History’s most infamous hyperinflation hit Germany in the 1920s, during the economically incompetent Weimar Republic. Hyperinflation so badly ruined the German economy that Germans later voted Adolf Hitler into power because he promised to fix things.
At the end of the First World War, Germany faced the prospect of paying off massive debts taken on during the conflict in addition to all the ongoing costs of running a government. Most of its debts were in its own currency, the German mark.
Because the German government had the exclusive right to produce German marks, the debt proved an irresistible temptation to begin printing money to pay its bills. Soon, all the new money caused a wild hyperinflation. In fact, the rate of inflation in Weimar Germany in 1922 was well over 100 per cent per month – it reached nearly 6,000 per cent by the end of year!
Then things really got out of control. Prices went up 1,300,000,000,000 times (that’s not a
misprint!) in 1923. That year, Germans paid 200,000 marks for a loaf of bread and 2 million marks for a kilo of meat. Prices rose so rapidly that waiters at restaurants had to pencil in new prices on menus several times a day. And if you ate slowly, you were sometimes charged twice what was printed on the menu because prices had gone up so much while you were eating!
In some places in Germany, people stopped bothering to take the time to count out money.
Instead, they tied paper bills into huge bricks and weighed the bricks of cash. For example, it may have cost two kilos of cash to buy a chicken. Although this catastrophe is one of the most famous, it probably wasn’t the first (it may well have happened in Ancient Rome too), and it was certainly not the last case. In Brazil, until surprisingly recently, the main newspa- pers used to print the rate of indexation, so that people were able to calculate that day’s prices given the previous day’s prices and the rate of inflation, and the last decade has seen hyperin- flations in, for example, Zimbabwe.
money because it first had to get more gold with which to back the new money. Because purchasing gold is expensive, governments were effectively restrained from increasing their money supplies.
A major break occurred in 1971 when, in order to pay for the escalating costs of the Vietnam War, President Nixon took the United States off the gold stan- dard and put the US on the fiat system, in which paper currency isn’t backed by anything. People just have to accept the currency as though it has value.
In fact, fiat is Latin for ‘Let it be done’. So when you say fiat money, you’re basically referring to how a government creates money simply by ordering it into existence. The problem with a fiat money system is that nothing limits the number of little pieces of paper that the government can print up to pay its debts.
The trouble with printing money to pay your debts and obligations is that as soon as the money’s out there, people spend it, drive up prices and cause inflation. And if you print more and more money, you end up with people offering shopkeepers and producers more and more money for the same amount of goods. The result is like a giant auction where everybody bidding on items keeps getting more and more money to bid with. The more money you print, the less each individual pound, euro, dollar, doubloon or whatever is worth.
If a government gets into the habit of rapidly printing new money to pay its bills, inflation can soon reach or even surpass 20 or 30 per cent per month, a situation referred to as a hyperinflation. Economists hate hyperinflations because they greatly disrupt daily life and ruin the investment climate.
Hyperinflation causes people to waste huge amounts of time trying to avoid the effects of rising prices. During the Weimar hyperinflation in Germany (which we discuss in the sidebar ‘Hyperinflation and Hitler’), men working at factories were paid two or even three times a day because money lost its value so quickly. Their wives waited at the factories to take the money imme- diately to the nearest shops, trying to spend the pay before it lost most of its value. Shopping may be fun, but not when you’re desperately racing against outrageously rising prices!
Hyperinflation also destroys the incentive to save because the only sensible thing to do with money during a hyperinflation is to spend it as quickly as you can before it loses even more of its value. Those people whose life sav- ings were in German marks during the Weimar hyperinflation soon found that what they had worked so hard to amass had become worthless. And people thinking about saving for the future were greatly discouraged because they knew that any money they saved would soon lose all value. The discourage- ment of saving causes major business problems because if people aren’t saving, no money is available for businesses to borrow for new investments.
And without new investments, the economy can’t grow.
Feeling printing press pressures: The politics of inflation
Even if the government isn’t trying to use inflation to avoid tax increases, one group in particular always pressures it to circulate more money. You may even be a member of this group – they’re called borrowers.
To understand the politics of inflation, you need to understand that one of the functions of money is as a standard of deferred payment. What does that mean?
Imagine that you borrow £1,000 to invest on your farm, promising to pay the bank back £1,200 next year. For the past several years, prices in the economy have been stable, and, in particular, the pigs that you raise have sold for £100 each. Essentially, your loan lets you borrow the equivalent of ten pigs with the promise to pay back twelve pigs next year.
But you have an idea. You lobby your MP to lobby the government to print more money. In a collective rush of blood to the head, the Treasury agrees and instructs the mint to print a load more money. All that new money causes an inflation, after which the price of pigs rises to £200 each. Now you have to sell only six pigs to pay back the £1,200 loan, leaving you with more pigs, you pig!
Lenders, of course, oppose the inflationary desires of borrowers. If you were putting money in the bank, you’d do everything in your power to stop the inflation. If the change goes through, not only are your profits ruined, but also you’re an outright loser. In the first year, your loan of £1,000 is the equiv- alent of ten pigs. But after the inflation, you get paid back the equivalent of only six pigs. You take a 40 per cent loss on the value of your loan. Too much inflation, and a lender ends up being a pig in a poke.
As long as economies use money, lenders and borrowers are always going to be lined up against each other, both trying to sway the government.
Stimulating the economy with inflation
A much more legitimate reason for governments to print more money has the very respectable name of monetary policy. Monetary policy refers to the deci- sions a government makes about increasing or decreasing the money supply in order to stimulate or slow down the economy.
We go into monetary policy in detail in Chapter 7, but the basic idea is that if the economy is in a recession, the government may print up some new money and spend it. All the goods and services it buys with the new money stimulate the economy immediately. In addition, all those businesses that received money from the government can now go out and spend that new money themselves. And whoever receives the money from them also goes out and spends it to buy things. In fact, this pattern can theoretically go on forever and stimulate a heck of a lot of economic activity – enough to lift an economy out of a recession.
If this result sounds too good to be true, that’s because it is. And the reason is inflation. When people start spending all that new money, it drives up prices. Eventually, the only effect of the government’s good intentions is that prices rise and no additional goods are sold. For example, if the govern- ment doubles the money supply, businesses double the prices they charge because each piece of money is worth half as much as before. Consequently,