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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Hyperinflation

What it is:

Hyperinflation is a period of extremely high inflation.

How it works (Example):

Imagine if $30,000 -- money that could buy you a car today -- was only enough to buy you dinner tomorrow. You're imagining hyperinflation -- a period of time that the International Monetary Fund defines as "beginning in the month that the rise in prices exceeds 50 percent and as ending the month before the monthly rise in prices drops below that rate and stays far below it for at least a year."

Hyperinflation happens when a country's money supply increases rapidly but its supply of goods and services don't. As you know, increases in demand without corresponding increases in supply creates increased prices for those goods and services. When this happens quickly, hyperinflation occurs.

Armed conflicts that require extraordinary defense spending, general fiscal imbalances or printing currency in order to pay off government debt are all common generators of hyperinflation because they increase money supply without a corresponding increase in goods and services. And the problem can quickly spiral because when sellers begin to believe that prices will keep going up, they keep raising prices. This usually creates crises in the banking industry because deposits dwindle and withdrawals soar. And all of these factors in turn discourage foreign investment in the currency and businesses using that currency.

Recovering from hyperinflation can take years, if not decades, and requires government adjustments to its fiscal policy.

Why it Matters:

Hyperinflation reduces the efficiency of the price system and the usefulness of a country's currency as a store of value -- that is, it often leaves a country's currency worthless. The problem is typically confined to developing economies, however, so investors in these economies should consider this additional risk when investing.

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