Five Steps to High Inflation

Inflation, wrote Milton Friedman, “is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.”

Niall Ferguson illustrates this very well as he describes the five steps to high inflation after the First World War:

  1. War led not only to shortages of goods, but also to
  2. short-term government borrowing from the central bank,
  3. which effectively turned debt into cash, thereby expanding the money supply,
  4. causing public expectations of inflation to shift and the demand for cash balances to fall
  5. and prices of goods to rise.

Pure monetary theory, however, cannot explain why in one country the inflationary process proceeds so much further or faster than in another. Nor can it explain why the consequences of inflation vary so much from case to case.

Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon.

Nearly a century before Ferguson reaches this conclusion, in 1919, the English economist John Maynard Keynes had theorized, in The Economic Consequences of the Peace that:

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls . . . become ‘profiteers’, who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than of the proletariat. As the inflation proceeds . . . all permanent relations between debtors and creditors, which from the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless . . .