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In our recent study Perceptions and Understanding of Money – 2020, we surveyed Americans to gauge how well they understand the mechanisms of money, including phenomena like inflation. We hope this “Everything You Need to Know” series will help improve understanding of money-related topics and issues that could not be more relevant today.

What is Inflation?

‘Inflation’ refers to a simple measure: how fast the price of goods and services rises in a given economy over a given period, per Investopedia. If the price of a mango at your local grocery store was 20 cents in the year 2000, and 80 cents at the same grocery store today, you are witnessing inflation.

The balance explains that inflation rates for specific goods and services can differ, but can generally rise or fall together if there is enough time. While the cost of an iPhone can steadily increase over a significant period of time, the price of gas can fall over the same period. Ultimately, however, both goods will cost significantly more in 50 years, just as a car or home was significantly cheaper (in dollar-for-dollar sense) 50 years ago.

The faster the cost of goods and services increases, the less your dollar can buy– this is inflation in a nutshell. If prices increase by 50% or more in a month, hyperinflation has occurred, causing the value of a currency to generally be so low that it has little to no purchasing power, except in astronomical amounts.

One must understand the causes of inflation to fully understand the concept of hyperinflation.

What Causes Inflation?

Inflation-causing behaviors that are pushed to the limit typically produce extreme inflation– in other words, hyperinflation.

In essence, inflation is the result of a growing money supply. One measure of the value of money is scarcity. When the US dollar was backed by gold, scarcity was virtually guaranteed. Because paper dollars and coins were legally convertible for gold, the amount of money in circulation was linked to the amount of gold in reserves. Those who had to exchange dollars for gold upon request – supposedly the US government – could not print more money than they could exchange for gold at any one time.

Once a currency is decoupled from a scarce medium of exchange such as gold (America began to reject the gold standard in 1933, per HISTORY) then a government is free to print money as it pleases.

Do you have increasing government debts? Print more money.

Should you save banks that have inflated a fortune by lending customer deposits to high-risk borrowers? Print more money and then ‘loan’ it to those banks.

Members of Congress deserve a raise? You know what to do: print more money.

Ultimately, the ever-increasing amount of money means a constant decrease in a currency’s scarcity, decreasing the value (purchasing power) of your dollars. This is how inflation happens. Take this expansion of the money supply to the limit and you have hyperinflation.

Stacks of German money in a Berlin bank during the post-World War I hyperinflation.  In 1923, one US dollar was worth 800 million Deutsche Mark.

Stacks of German money in a Berlin bank during the post-World War I hyperinflation. In 1923, one US dollar was worth 800 million Deutsche Mark.

What are the benefits of inflation?

The Federal Reserve notes that the ideal inflation rate is 2%, or just below. The stated advantages of moderate inflation are the promotion of economic growth and the prevention of deflation. The general idea is that deflation is a worse fate than inflation, as it can lead to lower prices, shrinkage of businesses and a decline in the economy.

In the Fed’s view, inflation should bring in higher wages (to keep up with rising prices), although this may not always be the case. Another benefit: As each individual dollar decreases in value due to inflation, the true cost of your debt decreases. That dollar in debt you owe is now only worth 50 cents, the theory goes.

Yet these perceived benefits often don’t outweigh the drawbacks that occur when extreme inflation strikes.

What are the drawbacks of inflation?

A column published in Forbes touches on the drawbacks of inflation, as the author openly questions whether America itself could go through a period of hyperinflation. Consider the indicators associated with extreme inflation, and whether these are features of the America of 2020. They include:

  • A stressed government budget (the United States public debt is over $ 26 trillion and increasing rapidly by the second)
  • Sociopolitical unrest (no elaboration necessary)
  • A “collapse” in the supply of goods (McKinsey notes that food supplies are among the victims of the pandemic)
  • A decrease in borrowing and lending (Quartz reported a notable drop in business loans earlier this year)

The signs of extreme inflation are there, and some argue it’s only a matter of time before Americans feel the pain right in their wallets, even more so than they already have.

The drawbacks of extreme inflation become obvious to those living on it, and typically include:

  • A higher cost of goods, often without a corresponding increase in wages to match the rising prices
  • Less investment and lending amid enormous economic uncertainty
  • Less production of goods and services due to less business investment, causing prices to rise further due to scarcity of products and services required
  • Loss of savings as the value of every dollar saved drops drastically
  • Hoarding goods and assets of tangible value, further limiting inventory (think toilet paper and ammunition in the early days of the pandemic)
  • Job losses as a result of less investments lead to shrinkage at individual companies

Because the US dollar plays a central role in the world economy, hyperinflation in America could create a chain reaction of global financial uncertainty.

Is Crypto An Alternative In Times Of Inflation?

Some see cryptocurrency as a response to the volatility of unsecured, non-scarce paper currency. Cryptocurrency is scarce by design meaning it is not subject to the dilution caused by increasing the money supply– that is, cryptocurrency is not subject to inflation as we understand it.

For this reason, many are turning to cryptocurrency as a hedge against increasingly volatile fiat currencies, including the US dollar.

Interested? Start mining cryptocurrencies with us. read this if you want to understand why mining makes sense.

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