What if the amount of money in circulation is falling in real terms (deflation), and prices are also falling in real terms, and yet nominally speaking the money supply and prices are rising astronomically (hyperinflation)?
As far as I can see, that's exactly what happened in Weimar, Germany (emphasis is mine):
But the main force which gave inflation its momentum was the steady decrease in the true value of money in circulation. This has been observed in all past rapid inflations and it is vital to understand it if inflation is to be coped with.... [P]rices began jumping much faster than the government could generate new money. Thus the total circulating currency fell drastically when measured in terms of its true value. One economist stated that, "In proportion to the need, less money circulates in Germany now than before the war. This statement may cause surprise but it is correct. The circulation is now 15-20 times that of pre-war days, whilst prices have risen 40-50 times." In fact, the total currency when calculated in gold value fell from 7428 million marks in January 1920 to a mere 168 million by July 1923.
So, measured in terms of gold, Germany experienced a catastrophic decline in its money supply. This would have been ameliorated by the very high velocity of money. That is, marks were changing hands at a far more rapid pace than during normal times, as everyone attempted to spend their currency before it could depreciate further.
If you consider that key equation MV = PQ, we might call MV the "availability of money." During Germany's hyperinflation, MV surely did not drop as precipitously as M (again, in real terms) because V was high and increasing. Perhaps, during certain periods of the hyperinflation, Germany did not have deflation in the sense that MV was not dropping. (I've argued that MV makes much more sense to look at than M alone.) But the problem is that velocity cannot just go up forever. It cannot remain sky-high when there are no more goods left to be purchased. There are physical constraints on production, and when the available goods are exhausted velocity must drop back again. Somewhere along the line, MV began decreasing in real terms.
If the figures quoted above are correct, the amount of money in real terms fell by over 97%. Velocity would have had to increase to 45 times its pre-hyperinflation values, in order to allow the "availability of money" or MV to remain stable. But you can't have 45 times normal velocity for very long, if ever. They were already at full employment and maximum productive capacity early in the hyperinflation. Once there is nothing else to buy and no one else to hire, there's nothing you can do with your money-- except burn it in your kitchen stove, as in one famous Weimar photograph. MV must fall in real terms.
Which brings us to the real crux of the matter: during hyperinflation, governments print money frantically in an attempt to stave off the real-terms deflation which threatens to crush the economy and put an end to most commerce. Yet, printing money actually exacerbates the deflation (emphasis is mine):
Once people lose confidence in a currency, they try to get rid of it. As Lord Keynes pointed out, this makes circulation speed up enormously, and hence prices rise faster than the government can print new money. Marshall, studying this process, concluded that, "The total value of an inconvertible [fiat] paper currency cannot be increased by increasing its quantity; any increase in quantity which seems likely to be repeated will lower the value of each unit more than in proportion to the increase."
In other words, you can print another trillion marks, which is equivalent to X ounces of gold, but the real value of all currency in circulation will decline by more than X ounces of gold. The paper currency will devalue at a faster rate than the rate you're printing it at. The faster you print, the worse the deflation in gold terms.
And thus, paradoxically, the Germans didn't have enough money, and that situation only grew worse:
Despite the proliferating billions of trillions of marks, the average citizen found it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks. Businessmen were strapped for money to buy materials and meet payrolls. The government faced the same problem. It appeared that there was not too much money around, but rather much too little. The clamor for more money grew on all sides. It seemed that any halt to the printing presses would bring business to a standstill and throw millions of workers out on the street. The government itself would be unable to carry on. Riding a tiger, it dared not dismount. On October 25, 1923, the Reichsbank noted that it had that day printed 120,000 trillion marks. Unfortunately, the day's demand had been for one million trillion.
Once confidence in the currency has been lost and hyperinflation is entrenched, you can't merely stop printing. The resultant deflation would mean the end of the economy. Running faster and falling behind is still better than letting everything come to a screeching halt. And yet the more you print the worse everything gets. What a horrible trap.
It's a trap that can be gotten out of by going to a new currency altogether, one backed by gold or by silver, or one pegged to another hard currency, or (in the German case) by backing it with land. A currency which is equivalent to something of tangible value can retain the people's confidence, which is the only way it can remain real money. The problem with a currency which is collapsing is that it isn't actually money any more-- it is not a store of value, it's not a unit of account, and it's not even a dependable medium of exchange. It's not money-- and the country has to stop using it and put in place something that is money. The old currency is hopeless.
It's a very strange thing to say, but deflation and hyperinflation are actually mutually reinforcing when deflation is seen in gold terms. There's no way to escape that trap, once it begins; the currency must be abandoned.
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