Venezuela

In Venezuela, High Inflation Could Morph Into Hyperinflation

The extreme economic condition that is now practically extinct across the globe could return in Venezuela if a range of corrective measures that are anathema to the socialist government aren't swiftly instituted.

Sabana Grande market in Caracas
Sabana Grande market in Caracas
Karelys Abarca

-Analysis-

CARACAS — Hyperinflation is often confused with runaway inflation. While this may be abstract for many, Venezuelans are finding the distinction to be uncomfortably relevant to their daily lives these days. This was largely a 20th century problem and is virtually a moot issue globally. Yet there is talk of its resurgence in the Venezuelan economy, which makes its causes and possible solutions nevertheless relevant.

As economist Michael K. Salemi points out, hyperinflation is when inflation exceeds 50% a month on average. It exists when price increases are so out of control that inflation becomes meaningless.

Historical examples of hyperinflation in Germany and Hungary, following the two world wars, aren't enough to explain the essential causes of this particular kind of economic tumult. Wars and the destruction of resources and productive capabilities don't cause hyperinflation. Latin American states, after all, have suffered this in peace time, during external debt crises. The principal cause of hyperinflation is lack of discipline in monetary policy, which creates uncontrolled increases in the money supply.

Hyperinflation occurs when economic policy bodies seek a remedy for the public spending deficit in excess liquidity. This usually earns governments a reprieve at the expense of the value of currency. It is also termed an inflation tax, which is the opportunity cost society pays for financing its deficits through de facto devaluation. Exacerbated growth in liquidity swiftly fuels price increases as citizens try to keep their purchasing power by buying consumer goods. This bid to avoid the inflation tax increases demand, and fuels inflation.

Hyperinflation has a snowball dynamic once the inflationary process has begun. It is the uncontrolled phase of price hikes. If a government finances itself by printing money, it will create inflation and foment economic and consumer behaviors that will in turn force it to print more money. And as more is printed (and wages rise), people spend more to avoid the inflation tax, and the government must emit more money, etc.

The disclipline problem

Venezuela faces a serious hyperinflation risk today, and not just because of the absence of inflation statistics over the past year that has fed suspicion and speculation. It is primarily because of the disorderly growth in liquidity, as Central Bank figures indicate. Between 2004 and 2014, Venezuela"s money supply expanded by more than 2,700%, with an average annual growth of 45%. This and other monetary indicators suggest a latent hyperinflation threat.

The key question is how to avoid the snowball dynamic. The only corrective measure is a disciplined monetary policy that generates trust among economic agents. The Central Bank must be given absolute autonomy, and there must be significant tax reform and spending policies that will ultimately minimize the opportunity cost for society. But history has shown that most governments spurn such measures.

Hyperinflation harms wealth distribution, perpetuates poverty cycles, transfers wealth from people back to the state thanks to the inflation tax, cheapens credit and negatively affects financial institutions. It reduces the efficiency of economies by creating negative expectations about the value of money and encourages hoarding of consumer goods, bartering and permanent shortages. Cases of hyperinflation during the 1970s and 1980s in Argentina, Bolivia, Brazil and Chile saw the growing use of U.S. dollars in transactions, as is happening now in Venezuela.

Venezuela effectively faces this threat in the medium term, especially for the budget deficit caused by falling oil prices. Yet it can still avoid the avalanche of price hikes at a time when inflation isn't threatening the world economy. Economist Jeffrey Sachs observes that blocking hyperinflation requires an integral economic stabilization program that includes exchange, tax, spending and labor policies, and a strengthening of economic bodies.

To fight hyperinflation, governments must understand relationships inside the economic system and accept the political and popularity costs of applying correct, and timely, measures.

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