start actually thinking in terms of this number even though they're paying in terms of another and after this had kind of said into the psychology of the society and of course while certain certain fiscal responsibilities on the side of the government was being addressed they made the switch to make units of real value and actual currency and printing money in terms of these you RVs and abandoning the crucero and telling people they could trade in their crucero for these you RVs and that was going to be the new currency and because people were used to the idea that this was a stable number and they were thinking of prices in terms of this stable number and because the the underlying causes of inflation had started to be addressed it actually worked and the number would stay stable and instead of having prices increase eighty percent a month it decreased drastically to something that's much closer for two you know a healthy economies level of inflation and I think that's really powerful actually that that you can recognize that one of the functions of money has broken down and then address it specifically and you know invent something new that addresses that same function sure it's a made-up currency it's just a number you're assigning things but it's serving this function and then apply that in a very real setting on the scale of an entire nation and solve an economic problem so hopefully this sheds a little bit of light on why it might be useful to break down the functions of money in terms of these three different categories and with that I will see you next video