Inflation and hyperinflation – what they are, what they are not
Inflation is an increase of the amount of money in circulation. Hyperinflation is simply very high inflation, which usually occurs at the last stage of fiduciary currency. Just before the collapse of paper money, there is most frequently a period of a highly dynamic growth of the amount of money in circulation. Consequently, it leads to an equally sharp rise in prices because a greater amount of money follows the same amount of goods. In a nutshell, newly issued money does not have cover in real goods. It has become customary to think that hyperinflation starts when prices increase by at least 50% in one month. On the other hand, we can talk about high inflation when the growth of money amount reaches the rate of 5% in a year.
Historically, gold was the best measure of inflation. Today the gold ore is also treated as the only currency that has no counterparty risk and that is why it was used in this study as an objective measure of inflation.
It should be emphasized once again that the term “inflation”, by definition, refers exclusively to an increase of money in the economy, the so called money supply. Yet what we popularly call inflation, meaning the growth of prices, is actually only an effect of inflation. It is significant because various indices, such as PPI, CPI, base CPI, and the like, are not direct indices of inflation, but indices of the price growth of some arbitrary selected products.
That is why real inflation may be at the level of, e.g., 9%, and the so called “base inflation of prices”, meaning the increase of prices excluding energy and food prices (the most important ones), may be only 1.2%. Governments simply call inflation what, in fact, is not inflation. The reason is obvious – price growth indices are usually lower than inflation, and from the media point of view, it is favourable for each government.
References to the present time
The last hyperinflation in Poland, still in the times of communism [in the People’s Republic of Poland – PRL], ended on 8 January 1990[i]. Since then the price of gold has grown by 1005%, which is presented in the chart below[ii]:
The oldest data that allow to reliably assess the course of the previous hyperinflation episode date back to 9 January 1984[iii].
Assuming that the abovementioned date from 1984 is the starting point for the observation of the gold price dynamics, the moment in which the price increase (998%) was comparable to today’s one (1005%) was on 9 September 1989.
The chart below shows the drop of the old zloty value which was reflected in the nominal increase of the gold price per ounce.
The similarity of both charts shouldn’t be surprising for anyone. All the hyperinflations in the human history had both the same fundamental reasons and a very similar course of events. They only differed in the scale of devastating the savings of citizens using a particular currency, which should be directly connected to various levels of the lack of responsibility of single countries’ politicians and governments.
What was the PRL politicians’ responsibility like? Generally, everyone who remembers those times knows that at that time, the authorities had many attributes but responsibility wasn’t one of them. Those who did not have a chance to encounter that reality can look at the next chart. This time it shows the whole range of the available data, that is the period from 1984 to 1990. To better depict the scale of the later inflation, the area of the previous chart has been marked with the red rectangle.
After 9 September 1989, within only three months, the gold rate grew 10 times additionally. Look at Chart 2 and Chart 1 again. In an analytical approach, did anything indicate the catastrophe at the end of 1989? Certainly, the situation looked bad, but hardly anyone could expect such a huge devaluation of the zloty.
If today in the Third Republic of Poland, the politicians were as much responsible as those in the PRL, it would mean that we could expect a very painful drop in the value of the zloty. Thus are we doomed to experience the same situation as during the collapse of the PRL? It should be honestly admitted that we are not necessarily.
First, the old zloty wasn’t introduced only in 1984, but 5 years after the Second World War was finished, on 30 October 1950[iv]. And although later all the successive governments contributed to deteriorating the new currency, the complete dismantling of the old zloty system took the politicians as many as 40 years. Today’s zloty has been in the market for only 20 years, so, at least theoretically, there is still time to stop the excessive money supply.
Second, the gold price will stop rising or it will even visibly decrease when the zloty strengthens permanently.
What is then responsible for strengthening the zloty? First of all, this will be investors’ belief that it will stop deteriorating. This perverse answer shows what the fiduciary money really is. It is only an issuer’s promise that in the future they will be able to exchange an investor’s money for another good, as much valuable, for example for another currency or raw material, and gold and silver belong to this category. In this sense, today’s currency is based on trust and belief in the promise of an issuer of a security. Yet if money is issued by central banks more or less dependent on their state governments, it is worth asking a basic question.
Does any sane person believe politicians?
Global investors have believed so far because they have taken a strange, by the way, assumption that such a big entity as a state will always be solvent. This naive belief made many financial institutions invest their capital in the bonds of the majority of western countries. Yet if paper currencies are only a promise of value, then what are the bonds denominated in these currencies? Bonds are nothing else than promises that in the future an investor will get… more promises – literally. It’s not a joke. That’s how the world financial system is built today.
The principle of the fiduciary currency is deceptively similar to the mechanism of valuation of publicly traded companies’ shares. The only difference consists in the fact that shares give the right to vote and notes don’t. And if we sometimes talk about the stock exchange in reference to a casino, then what are today the auctions of national states’ debts?
Does it mean that we shouldn’t trust ourselves and it’s necessary to come back to the gold standard? Not exactly. Long ago the free market found a way to deal with those who promise pie in the sky. The bankruptcy of an indebted entity is a simple remedy for a financial fraud. However, a bankruptcy is equally burdensome for both a creditor and a debtor. The first must accept the loss of the invested capital, and the latter will have a big problem from now on: how to rebuild the credibility which they destroyed so recklessly. Nevertheless, a bankruptcy and possible restructuring of indebtedness are the only effective and fair way of dealing with the lack of trust.
It is because a hyperinflation caused by the excessive money supply in the market and depriving the people of all their possessions is the alternative. In result, the state will be in dead end and it will have to turn into another entity. This scenario took place in Poland at the turn of the nineties, when the PRL collapsed under the burden of bad economic decisions, and a new entity, the Third Republic of Poland was created at its ruins.
Maybe it’s a pity that the zloty didn’t receive a statutory requirement that a part of the state’s reserves (e.g. 5-10%) should be kept in gold. This would ensure better stability of zloty in the event of a default of a foreign-state owing money to Polish government. Today’s gold reserves, estimated at 105 tons, have the market value of about PLN 14 billion, which is 4.7% of the NBP reserves[v]. Is it enough to ensure the stability of the zloty? It is definitely worth giving our attention to this issue to make sure that the Polish citizens’ savings are safe.
Especially because the official money supply measured as cash outside bank cashier’s offices accounted for 288% in the period between 30 Dec 1996 and 31 November 2010, and measured with the M1 aggregate, it accounted for as much as 532%[vi]. The inflation measured with the increase of the gold price in the analogical period amounted to 306%[vii]. On the other hand, the inflation measured with the CPI calculated by the Central Statistical Office amounted only to 89.5%[viii]. It is worth considering that according to the government data, the prices grew only by 90% within 14 years. This would mean that either we have twice as many citizens as there were at the beginning of the transformation or an average citizen is more than three times richer than 14 years ago and they keep the additional cash under their mattress. Everyone can judge themselves what it really looks like.
Today in Poland, there is no centrally controlled economy and the only one legitimate governing party. Yet all over Europe, the cancer of inefficient socialist pension systems is developing. The problem of uncovered public debts arises every now and then reflected in increasing interest rates, rising insurance costs for fx swaps or when all other pricing mechanism fail – rising gold prices.
Today Poland is much more integrated with external markets than in the second half of the 20th century. For example, the high inflation and later the US crisis at the turn of the seventies and eighties came to Poland only after 10 years. The crises of 2001 and 2007 got here only 1-2 years later. We wanted to be part of the global financial markets, so we have to consider higher requirements of these markets.
It is impossible to predict the exact date of the next crisis, yet it is highly probable that its main reason will be the excessive indebtedness and the increasing imbalance in public finances of the developed countries. At present the United States is the greatest debtor and China is the greatest creditor. Thus solving the issue of debts between those two major partners is significant for the stability of the whole financial system. It should be borne in mind that today’s gold price reflects the scale of the current lack of the global investors’ trust in politicians’ steps, both American and European ones. If this trust doesn’t come back, the only way to overcome the situation will be the further additional printing of currencies in the world, including the zloty. In such an environment, the nominal price of gold may grow tenfold again within a short period of time. This is a catastrophic scenario and we should hope that it won’t come true. Yet even the growth rate of prices below the hyperinflation threshold of 50% is extremely devastating for the economy. Thus the reason suggests that we count on the best, but be prepared for the worst.
In the end I will only repeat what is worth remembering through the whole life and teaching your children and grandchildren. The gold, generally, neither loses nor gains in value. It is the currency we pay with for gold and keep in our wallets and accounts that loses or gains in purchasing power. Thus the noble metals are always the most expensive at the last stage of the fiduciary currency collapse. It is exactly because the paper currency aims at its original value, that is zero. Thus inflation is not a positive power as some people try to present it – it as an ordinary tax, which quietly, but consistently takes this purchasing power from us.
The responsibility for the level of this tax is held directly and exclusively by those who have, at present, the opportunity to create the currency – in today’s world they are commercial banks and central banks, which are under a stronger or weaker influence of politicians. It is them that we should require a responsible management from, and if necessary, we should assess the effects of their acts and omissions.
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The opinions expressed in the article are only subjective views of the author and they shouldn’t be the basis for choosing any form of investment, saving, planned parenthood, favourite colour, or lucky number.
As his hobby, the author used to run a shop with noble metals and invested in the market of noble metals.