Hell, fear, and hyperinflation

Money is our means to undertake economic activity. It incumbent on the agents of government to ensure that money flows to all parts, such that the economy can flourish. Money is not the constraint on what we can achieve—we are—and a growing economy requires a growing amount of money. So why are politicians telling us that we cannot afford better healthcare or better education because we do not want to end up like the Weimar Republic, Zimbabwe or Venezuela?

To understand their motives and how they are deceiving us, we need to grasp some basic economics. The priesthood of economics are trained to instill a fear in all of us – a fear of hyperinflation. In the US, students of economics are likely to study from The Principles of Economics by Greg Mankiw. The sixth edition contains 33 graphs with data but only five with data for countries other than the US. All five are about hyperinflation!
In the land of monetary permahawks

hyperinflation is always just around the corner”.

Of course hyperinflation is a disaster, but is it just around the corner, and should the fear of hyperinflation stop us from improving our health and education? Or is it just a big stick for the capitalists to beat the workers, a weapon to destroy the state and democracy with it? Why is it that rising prices and rising wages are really bad, while rising house prices and rising CEO pay are not so bad? Does the push for ultra-low inflation end up damaging the economy over the longer term?

To try and answer these questions it is useful to look at some historical examples of hyperinflation. The five worse cases are all associated with a political crises – usually war. They are in reverse order (see also):

5.      Greece Oct 1944.                             WWII.
4.      Germany Oct. 1923                          French and Belgium occupation.*
3.      Yugoslavia Jan. 1994                       Bosnian war.
2.      Zimbabwe Nov. 2008                       Compulsory land redistribution.
1.      Hungary 1946                                  Post WWII under Soviet influence.

* French and Belgian soldiers occupied the Rhineland in Jan. 1923 to demand war reparations in coal. Germany responded with a general strike.

The most infamous example is the Weimar Republic but the story we often hear that the 1922-23 hyperinflation led to the rise of Fascism is not correct. The graph below shows a comparison of German and UK GDP per capita using the Maddison database (2016).

We can see that in terms of economic activity, the effects of hyperinflation of 1922-23  were relatively short lived – GDP was 6% higher in 1925 than in 1922. What happened next was more devastating. In the 1930s the global economy entered the Great Depression, and the German Chancellor Heinrich Brüning adopted austerity policies which exasperated the problem leading to a more persistent fall in GDP. As the 2008 economics Nobellist Paul Krugman wrote in his 2013 New York Times piece It’s always 1923:

the 1923 hyperinflation didn’t bring Hitler to power; it was the Brüning deflation.

See also The Economist Germany’s hyperinflation-phobia.

However, the growth plot does not tell the whole story. Hyperinflation has lasting consequences for some. Imagine we add a zero to the price of everything. For debtors, it is like a jubilee where in real terms their debts are reduced by a factor of ten. For creditors, it is nightmare as their saving are reduced by a factor of ten. Adam Fergusson in When money dies tells the story of how the plumber could raise prices daily and still afford to eat whereas the public servant or pensioner dependent on fixed income no longer had the means to repair a leak.

Although the top five hyperinflations were predominantly political, other examples – including the more recent case of high inflation in Venezuela – involve both political and economic mismanagement. Whether political or economic, there is one simple lesson we learn from all examples:

When prices are rising the last thing you should do is print more money.

This sentence contains an important clue about cause and effect—first prices are rises and then hyperinflation follows if the response is to print more money. Note though, nothing here to imply that increasing government spending causes inflation. The most important clues are at the maths. In 1911 Irving Fisher – a student of the physicist Josiah Willard Gibbs – wrote down the equation of exchange which states that the product of the quantity of money m times its rate of exchange or velocity V is equal to average price p times the quantity of transactions T:

m V = p T

sometimes also written as  m V = p Q. Although relatively simple, the application of this equation is far more subtle. If we assume that V and T only change slowly, then prices, p, are proportional to the quantity of money, m—see e.g. Chart 1 here (pdf). So when government spends and creates new money, m,  then prices, p, must rise? Actually no. This is wrong. Government spending may also increases the number of transactions, T, therefore prices, p, may be remain stable. Consequently, no-one can make the case the increasing government spending will necessarily cause inflation. Only if that spending fails to increase economic activity (a multiplier less than one) does inflation follow.

A more fundamental point is the exchange equation tells us nothing about cause and effect—which comes first, changes in prices or money?  The exchange equation completely ignores the dynamics associated with the basic drivers of price—supply and demand. For essential commodities like food and energy, demand is fairly constant and the strongest driver of price over the short term is supply. In a crisis, if our fresh water supply is cut, we will pay whatever we have for bottled water. Similarly, the price of oil has more to do with supply that the quantity of money. Supply and demand are the dominant drivers of price and inflation, and changes in the money supply are a secondary consideration. As this article concludes:

Based on our examination of countries that together constitute 91 percent of world GDP…….high inflation has occurred often when it has not been preceded by rapid money supply growth.

This is important because it means that most people propagating the standard hyperinflation myth have got their cause and effect the wrong way round. What happens first is a fall in supply causing prices to rise, then in response the government makes the mistake of printing money rather than raising interest rates. In all examples of ultra-high inflation or hyperinflation including Venezuela, inflation came first then money printing made things worse.

So next time someone raises the hyperinflation stick, tell them they need to go and study history, the exchange equation, and get their cause and effect the right way around. Governments spending does not cause hyperinflation – it’s a supply shock followed money printing and no-one is proposing that. Now can we get on with the more important task of  building a better world?


  1. Allen Bell -

    “Governments spending does not cause hyperinflation – it’s a supply shock followed money printing and no-one is proposing that”
    That doesn’t pass the smell test. There are people telling us we are in the crevasse of a supply shock which is the shortage of housing, shortage of nurses, shortage of whatever thing you would like more of. The housing shortage is the big one where costs in the UK are out on a limb on tables compared to other developed economies.
    Given this current supply shock, there are people advocating printing money to give to government to spend on building houses.
    That’s your ‘supply shock followed by money printing’ right there, and the Peoples Quantitative Easing fan boys are proposing exactly that.
    I agree with making the UK a better place but the preferred direction should be planning liberalisation imv, and blowing up agricultural subsidies.

    1. Charles Adams -

      “shortage of housing”

      which is why we see house price inflation running higher than CPI, solution build more houses, may be that is the planning liberalisation you suggest?

      “shortage of nurses”

      solution train more nurses. I do not see why building houses or training nurses is likely to be inflationary, which is my point.

  2. Graham -

    I believe Richard Murphy has pointed out that the government has been “printing money” through QE, but daren’t call it that, and it hasn’t produced inflation, but has made a lot of wealthy people a good deal more wealthy.

    1. Charles Adams -

      QE is subtle. It is more of an asset swap that new money. Money is created when government spends. When people buy bonds, money is swapped for bonds, but total capital is not changed just the class of that capital changes. QE is simply the reversal of this asset swap, the bonds are converted back to money.

      It does mean that the people that were invested in bonds need to look for a new home for their savings which might push up the price of other assets such as housing and shares. In that way, QE makes people with wealth more wealthy.

  3. Peter May -

    Interestingly Bill Mitchell (https://www.youtube.com/watch?v=Liv0DKvRLvA – towards the end) has said that it is supply side collapse that is the danger. Once you get that then even if you are spending only the same amount then it will be inflationary. I think he said the farms in Zimbabwe quickly produced 60% less than before so inflation was absolutely inevitable. That would be true for the Rhur (steel and coal production stopped dead) and Venezuela too (particularly as they are an oil specialist economy) – major collapse in oil production – inflation inevitable.

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