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Prices rose 8.6% between May 2021 and May 2022, the largest 12-month gain in the Consumer Price Index (CPI) since 1981. The May CPI report was only the latest 40-year high in the different measures of U.S. inflation rates.
The growing inflation surge after decades of price stability puts everybody on edge. In some quarters, people have even started talking about inflation’s wild first cousin, hyperinflation.
What Is Hyperinflation?
Hyperinflation is a rapid spike in extreme inflation, usually at a rate of at least 50% per month. This would equal an inflation rate of about 14,000% per year.
Some definitions refer to hyperinflation as “out of control” price increases. In a hyperinflationary environment, you could pay $5 for your morning coffee and $6 for the same cup of joe by the afternoon.
“Hyperinflation is a rare occurrence, and historically has only taken place when a confluence of factors collide, like poor monetary policy, corrupt governments and unstable economies,” says Daniel Milan, managing partner at Cornerstone Financial Services.
What Causes Hyperinflation?
Hyperinflation is caused by a rapid increase in a country’s money supply, typically when a government creates more and more money. As more money becomes available, the value of each individual unit of currency drops and prices rise.
“Often you see hyperinflation happen in times of war, which leads to economic turmoil, combined with excessive money printing by a country’s central bank,” Milan says. “This leads to a disconnect in supply and demand economics.”
Hyperinflation can also occur when a sudden increase in demand outpaces supply, called demand-pull inflation, or people lose confidence in a country’s monetary system.
“In all cases, goods become scarce, causing the price of goods to increase rapidly,” says Brian Graeme, manager of alternative manager research of GuideStone Capital Management.
What Are the Effects of Hyperinflation?
For individuals and economies, the effects of hyperinflation can be devastating. The prices of consumer goods rise too fast for wages to keep up, leaving consumers unable to pay for basic necessities.
“Hyperinflation will generally cripple the economy and at times cause a full collapse of the economic and monetary system,” says Brian Stivers, investment advisor and founder of Stivers Financial Services.
This collapse can occur in many ways, he says. People may begin hoarding products out of fear of future price increases or reduced supply, which exacerbates hyperinflation by creating even greater shortages, Stivers says.
People’s cash savings lose all value. This can cause the entire banking system to become destabilized as the loans banks hold lose value and depositors withdraw funds or stop making future deposits. The value of the nation’s currency can even collapse.
Milan says that an economy faced with hyperinflation will often fall into a deep recession or even depression.
How Is Hyperinflation Resolved?
Once hyperinflation has taken hold, it is not easy to correct. Countries have attempted various means of combating hyperinflation.
“The most common ways are drastically reducing government spending,” Stivers says. “This can create enormous pain, as all forms of spending often need to be slashed including social spending, military spending (and) subsidies.”
Hyperinflation can also be corrected by drastically cutting the money supply. However, this makes interest rates rise dramatically, making it difficult for consumers to make large purchases, such as buying a new house or vehicle.
“Some countries that have experienced hyperinflation have gone to the extreme of replacing their currency with a more stable foreign currency,” says Graeme.
This was the path Ecuador took in 2000 when it replaced its currency, the sucre, with the U.S. dollar. Similarly, in 1991, Argentina created a new version of its currency tied to the U.S. dollar, helping to stamp out hyperinflation.
Is the U.S. Headed for Hyperinflation?
Despite surging inflation, experts do not believe the U.S. is headed for hyperinflation.
Graeme is “highly confident” that the U.S. is not heading for hyperinflation for two reasons: First, the U.S. inflation rate remains materially less than the 50% per month required to meet the definition of hyperinflation.
Even with U.S. CPI running at 8% growth year over year, the current rate is less than the 50% per month that experts regard as the threshold for hyperinflation.
The worst inflationary period in the U.S. was during the 1970s and 1980s when annual CPI inflation reached 12.4% in 1980. Even then, the country did not fall into hyperinflation.
The second reason the U.S. isn’t heading for hyperinflation is that the Federal Reserve is actively reducing the supply of money. “This should make it extremely unlikely for inflation to materially increase from current levels, let alone reach the status of hyperinflation,” says Graeme.
The U.S. form of government, with its separation of powers, also makes it unlikely the U.S. will experience the hyperinflation typically experienced by countries ruled by a dictatorship or a repressive government.
“An argument can be made that all things are political to some degree, but there is a clear separation of powers between the Fed and the government that allows the Fed to act independently from the political forces with specific agendas,” he says.
How Can Investors Prepare For Hyperinflation
While it remains unlikely the U.S. will experience hyperinflation, it is still important to plan for inflation in your portfolio, especially if you’re investing for long-term goals like retirement.
“The best thing investors can do is to construct a balanced portfolio and stay prudently invested,” Graeme says. “This includes holding both U.S. and non-U.S. assets and real assets such as real estate and commodities.”
Real estate can be an effective hedge against inflation because rents, occupancy and demand for real estate all tend to rise with inflation. Commodities returns also tend to be positively correlated with inflation.
Treasury Inflation-Protected Securities (TIPS) can also serve as inflationary hedges as the principal is adjusted based on changes in the CPI. If inflation rises, the principal on a TIPS bond will rise proportionately, helping protect the purchasing power of future bond payments.
Fixed income investors concerned about inflation should avoid committing to long-term certificates of deposit (CDs), fixed annuities or other fixed income products that are not adjusted for inflation like TIPS, Stivers says.
“During high inflation and hyperinflation, it is likely that the Fed will keep raising interest rates dramatically,” he says. “Therefore, fixed-rate savings will continue to increase. Staying with shorter-term periods of one- to three-years may be preferable versus five- to 10-year rates of return.”
Another option is to invest in a mutual fund or exchange-traded fund (ETF) that actively invests to generate returns during an inflationary period, says John Richardson, chief operating officer of Ionic Capital Management.
For example, a fund may use inflation swaps based on CPI. These are swap contracts designed to transfer inflation risk from one party to another.
How to Budget for Hyperinflation
You should also look closely at your personal balance sheet and budget.
“Inflation and hyperinflation will make the value of saving worth less,” Stivers says. “So, it may be a good time to take savings and pay off debt so that as the interest rates rise to combat inflation, you will have less debt service to absorb.”
He suggests reducing any personal debt you have with variable interest rates, like credit cards, home equity lines of credit (HELOCs) and variable rate mortgages, or converting to a fixed rate if possible.
You’ll also want to check your budget for areas where you can cut back to produce extra cash flow, as this will help absorb the rising cost of goods. “This could be things like eliminating a gym membership, reducing cable or internet costs, eating out less, shopping wholesale, carpooling or [downsizing] the cost of your vehicle,” Stivers says.