There has been a tremendous amount of chatter recently in the financial press about the possibility of hyperinflation in the developed world. Hyperinflation is a period of runaway inflation, typically defined as an inflation rate in excess of 50% per month (12,875% annualized). Understandably, the thought of hyperinflation strikes horror into the hearts of investors, economists and policymakers everywhere - and with good reason. Hyperinflation renders bonds and savings accounts worthless while bringing the economy as a whole to a grinding halt.
It isn't surprising that financial commentators are wary of the possibility of hyperinflation, given that central banks all over the world have resorted to unprecedented amounts of quantitative easing (money printing) in a futile attempt to reinvigorate the global economy. The most famous historical episode of hyperinflation took place immediately after World War I, during the early years of the ill-fated German Weimar Republic. Pundits will often compare some aspects of the present situation with that foreboding period leading up to the early 1920s German hyperinflation.
The articles practically write themselves. And, if your success as a journalist is determined by how many clicks you can generate, then it is no wonder the German hyperinflation is a popular topic. It was an utterly horrifying experience for the German people. Their currency, the mark, ultimately depreciated from 4.23 marks to the dollar before World War I in 1914 to 4.2 trillion marks to the dollar in late 1923! This financial dislocation gutted the already war-torn German economy, leading to widespread unemployment, starvation and social unrest. So it is understandable why we should be aware of the possibility of hyperinflation and strive to avoid a repeat of the Weimar experience.
There is, however, a little known lesson buried in all the abject terror of the German hyperinflation. Quite simply, a nation doesn't need to experience a preposterously excessive hyperinflation to mortally wound itself economically and destroy its middle class. While most financial writers concentrate on 1922 and 1923 when the German hyperinflation moved from devastating financial crisis to ridiculous tragicomedy, it was really the year 1919 that broke the back of the German middle class.
From January 1919 to January 1920, the German wholesale price index increased by a factor of five. This effectively amounted to an 80% depreciation of the German mark over the course of a single year. What originally cost 1 German mark at the beginning of 1919 ended up costing about 5 German marks by the end of the same year. This massive devaluation was an economic disaster of the highest order for the German people.
An 80% loss in purchasing power over a scant 12 months is bad enough for cash and savings accounts, but mark denominated bonds, whole life insurance policies and other fixed denomination financial instruments did even worse. These financial assets were promises to pay a fixed amount of marks in the distant future when those marks would be almost assuredly worthless. Consequently, bonds and similar financial instruments lost far more than 80% of their market value during 1919.
The German stock market was no safe haven either. Although it rose from 97 in January 1919 to 166 in January 1920, this increase was an illusion. While it was technically a nominal price gain, once adjusted for the precipitous decline in the German mark over the same time, it turned into a loss of 66% in real terms.
Given these statistics, it is obvious that it wasn't the hyperinflation of 1922 and 1923 that really bankrupted the average Weimar Republic household. Instead, it was the rather pedestrian currency crisis of 1919 that did most of the damage. The middle class had their net worth decimated by the 80% depreciation that occurred in that year. Their long-dated bonds and whole life insurance became almost worthless while their savings and cash lost 4/5ths of its purchasing power. Even their stock holdings lost most of its value in real terms.
While wild rants about an imminent hyperinflation in the U.S. dollar might drive clicks and sell online ads, it misses the much more prosaic, although sinister, truth. Hyperinflations merely kick a national populace that is already down. Most of the real financial damage is done well before the hyperinflation arrives, during the initial currency crisis phase. And no paper asset of any kind - neither stocks, nor bonds nor nor cash - protect against such an event. This is why tangible assets like bullion, gemstones and art and antiques are such an important part of a properly diversified investment portfolio. They can help shield your wealth against devaluations both large and small.
