F.U.B.A.R. From Inflation to Hyperinflation

INTRODUCTION

The causes of events are even more interesting than the events themselves

Cicero Roman statesman, lawyer, scholar, philosopher and academic skeptic 106 BC-43 BC

The first part of the book which explains what money is, what hyperinflation is, the different types of inflation and how it occurs, is written in a simple and easy-to-understand explanation to give the reader who has no background in economics but a real interest to understand what is happening in the real world and to try and make sense of what may appear a very complex and difficult issue to deal with, so apologies to those whom I am teaching their ‘mother to suck eggs’ if you are one of these people you may feel it worthwhile just to skip onto Chapter 3 and the Roman empire where I am sure from there on in you will find new and interesting facts about the subject.

Throughout this book we will see how hyperinflation does not occur in isolation and how world events can shape the destinies of countries decades and sometimes centuries later, hyperinflation can be a slow-burning fuse, but when it blows the bang and damage can be devastating. I use the analogy of the economy being a car owned by you but being driven by a government, when a car dash light comes on to tell you there is a problem, the government doesn’t want to tell you there is a problem as they think you will blame them for the fault and you will take the car away from them as it will cost you money to fix it, so they continue to drive the car and ignore the problem, letting you know there is a light on the dash but don’t worry it’s nothing to worry about, everything is under control. The inflation is the light letting you know there is a problem, the problem is not the light itself. If the government continues to ignore the problem and eventually blows up the engine, they will blame the light say it was unexpected and not their recklessness in not solving the problem, but you are then left with a much bigger bill to fix the car.

Before discussing anything on hyperinflation and its causes, it is pertinent to clarify what the word F.U.B.A.R stands for, it is a military term and was first cited in ‘Yank, the Army Weekly’ and although it would not be appropriate to say what the F really stands for in polite society the rest means,

F****D

UP

BEYOND

ALL

RECOGNITION

It refers to decisions being made that are certain to end in defeat, failure or destruction, and that’s what essentially has happened throughout history when currency debasement occurred as in the Roman Empire or overprinting of currency as seen in modern history, and that money printing without a stable backing of a commodity (predominantly gold and silver) has led to the increase of the Money Supply and eventually leading to the ruin of the nation. Although it could be argued that the most famous case of hyperinflation in history was that of Weimar Germany (but by no means the worst or lasting the longest) and that Germany was ruined before Weimar after losing World War I, throughout the book we will find that the hyperinflationary events that occurred were not the cause of the downfall of the empires or nations but that it takes hold after bad decisions being made, in essence hyperinflationary periods do not occur as isolated incidents but are the final nail in the coffin for societies that borrow way beyond their means to fund expansionary policies, and involving themselves in wars which lead to a reduced supply of goods and services as manpower and resources which should be used to promote the wellbeing of its society are being diverted to more dangerous and destructive purposes.

We will also discover this wasn’t the first case in history where this happened and trace it back to as far as the Tang Dynasty in China (618-907 AD) and go on with an investigation of the Middle Ages and discover that the Money Supply does need to be expanded as the period of the Bullion famine shows that without it over a period of over 200 years very little progress was made in Europe. The history of banking which through the process of fractional reserve banking, has had a huge impact on the expansion of the money supply and increasingly so in the 21st century with modern technology now not being constrained by the need to have paper currency which at least needs paper, ink and printers to create it and so by default can at least minimise the impact, banks can create literally trillions in seconds at the press of a button.

In the conclusion I will try and piece together all the episodes discussed and determine if there is any relevance to what may be happening now and see if any dash lights are flashing up on the car, what I find may be a bit of an eye opener and may give you pause for thought.

1. WHAT IS MONEY?

Money is a commodity Karl Marx

A commodity that comes into several uses as a medium of exchange is defined as being money Murray Rothbard

Well, well, well, who would have thought it, Karl Marx, and a prominent member of the pro-free market Austrian school of economics agreeing, how is this possible? Read on and all will be revealed.

Before any attempt is made to start looking at any aspects of inflation, we need to initially get an understanding of what money is and what systems were being used to trade before the need for a concept of money to come into being. It is generally accepted that the barter system was used before the principles and use of money were established. Barter is quite simply allowing for the exchange of goods and services between two parties without the need for money. It is believed to date back to around 6,000 BC with the various tribes of ancient Mesopotamia which was then adopted by the Phoenicians who used it to trade with other cities. The obvious problem with barter is what economists call the ‘double coincidence of wants’ which simply states that both parties need to agree to the trade and secondly, both goods have equal value to the respective parties involved, what this means is should I make a chair to sell and someone else has a pound of pork sausages to sell?  Firstly the seller of the pork sausages has to want to buy a chair, secondly, they then have to hope that I am not a vegetarian and that I actually want to buy pork sausages and not beef sausages instead, then finally we have to agree on a value for the trade to take place, I might view my chair as being worth five kilos of sausages and the seller of sausages may think it only worth 1 kilo, again we have to decide a rate of exchange for the two different items for sale. An example ( a strange one!) is from the 1970’s there was a children's TV show in the United Kingdom called the multi-coloured swap shop; it was presented by Noel Edmunds and amongst the various guests and topical conversations, there was a part of the show which included a reporter called Keith Chegwin going to a different town every week and the kids brought along a toy they no longer wanted or played with and they would then try and hook up with another kid who didn’t want theirs, should they both agree a trade, toys swapped, everyone happy, barter heaven!! Money solves these problems, however as we shall see it can also create the problem of inflation leading to ruined individuals, families, communities, nations and even empires, where the need to resort to bartering has and is continuing to happen but before we get to the nuts and bolts of historical, present and potential future problems we need to take a deep dive look at the functions of money. The definition of money is quite simply defined as something that is generally accepted as a payment for goods and services and also to pay debts such as taxes. (Mishkin, 2007) Now that the simple part IS sorted, we must start thinking a little bit deeper and we need to ask ourselves what are the main functions of money? This part was broken down into broken down into four sections by the economist William Stanley Jevons in his 1875 book ‘Money and the Mechanism of Exchange’ they are as follows a medium of exchange, a unit of account, a store of value and a standard of deferred payment.

a/ Acts as a medium of exchange- A medium of exchange is quite simply an item which is accepted in return for a good or service, this item is termed as money, which takes all the problems and limitations that are associated with barter.

We can break money down into different categories, there is commodity money (or absolute money), representative money and a term which is starting to become increasingly used is fiat money. Commodity money consists of an object which can have an intrinsic value, (that is something that has a value or uses in itself) as well as the value they hold in which goods and services can be purchased (O’Sullivan et al, 2003) examples of this would include gold, silver, tea, copper, silk, corn and more commonly in recent times, cigarettes. Traditionally over the last 5,000 years gold and silver have become the de-facto standard of acceptable currency, the reason for this is money has to have certain properties which both gold and silver have; it needs to be fungible; this is where one unit is viewed as interchangeable with another, it needs to be durable, whereby the item must be able to being used repeatedly, it has to be portable where individuals can carry the money with them and then transfer it to other people when purchasing a good or service, it needs to be acceptable so everyone involved must be able to use the money for transactions to take place, it has to be divisible, this is the ability to divide it into smaller units, think of buying something worth £3.47 and using a £20 note to purchase to product, you would need smaller denominations to receive the change, in this example £16.47. (The properties of durability, portable and divisibility are starting to become redundant now due to digital payments) The two most important properties of money are that it must have uniformity whereby all versions of the same denomination must have the same purchasing power and finally, there must be a limit in the supply of money in circulation which ensures the value remains relatively constant. (As we will see later with the advent of fiat currency ignoring these two factors has caused individuals and nations alike an immense amount of problems damage and pain) However, as you can see all these items in themselves have a use, you can drink tea, and make food out of corn, but equally can be used as a form of money to buy other goods as the good has been subscribed to a value in the commodity money, for example five cigarettes could buy a kilo of sausages or one hundred cigarettes for a chair. This form of currency is not so unusual, and we will see an example in a little while.

Representative money, is any medium of exchange (usually printed on paper) that actually represents something of value but in itself has little or usually no value in its own right; To be more specific representative money has been used to mean a claim on an actual commodity again usually gold or silver but by no means limited to just those two commodities, it could be used to make a claim on grains, oil, etc. (Mundell, 2002) The face value of the representative money is greater than the value of the material of the substance that it is made of, we can see this with for example a £20.00 note where the cost of the ink and polymer that makes the note is not worth £20.00. As we shall see in a later chapter regarding the Song dynasty in China (around 960-1279 AD) representative money in the form of paper money arose partly because of the ‘clipping’ and therefore the debasement of the coin. Clipping the currency was practiced from the Roman Empire through to the Middle Ages and is a practice where you shave or clip part of the gold or silver coin, meaning it has less worth to it, for instance, if you had a 100-gram coin and shaved off 20 grams you have done two things, firstly reduced the value of the coin by 20% and secondly if you continued to shave other coins you would increase the money supply in the economy we can see this in the above example that if you ‘clipped’ 5 coins, in the end, you would have 6 coins. (5 x 20% gives you an additional coin) It’s a great way to very quickly and with minimum effort improve your profit margin, however not entirely risk-free as being caught ‘clipping’ coins could result in punishments ranging from getting your hand chopped off to execution, I suppose they are the historical equivalent of working in the drugs trade, huge profit margins if you get away with but prison sentences,  being murdered by other gang members (and sometimes by people from your gang) being the real downside of the business. Another major problem as we will come to see is that by doing this you inadvertently increase the money supply and without any other factors being changed (for instance increase the supply of goods, something we will look at later) it becomes a serious problem where inflation is concerned. Debasement effectively means the lowering of the value of a currency, clipping debases the value, so reducing the content of gold in the coin by either making it smaller or adding another metal in it. This was usually done to con the general public that the coin still has the same value; it tends to not be a very shrewd move as people catch on to this trick and we end up with a situation known as Gresham's Law.

Gresham's Law is an economic principle named after Sir Thomas Gresham (1519-1579) which states ‘bad money chases out the good’ The principle of this is if you moved from using gold coins and then started to try and impose bronze coins and insist, they have the same value as the gold coins people will hoard the ‘good’ coins (money) as they will use the ‘bad’ coins made of bronze instead. It is interesting to note that Gresham who was an English financier and advisor to Queen Elizabeth I never actually said the phrase, it was coined by an economist Sir Henry Dunning Macleod in 1860 after reading Gresham’s works, however, the concept actually dates back even further and is noted in Aristophanes’ play from around 5BC in his play ‘The Frogs', guess it goes to show our ancient relatives were a lot smarter and shrewder than we tend to give them credit for.

Fiat currency, what is it? What does it mean? The word fiat is Latin which translates as ‘Let it be done’. It first emerged in the English language in the 1630’s to represent ‘authoritative sanction’’, 1750 it also began to mean a decree, an order or a command, however it appears it was around the 1870s that the term ‘fiat money’ was beginning to be used with its modern meaning as money which has no backing of any commodity such as gold or silver behind it and is used as money purely because the government says it is money, it has no intrinsic value in itself whatsoever. The term fiat money is disingenuous as it is not actually money but currency as we shall see in C/ below. The most common form of fiat currency has been printed bank notes and although still widely used today is starting to be overtaken by the popularity of digital transactions, do not make the mistake but this is still fiat money. Digital fiat money is actually more dangerous by far than printed money, the main reason being at least there is a modicum of constraint with paper (or polymer as it is now) currency in that you need to have ink and paper to print on as well as the logistics of distributing it, as opposed to digital currency where eyewatering numbers can be added to an economy in a blink of an eye and distributed worldwide in the same blink.

The distribution of fiat currency is essential to the velocity of money which is a key factor in the creation of inflation and the equation MV=PT which was formulated by economist Irving Fisher is an integral part of understanding inflation, but for now, I’m going to leave you with bated breath for the explanation in a later chapter.

b/ A unit of account- Sometimes known as a measure of value, this ascribes values to each and every given good or service on offer. By developing a unit of account, it allows for a meaningful interpretation of the price of each good and service, it eliminates all the inefficiencies encountered with the barter system and the double coincidence of wants, meaning trade can become freer and easier to transact. Because the buyer can obtain the goods and services they require whilst the seller can use the acquired money to purchase what they wish. For this to happen, something vital must happen between not only the two parties involved in the transaction but the whole of the particular society involved. Two words can be used for the essential functions of buying and selling, but before we reveal the answer, have you ever wondered why is it when you give a £20 note or do a digital bank transfer to pay for something whether it be a good you have purchased or a service that is provided, it is accepted? Equally, why do you accept that note for something you are selling or for a service you are providing? What is it that creates the environment for these transactions to take place? Because we spend our whole lives involved in financial transactions and for the most part in economies that are run reasonably well, it is not an issue that anyone either asks or thinks about but asks the same question to anyone who has undergone periods of hyperinflation and there are only two words on their lips, the two words are CONFIDENCE and TRUST!!!! Without confidence or trust in the currency the seller would not take your money, because if they believe when it comes to buying items and it wasn’t accepted, they have effectively given their product away for free.

This is also what happens in periods of hyperinflation when the value of the currency (NOT money, there is a difference as we will see shortly) is being devalued at such rapid rates people spend their money as quickly as possible (related to Irving Fisher’s MV=PT formula, which will be explained shortly) because they don’t want to be left holding pieces of paper that can buy less ‘stuff’ with the money they are holding in several weeks (in really extreme cases prices were changing by the minute as we shall see in examples later!!)

For an economy to have a unit of account, it also allows for a standard accounting system to develop where profits and losses are not only made but have a way of being recorded, this is essential to any modern functioning economy as it not only allows the individual in setting up businesses to record how efficient they are but also for potential investors to fund future growth as they would need to understand in numerical terms firstly the businesses past performance thus enabling a decision to be made on potential future earnings and projections of profits. However, it has to be appreciated that this only works in an ideal honest world where the books presented for analysis of company reports are honest and haven’t been ‘cooked’ to distort or even deliberately lie about past performance earnings. Enron was an American energy firm which collapsed at the end of 2001 which saw not only investors suffer huge losses but many thousands of people lose their jobs probably the saddest part of it was many pensioners who had been previous employees lost everything and had to come out of retirement, some in their 70’s and 80’s and start working again to financially survive, however, most companies are generally quite honest in their dealings. The Enron scandal could have been spotted much earlier if investors and analysts hadn’t been blindsided by short-term greed, thus sparing many ordinary working people the pain and misery they ultimately endured.

c/ A store of value- We have to make a crucial difference between money and currency, most people tend to use the word interchangeably however there is a fundamental difference. If we look back to why you would accept a £20 note in payment for a good or service, we see that confidence and trust are required, the next stage that has to be analysed is the two terms value and buying power. Value comes in two forms absolute (or intrinsic value) and relative. (That is the perceived value) So what do we mean by this, suppose you went to buy a kilo of sugar, that is absolute whichever shop you visited a kilo weight is a kilo weight, it does not change, a kilo is a kilo and it ends there, however, the relative cost of that kilo of sugar varies, you could go into ten different shops and buy that kilo of sugar for ten different prices. Another factor to take into account is the time period involved; you will all be aware that a kilo of sugar in 2022 is much more expensive than in 1922, this relative value is usually referred to as buying or purchasing power. Here we have the fundamental difference between money and currency and that is money is a store of value which relates to any commodity which retains its purchasing power into the future, it is an asset that can be saved, retrieved, and exchanged at a later period of time, and have the same value to be able to purchase an equivalent good. To see this in practice we can see an example of a commodity product (in this case gold) holding its purchasing power not over several years or decades but several millennia yes that’s right around 2,000 years, don’t believe me well here are the figures, an ancient Roman toga would cost around 1 ounce of gold, an equivalent quality fine suit today would cost around £2,000, what is an oz of gold worth today well its fluctuating around £1,800 per ounce (early 2022) so if the ancient Roman hid an ounce of gold 2,000 years ago and came to dig it up now they could attire themselves in the style they are accustomed to. Now imagine if you hid £2,000 in paper currency today what do you think that would be worth in 20 years let alone 2,000?

d/ A standard of deferred payments- To understand what a standard of deferred payment is we need to understand what debt is. A simple explanation would be to regard debt as an amount of money (or currency) owed by an individual, business or government, they are known as debtors, to a lender who is known as the creditor. Debt repayment requires the total sum borrowed to be paid off in full, with an interest charge added on for the duration of the loan. It is this function which allows for individuals to purchase big ticket items such as houses and new cars, it gives businesses the means of expansion and enables governments to borrow, which in theory is meant to be spent for the benefit of its citizens on projects for example to develop and expand infrastructure spending. This doesn’t always go to plan as money can be spent recklessly due to ‘moral hazard.’ Moral hazard is where someone who is given money to spend but doesn’t suffer the consequences personally, if it is squandered, that responsibility is passed onto someone else, so if the government borrows money to spend on a particular project and the project fails, the individual government minister responsible for spending the cash doesn’t suffer personally in any financial capacity, it is you and I as taxpayers who are on the hook, and that debt unlike individual debt which is the sole responsibility of the borrower, government debt is passed onto future generations of children and grandchildren, an example of this is that the British government finally paid off its loan from the First World War with bonds issued in 1917 on the 9th March 2015, seems bad enough but it is actually much worse than that as that debt was rolled over debt going back to the Napoleonic Wars which ended in 1815 and can be traced even further back to the governments issuing bonds issued in 1720 to fund its liabilities for its disastrous involvement in the South Sea Bubble, that is many generations paying for the moral hazard of our forefathers and also goes to show that when we look back in history believing our forefathers were financially responsible, goes to show that this isn’t necessarily so. Money by allowing the deferring of a payment means a person can pay for a product and service at a future date, a simpler way to look at it is the sales slogan of ‘buy now pay later’. Deferring payments along with interest charges has led to the modern society we have today, however, irresponsible borrowing and lending have led to many problems for individuals, businesses and governments, and the usual solutions governments have found to get out of these problems have been to debase the currency, come off from the restraining effects of money and use a fiat currency, leading to the inevitable collapse of the economy causing financial devastation for many.

Now if we can rewind all the way back to the barter system that needs to be mentioned, firstly it never actually went away and with the advent of the internet barter sites are appearing where people can trade directly with one another but unlike the multi-coloured swap shop where you had to be in that town when the show was on to secure the potential numbers of people to trade with, the internet means you can barter with people from around the world and secondly it periodically makes a guest appearance when markets