What happens when inflation gets out of control?
We talked about what inflation is and why it is a feature of the fiat-based currencies of the world here, but have you ever wondered what happens with it gets out of the hands of the central banks which are tasked with keeping things in check?
Briefly, inflation refers to the rise in prices of goods and services every year. When inflation goes out of bounds, that is called HYPERINFLATION. It refers to a scenario when the price rise is excessive and quick. We’ve had a few instances of this happening in Germany, Russia and Zimbabwe.
So what generally causes this problem?
Too much money printing
Central banks are tasked with “printing” money to stimulate the economy and they have to do this at scale when the economy is in need (like times of crisis, for example, the slowdown during pandemic lockdowns in 2020). Basically, the money supply in the economy is increased so that borrowing and spending increase.
But when the supply is increased too much with respect to the resultant economic output, there would be hyperinflation. A cycle is created if there is no economic growth: more money means more spending means higher prices means more need for spending means more requirement for cash means even more money printing.
Demand-Pull Inflation: This simply refers to the situation when demand in the economy exceeds supply. S > D means an increase in prices because consumers are competing for the same goods and services.
In cases of hyperinflation, even daily use items like food and drinks prices rise very quickly. The value of the domestic currency depreciates very quickly in terms of the foreign ones and this makes imports more and more expensive. As money continues to fall in value, consumers’ purchasing power also falls.
A very recent example of hyperinflation was in Zimbabwe in the 2000s. Zimbabwe was involved in a war in the Congo, and droughts lead to a shortage of food in the country. They also borrowed funds from the IMF for development in the country. They printed a lot of money to fund expenses, causing the price rises. In fact, in 2007, the country actually had a daily inflation rate of 98%, meaning prices virtually doubled every 24 hours.
While hyperinflation is generally only caused due to wars, disasters or extreme corruption, you should be prepared for it by having a diversified portfolio of assets. Commodities and land in particular would help because these tend to rise with inflation mostly due to the limited supply.
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