Imagine having to cart around suitcases full of cash just to buy a simple item, such as a loaf of bread, and then, one month later, being asked to pay double.
Hyperinflation, defined as the cost of goods and services rising more than 50% per month, isn’t just something you read about in a novel. Populations throughout the world have experienced it. In 2016 for example, Venezuelans endured an inflation rate of 219% a month, with prices doubling every 18 days.
What causes hyperinflation?
Hyperinflation occurs when there’s too much money chasing too few goods and services. The basic requisite is for demand, to considerably exceed supply. You only need to imagine what would happen to fuel prices if there was only enough petrol for half the population.
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A number of events can lead to this scenario. Triggers may include war or natural disasters wiping out essential materials and the facilities used to produce them, or limited competition – if a small handful of companies control total supply, they can capitalise by charging whatever they like for highly desirable products.
Another perhaps more common culprit is when central banks, institutions that manage the currency and economic policy of a country, decide to increase the amount of money in circulation. During a recession, these banks make it cheaper to borrow and encourage people to spend rather than save. This is achieved by lowering interest rates, buying government bonds, and loosening rules on how much cash lenders must hold in their vaults.
Easier access to money should encourage everyone to spend again, creating jobs and giving the economy a much-needed boost. However, there’s also the risk that such measures spiral out of control, leading to empty shelves and companies, unable to refill them quickly enough, selling only to those who can afford to pay extra.
What happens when there’s hyperinflation?
The outcome of hyperinflation isn’t pretty. When prices continue to rise, people tend to hoard, simply to avoid paying more tomorrow. This type of behaviour fuels even greater shortages, and excessive demand from those left empty-handed, paving the way for prices to keep climbing.
Once this vicious cycle takes hold it’s hard to control. Eventually, any savings we have stored away in cash become worthless as even the basics become unaffordable. In the worst case, companies will be forced to shut up shop, triggering mass unemployment, diminishing government tax revenues, and the collapse of the economy.
The worst hyperinflation case on record occurred in Hungary. After World War II, most of the country’s industry had been destroyed and basic goods including food were in short supply.
Hungary’s government responded by printing huge amounts of money, an ill-advised policy that led prices to double every 15 hours, the value of wages to collapse and the population becoming even poorer. In the end, it took radical measures, the introduction of a completely new currency and several decades of patience to get the country back on track.
What does hyperinflation mean for personal finances?
Readers in the UK shouldn’t worry too much about what they’ve read so far. The extreme examples described above are rare and were generally caused by a combination of wars and seriously inept political decisions, the likes of which would struggle to get through the British parliamentary system.
But that’s not to say we’ll never experience a degree of high inflation in our lifetime. While it might not lead to us starving to death, it still poses a series of challenges that are worth addressing, including:
- Where to park your savings: If the Bank of England’s base rate is lower than inflation, any cash you have tucked away in a savings account will lose value. To match the cost of living, you may need to invest this money elsewhere, preferably in unaffected companies, property, foreign currencies, and maybe even gold.
- Increased cost of borrowing: When inflation is high, governments will aim to encourage people to spend less, usually by making it more expensive to borrow. Think carefully about whether these measures are likely to succeed. If they do, fixed loans are best avoided. And if they don’t, you might be better off locking into today’s superior rate, particularly when it comes to mortgages – the value of homes should rise in inflationary environments.
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than you originally paid in.
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