Venezuela is the only country in the world that is suffering from the ravages of hyperinflation. But, you wouldn’t know it from reading the press, where playing fast and loose with words is commonplace. Indeed, the word “hyperinflation” is thrown around carelessly and misused frequently, with claims that multiple countries are suffering from hyperinflation. The debasement of language in the popular press has gone to such lengths that the word “hyperinflation” has almost lost its meaning.
So, just what is the definition of this oft-misused word? The convention adopted in the scientific literature is to classify an inflation as a hyperinflation if the monthly inflation rate exceeds 50%. This definition was adopted in 1956, after Phillip Cagan published his seminal analysis of hyperinflation, which appeared in a book, edited by Milton Friedman, Studies in the Quantity Theory of Money.
Since I use high-frequency data to measure inflation in countries where inflation is elevated, I have been able to refine Cagan’s 50% per month hyperinflation hurdle. With improved measurement techniques, I now define a hyperinflation as an inflation in which the inflation rate exceeds 50% per month for at least thirty consecutive days.
Just what is Venezuela’s inflation rate? Today, the annual inflation rate is 10,398% per year. How do I measure elevated inflation? The most important price in an economy is the exchange rate between the local currency – in this case, the bolivar – and the world’s reserve currency, the U.S. dollar. As long as there is an active black market (read: free market) for currency and the black-market data are available, changes in the black-market exchange rate can be reliably transformed into accurate measurements of countrywide inflation rates. The economic principle of purchasing power parity (PPP) allows for this transformation. The application of PPP to measure elevated inflation rates is both simple and very accurate.
Evidence from Germany’s 1920–23 hyperinflation episode – as reported by Jacob Frenkel in the July 1976 issue of the Scandinavian Journal of Economics– confirms the accuracy of PPP during hyperinflations. Frenkel plotted the Deutschmark/U.S. dollar exchange rate against both the German wholesale price index and the consumer price index (CPI). The correlations between Germany’s exchange rate and the two price indices were very close to unity throughout the period, with the correlations moving to unity as the inflation rate increased.
Beyond the theory of PPP, the intuition of why PPP represents the “gold standard” for measuring inflation during episodes of hyperinflation is clear. Virtually all goods and services are either priced in a stable foreign currency (the U.S. dollar) or a local currency (the bolivar). In Venezuela, bolivar prices are determined by referring to the dollar prices of goods, and then converting them to local bolivar prices after observing the black-market exchange rate. When the price level is increasing rapidly and erratically on a day-by-day, hour-by-hour, or even minute-by-minute basis, exchange rate quotations are the only source of information on how fast inflation is actually proceeding. That is why PPP holds and why I can use high-frequency data to calculate Venezuela’s inflation rate.
Just how severe is Venezuela’s episode of hyperinflation? Well, that depends on the metrics used to measure severity. If one looks at the rate of inflation itself, Venezuela’s hyperinflation fails to make the Top Ten. Of the world’s fifty-eight episodes of hyperinflation that Nick Krus and I documented in the Routledge Handbook of Major Events in Economic History, Venezuela ranks as the 14th most severe hyperinflation. This is shown below in the frequency distribution of the days required for prices to double in the world’s hyperinflation episodes. At the peak of Venezuela’s inflation, which occurred in January 2019, it took 14.8 days for prices to double. This puts its rate at the upper-end of the mid-range of hyperinflation severity.
If one measures severity by the duration of a hyperinflation, Venezuela’s hyperinflation, which started in November of 2016 and has yet to end, is severe. It has lasted for thirty-six months and counting. As the frequency distribution and table below show, there have only been two hyperinflations that have lasted longer than Venezuela’s.
So much for the definition and accurate measurement of Venezuela’s hyperinflation. What about forecasts for the course and duration of Venezuela’s episode? Well, you can’t reliably forecast what heights a hyperinflation will reach, or when those heights will be reached.
Surprisingly, that impossibility hasn’t stopped the International Monetary Fund (IMF) from throwing economic science to the winds. Yes, the IMF has regularly been reporting what are, in fact, absurd inflation forecasts for Venezuela. The table below presents the IMF’s finger-in-the-wind forecasts (read: nonsensical folly). Indeed, the IMF’s forecasting folly should be apparent to the naked eye. Just look at the table below. The IMF’s forecasts for 2019’s year-end inflation have ranged from 200,000% to a whopping 10,000,000%.
Never mind. You can bet your boots that the financial press will continue to dutifully report the nonsense coming from the IMF citadel. When it comes to hyperinflation, both the IMF and the press are immune from economic science and the facts.
President Trump repeatedly and proudly proclaims that his trade war strategy and tactics are designed to narrow the trade deficit. But, the facts make it clear that the President’s strategies are not working. Indeed, his assertions have been refuted again and again. Most recently, the U.S. Commerce Department reported that the U.S. trade deficit for both goods and services in the first three quarters of the year jumped by 5.4% over the same period last year. The facts make it clear that Trump’s war plan is wrongheaded—a bust. Yes, Trump is losing his battle to shrink the trade deficit. Why?
President Trump, alongside many business leaders, has strong views on international trade, particularly the U.S. external balance. He believes an external deficit is a malady caused by foreigners who manipulate exchange rates, impose tariff and non-tariff barriers, steal intellectual property and engage in unfair trade practices. The President and his followers feel the U.S. is victimized by foreigners, as reflected in the country’s negative external balance.
This wrongheaded mercantilist view of international trade and external accounts has its roots in how individual businesses operate. A healthy business generates positive free cash flows – revenues exceed outlays. If a business cannot generate positive free cash flows on a sustained basis, take on more debt or issue more equity to finance itself, then it will be forced to declare bankruptcy.
Business leaders employ this general free-cash-flow template when they think about the economy and its external balance. For them, a negative external balance for the nation is equivalent to a negative cash flow for a business. In both cases, more cash is going out than is coming in.
But, this line of thinking represents a classic fallacy of composition. This is the belief that what is true of a part (a business) is true for the whole (the economy). Alas, economics is littered with fallacies. These cause businessmen to confuse their own arguments about international trade and external balances almost beyond reason.
The negative external balance in the U.S. is not a “problem,” nor is it caused by foreigners engaging in nefarious activities. The U.S.’s negative external balance, which the country has registered every year since 1975, is “made in the USA,” a result of its savings deficiency.
To view the external balance correctly, the focus should be on the domestic economy. The external balance is homegrown; it is produced by the relationship between domestic savings and domestic investment. Foreigners only come into the picture “through the backdoor.” Countries running external balance deficits must finance them by borrowing from countries running external balance surpluses.
It is the gap between a country’s savings and domestic investment that drives and determines its external balance. This is demonstrated by the “savings-investment identity.” In economics, identities play an important role. By definition, they are always true. Identities are derived generally by expressing an aggregate as a sum of parts, or by equating two different breakdowns of a single aggregate.
The national savings-investment gap determines the current account balance. Both the public and private sector contribute to the current account balance through their respective savings-investment gaps. The counterpart of the current account balance is the sum of the private savings-investment gap and public savings-investment gap or the public sector balance.
The U.S. external deficit, therefore, mirrors what is happening in the U.S. domestic economy. U.S. data support the important savings-investment identity. As shown in the table below, the cumulative current account deficit the U.S. has racked up since 1973 is $11.488 trillion, and the amount by which total savings has fallen short of investment is $11.417 trillion.
But, that is not the end of the story. Disaggregated U.S. data are available that have allowed Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprises researcher Edward Li and me to calculate both the private and government contributions to the U.S. current account deficit. As shown in the table, the U.S. private sector generates a savings surplus—that is to say, private savings exceed private domestic investment—so it actually reduces (makes a negative contribution to) the current account deficit. The government stands in sharp contrast to the private sector, with the government accounting for a cumulative savings deficiency—that is to say, government domestic investment exceeds government savings, resulting in fiscal deficits—that is almost twice the size of the private sector surplus.
Clearly, then, the U.S. current account deficit is driven by the government’s (federal, plus state and local) fiscal deficits. Without the large cumulative private sector surplus, the cumulative U.S. current account deficit since 1973 would be almost twice as large as the one that’s been recorded.
The straightforward implication of this analysis is that President Trump can bully countries he identifies as unfair traders and can impose all the restrictions on trading partners that his heart desires, but it won’t change the current account balance. The U.S. current account deficit is solely a function of the savings deficiency in the U.S., in which the government’s fiscal deficit is the proverbial elephant in the room.