This view is based largely on Cagan’s 1956 paper, “The Monetary Dynamics of Hyperinflation” and/or Sargent and Wallace’s 1981 paper, “Some Unpleasant Monetarist Arithmetic.”
Monetarists argue that creating lots of money given a stable velocity and a stable output leads to rises in inflation. According to this quantity-theory-of-money-based view, the origins of any inflationary process are to be found in the irresponsible fiscal policies of governments.
Budget deficits lead to a rise in the supply of money (by central bank printing) and consequently result in higher prices.
Hyperinflation is argued to occur when the government prints too much money, causing rising prices. As prices rise, the velocity of circulation increases – no one wants to hold cash for very long if its value keeps falling. Time horizons shorten as workers demand wages at increasingly regular intervals (weekly, daily, hourly, etc.), and dash out to spend their cash as soon as they can.
This means that even though the money supply is growing as rapidly as the government can crank the handle of the printing press, it can never keep up with rising prices. As prices rise, velocity rises, and so forth. Against this backdrop, a government will run a deficit because tax revenue can’t keep up with its spending, so it prints money to make up the gap.
The solution to an inflationary process from this perspective is to follow a path of austerity (reduce spending and/or raise revenues). This viewpoint clearly assumes that the money supply is exogenous and controlled by the central bank.
If you believe this line of argument, it is easy to see why you might well be worried about the deficits being run by countries such as the UK, the US, and Japan. Indeed, several investment banks have issued “hyperinflation” warnings over recent years, and some investors seem to regard the arrival of hyperinflation as simply a matter of time given the massive expansion of the central banks’ balance sheets.
But to say that the printing of money by central banks to finance government deficits creates hyperinflations is far too simplistic (bordering on the simple-minded). Hyperinflation is not purely a monetary phenomenon.
To claim that is to miss the root causes that underlie these extraordinary periods. It takes something much worse than simply printing money. To create the situations that give rise to hyperinflations, history teaches us that a massive supply shock, often coupled with external debts denominated in a foreign currency, is required, and that social unrest and distributive
conflict help to transmit the shock more broadly.
On the basis of these preconditions, I would argue that those forecasting hyperinflation in nations such as the US, the UK, or Japan are suffering from hyperinflation hysteria.
If one were to worry about hyperinflation anywhere, I believe it would have to be with respect to the break-up of the eurozone. Such an event could create the preconditions for hyperinflation (an outcome often ignored by those discussing the costs of a break-up). Indeed, the past warns of this potential outcome: the collapse of the Austro-Hungarian Empire, Yugoslavia, and the Soviet Union all led to the emergence of hyperinflation!
This is an edited version of James Montier’s white paper: Hyperinflations, Hysteria, and False Memories
