Democracy protects nations from hyperinflation

Study shows virtually no documented cases of hyperinflation took place in a democratic country.

KARACHI:

Chalk up another piece of evidence for the inherent stability of democracy as a form of government: of the 57 known cases of hyperinflation in history, hardly any have taken place in a democratic country, according to a recently published paper by two American economists.

The research was conducted by Steve Hanke and Nicholas Krus, two economic researchers working at Johns Hopkins University in the United States, and published last month by the Cato Institute, a think tank based in Washington DC. They document all known cases of hyperinflation in history, coming up with 57 cases in all, measuring the start date, the end date, the peak month, as well as the peak inflation rate.

While much of the 19-page paper is dedicated to footnotes, sources and the authors describing how difficult it was for them to get the data and how long it took (three years), the three-page data table they produce at the end offers some extraordinary insights.

For instance, of the 57 cases of hyperinflation, only three took place in democracies, and two of those instances were those of Germany after its defeat in World War I. The third was Peru, which saw a brief three-month period of hyperinflation.

The authors of the paper also appear to use a strict definition of hyperinflation: a period where the monthly inflation rate hits 50% or more. The period is said to end when monthly inflation goes below that level and stays below that level for over a year.

While nearly all Pakistanis complain about high levels of inflation, the country has never actually seen hyperinflation in its entire history. The highest rate of monthly inflation was 1.93%, which came in August 2008, the last month of President Musharraf’s tenure in office. At that rate, prices in Pakistan would have taken more than three years to double. By contrast, at the peak of Hungary’s hyperinflation in July 1946, prices doubled every 15 hours. Inflation in Pakistan is not good, and has been worse, but it does not even come close to hyperinflation by any stretch of the imagination.

The authors of the study note that there are three major types of circumstances that lead to hyperinflation: war, extreme political mismanagement, and the transition from a command to market-based economy. They have very little to say about why democracies seem to do so well in containing inflation.

Felix Salmon, a columnist at Reuters, notes that hyperinflation is about a lot more than just a few policies going wrong: it is usually a symptom of absolute catastrophe hitting a country.

What Salmon leaves out, however, is that bad decisions alone are not enough: they need to be compounded by more bad decisions and either a complete lack of viable alternatives (as in the case of post-war Germany) or a dictator who can simply decide to go ahead with them with no checks and balances at all.

In a democracy, it is almost impossible to undertake a policy that would rob every single person in the country of their savings, and every single investor of the returns on their investment.

The government can be of whatever political leaning, but every single person in their constituency will be hit – and hit hard – by hyperinflation.

It makes no sense for any elected official to pull the trigger towards that level of insanity. Even if a government makes a mistaken lurch in that direction, it will be pulled back by the checks and balances that exist even in the weakest of democracies.

Published in The Express Tribune, September 9^th, 2012.