Hardly a day passes without news stories about the dire economic (and political) situation in Venezuela. One of the most damaging economic problems any country endures is hyperinflation, which is usually defined as a monthly inflation rate exceeding 50%. Venezuela is currently the only country in the world experiencing hyperinflation, although its current annual inflation rate of about 121,000% is actually modest by hyperinflation standards (the 23rd most severe in history). This high rate combined with its 28-month duration (the 5th longest in history) has been devastating for the people of Venezuela.
The worst hyperinflation episode in history occurred in post-World War II Hungary. In July 1946, Hungary’s monthly inflation rate is estimated to have been 41,900,000,000,000,000%. If we add another 13 zeroes to this monthly rate, we get an estimate of the total hyperinflation that Hungary experienced between August 1945 and July 1946.
It’s hard to imagine the ruinous impact of such inflationary episodes. In The Writer and the World, British essayist and travel writer V.S. Naipaul provided one of the more poignant descriptions of the curse of hyperinflation. Writing about Argentina’s hyperinflation of the late 1980s, Naipaul wrote, “Another aspect of inflation is that you cease to worry about productivity … it is much more important to protect your working capital than to think about long-term things like technology and productivity … Your money is disintegrating. It’s like a cancer. You live day to day … You cease to plan, you’re just happy to make it to the weekend.”
What causes hyperinflation, and why have countries throughout history been ensnared in such turmoil? In 1970, economist Milton Friedman offered a clue to the underlying cause when he wrote that “inflation is always and everywhere a monetary phenomenon.” Friedman was referring to periods of significant and sustained inflation, not to short-term bouts of rising prices. In other words, he maintained that hyperinflations are sustained periods of high inflation caused by excessive monetary expansion.
Why would a nation’s monetary authority increase the money supply to such a great extent? The underlying source of the problem is often a country’s fiscal policy imbalance, where government spending far exceeds tax revenue. The United States has been running budget deficits for some years, but the U.S. Treasury has had no trouble financing these deficits by selling bonds to domestic and foreign investors. Economically weak economies, however, find that investors shy away from purchasing their bonds. This lack of demand for bonds at normal interest rates causes interest rates to rise to unreasonable levels. Lacking the ability to finance deficits by selling bonds (borrowing), countries such as Venezuela today and Zimbabwe in recent years have resorted to printing money to pay the bills. In fact, these countries printed so much money during these episodes that their currencies became worthless paper littering the streets. Becoming fiscally responsible is very challenging, but it’s a necessary step toward restoring a healthy economy by squelching the temptation to print money.