With Steve Hanke, Professor and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University
A recent article in The New York Times describes the state of hyperinflation in Venezuela, with numbers ranging from 26,000% to 52,000%. Steve Hanke tells us what those numbers really mean. Hanke is Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University. He is also a Senior Fellow and Director of the Troubled Currencies Project at the Cato Institute in Washington, D.C.
The standard definition of hyperinflation is when the inflation rate is 50% per month or more. This 50% threshold must be sustained for 30 consecutive days or more. Using this definition, Hanke developed the Hanke-Krus Hyperinflation Table of the 58 worst cases of historical hyperinflation.
Hungary tops the list, with its worst inflation in July 1946 when prices doubled every 15 hours, for a daily inflation rate of 207% and a monthly inflation rate of 4.19 x 1016%.
Causes Of Hyperinflation
Sadly, hyperinflation is always caused by a government spending more money than it collects from taxes, bonds, and profits from state-owned enterprises.
Historically, government revenue would dry up during wars or major socio-economic or political transitions. At such times, if the government directed its central bank to print more money, there’d be an explosion of money supply and prices would go through the roof.
In March 2007, Zimbabwe’s President Robert Mugabe had his central bank print money to give his bloated bureaucracy a pay raise. By November 2008, inflation was out of control, with prices doubling every 24.7 hours. This put Zimbabwe at #2 on the hyperinflation list, with a daily inflation rate of 98%.
Inflation finally ended when citizens refused to use Zimbabwean currency, which collapsed and gave way to the U.S. dollar.
Managing Currency Exchange Rates
As Steve notes, there are three ways to manage a currency. You can let it float, you can fix it, or you can tie it to the dollar or some other strong currency. Most countries end up having a fixed, official exchange rate, with all kinds of exchange controls. But on the black market, the currency always floats. And in hyperinflation, it sinks like a stone.
Hanke looks at purchasing power parity to accurately gauge how a currency fares against other major currencies. Once hyperinflation kicks in, people move away from the local currency and switch to a stable foreign currency such as the U.S. dollar.
Today, Venezuela is the only country with hyperinflation, which resulted from massive government subsidies at a time when its major source of revenue, the state-owned oil company, was running at a loss. Venezuela also fell victim to a global drop in oil prices and to its own poorly-maintained oil infrastructure.
In addition, the international bond market lacks confidence in President Maduro’s governance and has no appetite for Venezuelan bonds.
As a result, nine out of ten Venezuelans don’t earn enough to buy sufficient food. Store shelves are empty and goods are traded on the black market, using foreign currencies. Venezuelans have lost an average body weight of 24 pounds each. Malaria is on the rise, crime is on the rise, and 2.3 million Venezuelans have fled the country, including more than half of its doctors.
The Tanzi Effect
The Tanzi Effect also bites into government revenue. Here’s how it works: Citizens compute their taxes as of year-end but typically pay them three to four months later. In the interim, hyperinflation eats into the purchasing power of those tax collections. To make up for the shortfall, a government gets its central bank to print more money, which exacerbates inflation.
Hyperinflation In The U.S.?
Switching gears, Steve notes that the U.S. has high national debt, spends more than it earns and has a fiat paper currency.
Even so, Hanke isn’t concerned about hyperinflation. That’s because 90% of our money supply is produced by commercial banks, not the Federal Reserve. Additionally, the Dodd-Frank legislation of 2010 reined in risk-taking by banks. As a result, our money supply is growing rather slowly, at a 4.2% annual rate.
So Americans can rest easy because hyperinflation isn’t even remotely on the cards for us as things stand today.
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Steve Pomeranz: I recently read a New York Times article describing the state of hyperinflation in Venezuela. Numbers ranging from 26000% to 52000% were quoted. And I started realizing that these numbers were just too big for me to understand. Kind of like thinking about the distance between galaxies or the size of the universe.
So I asked Steve Hanke, Professor of Applied Economics and Co-Director of the Johns Hopkins Institute for Applied Economics Global Health and the Study of Business Enterprise to join me. Professor Hanke is also a Senior Fellow and Director of the Troubled Currencies Project at the Cato Institute in Washington. He is a well-known currency reformer and commodity trader. Professor Hanke, welcome to the show.
Steve Hanke: Great to be with you, Steve.
Steve Pomeranz: So let’s start at the very beginning. What is the definition of hyperinflation?
Steve Hanke: The standard definition now in convention is the inflation rate has to be 50% per month or greater, and I’ve added a little twist to that. Since I can measure it every day with high-frequency data, I’ve said that the 50% threshold has to be broken for 30 consecutive days. So if you’re 50% per month for 30 consecutive days, you’re in the league. And the league, it contains 58 countries in world history.
Steve Pomeranz: There’s a printed list here I’m looking at, countries like Hungary in 1945. The time required for prices to double in Hungary during that time was 15 hours. And it’s 4.19 times 10 to the 16th power percent for the monthly inflation rate. I want to get in to the implications of living under that type of phenomenon but this is something that changes a lot. I mean, we always hear for this to be hyperinflation it has to last for 30 days. So maybe currencies may hit these high numbers, but they move away from them. What are some of the causes of this type of hyperinflation?
Steve Hanke: The cause is always the same and that is the government is spending money and they don’t have sources to finance that spending. The normal sources would be taxes or revenues from bonds that they issue, or if they have state-owned enterprises that generate profits would be a source of revenue too. If all of those dry up for one reason or another.
Let’s say you’re in the middle of a war, or you’ve just gone through a transition going out of communism into a free economy, but the problem is you don’t have any tax sources because under the Communist system, in Russia anyway, there weren’t taxes. So if you don’t have sources to finance the government, the government goes to the central bank and they essentially tell them to turn on the printing presses and extend credit to the government. When they do that the money supply starts exploding and it’s then that you actually observe prices going through the roof.
Steve Pomeranz: In 2007 or thereabouts, Zimbabwe went through a period of hyperinflation. Robert Mugabe printed money to pay the bloated bureaucracy, as I read, and also to line his own pockets, and I love this. By that time Mugabe declared inflation illegal in 2007, so what was going on there?
Steve Hanke: Well, it was the same thing. Government spending a lot of money, revenue sources all drying up, so they go to the central bank and in that case, Mugabe about 80% of the budget is to pay civil servants, and he wanted to give them a pay raise on top of everything else. So, you go to the central bank, and they turn on the printing press, and away you go. And Zimbabwe, actually in November of 2008 had the second highest behind Hungary in hyperinflation in world history, prices were doubling every 24.7 hours. So the daily inflation rate was 98%, almost 100% a day you see.
So what happened, it stopped when finally people just got fed up with paying a bus fare with a wheelbarrow full of Zimbabwe dollars, and they just went on strike. I mean, they said, we’re striking, we’re not going to use this currency anymore and that country spontaneously dollarized. And that was the end of the Zimbabwe dollar on the street; it took until early in 2009. Then the government finally threw in the towel and said, yes, we’re officially dollarized. We’re going to be keeping our budget in dollar terms.
Steve Pomeranz: Yeah, so you’re talking about this idea. So there’s three ways to manage a currency. You can let it float, you can fix it, or you can tie it to the dollar or some other strong currency. So Zimbabwe I guess had a floating currency.
Steve Hanke: Well, most of these countries end up having an official fixed exchange rate, and they have all kinds of exchange controls and everything surrounding the fixed exchange rate. But on the black market, the currency always flows, it’s a free market, and it floats. And of course, in these hyperinflation cases, it sinks like a stone. And when it sinks, that is something that I look at to measure the hyperinflation because I look at the changes in the free market or black-market exchange rate. And through something called purchasing power parody theory, I can transform those changes in the exchange rate into an implied inflation rate.
Steve Pomeranz: Yeah.
Steve Hanke: That’s why I can measure very accurately these hyperinflations. Literally, I can do it on an hourly basis, I just do it once a day.
Steve Pomeranz: I wanted to ask you about that. This purchasing power parody is this like the cost of a Big Mac from one country to another? Is that the kind of thing you’re talking about?
Steve Hanke: Yes, it is. If you look at the Economist Magazine Big Mac index that you were alluding to, that’s based on purchasing power parity theory. And the reason that it works so well on these hyperinflations is that once the inflation really gets revved up and you’re going over 50% per month, you’re in a situation where everyone is thinking in terms of not the local currency but in terms of some foreign anchor currency like the US dollar.
Steve Pomeranz: Yeah.
Steve Hanke: For example, that’s what happened in Zimbabwe. Now we have the only hyperinflation existing in the world today is in Venezuela. And it spontaneously dollarized the country and everyone, the unit of account, the unit to measure anything in, the yardstick, so to speak is the US dollar. So everyone in their head is thinking in terms of US dollar and, even if they quote you a price in bolívars, what they do, they know what the dollar value of the bag of sugar is. And they look at the exchange rate on the black market and translate it very quickly on a calculator and tell you well this is if you want to pay in bolivars, this is the price. But in fact, everything really is basically priced in dollars.
Steve Pomeranz: Which is ironic because I think that’s the last thing the government wanted. They wanted to set up a different form of government. More socialist type of government, get away from capitalism, and the dollar and the US were kind of the perceived enemies, so to speak. And yet, it’s come back to the fact that things have deteriorated to such a level, that now, as I said, ironically, the dollar is more important. What is actually, what was the course leading up to this hyperinflation in Venezuela?
Steve Hanke: Well, you put your finger on it. A little bit of it is the social regime that they have, actually with Chavez, and then now Maduro who now is the president of Venezuela. They have a huge number of subsidies and government giveaways of all types, and they spend a lot of money. But the revenue sources started drying up because the state-owned oil company, which was a big generator of revenue, actually started generating negative cash flows.
The oil price went down that was one big aspect but the facilities are in just disrepair at the state-owned oil company that they can’t produce very much oil so the oil production is now back at 1947 levels. The oil productions collapsed. The prices are relatively weak for oil. So the revenue source from this state and oil company is completely dried up. Then in addition to that, the international bond market dried up. And they couldn’t issue any more bonds internationally.
Steve Pomeranz: Yeah.
Steve Hanke: And locally the banks wouldn’t buy any more government bonds, so that’s dried up. And then you have taxes, but the problem is once the inflation gets going, it’s something called a Tanzi effect. And the Tanzi effect is as follows. Let’s say you get your tax bill in January, and you have until July to pay the bill, just hypothetically, well, imagine the amount the government’s getting in real terms if it’s where there’s a way, melts away from January until July when you’re actually paying the thing.
Steve Pomeranz: Yes.
Steve Hanke: So the government has no revenue and like a good socialist government, they want to spend a lot of money, so they just go to central bank and tell them to print.
Steve Pomeranz: I see. Well, the US went through a period of inflation, definitely not hyper-inflation. But I remember in the early 80s, inflation was something around 10% and people were hoarding. People were buying sooner rather than later. And anticipating higher costs, higher prices in the weeks and months to come. I’m trying to imagine what life would be like multiplying that by thousands and thousands of percent to see what life is like.
I read an article that said nine out of ten Venezuelans don’t earn enough money to buy sufficient food and Venezuelans have lost an average of 24 pounds each. Malaria’s on the rise, as is crime and people are getting out. Those that can are getting out. 2.3 million Venezuelans have fled the country, including more than half of the nation’s doctors. Inflation rate in the last 12 months as of this writing was 52,000%. Who gets more hurt under these conditions in a country like that? Is it the rich or the middle class?
Steve Hanke: Well, it’s the middle class and the poor that get clobbered. Anyone with real money in Venezuela, they don’t have it in Venezuela, it’s all in Miami.
Steve Pomeranz: Yeah.
Steve Hanke: Or Panama, or the Caymans, or someplace like that. And they also, if they have wealth, they have that wealth, if any of it is in Venezuela, it’s certainly not in liquid assets, it would be in some kind of real physical assets and those appreciate with the hyperinflation.
Steve Pomeranz: Yeah, yeah.
Steve Hanke: So if hyperinflation hits, what do you do? You get a bolívar. It’s like a hot potato, you want to get rid of it as fast as you can. So you essentially have two ways for most people. They can either go to the black market and get dollars, or alternatively, they can buy something. They could buy a car or buy sugar and groceries and so forth. The problem is in socialist Venezuela, they have shortages of most commodities, and the shortages are in particular done at the low end of the thing
Steve Pomeranz: Yeah.
Steve Hanke: Like groceries and things like that. So there’s very little to buy, so the black market is the obvious avenue. The only way you can save yourself, so to speak, is get rid of the bolívars in the black market and get dollars.
Steve Pomeranz: But the conversion rate, and this is what ‘s happening, this is why the conversion rate is spectacularly low, is because everybody’s trying to do that. They’re selling-
Steve Hanke: Yeah, of course.
Steve Pomeranz: Bolivars and buying dollars.
Steve Hanke: Right, and that is part of, in essence, the currency, the bolivar, is losing value. It’s losing purchasing power. You can see it on the foreign exchange market. But getting back to the Big Mac index and so forth you can see that the purchasing power of the currency is just withering away, it has no purchasing power and that means prices are going way up.
Steve Pomeranz: Let’s talk about the US for a second. The US spends more than it earns. It’s called the deficit. We have a Fiat currency, a paper currency not really backed by anything except the capacity of America to produce goods and services and create revenue from that. What’s the differential here with regards to our rates of inflation? They say our rate of inflation is only 2%. You think that’s a real number?
Steve Hanke: Well, there are various ways to measure it and a whole array of price indices that they use, but it’s relatively low. And it’s been relatively low, certainly since the Great Recession started in the United States. And many people are always confused about this because they say, oh, the Federal Reserve, we’re running a deficit and we’ve had quantitative easing.
Steve Pomeranz: Yeah.
Steve Hanke: And the balance sheet of the Federal Reserve’s exploding and the, what I call state money, the money produced by the Fed has gone way up, so people say, oh, we’re going to have a…many people are saying we’re going to have a hyperinflation. Well, they don’t understand that the broad money supply, broadly measured at the time the Great Recession started, about 90% of the money supply is produced by commercial banks.
It isn’t produced by the Fed. The Fed produces a very small chunk. Even after quantitative easing it and so forth. That proportion that the Fed produces of the broad money supply in the United States went from about 10% up to today it’s about 16% or something like that. But we never add hyperinflation because actually the bank money produced by banks, that portion is the elephant in the room.
And after the Great Recession started and Lehman Brothers went bank where it happens so forth and so on and you had this Dodd-Frank legislation. And basically, the regulators started going after banks regulating them more stringently. And the banks basically stopped producing money, stopped producing credit.
Steve Pomeranz: Yeah.
Steve Hanke: And the money supply actually hasn’t grown very rapidly, it’s growing very slowly.
Steve Pomeranz: Yeah.
Steve Hanke: The broad money growth in the United States measured by so-called Divisia M4 index is only growing at 4.2% per year. Which is a fairly slow rate.
Steve Pomeranz: Well, we are out of time, unfortunately. But I want to thank you for taking your valuable time. My guest is Professor Steve Hankie, Senior Fellow Director of Troubled Currencies Project at the Cato Institute in Washington. And Co-Director of Johns Hopkins Institute for Applied Economics. And by the way, Johns Hopkins just received kind of a big gift from kind of a big billionaire. You guys happy about that? Michael Bloomberg?
Steve Hanke: Yes, he’s been, well, his last contribution was $1.8 billion to the university. He’s donated much much more than that in prior years, plus he was not only a graduate of Hopkins but graduate of mechanical engineering, but also was chairman of the Board of Trustees at Hopkins, and so he’s contributed in many ways. In some ways, his vision and time and effort when he was on the board is extremely valuable. It doesn’t quite get the headlines that 1.8 billion does, but
He did a marvelous job when he was chairman of the board of trustees.
Steve Pomeranz: Professor Steve Hanke, thank you so much for joining us and to hear this and an interview again or to join the conversation. Contact us at stevepomeranz.com. And while you’re there sign up for a weekly update where you could hear this and other interviews like this at your convenience. Also get a complete summary or the transcripts that stevepomeranz.com, Professor Hanke, thank you so much.
Steve Hanke: Thank you, Steve, have a good Turkey Day.
Steve Pomeranz: Thank you, bye bye.