Hyperinflation and the Zimbabwe Story!

Every  time I go to buy something from the vegetable market, I get a shock. Heights was when I was told that tomatoes are for  Rs. 70 a kg! And not just vegetables! The ever growing inflation is omnipresent and more often than not, I am calculating whether I am getting a raise or my earnings are actually decreasing on real basis, that my purchasing power is decreasing!

Now, question is, what is purchasing power? Simply put, it is the amount of goods that I will be able to buy for a certain amount of money. I used to buy one Deo for Rs.95 while  I was in college, now I am able to buy the same for Rs. 175!! So while I was able to buy a Deo for Rs 95, now it is for Rs 175. Product is the same, but I have to now pay more or the value of my money has decreased! And in this example, by more than 80 percent!!

The phenomena explained above is called inflation. And believe it or not, some amount of inflation, that is, price rise is actually good for the economy. I have explained this in my article on inflation           

                                 

                                       Both the Extremes are bad!  
Here, in this article, I will be talking about the third balloon in the figure; When the inflation goes too high! We call an abnormally high inflation as Hyperinflation. How Abnormal? The inflation percentage was 7.6 billion percentage for two years. Yes, you heard it right! And we are crying over the poor 8.4 % that we are facing! Imagine the kid here, with all that cash!  And  what was he going to buy? A loaf of bread!

                                                     
                                                                                                 

                                                                                                    

So, what is hyperinflation? Hyperinflation is when a country experiences very high and usually accelerating rates of inflation. The general price level within an economy increases rapidly as the official currency quickly loses real value(Imagine buying that Deo for ten thousand bucks! Or even more!). Meanwhile, the real value of economic items generally stay the same with respect to one another (You are still getting the same deo! And alas, only one deo!), and remain relatively stable in terms of foreign currencies(Think of Rupee sliding!).

Unlike regular inflation, where the process of rising prices is not that much highlighted and is, generally taken not that badly by the masses, hyperinflation sees a rapid and continuing increase prices and in the supply of money, and the cost of goods.Hyperinflation is often associated with wars, their aftermath, sociopolitical upheavals, or other crises that make it difficult for the government to tax the population, as a sudden and sharp decrease in tax revenue coupled with a strong effort to maintain the status-quo can be a direct trigger of hyperinflation. Or simply, very poor governance and greed. Couple that with people trying to get rid of their currency  since they know it will lose even more value. This then becomes a vicious circle, forcing the central banks to print more money, thus further lowering the value of the currency and this goes on!

One of the most famous examples of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion, doubling every 28 hours!

Huh, talk of starving Billionaires!

                  

                  

                              

So, without much ado, let’s see what exactly causes hyperinflation?  If we go by definitions, it occurs when there is a continuing and accelerating rapid increase in the amount of money that is not supported by a corresponding growth in the output of goods and services.

The price increases that result from the rapid money creation creates a vicious circle, requiring ever growing amounts of new money creation to fund government activities.

The above situation is actually called Supply Shock!

Now, think of you winning a huge lottery by some chance. Now, when you go to the local vegetable market, you will not bargain and pay the guy that Rs 70 for that one kilo for the tomatoes! Repeat this a few times  and the vegetable vendor  will raise the prices, sensing an opportunity to gain more profits. So, eventually this guy will have more money, so he will pay more the guy selling, say, milks and the whole chain will be getting more money like this!  Slowly, the whole area near you will have more money to spend, but same things to buy. And they will be willing to pay more now!

Just up the stakes and think of more money floating around the economy without actually more goods being produced. As such, more money will be available to buy the same things and this will lead to rise in prices. Such rapidly increasing prices cause widespread unwillingness of the local population to hold the local currency as it rapidly loses its buying power. Instead they quickly spend any money they receive, which increases the velocity of money flow; this in turn causes further acceleration in prices!

Usually, the excessive money supply growth results from the government being either unable or unwilling to fully finance the government budget through taxation or borrowing, and instead it finances the government budget deficit through the printing of money (Like I said earlier, poor governance!).

So in general, an unlimited and nonsensical printing of money combined with no real GDP output provides the impetus needed for hyperinflation!

So, how do we tackle this? There are very limited things a country can do after things have gone back. China had to switch currencies when it was plagued with Hyperinflation and the  overall impact of inflation was 1 Renminbi = 15,000,000,000,000,000,000 pre-1948 yuan!!  Recently, Zimbabwe had to abandon the local currency!

In fact, at independence in 1980, the Zimbabwe dollar (ZWD) was worth about USD 1.25. Afterwards, however, rampant inflation and the collapse of the economy severely devalued the currency. Inflation was steady before Robert Mugabe in 1998 began a program of land reforms that primarily focused on taking land from white farmers and redistributing those properties and assets to black farmers, which disrupted food production and caused revenues from export of food to plummet. Result was that to pay its expenditures their Reserve Bank printed more and more notes with higher face values.

Just for the sake of figures, Hyperinflation began early in the 21st-century, reaching 624% in 2004. It fell back to low triple digits before surging to a new high of 1,730% in 2006. The Reserve Bank of Zimbabwe revalued on 1 August 2006 at a ratio of 1 000 ZWD to each second dollar (ZWN), but year-to-year inflation rose by June 2007 to 11,000% (versus an earlier estimate of 9,000%). Larger denominations were progressively issued , with denominations reaching trillion dollars and then everything collapsed, with that trillion dollars good enough just buy one piece of bread!

So, after all this, the best thing I learnt is that the dreams I used to have during my childhood: A rupee printing machine is actually not a great idea at all!