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Hyperinflations are caused by extremely rapid growth in the supply of "paper" money. They occur when
the monetary and fiscal authorities of a nation regularly issue large quantities of money to pay for a large
stream of government expenditures. In effect, inflation is a form of taxation where the government gains at the
expense of those who hold money whose value is declining. Hyperinflations are, therefore, very large taxation
schemes.
During the German hyperinflation the number of German marks in circulation increased by a factor of
7,32 × 109. In Hungary, the comparable increase in the money supply was 1,01 × 1025. These numbers are
smaller than those given earlier for the growth in prices. In hyperinflations prices typically grow more rapidly
than the money stock because people attempt to lower the amount of purchasing power that they keep in the
form of money. They attempt to avoid the inflation tax by holding more of their wealth in the form of physical
commodities. As they buy these commodities, prices rise higher and inflation accelerates.
Hyperinflations tend to be self-perpetuating. Suppose a government is committed to financing its expendi-
tures by issuing money and begins by raising the money stock by 10 per cent per month. Soon the rate of infla-
tion will increase, say, to 10 per cent per month. The government will observe that it can no longer buy as much
with the money it is issuing and is likely to respond by raising money growth even further. The hyperinflation
cycle has begun. During the hyperinflation there will be a continuing tug-of-war between the public and the
government. The public is trying to spend the money it receives quickly in order to avoid the inflation tax; the
government responds to higher inflation with even higher rates of money issue.
How do hyperinflations end? The standard answer is that governments have to make a credible commit-
ment to halting the rapid growth in the stock of money. Proponents of this view consider the end of the German
hyperinflation to be a case in point. In late 1923, Germany undertook a monetary reform creating a new unit of
currency called the rentenmark. The German government promised that the new currency could be converted
on demand into a bond having a certain value in gold. Proponents of the standard answer argue that the guaran-
tee of convertibility is properly viewed as a promise to cease the rapid issue of money.
An alternative view held by some economists is that not just monetary reform, but also fiscal reform, is
needed to end a hyperinflation. According to this view a successful reform entails two believable commitments
on the part of government. The first is a commitment to halt the rapid growth of paper money. The second is a
commitment to bring the government's budget into balance. This second commitment is necessary for a suc-
cessful reform because it removes, or at least lessens, the incentive for the government to resort to inflationary
taxation. Thomas Sargent, a proponent of this second view, argues that the German reform of 1923 was suc-
cessful because it created an independent central bank that could refuse to monetize the government deficit and
because it included provisions for higher taxes and lower government expenditures.
What effects do hyperinflations have? One effect with serious consequences is the reallocation of wealth.
Hyperinflations transfer wealth from the general public, which holds money, to the government, which issues
money. Hyperinflations also cause borrowers to gain at the expense of lenders when loan contracts are signed
prior to the worst inflation. Businesses that hold stores of raw materials and commodities gain at the expense of
the general public. In Germany, renters gained at the expense of property owners because rent ceilings did not
keep pace with the general level of prices. Costantino Bresciani-Turroni has argued that the hyperinflation de-
stroyed the wealth of the stable classes in Germany and made it easier for the National Socialists (Nazis) to gain
power.
Hyperinflation reduces an economy's efficiency by driving agents away from monetary transactions and
toward barter. In a normal economy great efficiency is gained by using money in exchange. During hyperinfla-
tions people prefer to be paid in commodities in order to avoid the inflation tax. If they are paid in money, they
spend that money as quickly as possible. In Germany workers were paid twice per day and would shop at mid-
day to avoid further depreciation of their earnings. Hyperinflation is a wasteful game of "hot potato" where in-
dividuals use up valuable resources trying to avoid holding on to paper money.
The recent examples of very high inflation have mostly occurred in Latin America. Argentina, Bolivia,
Brazil, Chile, Peru, and Uruguay together experienced an average annual inflation rate of 121 per cent between
1970 and 1987. One true hyperinflation occurred during this period. In Bolivia prices increased by 12,000 per
cent in 1985. In Peru in 1988, a near hyperinflation occurred as prices rose by about 2,000 per cent for the year,
or by 30 per cent per month.
The Latin American countries with high inflation also experienced a phenomenon called "dollarization".
Dollarization is the use of U.S. dollars by Latin Americans in place of their domestic currency. As inflation
rises, people come to believe that their own currency is not a good way to store value and they attempt to ex-
change their domestic money for dollars. In 1973, 90 per cent of time deposits in Bolivia were denominated in
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