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Explaining Hyperinflation

Zero Hedge: This is a post in three sections. First I want to outline my conception of the price level phenomena inflation and deflation. Second, I want to outline my conception of the specific inflationary case of hyperinflation. And third, I want to consider the predictive implications of this.

Inflation & Deflation

What is inflation? There is a vast debate on the matter. Neoclassicists and Keynesians tend to define inflation as a rise in the general level of prices of goods and services in an economy over a period of time.

Prices are reached by voluntary agreement between individuals engaged in exchange. Every transaction is unique, because the circumstance of each transaction is unique. Humans choose to engage in exchange based on the desire to fulfil their own subjective needs and wants. Each individual’s supply of, and demand for goods is different, and continuously changing based on their continuously varying circumstances. This means that the measured phenomena of price level changes are ripples on the pond of human needs and wants. Nonetheless price levels convey extremely significant information — the level at which individuals are prepared to exchange the goods in question. When price levels change, it conveys that the underlying economic fundamentals encoded in human action have changed.

Economists today generally measure inflation in terms of price indices, consisting of the measured price of levels of various goods throughout the economy. Price indices are useful, but as I have demonstrated before they can often leave out important avenues like housing or equities. Any price index that does not take into account prices across the entire economy is not representing the fuller price structure.

Austrians tend to define inflation as any growth in the money supply. This is a useful measure too, but money supply growth tells us about money supply growth; it does not relate that growth in money supply to underlying productivity (or indeed to price level, which is what price indices purport and often fail to do). Each transaction is two-way, meaning that two goods are exchanged. Money is merely one of two goods involved in a transaction. If the money supply increases, but the level of productivity (and thus, supply) increases faster than the money supply, this would place a downward pressure on prices. This effect is visible in many sectors today — for instance in housing where a glut in supply has kept prices lower than their pre-2008 peak, even in spite of huge money supply growth.

So my definition of inflation is a little different to current schools. I define inflation (and deflation) as growth (or shrinkage) in the money supply disproportionate to the economy’s productivity. If money grows faster than productivity, there is inflation. If productivity grows faster than money there is deflation. If money shrinks faster than productivity, there is deflation. If productivity shrinks faster than money, there is inflation.


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Where is the Inflation?

Our critics always ask us where the inflation is. The answer is that banks are keeping a higher percentage of reserves and new financial securities aren't being created as fast. Second, if not for the massive printing of money, there would be a lot of deflation and the printing press has preventing that. The third reason is that people and firms aren't spending money as fast and the "short-term" savings rate has increased as a result (I'm referring to money velocity). The fourth reason is the official inflation rate is understated because their inflation metrics only look at non-volatile commodities and they exclude real estate because they classify it as an investment.

Basically, unless the money is removed from the money supply first or the required reserve ratio is raised, then as soon as the economy starts to recover, then we will be hit by hyper-inflation.

What is problematic about

What is problematic about measuring inflation in terms of money supply? What's "productivity" got to do with it?

I explain inflation like this:

Door County, WI.

50 years ago it was a group of farming communities noted for their cherries and, more importantly, their delicious and succulent cherry wine.

A hamburger at a Door County restaurant would cost you about what it would cost in Arizona, Pennsylvania, Texas, or Illinois.

Enter the tourists.

Being located on a long peninsula in the middle of a lake which is actually a freshwater ocean, the area is a natural to become a draw for tourists from around the world.

These tourists brought a lot of money with them, and they kept coming back because they found that they could buy hamburgers for the same price they could anywhere else, while enjoying beautiful views (and that wonderful wine).

It took a while, but not too long, for the people who sold the hamburgers to realize that there was suddenly a whole lot more money floating around than there used to be. Cautiously they began to raise the prices of their hamburgers and were delighted to find that the tourists didn't seem to mind - even the ones who hadn't had cherry wine with their breakfast.

Who did mind? The farmers, truck drivers, and high school students who were born and raised there certainly did. They were forced to pay more for their hamburgers, not because of any major improvement to the hamburgers themselves, but simply because there were more dollars out there to be spent on whatever, so supply and demand buoyed up the price of hamburgers.

Supply of dollars goes up

price of dollars in terms of hamburgers (how many burgers you have to sell to get one of the dollars) went down.

In other words, a rising tide lifts all ships: new dollars have to go somewhere - the stock market, gold, commodities, even great wine.

It is what it is and it ain't what it ain't. Also there's pandas.

"Anyone who thinks you can't create something out of nothing never dated a drama queen."


Love Door County

Grew up across the Bay in the U.P.

I don't care for the cherry wine, though. Tastes like cough medicine.

Otherwise, good story.