Digix Writer · Follow
--
By Lucia Ziyuan*
With the rising interest in cryptocurrencies and alarming signs of dollar collapse, it’s about time we revisit history for signs of hyperinflation and potential ways to combat it.
Hyperinflation is when monetary devaluation happens so rapidly and out of control that inflation exceeds 50% per month or 100% over three years. Hyperinflation is a relatively recent phenomenon of the last century after fiat currency became widespread.
Unlike gold or silver, fiat currencies are paper money with no intrinsic value. Ever since the US dollar’s uncoupling with gold in 1971, the paper bill’s denominated value is no longer backed by a physical commodity. Instead, its value is determined by supply and demand, backed by our trust in the issuing authority’s ability to keep interest rate low.
The use of paper money is a necessary condition for hyperinflation to occur. In almost all documented cases of hyperinflation, it is caused by government’s attempt to finance budget deficit by over printing money.
Here let’s survey a few of the most prominent episodes of hyperinflation.
A brief history of hyperinflation
Episode 1–Hyperinflation in the postwar Weimar Republic
Weimar Republic — the name of the German government between 1919 and 1933 — saw one of the most catastrophic hyperinflations in history. During the postwar years, Weimar government ignored rising inflation and commissioned 130 printing companies to print more money to pay off war debt. Records show that price rose to a ridiculous level — one loaf of bread cost 250 marks in January 1923 compared to 200,000 million marks in November 1923. The German mark became worthless. People collected their wages in suitcases.
Children using bundles of german marks as building blocks in 1923. Image source
The inflation was worsened by workers’ strikes that lasted 8 months, causing even more economic panic and political turmoil. People lost their faith in the Republic, leading to rising popularity of the radical right wing. The government tried to regulate hyperinflation by demonetising the now worthless Pepiermark and introducing a new currency called Rentenmark, at the rate of 1 trillion papiermark for 1 rentenmark.
Episode 2–Hyperinflation in Venezuela since 2008
Venezuela is still coping with one of the worst hyperinflations since Weimar Republic. It’s reported that in 2016 the oil-dependent country had a negative growth rate of -8%, an inflation rate of 481% and an unemployment rate of 17%. According to Bloomberg’s cafe con leche index, the country’s annual inflation has reached an alarming rate of 4,067%: a cup of coffee that was 1,800 bolivars 12 months ago now costs 75,000 bolivars.
In the middle of this cash crisis, the Venezuelan government introduced new banknotes of bigger denominations–a typical government intervention in an attempt to curb inflation. Instead of alleviating the inflation, the new banknotes soon fell to the wayside as coins and bills only represent 8% of total liquidity in this country. The graph below reveals a change in Venezuelan diet due to skyrocketing food prices, and an average weight loss of 9kg for every 3 in 4 Venezuelans as a result.
Image source: Bruegel.org
For the crypto enthusiasts, there is a bright side to this sob story. The combination of economic crisis, supply of free electricity thanks to socialist subsidy, and lack of crypto regulation has led to a thriving bitcoin economy. Thousands have taken to mine bitcoin and many online exchanges have mushroomed. Venezuela became one of the first countries where bitcoin saw mainstream adoption.
Episode 3–Zimbabwe’s hyperinflation since 2008
The world watched the African country’s economy go up in flames as the bank printed $100 trillion notes back in 2008. In September 2008 the annual inflation rate hit 471 million percent, and quickly escalated to 89 sextillion in Nov 2008, setting a new record in history.
Currency instability in Zimbabwe started as early as the 1990s when president Robert Mugabe embarked on land reform and took back private farms to evict white landowners. The move led to a steep decline in food production for a decade with adverse effects on other sectors such as banking and manufacturing. To make matters worse the government started printing money to finance the war in Congo in 2000.
Zimbabwe annual inflation rate reached a peak of 89.7 sextillion (10²¹) percent. Image source
The hyperinflation got so out of hand that Zimbabwe had to stop printing money. In 2009 the country started using US dollars. The WSJ reported in 2011 that a Wall Street trader bought quintillions of Zimbabwe dollars–that’s thousands of trillions–for between $1 and $2 each. The Zimbabwean government even offered to swap old deposit accounts into US dollars at $5 for each Z$ 175 quadrillion (175,000,000,000,000,000) for $5.
One hundred trillion dollar note issued in 2008. Image source
As of today, the country is still plagued by inflation thanks to the new Zimbabwean dollar. Similar to Venezuela, demand for alternative currencies in Zimbabwe has soared. Ironically for skeptics of bitcoin, Zimbabweans are turning to the digital currency as a store of value. Bitcoin is traded on local exchange Golix at at $13,000 BTC/USD compared with a spot rate of $9,106.21 BTC/USD at the time of writing. Golix even wrote a help article on their website about why Bitcoin price is higher on African exchange, citing reasons including “Bitcoin is better than the money we’re using now”.
The appeal of cryptocurrencies
A brief walk down the history of hyperinflation is enough to warn us against the fragility of fiat currencies. Because fiat money is not backed by any physical reserves and has no intrinsic value, its value is dependent on our good faith and credit in the economy. When excess currencies are in circulation and we lose confidence in a piece of paper’s ability to retain value, money loses its value overnight.
Today, the U.S. dollar is the world’s reserve currency, and an increasing number of experts are raising concerns about the excess US dollar supply beyond domestic needs (see below US money supply graph). If there is an oversupply of world reserve currency, we could face inflation on a much larger scale with disastrous results.
Image source: tradingeconomics.com
The booming cryptocurrency scene symbolises an alternative to the paper money based, central bank regulated economy. Here is why cryptocurrencies can build a parallel economy that is immune to hyperinflation.
№1 — the supply of cryptocurrencies is transparent
There are two types of inflation:
- Monetary inflation: increase in money in circulation
- Price inflation: rise in price level
Over the long run, price inflation is caused by increase in money supply, and in the current system money supply is determined by a few elected officials at the central bank with fairly opaque processes and policies.
For example, the average folk on the street will have no idea that the Fed (Federal Reserve System) regulates money supply with fractional reserve banking. This means the banks and lenders only need to keep a fractional amount of money in their reserve — 0 to 10% — and banks are charging interests on 90% of the money that they do not own.
With cryptocurrencies, the general idea is that there is no centralised entity to govern the money. Money supply is not controlled by a few political elites. Rather, the rules governing the supply are built into the code. Because the protocol and process are fully transparent, any average citizen can monitor and view the creation of money in real time.
If the fiat money based economy is built on our trust in the central banks and their ability to make good decisions for us, the crypto economy eliminates the need for that trust.
№2 — the supply of cryptocurrency is finite
Most cryptocurrencies are designed to have set limits in supply. This attribute is often codified in the coin’s protocol, and no one will be able to change it unless a majority of people decide on a new consensus algorithm. That means no speculator or government official can intervene or manipulate the money supply in any way.
As an example, Bitcoin is technically deflationary because there will never be more than 21 million bitcoins. While other coins (litecoin, dogecoin, dash etc) have different supply algorithms, they all have fixed supply limit.
Over time we can expect to see annual inflation rate slowly decrease and stabilise as the supply of coins reach their limit. Below graph by Roman Korba is an attempt to forecast cryptocurrency inflation rates.
Here is another cryptocurrency supply and inflation rate projection:
In comparison, in the traditional Fiat based economy there is no hard limit to how much US dollar or Euro can exist at any point in time. The government can use a tool called “helicopter drop” to introduce a large amount of money to stimulate economy.
№3 — the supply of cryptocurrency is predictable
The mechanism of supply may differ by crypto, but one thing they share in common is that the amount of cryptos in supply is completely predictable.
This means that the producers of the economy will be able to project the real demand and supply of markets more accurately. History has repeatedly showed us how the central banks often fail to match growth of goods in exchange with the currency in circulation so that the price is “right”.
For example, bitcoin is minted into existence at fixed rates determined every four years. The predictability of how much cryptocurrency will be created at what rate gives both producers and consumers better visibility into the real market demand. Some economists even argue that goods and services will decrease in price but entrepreneurs will benefit from it as profit ratio will remain the same.
What does cryptocurrency mean for the average consumer
A few ways cryptocurrency can be leveraged for day to day lives for the average consumer:
- Lower cross-border remittance cost: During the Zimbabwean hyperinflation crisis, bitcoin became widely adopted for cross-border remittance.
- Peer to peer payment: For example, Venezuelan bitcoin users rose from a few hundred in 2014 to 85,000 in 2016. Because cryptocurrencies are immaterial and highly divisible, they are primed to be used for P2P payment.
- Preserving personal wealth: the Zimbabwean hyperinflation taught us a cautionary tale of personal wealth. Cryptocurrencies backed by physical reserve such as gold like DGX can offer a stable store of value over the long haul.
It will take a few more decades for a crypto economy to be sustainable on its own, but the potential is huge. And unlike the old times, anyone can take charge of their own crypto finances, instead of leaving it up to the folks at central banks to determine our money’s worth.
(*The views and opinions in this op-ed are solely those of the author. They do not necessarily reflect the official position of the company, Digix.)
