Hyperinflation is part of the experimental data that any good economic theory should be able to explain. There are many different economic schools of thought and they often have very different views of hyperinflation. I am trying to collect as many different explanations here as I can. I think it is fun to be able to understand this problem from many different angles. If you know of any other explanations, then please post them in the comments. A good explanation should fit with some common characteristics: there are always high government debt and deficit levels, hyperinflation can start very suddenly, it often accelerates, it can go on for years, it is very hard to stop, but sometimes it is stopped by balancing the government budget.
The biggest flaw in most people's understanding of hyperinflation is that they think if we have low inflation now we are safe for a long time. As you read through each explanation, try to imagine how fast things could switch from low inflation to hyperinflation.
Equation of Exchange with Positive Feedback Loop
There can be a feedback loop where the more the central bank makes money and buys bonds the less people want to hold bonds, but the less people hold bonds the more the central bank has to monetize so the government has cash to operate. This results in a flood of new money and inflation. The inflation causes the velocity of money to go up. Governments almost always try to fight inflation with price controls. The resulting shortages reduce the real GNP. Using the
equation of exchange view of hyperinflation
we can see that if the money supply is going up fast, the velocity of
money is going up fast, and GNP is going down that prices will go up
very fast. But nobody wants to hold bonds in a currency that is dropping fast, so this can
spiral out of control.
Hyperinflation can be simulated using this view.
Corrected Modern Monetary Theory
A
simple model makes it easy to understand hyperinflation. In this model all government spending uses newly made money and we imagine money collected from taxes and bond sales is just destroyed. In this model bonds are paid off with newly made money. If much of the government debt is short term, and people stop rolling over bonds, then the government would end up paying off lots of bonds with lots of new money. If there is a full bond panic, then this could result in hyperinflation.
Unsustainable Interest Expense
If the deficit is large then the debt and the interest on the debt can both be growing faster than the tax base. In this case then, at some point, the interest on the debt adds so much to the debt that it is clear there is no hope of really paying this off. Often about when this is becoming clear the interest rates go up and the interest expense shoots up so that it is obvious to all this can not go on. The alternative is for the central bank to peg interest rates by buying bonds very fast. Either way, it gets to where all the government can really do is print money to pay off the debt. This then makes lots of new money and the value of each unit goes way down.
Inflation Tax View
Inflation is a tax on those who hold money. The higher taxes are the more people change their behavior to avoid the taxes. As the inflation tax gets higher and higher people change what they do so that the real value of the money they hold goes down. This involves spending money faster and keeping lower real balances. This can make the total real value of the currency outstanding go down even as the nominal value is shooting up. But the lower the real value of currency out there to collect an inflation tax from, the more drastic the same real value of inflation tax impacts price levels. In other words, the more people try to avoid the inflation tax the more extreme the government has to get about printing money to get the same real amount. But the more extreme the inflation tax the more people try to avoid it. This can
spiral out of control, often to where people avoid that currency altogether.
Search for Krugman here for more.
Backing View or Real Bills Doctrine
In the
Real Bills Doctrine a bank can issue as many notes as it wants without causing inflation as long as it gets assets of real value that could be sold to withdraw the notes. If it is getting bonds they should be for less than 60 days and come with collateral. In hyperinflation the central bank buys government bonds. The problem here is that the only collateral is a real tax base. So the more bonds they buy the less real collateral they have per bond. Also, they typically buy long term bonds which go down in value as interest rates go up. So the current value of the assets backing the notes per note issued goes down. The value of notes is determined by the value of the assets per note, so the value of the notes goes down if the value of the assets goes down. This can spiral out of control. As the notes go down, the value of the bonds goes down, but as the value of the bonds goes down, the value of the notes goes down. As you get hyperinflation the government gets weaker and the amount of real taxes collected goes down. This further reduces the value of the backing/bonds at the central bank. This feedback loop can go on and destroy the currency.
A central bank backing its currency with long term bonds is like backing the currency with the future value of the currency. Holding a 30 year bond as backing is like backing the currency with the value of the currency 30 years from now. There is a dangerous recursion here. Once the future value starts going down, the backing goes down, which reduces the current value of the currency, which reduces the future value, and things
spiral out of control.
Supply and Demand
If a currency is losing value fast the demand for that currency goes down. This makes the value of the currency go down even more. If the government needs to print money to cover a deficit of a certain real total value, to cover real expenses in the real world (employees, retired people, unemployed), then as the value of the currency goes down it is forced to increase the supply faster and faster. This can spiral out of control with supply going up fast while demand goes down fast and the currency gets destroyed.
Rational Expectations
Rational expectations theory holds that economic actors look rationally into the future when trying to maximize their well-being. History shows that when the government starts using new money to fund a big deficit that the currency will go down. Once economic actors expect the currency to go down, they work to avoid that currency. The faster it is going down the harder they work to avoid it. The more people try to avoid the currency the more it goes down. You can get a feedback loop or panic. Eventually everyone is out of that currency.
Half Dead Money
Good money is both a store of value and a medium of exchange. During hyperinflation the currency is no longer a good store of value. It can be viewed as half dead money. Such money often keeps losing value till it eventually becomes completely dead.
Replaced as Store of Value
The higher the inflation the more the store of value function of the currency is replaced by other things. In the past if someone did not need their money for 6 months, then the money might stand still for 6 months. But the higher the inflation rate the less sensible it is to use the currency as a store of value. So people who don't need their money for some time use something else as a store of value. This might be another currency, purchasing goods in advance of when they are needed, buying gold or silver, or not selling something till they need the cash. The less the currency is used as a store of value, the higher the velocity of money, and the higher the inflation. But the higher the inflation, the less it is used as a store of value. This makes a
death spiral that is hard to escape from.
Loss of Confidence or Faith
For some reason the public becomes less confident in the currency. This may be from too much new money, from central bank monetizing government debt, from war, from corrupt government, or whatever. As the public loses confidence they don't want to hold the currency as long and the velocity of money goes up. However, as the velocity goes up the prices go up, which makes confidence even lower. This can spiral out of control.
"If there is a real loss of confidence in the dollar, then I think we
are in trouble. That is something that has to be watched." - Paul Volker
Inflate Away the Debt
The idea here is that those in charge have decided to inflate away the national debt by printing money and this causes hyperinflation. If politicians have ever made such a decision I can not find them admitting it publicly. To me hyperinflation happens when there is no good way out of a bad situation. I doubt there was ever a "vote for hyperinflation". Perhaps they voted to monetize the debt but did not understand it would cause hyperinflation. I can not even find that though.
When Politicians Get Control of Printing Press
Politicians can spend unlimited amounts once they are able to get as much money as they want from the printing presses. Usually this is done by getting control of the central bank and making them buy as many government bonds as needed. Once this is how things work, all restraints on the amount of money are gone. The more they print, the higher the prices. The higher the prices, the more they print. They print and spend into oblivion.
Khan Academy
The
Khan Academy video explains hyperinflation as two feedback loops. First, the more the government prints, the higher the prices go, but the higher the prices go, the more the government needs to print to pay for whatever it needs to pay for. The other cycle is that the faster prices go up the more people hoard real goods. But the more people hoard real goods and less cash, the bigger the impact of constant real value of new money (and so bigger nominal value). Hoarding can be done by buying extra stuff ahead of when they normally would or waiting to sell things until prices have gone up. They keep less cash and more real goods. These two cycles can
spiral out of control.
Addiction to Monetary Heroin
The economy and government get addicted to cheap money. The longer our reliance on it and the greater our dependence, the
more it takes on the toxic dynamics of an
addictive drug: we can only
sustain a feeling of wellbeing by increasing resort to it. If at any point the cheap money is removed the economy and government will nearly fall apart. But over time a larger and larger dosage is needed. Eventually the patient dies.
Taxes for Bond Holders
Bond holders that are paid with money collected from taxes can expect to get the value of their initial investment back plus interest. However, when governments start printing money to pay bond holders the value of the money will be going down and holding bonds for years is a bad deal. Bond holders know this and can head for the exits when governments start doing this. The faster bond holders exit the faster the government will print. So this can spiral out of control in a bond panic.
Market Perception
If the market thinks that the central bank is funding the government deficit with new money, then you will get hyperinflation. There can be deficit spending, and even monetization, as long as the market thinks the deficits will be controlled eventually. It must expect that in the future the monetization will unwind, stop, or at least slow down. Once the market thinks the deficit will not be controlled, and the monetization will continue without bound, then hyperinflation comes. It is like things go too far and something snaps. Initially the market is willing to buy government bonds but after this tipping point they are not. The central bank becomes the only bond buyer and is funding the deficit with no way to get back to the previous state.
Government with Real Foreign Obligations
If a government with a large deficit needs to pay another country some real amount (say gold bars for war reparations, oil being imported for military, government debt denominated in a foreign currency, imported food for local population), then as it attempts to do so by printing local currency, it causes inflation. The more inflation the more it needs to print to pay the same real amount to the foreign country. This can spiral out of control.
Bond Market Bubble
The central bank buys up more and more bonds driving the price of bonds up and interest rates down. At some point this bubble pops. As it pops, people stop rolling over bonds and the central bank is forced to monetize everything so the government still has cash to stay in operation. This makes for a flood of new money and causes hyperinflation.
Wage Price Spiral
Government wages, unemployment benefits, social security benefits, medical benefits, retirement benefits, etc. are indexed to inflation. This means that the government expenses go up right away with inflation. As government pays out more money in wages and other things, that new money can add to the inflationary pressure, making prices go up more. If the government is deficit spending and the central bank is monetizing debt, this can
spiral out of control.
This does not work for private wages. There is no way that private wages going up can ever spiral out of control making wheelbarrows full of money. The spiral needs to include government to get the new money and keep going.
Diminishing Real Stock of Money
With inflation you can have a
diminishing real stock of money. It can get to where economists and business people are advising the central bank that the economy does not have enough money. So the central bank makes more money. After this the velocity of money goes up and inflation goes up more, making the real stock of money even lower. This cycle repeats until the real stock of money is virtually zero, as nobody wants the money.
State Theory of Money
In the
State Theory of Money, fiat currency is a creation of the state. The state has a monopoly on the creation of this fiat currency. By making and spending money as well as taxing back some of this money it can regulate the quantity and the value of this money. If for some reason the spending and creation of money get too out of balance with the taxing, then the value can go down. If they are way out of balance, then the value can go down fast.
The Quantity Theory of Money
The velocity of money can go from changing hands on the order of once a month to changing hands on the order of once a day. This can account for a
factor of 30 chance in price. However, prices can go up by factors of even billions. The vast majority of this price change is simply due to the quantity of money. The more money you make the less it will be worth. In hyperinflation the central bank makes lots of new money to fund the government deficit and the value goes down proporionally.
Cagan's Explanation
In
Cagan's explanation of hyperinflation, the velocity of money goes up as people's expectation of inflation goes up. Over the long term the higher the quantity of money the lower the value. People's expectation of inflation is adjusted up if their previous expectation was exceeded. In this model you can sometimes get control of inflation by stopping the money creation and sometimes things have passed a tipping point where even if you stop making new money the currency will keep crashing.
This model does not address why a government would not be able to stop making money but that is simple, if they are spending more than they get in taxes and nobody is buying their bonds.
Government No Longer Wins by Money Printing
For modest amounts of inflation when a government prints money (or borrows from a central bank that prints) it gets ahead. It has the new money that was printed and downside of prices going up is shared over a wide base, not just the stuff it buys. Often prices go up long after the new money is spent. So initially the government is better off after the money printing. Eventually some tipping point is passed and for each amount of money printing the prices on just the stuff government has to pay for go up more than what it got from the money printing. So each time it prints it gets worse off and needs to print more. However, if they are spending much more than they get in taxes and nobody is buying their bonds, they are trapped and all they can do is print (or borrow from the central bank which makes the money). So there is a
death spiral with uncontrolled money printing.
Keynesian Bubble Economics
Most government economists are Keynesians. When a bubble pops
Keynesians advocate money printing to mop up and make a new bubble. To clean up the previous mess and make a new bubble takes more money printing than the previous bubble did. So you get a sequence of larger and larger bubbles. Eventually it is not possible to make a new larger bubble without making so much money that the currency collapses.
Theory of Reflexivity
Perceptions tend to create their own reality. If people believe the money is going to become worthless, then it probably will.
Democracy Causes Hyperinflation
There have
been studies that indicate
democracies are more prone to hyperinflation than dictatorships. Democracies are more prone to run large deficits because of trying to give too many things to too many different people. Once the budget is out of control then inflation can get out of control.
Friedman said, “inflation is neither a capitalist nor a communist phenomenon. In our modern world, inflation is a money printing phenomenon."
Lenin's View
There is no subtler, no surer way to overturn the existing basis of
society to than to debauch the currency. The process engages all the
hidden forces of economic law on the side of destruction, and does it in
a manner, which not one man in a million is able to diagnose. -As reported by Keynes
Keynes View
Keynes wrote about hyperinflation:
"In the latter stages of the war all the belligerent governments practiced, from necessity or incompetence, what a Bolshevist might have
done from design. Even now, when the war is over, most of them continue
out of weakness the same malpractices. But further, the governments of
Europe, being many of them at this moment reckless in their methods as
well as weak, seek to direct on to a class known as "profiteers" the
popular indignation against the more obvious consequences of their
vicious methods. [...]
"The inflationism of the currency systems of Europe has proceeded to
extraordinary lengths. The various belligerent governments, unable or
too timid or too short-sighted to secure from loans or taxes the
resources they required, have printed notes for the balance. In Russia
and Austria-Hungary this process has reached a point where for the
purposes of foreign trade the
currency is practically valueless. [...]
"The preservation of a spurious value for the currency, by the force of
law expressed in the regulation of prices, contains in itself, however,
the seeds of final economic decay, and soon dries up the sources of
ultimate supply. If a man is compelled to exchange the fruits of his
labors for paper which, as experience soon teaches him, he cannot use to
purchase what he requires at a price comparable to that which he has
received for his own products, he will keep his produce for himself,
dispose of it to his friends and neighbors as a favor, or relax his
efforts in producing it.
When money permanently escapes central bank
The central bank is like a huge market player. When it is buying bonds it drives up the prices and lowers the interest rates at the same time it is injecting liquidity. If it later wants to withdraw that liquidity by selling the bonds then the prices of bonds will be lower and it will not be able to withdraw as much as it injected. If it bought long term bonds and interest rates went up substantially, then the value of the bonds will be far less than what it paid earlier. This means that even if it sold all the bonds it would not be possible to withdraw all the money it injected. Note that with short term bonds it could just hold them till they were paid off and not lose money but if there is an inflation problem and it has to wait 30 years to withdraw the money then it has failed. If inflation goes up and bonds drop in value then it can't effectively fight inflation as the assets it has to withdraw cash are no longer valuable enough to do the job. Normally a central bank should be able to withdraw all the money it has created at near the value it originally had. However, a central bank holding lots of long term bonds where the value has crashed can no longer do this. The money is out there but can not be withdrawn. The central bank has lost control of it.
Flaw in "Government can't run out of money"
There are those who think a government can't run out of money because it has a printing press. Hyperinflation exposes the error in this way of thinking. If the government is increasing the money supply too fast, then their currency is not a good store of value and people won't want to hold it. As people want to hold it less and less it makes it worse and worse as a store of value. As prices go up the government needs more and more money, but since it thinks it can't run out of money it just prints more. This can
spiral out of control. The government can print so much currency that it is no longer accepted as money. At that point the government is out of money even though it has a printing press.
Unsustainable Currency Peg
Sometimes a central bank is trying to both peg the local currency to a foreign
currency and print money to help a government that is running a deficit. By doing this it does not really have enough reserves to support the peg and can rapidly lose much of the reserves it does have attempting to maintain this unsustainable currency peg. There are also times where the government just takes a central bank's reserves. Eventually the central bank's reserves get dangerously low and has to give up the peg. At this point the currency can suddenly crash and they can get hyperinflation.
Hard Money View
Paper currencies all seem to fail eventually.
Like a Nuclear Reactor
The policymakers at the Fed think they are dialing a thermostat up and
down, but they're actually playing with a nuclear reactor. A runaway chain reaction can melt the whole thing down. Paraphrase of Jim Rickards, Currency Wars.
QE Trap / Roach Motel of Monetary Policy
Once the government/central-bank has artificially lowered interest rates to stimulate the economy, it is very hard to ever stop. If they even hint that they might slow down a bit on the money creation then interest rates shoot up and hurt the recovery, so the central bank can not slow the money creation. In fact, they will have to print faster to try control interest rates once they start going up. But the more money they make the more inflationary pressure there is, which will push interest rates up. So the central bank ends up fighting harder and harder to try to keep rates down by making money faster and faster. This spirals out of control and you get hyperinflation.
Non-Linearity of One More Trillion
The government can keep adding trillions in debt one by one. But at some point the market reacts very differently to one more trillion in debt than it did for all the previous times one more trillion in debt was added. When we get this "non-linear reaction" we say the government has passed some "tipping point" and things start to "spiral out of control". You can see this in all the previous cases of hyperinflation and yet people always seem surprised when it happens to them. Since even people who understand the danger of hyperinflation don't know exactly when the tipping point will come, as they warn of the danger for years they will be viewed as being proven wrong for years, right up till when it hits.
Borrowing To Pay Interest
After things get so bad that the government has to borrow just to make the interest payments on the debt, then things have gone too far. To service the current debt they must go further into debt. Bond holders can tell where this is going and flee. The central bank becomes the only bond buyer. The more the government borrows, the higher the interest payments, and the more they have to borrow. But as they do this the central bank is making new money. This can spiral out of control making hyperinflation.
Mises/Austrian Crack-up-boom
Money is, like any other good,
subject to the irrefutably law of diminishing marginal utility. It is this law, which is implied by the
axiom of human action, which is at the heart of
Mises's praxeology. If the central bank is expected to increase the money supply in the
future, people can be expected to rein in their money demand in the
present — that is, increasingly surrendering money against vendible
items.
"Once public opinion is convinced that the increase in the quantity of
money will continue and never come to an end, and that consequently the
prices of all commodities and services will not cease to rise, everybody
becomes eager to buy as much as possible and to restrict his cash
holding to a minimum size. For under these circumstances the regular
costs incurred by holding cash are increased by the losses caused by the
progressive fall in purchasing power. The advantages of holding cash
must be paid for by sacrifices which are deemed unreasonably burdensome.
This phenomenon was, in the great European inflations of the 'twenties,
called
flight into real goods (Flucht in die Sachwerte) or
crack-up boom (Katastrophenhausse).
The mathematical economists are at a loss to comprehend the causal
relation between the increase in the quantity of money and what they
call "velocity of circulation."" -
Mises
Ken Rogoff
"It's pretty basic. Usually, governments desperate for money start
printing currency, lots and lots of currency, and go out buying things."
Modified Dornbusch Overshoot Model
In the
Dornbush Overshoot Model the exchange rate for a currency initially drops more than the eventual value in response to a one time monetary increase, so that higher local interest rates provide comparable value to investors. Local prices are slow to adjust and exchange rates adjust much faster to changes in the money supply. However, when the monetary injections are repeated, and not a one time thing, then you get repeated "overshoots" and the currency just keeps going down on the forex markets. Because of the "overshoot" issue it goes down more than linearly with the monetary increase. The higher cost of imports, and exports being bought up with cheap local currency, eventually overcome the sticky nature of local prices and make prices go up fast.
Interest Rate Below Inflation Rate
If the central bank loans out money at interest rates below the inflation rate then it makes sense for both government and banks to borrow money. Companies can easily make money if they can borrow from banks at an interest rate lower than the rate prices are going up. They can borrow and buy just about anything. Often they buy inputs for their business before they are needed, which can be viewed as increased demand. The more they borrow the more the inflation rate goes up and the better off the borrowers are. This can
spiral out of control.
Going Galt
When a government is in trouble it often increases taxes of all kinds and tightens up on the enforcement of existing taxes. Inflation is a tax on those with money. Government spending is an overhead that the productive parts of the economy have to support in one way or another. At some point the burdens on an employer can be so great that he is better off to pay the cost to relocate or shut down than to continue in the current environment. This is called
Going Galt. However, the more employers shut down the smaller the pool of productive people there is for the government to extract wealth from, so the higher government increases the various taxes, including inflation. But the higher the burden on the productive parts of the economy the more business and capital flee that government. This can
spiral out of control, resulting in hyperinflation.
Attempt to Inflate Asset Prices
In
this explanation of hyperinflation, the central bank wants to inflate asset prices (stocks, bonds, real estate) to create a
wealth effect, so they print lots of money. However, this increases the prices of the necessities like food and energy more. Wages do not go up as fast as food prices. People have to sell assets to get money for necessities. This causes asset prices to go down in real terms. This causes the central bank to print more money. You have a
positive feedback loop that gets out of control.
Each Fiat Money is a Bubble
There is no real value to the paper in fiat money, so
fiat money is just a bubble. Hyperinflation is when the bubble pops.
Alternative Method of Defaulting
When a government that can print money has no chance of paying off the bonds it has sold with taxes it can collect, it is effectively bankrupt. It could default on the debt or it could print money to pay off the debt. If it
prints money to pay off the debt then inflation/hyperinflation makes the value of the currency go down so much that bond holders only really get the value of pennies on the dollar, but legally they were paid off in full.
Havenstein Moment / Kick the can down the road
Governments that spend much more than they get in taxes will eventually reach a point where the public does not want to lend the government enough money. At this point, which can be called the
Havenstein moment, the government has a choice of either cutting back spending to match the money it can get or getting the central bank to print money and "loan" it to the government. In the short term it is easier to just print more money than to make the hard spending cuts. This is sort of "kick the can down the road" approach. However, in the long term this results in much more pain. Once a government starts down the money printing path it is very hard to ever turn back. Sadly, politicians usually seem to focus on the short term and pick the money printing path. This eventually leads to
hyperinflation.
Kuroda and Peter Pan
"the moment you doubt whether you can fly, you cease forever to be able to do it."
Deficits Don't Matter Until They Do
As long as people are loaning the government more and more money, then deficits don't really matter. But when the public does not want to loan any more money and the government has to get the central bank to print money, then the deficit matters. But by then it is too late. Now they are printing money fast. People are even less interested in buying government bonds. If they raise interest rates it makes the government more clearly bankrupt, and also makes people less interested in buying bonds. At this point there is no easy way to avoid high inflation.
Debt Bomb Exploding
When a government that prints its own money sails into the zone of insolvency you can have a
debt bomb explode. If they let interest rates go up, then the interest on the debt takes all the tax money and nobody will buy the bonds. If they hold the interest rates down, then the yield is so low nobody buys the bonds. Either way, the central bank ends up monetizing a huge amount of debt in a surprisingly short period. The explosion of new money makes the money worth far less.
War of Attrition
One group does not want to cut spending and another group does not want to increase taxes. The stand off results in money printing and inflation till one group gives in. Thus
hyperinflation can be viewed as a war of attrition.
Escape From Liquidity Trap
When a central bank makes money and buys bonds they initially force up the price of bonds and force down the interest rates.
At lower interest rates the velocity of money is lower. So printing lots of money does not immediately result in inflation (see
equation of exchange). However, the velocity of money also depends on the inflation level. So if the central bank tries to hold down interest rates forever it eventually results in runaway inflation. You get to a situation where the more inflation there is, the more the velocity of money goes up, which causes more inflation, and suddenly the economy has escaped from the liquidity trap and has high inflation.
Double Laffer Overshoot
The
Laffer Curve shows how after some point higher tax rates result in lower total taxes collected. There is also a Laffer Curve for money printing, which is really an inflation tax on those holding money. After some rate more money printing does not result in more real wealth for the government. World events and public confidence can shift these Laffer curves around. Hyperinflation is when the government has overshot the optimal point on both the regular tax rate and the money printing rate. Any further attempts to increase real revenue for the government fail and make the economy worse off. The only real fix at that point is to cut government spending, and after all other possibilities have been exhausted, that is how hyperinflation will eventually be halted (maybe years later).
Bond Traders vs Investors
As a central bank drives up bond prices
by buying them it can make sense for a trader to hold bonds. However, the lower the interest rate the less sense it makes for a long term investor to hold bonds. So the longer the central bank does this the higher the percentage of bonds are held by traders and the lower percentage held by long term investors. When bond prices stop going up and start going down they can do so very suddenly because by that point a very high fraction are held by traders who sell very quickly when prices are dropping. The sudden flood of sellers makes the central bank have to print money like crazy and buy bonds like crazy or the government won't be able to raise cash by selling bonds.
Central Bank Sucker Punch
For years the market lets the central bankers think they control the markets. This tricks the central bank in to buying up lots of bonds. Then very quickly the markets make the bonds and currency worthless. The central bank is destroyed.
Instability of Velocity of Money
If conditions are such that the price increase from a velocity of money increase results in further velocity of money increase and further price increase then we can say that the velocity of money is unstable. This spiral can result in hyperinflation.
Modern Monetary Theory and Monetary Realism
In these theories hyperinflation is viewed as a political issue and not a monetary issue. They will say things like, "
Contrary to popular opinion deficit spending and high government debt levels are not the actual cause of a hyperinflation". They look for some trigger to blame the whole hyperinflation on. This may be a supply shock, a loss of productive capacity, corrupt or unstable government, or external factors like war. This will be some reason the government was deficit spending and has high debt levels. While normally very into detail, even at the level of each debit and credit for monetary operations, when it comes to hyperinflation, they skip over all the detail of the mechanics of hyperinflation.
They always name the initial trigger after the hyperinflation has started and they know to go looking for one. They do not seem to have any ability to predict hyperinflation ahead of time and never discuss the mechanics of how it works or goes on for so long. If Japan gets hyperinflation, then they might trace things back to the tsunami and say that was the core cause; however, they could not tell you now if the tsunami will lead to hyperinflation in the future.
These two theories do not seem to help at all in warning when hyperinflation might start nor in really understanding how it works. All the other theories above can give you some insight to how hyperinflation happens. These are more like, "sometimes war causes hyperinflation", without talking about how or any of the steps that go on so you might be able to predict which wars would cause hyperinflation.
Since these two schools of economic thought seem unwilling to explain the mechanics of hyperinflation in their own theories, I will do it for them. In these theories government bonds are part of the money supply. Each time the government makes a new bond out of thin air and sells it, they add to the money supply. In these theories, if the government budget and deficit are out of control, then the money supply is also out of control. Note that for this to work in practice, the central bank will have to buy the bonds as the pool of people with money who are foolish enough to buy bonds in the inflating currency soon dries up. As prices go up the government needs to make more bonds to be able to handle the new higher prices. However, the more bonds they make the more prices go up. This spirals out of control, making hyperinflation.
Update:
Cullen responded to this.
Bond Currency Spiral
If the central government is spending much more than it gets in taxes, and the central bank is buying up bonds, then eventually the currency may start to lose value. If the currency is going down people may reduce holdings in those bonds but this then forces the central bank to buy more so that the government can keep selling new bonds. The faster the central bank prints money and buys bonds the faster the currency goes down. The faster the currency goes down, the faster people rush to get out of bonds. You can get a death spiral where the currency crashes.
Blind Men Describing an Elephant
Above are more than 30 different explanations for hyperinflation, yet they are not
contradictory. They are just different ways of
talking about what is going on. There is clearly some overlap. It reminds me of the
blind men describing an elephant. At the core of each of these explanations the central bank is funding the government's deficit spending with new money. Many explanations have some sort of tipping point or feedback loop. There seem to be many different adverse feedback loops that all operate during hyperinflation. I challenge anyone to find any error in any of these explanations or any contradiction between them.
Predicting the Timing
I think that you really can understand the mechanics of hyperinflation if you can understand all these different explanations. You can understand which currencies have a higher risk of hyperinflation. However,
predicting when hyperinflation starts is a much harder problem. The reason is that
hyperinflation is a positive feedback loop with characteristics similar to positive feedback loops in nature. You can tell when there is a high risk of an avalanche or volcanic eruption but not exactly when it will start. I think
polling could be used to help predict hyperinflation. I also think that
a simulation could be fitted to historical data and then used to improve prediction of hyperinflation.
Others Views of Hyperinflation
As I think of other ways to explain hyperinflation I will add them. If you know of any more, please comment. I do not mean to leave any theory out. While I have the names of many other theories (Thanks Tom!), I am finding it hard to locate explanations of hyperinflation for many of them. If your favorite economic theory is not shown in this list, please let me know how it explains hyperinflation and I will add it. If I have not accurately explained hyperinflation in your economic theory, then please comment with a better version. If your economic theory does not have an explanation for hyperinflation, then I claim there is a big hole in your theory that someone should work on.
Rejected Explanations for Hyperinflation
Hyperinflation is a complete loss of faith in a currency. Hyperinflation can go on for years and end in a complete loss of faith in the currency. However, during those years of hyperinflation, before the end, there is a declining faith but not a complete loss of faith. Hyperinflation is the process, not the end result.
Drop in productive capacity. During hyperinflation real productive capacity goes down. This is because credit is no longer available, price controls make all kinds of shortages, governments usually raise taxes, and it is just hard to do business in a hyperinflation environment. In most cases this loss of productive capacity is part of a feedback loop but as much an effect of hyperinflation as it is a cause. There are some hyperinflations where the government deficit can be traced back to a drop in taxes from a drop in productive capacity, but this does not work as a general explanation for hyperinflation.
Political event not a monetary phenomenon. Yes, politics is the root cause for trouble but the way it causes trouble is by getting the government to deficit spend and get a huge debt that the central bank starts monetizing. Central banks monetizing out of control government debt is a monetary phenomenon. Can't we look a little closer at the mechanics of what is going on? Can't we be a bit more scientific than just saying "hyperinflation is due to politics"? We are talking about a feedback loop that includes money printing, higher velocity
of money, and a rapid drop in the value of the monetary unit. It is absurd to say "hyperinflation is not a monetary phenomenon". This is not facing the facts. It is so wrong it is painful. Please stop this anywhere you see it.
Caused by foreign currency speculators
Some have claimed that hyperinflation is caused by currency speculators. There are speculators betting against currencies all over the world. If they could cause hyperinflation and win big, then all the currencies would have hyperinflation. A successful speculator figures out that a currency is going to go down before it does and his bets against it. This does make it happen a bit sooner. However, speculators always cash out their positions and so undo any net influence they had on the direction the currency was being pushed. In the long run, foreigner speculators have no ability to make a central bank add zeros to their notes or print so much money that people need wheelbarrows to carry it around. Also, a country can get hyperinflation even when there is very little foreign currency trading going on. When politicians and central banks cause hyperinflation they always try to direct public anger away from themselves, but this is just a diversion and not the truth.
A mad man running the central bank could make hyperinflation
A number of people have said that if a mad man was in charge of the central bank then there could be hyperinflation. This does not help to explain any of the many historical cases of hyperinflation. It is just someone saying they don't feel there is a risk of hyperinflation without bothering to explain any rational theory of hyperinflation.
Rejected explanations for why hyperinflation can not happen
Any explanation of why hyperinflation can not happen that contradicts the hundreds of cases of historical hyperinflation should be rejected immediately. For example, if someone says, "the public will never stop buying government bonds", while in hundreds of cases they did stop buying government bonds, then reject immediately. If someone says, "central bankers would never do that", while there are hundreds of counter-examples where central bankers did participate in hyperinflation, just reject immediately.
Anyone who says hyperinflation can not happen without first explaining their theory for the mechanism of hyperinflation should be asked to explain their theory for the mechanism of hyperinflation used in making their prediction.
Prize for Additional Hyperinflation Explanations
I am now offering a prize for additional hyperinflation explanations. See
details of prize here.
