Saturday, June 23, 2012

What causes hyperinflation?

Inflation has been gradually creeping around the world due to a variety of reasons. These range from loose government monetary policies to supply bottlenecks creating shortages. But what about hyperinflation? When does inflation get out of control and become hyperinflation? Hyperinflation is defined as an inflation rate of 50% or more in a single month. What differentiates it from inflation is the root cause. Hyperinflation is solely caused by excessive money supply. Debts and deficits reach unsustainable levels. And governments resort to cover expenses through more and more money printing. The value of the currency falls and people lose confidence in the currency. And for a currency to carry weight as well as purchasing power, confidence of people in it is the key.

The hyperinflation in Germany is a classic case in point. From January 1919 until November 1923, the average price level increased by a factor of 20 bn, doubling every 28 hours. The more troubling fact is that hyperinflation is not necessarily a rare event. Since Germany, there have been 29 additional hyperinflations around the world. This is where gold comes in. When confidence in a currency is lost, there is a scramble for hard assets having value. Gold fits the bill nicely. For instance, during the German hyperinflation, an ounce of gold traded for 170 marks in January 1919. That same ounce was worth 87 trillion marks by November 1923. Thus, it goes without saying that gold is a big hedge against inflation. And one must accumulate more of it in today's environment where governments in the developed world are resorting to excessive money printing.

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