Hyperinflation is a term used to describe very rapid and uncontrolled increases in the general price level of an economy. Officially, inflation tips into hyperinflation when rates hit 50% per month, or 1000% per year.
A country experiencing a ‘mild’ episode of hyperinflation with monthly inflation running at 50% would see prices in its economy double in around seven weeks. When Weimar Germany saw a more serious episode of hyperinflation in 1923, the monthly inflation rate hit 29,500%, meaning prices doubled every 3.7 days.
With US Consumer Price Index (CPI) inflation running at almost a 13-year high, Twitter co-founder Jack Dorsey caused a sensation last week when he tweeted that “Hyperinflation is going to change everything. It’s happening”. Are we about to enter a new age of hyperinflation?
What causes hyperinflation?
A study by Steve Hanke, of John Hopkins University, documented all 62 known cases of hyperinflation and identified some common patterns behind all of the episodes.
They often occur under extreme conditions. “War, political mismanagement, and the transition from a command to market-based economy – to name a few”, Hanke explains.
These events all put pressure on government budgets, and governments try to plug the deficit by printing money.
The increase in money supply pushes up inflation, leading to demands for higher wages for public sector workers, which governments must pay. Problems are made worse by falling tax revenues. Taxes are often due many months after they accrue, and with prices increasing rapidly, their real value quickly tumbles.
The combination of lower tax revenues and higher public sector wage bills leaves governments with soaring deficits, which they try to plug again with another round of money printing. At this point, inflation starts to grow uncontrollably, and hyperinflation takes hold.
Deficits have grown over the past 18 months as governments tried to cushion their economies from the ravages of the pandemic. Could this be the start of a hyperinflationary spiral?
Ryan Dusek, Director in the Commodity Risk Advisory Group at Opportune LLP a global energy business advisory firm, argues that the economy is headed for pandemic-induced hyperinflation thanks to a combination of high crude oil prices and unprecedented government stimulus.
It is worth noting, however, that this is not a majority view. In a conversation with CNBC, Mohamed El-Erian, Adviser at Allianz and Gramercy argued that although inflation could become higher and more persistent, “we’re not anywhere near risk of hyperinflation”. Cathie Wood, founder of ARKinvest also argued that deflationary forces would overcome the supply chain-induced inflationary pressures currently “wreaking havoc”.
One of the best known periods of hyperinflation took place in Germany following the First World War. This was a time of significant economic difficulty: the country saw reparation payments, capital flight abroad and flagging foreign trade. Facing a growing budget deficit, the German government printed money to meet its expenses.
In early 1922, 160 German Marks were equivalent to one US dollar. By November 1923, the currency had depreciated to 4,2trn Marks to the dollar, and there are apocryphal stories of bank notes being worth so little, they were used as toilet paper instead.
Brazil experienced hyperinflation between December 1989 and March 1990, driven in part again by the government printing money to try and address soaring budget deficits. This period saw monthly inflation top 80%, with prices doubling every month.
Venezuela has been a more recent and prolonged victim of hyperinflation, with estimates suggesting monthly inflation rates of almost 200% in September 2021. Hyperinflation first took hold in 2016, brought about when prices of oil – the second largest source of government revenue – tumbled. The government began printing money to finance its operations and hyperinflation ensued.
Since then, Venezuela has only sporadically published inflation statistics, so alternative measures have sprung up. Bloomberg has created a ‘cafe con leche index’, which tracks the price of a white coffee served at a certain cafe in eastern Caracas, the Venezuelan capital. These figures suggest the price has jumped to 7.88 Bolivars from 0.52 Bolivars over the past twelve months, implying an annual inflation rate of 1,415%.
How do stocks react to hyperinflation?
Finding data on the stock market reaction to hyperinflation may prove challenging as there are only a handful of examples of hyperinflation from this millennium, and these countries often have poor data collection or limited stock market activity.
In the 1920s, the German stock market grew substantially during hyperinflation. According to the New York Times in 1921, the Berlin Bourse saw its principal shares end the year at “a substantial advance”.
It went on to say that this was ascribed to “the enormous inflation and great depreciation of the German paper currency during 1920”.
“The Frankfurter Zeitung calculates that the combined value of twenty-five stocks on the Boerse [Berlin Stock Exchange] was 5,424 in September 1919, rising to 7,792 at the beginning of January...and to 15,362 at the end of last December.”
Brazil’s period of hyperinflation also coincided with a rising stock market. The Bovespa increased until March 1990, even as monthly inflation rates hit 80%. The two biggest drops in the history of the index until that point happened shortly after, with the Bovespa falling by 21% on 20 March 1990 and a further 22% on 21 March. These drops took place during the first week of a new government administration, and coincided with news of a radical inflation stabilisation plan hitting the news.
Brazil hyperinflation and stock index
In theory, share prices can rise during a period of hyperinflation because where firms can pass higher prices onto consumers, they have a chance of maintaining profit margins and seeing share prices keep up with inflation.
But higher share prices do not necessarily mean higher real returns. Even if share prices are increasing during hyperinflation, they need to keep pace with very rapidly escalating inflation rates and firms need to maintain production during the shock of a hyperinflationary period - a big ask.
Inflation adjusted returns for the Bovespa suggest that annual returns were negative in 1989 to 1990 as hyperinflation took hold, even as share prices increased.
History also suggests that hyperinflation proves difficult for income investors, as dividend yields struggle to keep up with soaring prices. Research into the same period suggests that dividend yields plunged in Germany as hyperinflation took hold.
And this makes sense – with prices doubling every few days during Weimar hyperinflation, it would be almost impossible for quarterly, let alone annual dividends to keep pace.
How to prepare for hyperinflation
Economic theory suggests that savers would be hit hard by a period of hyperinflation. Governments typically raise interest rates to try to dampen inflationary pressure, but if hyperinflation truly takes hold and prices double every few weeks, the real value of savings would be quickly eroded nevertheless.
Bonds are also one of the worst assets to own during hyperinflation, with rising inflation rates eroding the real value of interest payments, as well as the amount investors receive on maturity. Hyperinflation also reduces the diversification benefits of bond holding.
In a briefing note seen by Capital.com, Dirk Hofschire, senior vice president of asset allocation research at Fidelity says that “stock-bond correlations tend to rise when inflation is higher. So bonds may provide less diversification benefits in that kind of environment”.
Best investments during hyperinflation
It is worth noting that hyperinflation is so rare that evidence on investing during hyperinflation is scarce. Investors can, however, think about how to protect their portfolios from high inflation.
A recently published research paper, The Best Strategies for Inflationary Times, found that energy-linked companies focussing on production of oil, gas and renewable energy have outperformed others during periods of high inflation in the US.
This is partly due to a cost correlation – currently, high energy prices are a significant driver of US inflation rates. This means that high energy prices boost both energy firm profits and overall inflation rates in the wider economy.
It is also worth noting that this study defines ‘high’ inflation as above 5% per year – this is significantly lower than the 1000% annual inflation rate that defines a hyperinflationary period.
During periods of high inflation, hedges like gold also become more popular. Could we see its popularity increasing as fears about inflation grow?
Collectibles may also become more popular as inflation rates soar. The research paper mentioned above found that real annual returns for art, wine and stamps were all positive during inflationary episodes. Although again, the paper studied periods of the inflation rate of above 5%, far lower than the threshold that would mark hyperinflation territory.
It is worth noting that when hyperinflation does take hold in economies, we can even see a return to barter economies, where exchange of goods replaces money. News reports from Venezuela have highlighted stories of workers getting paid in eggs and shops asking for barter over currency since money so rapidly lost its value.
Though the data available on real estate prices during hyperinflation are scarce, economic theory suggests that house prices could increase along with the general price level in the economy, although the shock of hyperinflation could certainly dampen housing market activity. Borrowers (especially those on fixed rate mortgages) would greatly benefit, seeing the value of their debts eroded in real terms as prices rise.
Economic theory suggests that savings and bonds lose out as runaway inflation erodes their value. Gold and other collectibles may become more popular, as may stocks in industries like energy that traditionally perform well under high inflation. It is worth noting that hyperinflation is so rare that evidence is scarce. Research into investing during high inflation also assumes much lower rates than we would see in a hyperinflationary period.
Savers and bond-holders suffer during hyperinflation as the real value of their assets is quickly eroded. Popular inflation hedges like gold, and even alternative investments like collectibles may perform well during periods of high inflation, but evidence on their performance during periods of hyperinflation is scarce.
Borrowers (especially with fixed-rate loans) benefit during hyperinflation as the real value of their debts is rapidly reduced.
Inflation hedges such as gold and collectibles may also become more popular, but evidence on their performance during periods of hyperinflation is scarce. Evidence from Germany and Brazil suggests that stock markets can grow during periods of hyperinflation, but that increasing real returns do not necessarily follow.