Let’s start with what is inflation and how it is measured. Inflation is the rate of increase in the price levels of goods and services in an economy over a period of time. Simply put, it is the increase in price levels where the same unit of currency buys less than it did in previous time periods. Inflation is generally expressed in percentage and it results in the decrease in the purchasing power per unit of currency.
Hyperinflation is very high, rapidly, and continuously increasing inflation. While inflation is a measure of the pace of rising prices of goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month!
To illustrate with an example, let us assume that grocery shopping this month costs 1000 SEK per week. In the scenario of hyperinflation, it would cost 1500 SEK per week the next month and 2250 SEK the month after that, and so on! If salaries do not rise at a similar rate with the inflation in an economy, the quality or standard of living for the people goes down due to a reduction in purchasing power.
Many central banks around the world like the Federal Reserve, European Central Bank as well as Sweden’s central bank- Riksbank have an inflation target of about 2 %. The idea is to keep inflation low and stable to create good conditions for a favorable development in the economy. (1)
If a central bank supplies too much money, it can lead to hyperinflation, where prices rise and a huge drop in the value of money. Hyperinflation has occurred historically in terms of severe economic turmoil and depressions.
A recession is a contraction (reduction) in a business cycle due to a decline in economic activity, lasting for many months. An economy is said to be in a recession when there is negative economic growth as measured by GDP (Gross Domestic Product) in two or more consecutive quarters.
An economic depression is a sustained, long-term downturn (little or no growth) in an economy for more than a few years. They are generally categorized by a significant increase in unemployment, a decrease in production, and a drastic drop in total demand. As per the IMF (International Monetary Fund) the world economy will experience the worst economic downturn since the Great Depression of 1930. The global growth in 2020 is projected to fall to -3% (sharp downgrade of 6,3% from January 2020) (2)
The response to depression is usually an increase in the money supply by central banks, with the intention to encourage banks to lend to consumers and businesses to spur spending and investment. However, if the increase in the money supply is not supported by economic growth as measured by GDP, it can result in hyperinflation. If GDP, which is a measure of goods and services in an economy isn’t growing, businesses raise prices to boost profits and stay afloat. Since consumers have more money, they pay higher prices which leads to inflation. As the economy deteriorates further, companies charge more, consumers pay more and central banks to print more money-leading to a vicious cycle and hyperinflation. (3)
Many countries have faced hyperinflation historically. Some notable examples are Venezuela (2016), Hungary (1946), Zimbabwe (2007), Yugoslavia (1992), and The Weimar Republic (1920). A common factor in all of these scenarios was the abandonment of fiscal prudence and excessive money printing. The inflation rates began to increase and in the case of Zimbabwe reached a point where daily inflation was as high as 98%: meaning it took only 24,7 hours for the prices to double! Due to hyperinflation, a currency crisis began to unfold and the currency exchange rate for the Zimbabwe dollar began to depreciate due to a run on its currency. The government responded by introducing various reforms to reign in the hyperinflation. It resorted to printing Billion Zimbabwe Dollar as well as Trillion Dollar notes! The Zimbabwe dollar was introduced in 1980 to directly replaced the Rhodesian dollar (introduced in 1970 at par (1:1)) at a similar value to the US Dollar. In efforts to salvage the currency and reign in hyperinflation, it was redenominated three times (2006, 2008, and 2009) with denominations up to a 100 Trillion Z$ banknote issued. Over time, hyperinflation in Zimbabwe reduced the Zimbabwe dollar to one of the lowest valued currency units in the world.
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In today’s scenario, money printing by central banks and vast stimulus packages are returning people once again to one of the oldest stores of wealth: gold. It is seen as a way to retain purchasing power and a hedge against inflation. It is believed that the massive expansions of the central bank balance sheets around the world will likely depreciate the value of their currencies, thus leading to inflation of commodities or hard assets like Gold. The price of gold has already risen sharply this year, touching a seven-year high in USD terms and an all-time high in SEK terms! The gain since the beginning of the year 2020 has been more than 20% at the time of writing this article (2020-05-18)
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Disclaimer: This article is for informational purposes only and is not intended as an investment analysis or recommendation to sell or buy commodities. Tavex is not responsible for any decisions made based on this information. Investing is associated with opportunities and risks, and the market value of commodities can both increase and decrease. Past or future yields on the commodities and financial ratios shown above do not represent a promise or an indication of future earnings.