History is full of examples in
which foolish monetary policy has resulted in severe hyperinflation.
Under such regimes there is a complete loss of confidence in the
underlying currency, producing an astronomical rise in prices. A cycle
quickly ensues as government prints more currency to compensate for its
instant loss of value.
It is a vicious cycle triggered by the massive expansion of the currency
supply, which contrary to gold
and silver, can be limitlessly created.
Understood properly, it is not that prices go up, it is the value of the
currency what keeps going down because of its expansion and the speed to
which it is put into circulation.
As an important economic principle states, "currency may be created
at will, but not wealth". If the solution were that simple,
poverty could be eliminated by the distribution of currency. The
limitless creation of currency would suffice to meet the demands of
struggling individuals and economies. As you can see, this notion is
completely absurd.
Hyper-inflationary periods typically occur under extreme geopolitical
conditions such as war or civil unrest. The cost of financing these
types of events is heavy, causing government to turn to cheapest alternative
for funding: printing currency not backed by precious metals. The
results are often catastrophic, devastating economic activity and destroying
business confidence.
China's mid-twentieth century hyper inflationary feat is exemplary in
providing an accurate presentation of the speed with which this process
unravels. A recent study published by Steve H.Hanke and Nicholas Krus
of the "Cato Institute" estimated that between October 1947 and
mid-May of 1949 it took an average of 5.34 days for prices measured in
yuan to double.
During the peak of the hyperinflation in April 1949, the rate of inflation
was an astounding 5070%.
This occurred in midst of a bloody civil war as the Nationalists and
Communists fought over control of the country. Fighting seized a month
later, culminating in a communist victory and the founding of the People's
Republic of China under Mao Zedong in October 1949.
Both sides attempted to finance their military costs through excessive
printing. In the end, this backfired as Communists attempted to unify
China under a single currency while a few currencies circulated.
It is important to note that during the decade prior to the
hyperinflation, the Nationalist government had run high levels of deficit
spending to finance the war with Japan which persisted from 1937 to
1945. Not coincidentally, China underwent another less drastic
hyper-inflationary period from July 1943 to August 1945, during which prices
doubled every 15.2 days.
It is interesting to note that during the middle of second period of
hyperinflation, the Chinese government replaced outstanding notes for a new
"gold" yuan at a conversion of three million to one. The word
"gold" was simply inserted as a futile attempt to instill
confidence in the new fragile currency, as there was no convertibility in
place. These notes remained unbacked and debt-based.
The most drastic government measure was a prohibition of individual
ownership of gold and
silver, forcing their redemption in the newly created "gold
yuan". Prices and exchange rates were frozen, imposing severe
punishments on speculators and those who operated under the country's thriving
black markets.
These measures are typical of governments attempting to fight off the
unintended consequences of their poor policy. In the end, free markets
and real money always prevail.
Chaos quickly erupted as the instituted price controls made merchants
refuse the sale of their products. By November 1948, the government was
forced to remove the previously instated measures.
Only the centralization of power throughout mainland China, achieved
through victory of the Communists, would bring greater stability to the first
quarter of 1950.
In preparation for this, the People's Bank of China (PBOC) founded in
December 1948 , began issuing its privately backed notes within all areas
dominated by Mao's troops, and rejected the former "gold
yuan".
By July of 1949, the PBOC estimated a currency supply exceeding 60
trillion gold yuan. A few months prior in November, the currency supply
was at a mere 3.4 billion.
While the value of the currency sank in China, the
Kuomintang decided to distribute 40 grams of gold per person. Thousands of
people came out and waited for hours to receive this amount of gold. The
police, equipped with high-caliber weapons, could do little to maintain
order. Ten people were crushed to death.
As we have seen, the tragic story of Chinese hyperinflation is yet another
example of government testing the limits of the creation of currency.
The outcome of printing is never the creation of wealth but the
proliferation of misery.
During these periods, wealth is rapidly transferred to those who own
tangible assets such as gold and silver.
Those who hold their wealth in fiat paper fall victim to this scheme as their
wealth is virtually stolen.