Precious metals such as gold and silver are valuable because of their inherent scarcity. This means that currencies either made from these metals or backed by physical stores of the metal are also inherently valuable.
Fiat currencies, on the other hand, are valuable only because a trust relationship exists. We trust that the government issuing the currency will continue to support the currency and that it will continue to be a valid form of payment. We also trust that the government won’t overprint the currency, thereby devaluing the money we already have.
When this trust is broken, currency collapse often follows closely after. Rory Brown, Lydian Private Bank Founder, shares details about why currencies fail.
Hyperinflation Spells the End for Fiat Currencies
When governments get themselves into financial trouble, either through mismanagement or because of war or some other major financial emergency, the easiest solution is to print more money. This fills the coffers with needed funds and allows the government to satisfy their obligations.
However, overprinting or over minting currency has the unintended consequence of driving inflation as the value of the money supply is diluted. If a critical mass of monetary overproduction is exceeded, an economy can spiral into hyperinflation, where the value of the currency drops dramatically daily. The end result of hyperinflation is nearly always a complete devaluation of the currency and a collapse of the money supply.
Germany’s Weimar Republic
After World War I, Germany faced a staggering debt and extensive reparations it was obligated to pay. Unable to satisfy these obligations the government began furiously printing money, touching off runaway inflation that, at its height, was doubling the price of goods every 3.7 days. Eventually, this process reduced the value of the papiermark to zero.
People famously used paper bills as wallpaper for their homes. They also found it more efficient to burn stacks of currency to heat their homes than to use the money for its intended purpose.
Zimbabwe in the early 2000s is a classic case of how overspending, coupled with supply-side emergencies, can intertwine to bring down a currency.
The country was embroiled in a war in the Congo that could only be supported by printing money. This was likely enough to spark hyperinflation by itself. Unfortunately, the country was also facing shortages of food and other locally produced goods due to drought and farm confiscations.
This combination of a weakened currency and demand for essential goods greatly outstripping the supply was too much for the economy to bear. Hyperinflation in Zimbabwe got so bad that prices were doubling every day. The local currency collapsed entirely, and the situation only stabilized once the government switched the official currency to the U.S. dollar.
This is the most recent example of hyperinflation destroying a currency, and it occurred because of governmental mismanagement.
Former President Hugo Chavez had instituted price controls in his country that drove domestic producers out of business. As a result, the government began importing needed goods. This worked well while the country was still flush with oil cash.
However, in 2014 the price of oil dropped dramatically. Suddenly, government-owned oil companies were losing money at an alarming pace, and the government could no longer afford normal activities. It began printing money to keep the lights on.
The hyperinflation this process touched off is one of the most dramatic in recent history. By 2019 the country’s inflation rate hit a staggering 10,398% per year. Citizens abandoned the bolivar and began using eggs as currency.
This situation is still developing today, but the Venezuelan economy is already in shambles. It is a cautionary tale about how badly, and quickly, fiat currency can fail.
About Rory Brown: Mr. Rory Brown is a Managing Partner of Nicklaus Brown & Co., the Chairman of Goods & Services, Nearshore Technology Company, and a member of the board of directors of Desano. He is passionate about delving into the history of money and how our modern currency has evolved into what it is today. In his spare time, he writes about the history of the Lydians – the first civilization to use gold and silver coinage.