At the end of my recent run of entries on the work of the credit ratings agencies (CRAs), I said that one consequence of CRAs warnings of ‘high’ government deficits for sustained periods is the increased fear of hyperinflation. Search through the blogosphere and you’ll find many references to this phenomenon. Countries with growing budget deficits and nominally high government debt are meant to be facing this danger; one that threatens to turn the USA and UK into the next examples of hyperinflation victims. Are these dangers real and the fears justified?

Warnings in the media have increased of impending doom over hyperinflation in the US economy. These gloom-mongers base their fears on the belief that hyperinflation is imminent after several years of public deficits above a certain level. Fortunately for us, there are dissenting voices guiding us to the real foundations of hyperinflation and pointing to key facts on inflation. For instance the long-run average rate of consumer price inflation in the US is 3.5%, based on access to CPI data since formation of the Federal Reserve Bank in 1913.

Is this average rate high? This depends on your view of the costs and benefits of inflation. The period through which inflation has averaged 3.5%, though, is marked by the greatest increase in living standards in US history. So it can hardly be said that inflation at this rate has been disastrous for the US. But those who believe in the imminence of hyperinflation foresee a period marked by far higher increases in the general price level and debasement of the US dollar. They argue that government spending must be slashed and debt repaid if the country is to avoid catastrophe.

So what is hyperinflation? Biz/ed has a good explanation of it in our Virtual Bank section. As in this example, the case most commonly referred to when illustrating periods of hyperinflation is that of Weimar Germany. In recent years, though, Zimbabwe has provided another opportunity to study the pre-conditions, effects and consequences of this phenomenon. The historical review provided at this site identifies the most obvious conditions needed before hyperinflation can take hold. Three persistent factors are: regime change, foreign denominated debt and war.

The review available at the link above shows how Weimar Germany was not the only post World War 1 case of hyperinflation. Others included Austria, Hungary, Poland and Russia. But Weimar is the example that persists and the article shows how monetary meltdown occurred there due to reduced private sector demand, shattered public confidence in the currency, extreme government intervention in the currency markets and the ultimate failure of the currency. Another good explanation of the economic failure of Weimar Germany shows again that the keys to hyperinflation there were large debts in foreign currencies and huge losses of productive capacity due to war. These factors led directly to massive increases in the money supply and runaway demand-led inflation.

How about Zimbabwe, then? Here the evidence is still fresh as the underlying factors were put in place in fairly recent years. Unequal land distribution led President Robert Mugabe to redistribute farmland. This led to violence, fleeing farming communities and plummeting agricultural production. Zimbabwe had to import food using hard currency which increased their foreign denominated debt. In the end corruption, regime change, productive collapse, foreign denominated debt and the eventual collapse of the tax system led to excessive money-printing and hyperinflation. Zimbabwe was to suffer a decade of lost economic growth and soaring unemployment.

Can these events and factors be repeated in the US? Not as long as the following conditions are sustained: they issue debt in domestic currency; no severe event or set of events is suffered such as losing a war, experiencing regime change or having extreme government corruption; no collapse in productive capacity; no end to tax compliance. In short, there’s very little danger if any at all of the US suffering hyperinflation. Doom-mongers may have other reasons to drive hyperinflation fears, but these may have more to do with wishing for a smaller-sized state, lower government spending and taxation, than real macroeconomic concerns.