There’s been a lot of talk about inflation and even hyperinflation lately.
So in a last of a series on inflation, money supply and interest rates, I thought it would be a good idea to see what happened during the infamous hyperinflation of the 1920s German Weimar Republic. And, to see if similar conditions could develop today to push our world into a high-inflationary period.
There are a lot of causes, extreme shocks or unique circumstances that seem to prelude most inflationary and hyperinflationary periods. And it’s not usually just one but rather a combination of political, social and economic factors that all converge to form a period of extreme inflation.
Declining confidence in a nation and paying for expensive “wars” are often prerequisites since they erode a country’s finances.
One of the most popularized inflationary crises is that of the German Weimar Republic following the First World War. A really good summary can be found in the paper From Inflation To Hyperinflation: Reasons For German Macroeconomic Impotence In The Inflation 1918-1923 by Jonathan Schacter.
In particular, the paper points out that hyperinflation is not the necessary outcome of inflation. In most cases, governments can control inflation. So, there must have been reasons for the massive inflation in the German case. These reasons were both domestic and foreign, including political, economic as well as fiscal and monetary policy issues.
At the beginning, the paper goes on to say, it was the Treaty of Versailles restrictions and war reparation payments following Germany’s defeat in the First World War that had a major impact on inflation. These were payable only in foreign currency or gold. With their gold reserves already depleted, the German government tried to buy foreign currency by printing German marks to pay for these debts. With increased borrowing and money supply (i.e. debt monetization), German marks in circulation soared and its foreign exchange rate collapsed, causing a vicious downward currency depreciation spiral. As money supply increased and the currency devalued, domestic prices rose, imports became more costly and the trade imbalance worsened, further exacerbating inflation. As the rate of inflation increased, the government’s tax revenue also decreased significantly in value due to the lag between tax assessment and collection in a fast rising price environment.
As foreign investors lost confidence in the German economy and political institutions, they moved their assets out of Germany and the value of the paper mark plummeted further. At the same time, German citizens bought food and supplies before prices went up further while also moving cash in to hard assets. Interestingly, but not surprisingly, the German stock market did well during the inflationary period since it was one of the few real assets Germans could get their hands on. This further supports my view that the real assets like stocks, houses, condos, cottages, property, land and farmland will likely continue to increase if inflation really starts to develop around the world. Ultimately, the Weimar Republic faced a liquidity crisis, and the only recourse was for the central bank to print more bills, contributing to the self-reinforcing inflationary cycle.
So what does all this mean for us today? Various measurements estimated that at the time, German government debt was approximately half the value of national wealth, and four times the German government revenues. By comparison, current U.S. government debt is just under 20 per cent of total U.S. national assets and just less than four times government revenues, based on recent USDebtClock.org figures.
So while U.S. debt levels are high, they are not as high as those experienced in Germany in the 1920s. More importantly, however, the U.S. currently has a greater ability to tax and borrow to finance itself, at least for now. While this could add to inflation going forward, many other social, political and economic factors would have to fall into place before we see a hyperinflationary scenario like what happened in Weimar Germany.
Bottom line, inflation is ever present but in the past three decades throughout North America, it has been relatively low at about 2.5 per cent. Over that past 100 years, it’s averaged around three per cent.
We can still have bouts of 10 per cent or 15 per cent annual inflation that can last a couple of years but a hyperinflationary period is less likely.
Currency is also a relative game. The U.S. dollar, for example, has not changed much against a basket of other currencies in the past several years, making it still, for now, the foundation of the global economic and political system.
As historical examples will show, hyperinflation is a near-perfect storm of political, social and economic factors. That likely won’t happen any time soon in our western world but anything can, and eventually, will happen, given a long enough time period.
While we can’t do much about what governments do, we can track government money supply figures and debt levels to invest accordingly in case more inflation develops.