Hyperinflation: Lessons from South America; G. Swanson

That's what it's like under hyperinflation. In Argentina, supermarket prices are increased twice daily. During the two weeks we were in Brazil recently, interest rates rose 100% from 330% to 430%. Bolivia's demand for money is so great that its third largest import is currency. Inflation, to say nothing of hyperinflation, seems to be the forgotten bandit of the eighties. Inflation was once the chief scourge of every respectable U.S. economist. Today we seem to have other things to worry about: pockets of se vere unemployment, a lack of competitiveness internationally, the fear of a recession, even the possibility of disinflation. The chief reason inflationary concerns have abated is that, contrary to traditional economic theory, the huge U.S. federal deficits of recent years have not yet translated into spiraling prices. UntiI this decade, the postwar years had demonstrated a direct correlation between def icits and inflation. When deficits rose, price and interest rate increases were sure to follow.

During the past six years, however, the annual deficit has almost tripled, with the national debt almost doubling, but nominal interest rates have actually fallen. Whatever the reason for this aberration, we can consider ourselves fortunate. But for how Dr. Swanson is Associate Professor of Economics at the University ofArizona. This article, reprinted from the 1986 Annual Report of Figgie International Inc., reports on his study of hyperinflation in Argentina, Bolivia, and Brazil. long? Most economists would argue that the trend is simply not sustainable. South Amer ican countries such as Argentina, Bolivia, and Brazil-all of which have suffered annual in flation rates into the triple digits in recent years -offer conclusive proof that no country can indefinitely get away with spending more than it makes. The United States has something to learn by the plight of these countries. It would be a mistake to write them off as hopelessly backward, having no relevancy to such a pow erful, sophisticated economy as ours. Argen tina as recently as the 1920s was the fifth most productive nation in the world. Now it is 70th, with hyperinflation the major culprit.

At a critical juncture, Argentina, Bolivia, and Brazil were not willing to bite the bullet and take the steps necessary to prevent high in flation. Make no mistake about it, neither is the United States. We all seem to share a love af fair with the hot fudge sundae diet; the notion that we can eat as much as we like without get ting fat. But eventually the piper has to be paid. Increasing the amount of currency circulating in an economy in order to payoff debt, without increasing production, will inevitably lead to higher prices. In each country we visited, large deficits and high inflation go hand in hand. And when runaway inflation starts, it moves quickly . . . in a matter of months, or even days! To a certain extent, it is the fluctuation in inflation rates that is difficult to live with, rather than the rates themselves. Argentina learned to' cope with 100% annual inflation, but when it rose to 500% the result was virtual 8 THE FREEMAN. JANUARY 1988 chaos. In the United States we've become ac customed to 5% inflation, but a sudden in crease to 20% would profoundly change our economic realities. In fact, even 5% took some getting used to. When President Nixon imposed wage and price controls in 1971, the national inflation rate was a whopping 4.7 %.

The Consequences of Hyperinflation What would life be like in the United States with an inflation rate of 20% or more? South America offers a number of clues. At one time in Argentina, a pair of shoes cost as. much as an entire steer. With hyperinflation, prices cannot be used as benchmarks for decisions, since yes terday's prices do not offer any relevancy for today. In fact, it isn't unusual for South Amer ican shoppers to see the price of bread increase between the time they enter a grocery store and the time they leave it. Savings lose their value. The only incentive is to spend. Paychecks are cashed immediately and turned into hard goods like washing machines, refrigerators, and radios. And that's assuming they are available. Consumers are forced to pay cash for every thing, including homes. Above all, political and social certainty is lost. In the United States we are accustomed to stability. We know that if today $300 is a good price for a 19-inch color television set, it will be an equally good price tomorrow. Not so in the South American economies we are studying. Beset by hyperinflation, it is nearly impossible for individuals to judge their status in life, since status is so closely related to the control over what they are able to consume.

As a political problem, inflation is much more illusive than, say, unemployment, which simply provokes a call for more jobs. Citizens don't necessarily demand an end to inflation, only to the personal hardships that result. Once wages are tied to prices so that people can be assured that their purchasing power is not dam aged, they are usually satisfied. In that case, another problem actually arises when inflation is temporarily curbed and wage increases are halted. Workers tend to feel they are worse off when their monthly paychecks no longer in crease routinely. Governments also become accustomed to inflation, using it as an all-too easy way to lower their outstanding debt. In these three South American countries hy perinflation has created more wrongs than leg islators can put right. In order to protect in dustry, governments have been known to close their borders, which might help domestic com panies in the short-term, but makes long-term competitiveness impossible. Unchecked hyper inflation inevitably plays havoc with an entire nation's standard of living. The need to survive begins to dominate individual actions, making long-term planning impossible. During hyper inflation, short-term is considered three days; long-term, two weeks. According to a top ex ecutive at Banco Palmares, "The name of the game in terms of planning during periods of high inflation is guessing what ways the gov ernment is going to try to correct their bad choices. "

For individual businesses, good management is always a crucial ingredient for success. We found that during hyperinflation it becomes even more critical. New information must be absorbed rapidly, because today's political or monetary event can negate yesterday's wise business decision. In Brazil the government re cently gave approval to automotive suppliers to increase the price of stainless steel by 60%. Such business decisions are needed to reassess inventory levels and production scheduling. A thorough knowledge of financial and currency markets is vital, since managing a company's money could become more important than in creasing sales or even productivity. During high inflationary periods, managers turn from production management and long term planning to financial arbitrage in order to make short-term profits by borrowing dollar de nominated funds and lending them in local cur rency. Many South American companies invest their money in other countries, or at least place their assets in a more stable currency, which in the past has been the U. S. dollar.

Some of the most successful South American companies make collections in seven days, while delaying payment for thirty days or longer. Prices are increased rapidly, and inven tories are often built up and warehoused, with expectations of selling them in the future at substantially higher prices. Other South Amer ican companies cope with hyperinflation LESSONS FROM SOUTH AMERICA 9 HYPERINFLATION IN BOLIVIA, i •I 1985 Inflation Ratef--was 672'3"0! ExhibitIII - Argentina ~ "\ J \ I \ I \ I \ I LJ - Inflation -·Deficit* •••Estimated A *-/, / ,... ~ so 20 40 30 10 90 250 290 390 230 360 340 320 330 ~20 310 370 200 210 no 220 400 280 350 260 240 270 300 380 190 170 180 160 130 150 140 120 100 110 1985 Inflation Rate was 227'3"0! AND BRAZIL, ARGENTINA ExhibitII ---....--------1 Brazil 1-------,lF-------------j .~ 80 1-- #- =~:}~;:~n ~ 70 •••Estimated ~ (l) 60 c... 230 220 210 200 190 180 170 160 150 140 130 120 110 100 90 ~ 80 C 70(l) ~ 60 ~ 50 40 30 20 10 i, I 1985 Inflation Ratewas 11,749'3"0!

_ ExhibitI Bolivia ~, J'" - Inflation I-- Deficit* I•••Estimated / It. */ ~, /I ~ J/,,420 410 400 390 380 370 360 350 340 330 320 310 300 290 280 270 260 250 240 230 220 210 200 190 180 170 160 150 140 130 120 110 100 90 ~ ~ 80 C 70(l) ~ 60 ~ SO 40 30 20 10 '77 '78 '79 '80 '81 '82 '83 '84 '85 *Includes net lending by public sector SOURCE: International Monetary Fund '77 '78 '79 '80 '81 '82 '83 '84 '85 *Includes net lending by public sector SOURCE: International Monetary Fund '77 '78 '79 '80 '81 '82 '83 '84 '85 *Includes net lending by public sector SOURCE: International Monetary Fund 10 THE FREEMAN. JANUARY 1988 through a strategy of vertical integration. In other words, by acquiring raw materials and production and distribution facilities, some concerns have been able to minimize the im pact of price fluctuations, as well as govern ment regulations. Because events occur so rapidly under hy perinflation, those companies who can main tain their flexibility are best off. In many in stances, a one-day delay in making or imple menting a decision can be devastating. Often there isn't time to put orders in writing, so ef fective oral communications are vital. But at some point flexibility becomes the antonym of stability, and taken to its extreme creates chaos. How is a Brazilian firm, faced with an annual interest rate of 70% in November of 1986, supposed to make a proper investment decision when 90 days later the actual interest rate on loans soars to 550%? Neither indi viduals nor businesses can be heavily leveraged since interest rates are so unpredictable. It is enough to cause even the best laid plans to fall apart.

Once hyperinflation becomes a reality, poli ticians inevitably succumb to the lure of legis lating it out of existence. During the past de cade, Argentina, Bolivia, and Brazil all at one time or another addressed their hyperinflation problem with the simplest of solutions; they outlawed it. While government intervention often has a short-term salutary effect, making it irresistible to politicians, in the end all govern ments-including our own-have had to con clude that more fundamental solutions are needed to attack the root of the problem, not just the symptoms. In 1986, President Jose Sarney of Brazil, in an attempt to do something dramatic about an inflation rate that threatened to soar to 500% or more, instituted an anti-inflation program that froze prices, controlled wages, and lopped three zeroes off the Brazilian currency. The plan succeeded in temporarily curbing infla tion, but higher prices were quickly replaced by other problems. Severe shortages of daily ne cessities such as eggs, meat, and milk developed. Black markets quickly filled the vacuum, resulting in higher prices that didn't show up in official inflation figures.

White-collar crime inevitably increased as well, as a never-ending spiral began, with the government implementing a maze of regula tions and citizens just as quickly developing in novative strategies to evade them. One distrib utor of heavy machinery told us that because used equipment is not subject to wage and price controls, he routinely leases for a month or two, then turns around and sells the equipment at twice its original price. Many companies get around wage controls by giving their em ployees loans that are not expected to be re paid. In all three South American countries we are studying, this kind of subterfuge, necessary as a means of survival, gives a sense of legiti macy to breaking the law, threatening a na tion's moral fiber. "Inflation," a top South American officer of the Bank of Boston told us, , 'is an immoral tax that leads to immoral values. " Because hyperinflation can so easily become a way of life, the best-some might say the only-foolproof solution is to avoid it in the first place. Once underway, hyperinflation can only be thwarted by a painful reduction in gov ernment spending and by a halt to the printing of money not backed by the production of real goods and services. As the noted author Peter Drucker likes to say, "You can't consume what you haven't produced. "

Hyperinflation is by no means a certainty for the United States, but we have managed to create conditions conducive for its arrival. In investigating what the lessons from South America can teach us, we have taken a "What if?" approach. As a further caution, however, it is important to note that in coping with hy perinflation, South America has had one weapon at its disposal that would be unavail able to us. At least these countries have a world currency to fall back on. The U.S. dollar pro vides them with some measure of stability. But in the event of hyperinflation in the United States, what currency could we tum to? 0 11 Invasive Government and the Destruction of Certainty by Ridgway K. Foley, Jr. L aw exists. It exists in the inexorable rules of consequence which govern the universe, including the inescapable rules attendant upon human action. It exists in posi tive or man-made rules and orders imposed by human beings, acting singly or in concert, upon other men.