Flash Point: How to Spot Hyperinflation

We maintain that hyperinflation is not just a case of large-scale price inflation but essentially, a loss of confidence in the currency causing holders of currency units to immediately convert them into hard assets. This creates a positive feedback loop that exacerbates the runaway price problem (our use of the term ‘positive feedback’ is the correct usage and counter to how most pundits use the term. See Negative Feedback, theTragedy of the Commons, and Complex Systems).

The economic measure of this is called the “velocity of money” or the number of times it changes hands in the economy. If the velocity grows sharply then we should become concerned that we may be on the edge of hyperinflation. So where does the US stand? Consider the following graph:

Figure 1. Velocity of the M2 money stock. Click to open in a new window.

For the broadest measure of the money supply, M2’s velocity has been decreasing since the late 1990s and is currently at record lows for the period the available data covers. Velocity is a calculated rather than a measured quantity and is the ratio of nominal GDP to M2. The interpretation is that the money supply has been growing faster than GDP since the late 1990s. Or in the interpretation of velocity, the rate of circulation of available money in the economy has been slowing. Should this begin to show a large sharp increase (upturn in the graph) then we would want to look for signs that hyperinflation might be emerging.

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