Hyperinflation is defined as an extremely rapid or out of control inflation that consequently erodes the real value of the local currency, and causes the population to minimize their holdings of the local capital.
Under these conditions the official currency quickly loses real value so the general level of prices within an economy increases. Hyperinflation usually happens when there is a large increase in the money supply not supported by the growth of the gross domestic product (GDP), resulting in a disparity in the supply and demand for the money. If this isn’t addressed it causes prices to increase, as the currency loses its value.
Throughout history, this phenomenon of hyperinflation has occurred a total of 55 times. This has occurred equally in some of the largest economies in the world today like China and Germany, as in some developing countries in Latin America during the 1980’s debt crisis.
War is usually one of the most common precursors to hyperinflation since there is a loss of confidence is the ability a currency has to remain valuable in the aftermath of the conflict. Due to this fact, there is usually a risk premium attached to acceptance of the money by sellers.
Here we can see some examples of hyperinflation and the circumstances by which they have affected these close neighbors to Latvia.
Estonia - January 1992 - February 1992
Highest Monthly Inflation Rate 87.2%
During Russia’s transition in the 1990’s there was a lack of confidence in local currencies and Russian banks. Capital flight estimates from Russia were about $20 billion a year starting in 1991.
As a former Soviet republic, Estonia faced a near hyperinflation in 1992, but regardless, the country wanted to reduce inflation at whatever cost and join the West economically. In June of 1992, Estonia successfully established the kroon as its own independent currency thus becoming the first country to break out of the ruble zone. Adopting the currency board made it possible to fix the exchange rate of the kroon with that of the German mark to ease macroeconomic stabilization. Estonia was also the first post communist country to decide for full convertibility in 1994. Estonia proved currency boards are the right choice for small economies looking for macroeconomic credibility and a flexible domestic market, but understood that a fixed, misaligned exchange rate could consequently lead to extended inflation.
Lithuania - January 1992
Highest Monthly Inflation Rate 54%
The Soviet ruble was at the heart of Lithuania’s monetary problems at the time. The Soviet government was printing more rubles in a month than it had originally planned to print during the entire year. In consequence, and despite price controls, inflation was in triple digits. Hyperinflation occurred due to a rapidly increasing supply of rubles chasing a shrinking supply of goods. The ruble headed for total collapse, as officials did not understood this facts and no effect upper limit to the supply of the currency was set. The Lithuanian leadership had to come up with a way of getting a distinct currency and as a consequence hopefully decreasing inflation. Even though Lithuania had already declared its independence, the rest of the world did not recognize it, so the new currency, the “vagnorkės” had to be printed in total secrecy. The transition from the ruble to the temporary currency was no plain sailing either, as there were many factions that tried to capitalize on the instability of the situation and the fact that the hyperinflation had not yet reached Russia. The second financial reform in Lithuania happened in 1993, when vouchers were replaced with litas. One more time, controversial decisions and suspicions of KGB involvement were ample.
Ukraine - January 1992
Highest Monthly Inflation Rate 530.30%
Ukraine was plagued by high inflation since its independence in 1991. This was a common experience of all post-Soviet and Eastern European economies, but in this case it didn’t declined in 2–3 years, like it happened in Poland or Latvia and other Baltic states, here it continued to accelerate. In 1992, Ukrainian budget deficit reached 12.2% of GDP, which, in the absence of access to capital markets, was financed predominantly by issuing money, reaching 2000% inflation. In hyperinflation, prices rise so meteorically that any concept of “inflation” is no longer even relevant. In 1993, the situation with the budget deficit improved marginally, however, the need to counterbalance the economy with even higher inflation to have an effect on the real economy resulted in price growth of over 10,000% that year. This situation made Ukraine the first country in the world with over a hundred-fold annual price level increase that wasn’t a result of a war. It wasn’t until September of 1996 that the inflation lowered enough to allow for the introduction of a local currency, the hryvnia.