Exploding Prices:

Giving Perspective to Risks of

Hyperinflation in the US

February 2011

By: Andrew Bell

Summary

Worries of hyperinflation in the US are overblown but risks of high inflation are quite real. These
conclusions are drawn after analysing data on past instances of hyperinflation, the expansionary
monetary of the US Federal Reserve Board over the past 3 years (popularly termed “Quantitative
Easing”), and data on the compensation rates for low skilled labour around the world.

The worst case scenario currently possible, but not plausible, sees all economic variables pulling at
near to their highest conceivable inflationary value and resulting in an inflation rate that closes on
the lowest instance of hyperinflation; where price levels in Serbia increased 8 fold over the course of
11 months in the 1990s.

The worst case scenario that is plausible sees most economic variables adding to inflationary
pressures resulting in high inflation (prices near to doubling in some instances) that leads to
decreases in living standards for many US citizens. The decreases in living standards then spur social
unrest and possible social contract defaults.
Introduction

After finding the collected data about periods of hyperinflation in the past century it seemed timely
to release the data in order to better understand the risks of inflation in the current day US economy.
The data contained in Figure 1 has been taken from page 381 of the 2002 textbook written by Caves,
Frankel, and Jones titled “World Trade and Payments: An Introduction”, Ninth Edition.

Fig. 1 Cases of Hyperinflation in the 20th Century

Start End Elapsed Time P final / P E final / E

Country
Date Date (months) initial initial
Austria Oct-21 Sep-22 12 93 29
Germany Jul-22 Dec-23 18 1.79 x 1010 1.41 x 1010
Poland Jan-23 Jan-24 14 699 491
Hungary Mar-23 Feb-24 12 44 12
Hungary Aug-45 Jul-46 12 3.81 x 1027 3.04 x 1027
Nat. China Sep-45 May-49 45 1.05 x 1011 1.19 x 1011
Bolivia Apr-84 Sep-85 18 974 2129
Peru Sep-88 Aug-90 24 7,242 11,600
Argentina Apr-89 Mar-90 12 204 294
Brazil Nov-89 Mar-90 5 12 8
Ukraine Apr-91 Dec-93 33 4,772 799
Belarus Apr-91 Feb-92 11 8 6
The Congo Oct-91 Sep-94 36 237,499 284,519
Tajikistan Jan-92 Dec-93 24 1,088 743
Serbia Feb-92 Jan-94 24 3.66 x 1022 8.3 x 1020
Armenia Sep-93 May-94 9 139 99

Observations

A striking observation is that the changes in price levels (P final / P initial), also known as inflation,
have a huge amount of variation. This shows that on a case by case basis the instances of
hyperinflation are quite different. Additionally, as noted by the text, the changes in the exchange
rate (E final / E initial) of countries experiencing hyperinflation are essentially the same order of
magnitude as the changes in price levels. This suggests that both the exchange rate and the inflation
are closely linked.

It is also important to note that the case of German hyperinflation, often used to stir emotions in
debates about the US economy, is an outlier in the data set. Inflation of the magnitude experienced
by Germany in the 20s, Hungary and China in the 40s, and Serbia in the 90s is uncommon and much
higher than the other cases recorded in the data set.

To give additional perspective, if the inflation is thought of as volumes of beer then: current US
inflation is running between 2 and 5 shots of beer (about ¼ pint); the Serbian instance of
hyperinflation, the lowest on the chart, equates to 43 pints of beer; yet the German case would be
equivalent to 10.6 million kegs of beer. So current inflation might get an 8 year old drunk, ‘90s
Serbian inflation would be trouble for a group of 4-8 university students, and 1930s German inflation
could keep a raging party going for about 723 years without stop (that’s 40 kegs a day, a number I
associate with a once a year party for 1200 – 1400 people). This explains why the German case had
such a terrible hangover.1

Monetary Policy

A significant driver of concern for inflation is the monetary policy of the US over the past three years.
This expansionary policy, termed quantitative easing (QE), has been enacted in two major policy
decisions since the crisis. The first instance of expansionary monetary policy (QE1) after the crash of
September 2008 saw the US Federal Reserve expand their balance sheet by 1.32 tn US$, an increase
of 145% between September and December 20082, 3. The second round of expansionary monetary
policy (QE2) was announced in the fall of 2010 to be estimated at 0.6 tn US$ over the course of about
8 months.

In order to frame these values with some amount of perspective the money supply of the US was
compared to the instances of monetary expansion4. In September 2008 US M1 was $1.461 tn $US and
M2 was $7.89 tn $US. This means that QE1 represented a 90.3% increase in M1 and a 16.7% increase in
M2 (using September 2008 M1 / M2 values). The proportionately smaller QE2 represents a 33.8%
increase in M1 and a 6.89% increase in M2 (using September 2010 M1 / M2 values).

Turning once again to the “World Trade and Payments” text, the variety of models for inflationary
outcomes of expansionary monetary policy suggest that the most extreme case of expected
inflation is the result of using the frictionless neoclassical supply relationship5. This model contains
no consideration for frictions in any markets. This means that prices, wages, capital flows, and other
macroeconomic variables adjust to shocks such as monetary policy immediately. It was used
because it represents an extreme forecast of monetary policy effects, giving the ability to provide an
“at most” scenario. The model states that increases in money supply are translated directly to
increases in the price level; inflation. Thus the QE1 policy adopted by the US Federal Reserve would
be expected to translate to an inflation rate of 90.3% at the very most. Equally, the QE2 policy of the
Fed would be expected to raise inflation to 33.8% in the very worst modeled outcome.

Returning to the chart in Figure 1 it is clear that even the worst cases of predicted inflation associated
with the expansionary policy of the Federal Reserve over the past 3 years are significantly below the
lowest case of hyperinflation in the past century. This offers an amount of comfort in that there is
still significant inflationary breathing room in the US economy before the term “hyperinflation” can
justly be applied. This is not to say that inflation shouldn’t be a concern, a 90% inflation rate can
become troubling if there is a change in any of the many economic multipliers that exist.

Price Levels

Another set of metrics with which to measure inflationary pressures are global price imbalances. As
global production, distribution, and sales have become increasingly open, the economic theory
Purchasing Power Parity (PPP) suggests that price levels will trend toward an equilibrium point over
time. This trend has been observed in many of the goods markets around the world. The
convergence is especially evident in markets for global commodities and transportation. Fixing
vessels and buying metals is priced with little variation across locations.
Yet there is still one area where significant imbalances continue to exist, the market for labour. The
unskilled labour market offers the best example of how these imbalances materialize. The minimum
wage in countries containing 3.7 billion people, about 60% of the world’s population, was analysed to
gain an understanding of the nominal compensation for the world’s lowest skilled labour. This data
was chosen in order to glean how much adjustment would be required to bring labour compensation
rates around the world closer to an equilibrium value.6

Two watershed wages were chosen as illustrative benchmarks, $2 and $20 USD per day, such that
both values are one order of magnitude apart. The results of parsing the data in this manner include
the observation that 30 countries, with a total population of 808 million people, were found to have
minimum wages above $20 USD per day. The average wage in this group was found to be $75.59
USD per day. On the other extreme there were 32 countries, with a population of 933 million people,
where the minimum wage was less than $2 USD per day. For these 32 countries the average
minimum compensation was found to be $1.24 USD per day.

The countries where minimum wages were found to be between $2 and $20 USD per day accounted
for 2 billion people across 80 countries. In these countries the average minimum wage was
calculated to be $7.39 USD per day.

The wage data above is related to inflationary pressures because inflation is one of the mechanisms
by which prices adjust across national boundaries. More specifically, in the US, where the minimum
wage is $58 USD per day, there is room for an order of magnitude change in compensation rates
which would place the minimum wage in the band containing the majority of the population of the
studied data set. The adjustment process is bound to contain shifts in a number of economic
variables such as exchange rates, price levels, shifts in the standard of living, and others. For the
purposes of this paper the goal is to consider inflationary potential which can be done by assuming
all of the adjustment process is worked out through inflation. In this case inflation of an order of
magnitude falls in the realm of possibility, an extreme possibility but still a possibility.

Thus, from the perspective of global imbalances in the labour market, an inflationary period that saw
prices in the US rise by a factor of 10 should be considered a tail end maximum with extremely low
probabilities of actually happening. This is useful as developing an upper bound for inflation
targeting while also showing what type of economic adjustment would be required for the resulting
inflation to occur.

Conclusion

Because of the different stories being told by these analyses it seems likely that the middle road will
be the one traveled by the global economy. Labour compensation rates put downward pressure on
the US dollar (upward pressure on prices) while commodities and goods markets hold prices and
exchange rates to their current level. Expansionary monetary policy adds additional upward
pressure on prices in the US.

None of the factors examined in the course of writing this paper suggest that extreme
hyperinflation, of the magnitude seen in 1930s Germany or any of the other 4 instances of extreme
hyperinflation, are at all likely to materialize in the current day US economy. Similarly hyperinflation
at the lowest levels appears to be an extreme case for the US economy to follow. To reach the levels
of inflation recorded in the lowest recorded case of hyperinflation, in Serbia over 11 months in the
1990s, a near perfect combination of economic variables would need to be achieved. In this scenario
there would have to be almost nothing pulling price levels down and all variables adding to inflation
would need to be quite close to their maximum foreseeable levels. This is especially unlikely with the
advancements in central banking knowledge.

This analysis is not one that suggests inflation will not be a problem in the future, only that it is
unlikely to become a crippling problem given the current state of the US economy. Inflation that
does not merit the title of “hyperinflation” can still have devastating effects on the economy.
Increases in the price of staples of the American economy, such as food, oil, and steel, do not have to
be much higher than a doubling for major cracks to be exposed. The repercussions of maximized
efficiency in industry are that such calculations are only able to maximize at current price levels.
Significant deviations in the price of inputs to an extremely streamlined process can invalidate the
profitability of the whole operation.

The area of highest risk identified by this analysis is that high, not hyper, inflation materializes in the
US which causes significant decreases in living standards to a large segment of society. In the
correct socio-economic setting these decreases in living standards could be enough to motivate
large instances of social unrest. One such setting that is likely to occur is, to borrow a term from
Meredith Whitney, many instances of social contract defaults. These instances have already begun
as states and municipal governments are balking on the services they had previously agreed to
provide.

Data and calculations are available in Microsoft Excel format upon request.
NOTES
1 – Inflationary Brews

For the purposes of the above example a 1% increase in price levels is assigned the volume of 1 shot,
or 29.5 mL. For other calculations a pint has a volume of 473 mL, and a keg has a capacity of 50 L.

Estimates for current levels of inflation are 2% and 5% per annum.

Monetary Expansion

2 - “Quantitative Easing Has Begun”

http://blogs.reuters.com/great-debate/2008/11/14/quantitative-easing-has-begun/

3 - “Quantitative Easing Explained”

http://www.ft.com/cms/s/0/69e8c92c-e758-11df-880d-00144feab49a.html#axzz1EL2DLOA5

4 – M1 and M2 Data
http://www.federalreserve.gov/releases/h6/hist/h6hist1.txt

5 – Frictionless Neoclassical Supply Relationship

“World Trade and Payments”, page 555.

“In the frictionless neoclassical model, any increase in aggregate demand goes entirely into prices
and wages rather than output or employment. A 10 percent monetary expansion, for example,
simply raises W [wages] and P [prices] by 10 percent,” page 555.

6 – Minimum Wage Comparisons

Due to the nature of the calculations and comparisons data precision needs are low. A big picture or
approximation is all that is required to demonstrate that significant variation exists in the nominal
global minimum for labour compensation. For this reason data sources were chosen for speed of
calculation and analysis over accuracy.

Minimum wage data was collected from WikiPedia

http://en.wikipedia.org/wiki/List_of_minimum_wages_by_country

Currency exchange rates were collected from the Financial Times

http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=WORL-230211

Population data was collected from the World Bank

http://data.worldbank.org/indicator/SP.POP.TOTL