A Simple Example and Explanation of Hyperinflation

To understand hyperinflation, this example from Art Cashin dealing with the price of a German loaf of bread is enlightening:

To understand the incomprehensible scope of the German inflation maybe it’s best to start with something basic….like a loaf of bread. (To keep things simple we’ll substitute dollars and cents in place of marks and pfennigs.  You’ll get the picture.) In the middle of 1914, just before the war, a one pound loaf of bread cost 13 cents. Two years later it was 19 cents. Two years more and it sold for 22 cents. By 1919 it was 26 cents. Now the fun begins.

In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid month it was $100 billion. Then it all collapsed.

Many people know that the Supply of Money is related (generally with a lag) to price inflation. Few understand that all hyperinflations occur when the Demand for Money collapses. At some point in the process of inflating the supply of money, people recognize what is happening and begin to spend money faster (the “velocity” of money) increases) in order to avoid expected price increases.

When matters become especially obvious, no one wants to hold money. Vendors refuse to accept it and exchange goods only for other goods (barter).  In monetarist terms, the velocity of money accelerates rapidly. At this point, the government or central bank has lost complete control. Changes to the money supply are dwarfed by changes in money demand. Hyperinflation is the result.

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