Chinese Hyperinfaltion:1939-1950

Origins of the Chinese hyperinflation

To preserve confidence in the new currency, the Decree contained provisions to establish a “Currency Stabilization Fund.” The Fund was to buy and sell foreign exchange in order to keep the exchange rate of the Chinese currency approximately constant relative to certain foreign currencies. The Decree also contained provisions to alter the function of the Central Bank. Instead of merely being an arm of the Nationalist Treasury, the Central Bank was to become a “banker’s bank” distinct from the Nationalist Treasury.[17] Also, the Decree maintained that “plans of financial readjustment have been made whereby the National Budget will be balanced.”[18] And, according to Finance Minister Kung, “The government is determined to avoid inflation . . . .”[19]

The wording of the Decree was the government’s attempt to quell fears of inflation. Chinese newspapers ran editorials assuring the public that the Nationalists had nothing but the best intentions for the Chinese economy, and the move to a paper currency was heralded by economists around the world as a step toward a modern banking system. But, despite the provisions of the Decree, the Central Bank was never removed from the Treasury’s control. Even more fraudulent was the assurance that the budget would be balanced. Indeed, the government deficit increased in the years following the currency reform.

In retrospect, Kung’s statement seems like a cruel joke on the Chinese people. The currency reform destroyed the private banking system which had served the Chinese economy well, and placed control of the currency in the hands of a corrupt and inept government. Inflation began almost immediately. Eventually the inflation became so severe that it helped bring about the collapse of the Nationalist regime. Thus, monopoly power over the currency proved fatal to the Chinese economy, since the inflation that Kung was “determined to avoid” occurred with a severity and length unparalleled in history.

Inflation in ancient Rome

Quantitative easing in ancient Rome
It would seem clear that the major single cause of the inflation was the drastic increase in the money supply owing to the devaluation or debasement of the coinage. In the late republic and early empire, the standard Roman coin was the silver denarius; the value of that coin had gradually been reduced until, in the years before Diocletian, emperors were issuing tin-plated copper coins that were still called by the name "denarius." Gresham's law, of course, became operative; silver and gold coins were naturally hoarded and were no longer found in circulation.

During the fifty-year interval ending with the rule of Claudius Victorinus in A.D. 268, the silver content of the Roman coin fell to one five-thousandth of its original level. With the monetary system in total disarray, the trade that had been hallmark of the empire was reduced to barter, and economic activity was stymied.

Fiat Money Inflation in Revolutionary France, by Andrew Dickson

Fiat Money Inflation in France, by Andrew Dickson


It progressed according to a law in social physics which we may call the "law of accelerating issue and depreciation." It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible.

It brought, as we have seen, commerce and manufactures, the mercantile interest, the agricultural interest, to ruin. It brought on these the same destruction which would come to a Hollander opening the dykes of the sea to irrigate his garden in a dry summer.

It ended in the complete financial, moral and political prostration of France-a prostration from which only a Napoleon could raise it.

So, even France in eighteenth century had its version of Paul Krugman, Ben Bernanke and quantitative easing.
It is needless too say that fiat currency inflation did not work. But it so interesting how people get seduced by this idea.

Three stages of inflation

Every inflation eventually leads to a deflation. There are three stages of inflation.

The initial stage of inflation overlaps with the previous deflation.
People are unsure about their investments and some think that deflation will continue. Value investors perform best in the initial stage of inflation. People who take cheap loans also win. Credit starts to flow to sectors where fundamentals are the best. Every inflationary cycle is different.

In the intermediate stage of inflation, credit continues to flow to sectors where credit is already flowing. The reason is that it is easiest to pay off the debt with a profit if more debt is taken after you have taken debt and more people buy the same assets that you bought. Momentum traders perform best in the intermediate stage of inflation. Technical analysts are mostly momentum traders. When people talk about inflation proofing their portfolio, they usually refer to only the intermediate stage where they see constantly rising prices. That is a mistake because inflation has a full cycle with profit opportunities in each stage.

In the terminal stage of inflation, every talks about investing. People who missed the boom of last few years want to jump in. There are new acronyms. Very soon inflation will be over and deflation will follow. There will be tightness of money.
Cash will soon be king. Risk averse people who hold cash and government bonds win. When deflation takes hold, some bold and prudent short sellers have a party time.

Unfortunately, it is hard to know which stage of the inflation cycle we are in exactly. But we only need to be approximate and more right than wrong to make money in the longer run.

Great quotes about inflation

"Inflation is always and everywhere a monetary phenomenon." — Milton Friedman

"Everyone loves an early inflation. The effects at the beginning of an inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the later effects, but the later effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation. " - Dying of Money: Lessons of the Great German and American Inflations by Jens O. Parsson


"Inflation profiteering had consisted of borrowing paper marks, converting them into goods and factories, and then repaying the lenders with depreciated paper. It was a process of which both Kutisker and the Barmats were pastmasters. Deflation profiteering, whose possibilities these Lithuanians (unlike Stinnes) rapidly saw, consisted of selling everything available for the new stable marks and — in this period of the tightest imaginable credit — lending the proceeds at extravagant rates of interest. " -When Money Dies: The Nightmare of the Weimar Collapse
by Adam Fergusson


"I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments."- Friedrich August von Hayek

"Inflationism, however, is not an isolated phenomenon. It is only one piece in the total framework of politico-economic and socio-philosophical ideas of our time. Just as the sound money policy of gold standard advocates went hand in hand with liberalism, free trade, capitalism and peace, so is inflationism part and parcel of imperialism, militarism, protectionism, statism and socialism." - Ludwig Von Mises

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves." - Alan Greenspan

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered." - Thomas Jefferson