Hyperinflation and Entrepreneurs: An Examination
There are few disasters that can befall a nation more grievous than hyperinflation. Hyperinflation, however, is unique. Unlike war or famine, where the force of destruction comes from without, during hyperinflation the source of destruction comes from within. This implosion is a necessary result of the corrosion of the value of money.
When the value of money is destroyed, no aspect of society is left untouched. In every nation that endures it, it marks both the people and the culture in ways unique to only hyperinflation. The memories of long lines for food, uncertainly about the near future, and scarcity of basic necessities are difficult to forget.
Out of all the effects of hyperinflation, one stands above them all as the most destructive. Namely, the effects hyperinflation has on the entrepreneur. The rapidly declining value of money affects everyone in society, but it affects the entrepreneur in a specific way. Rapidly declining values of money make it difficult to keep accounts of profit and loss. Without a method to determine profit and loss, disaster is shortly to follow.
To illustrate these effects, let us look at the normal functions of an entrepreneur. Entrepreneurs provide goods and services to consumers. In order to do this, they have to purchase different resources, often referred to as the “factors of production”, in order to provide those goods and services.
Entrepreneurs receive income from the purchase of their goods, which is used to buy factors to produce more goods. Profit is anything that is left over. To end the process with as much profit as possible is the goal of every entrepreneur. This means that entrepreneurs will discontinue products or lines of production that are not profitable and move into ones that are profitable.
However, this entire process runs into trouble under conditions of hyperinflation. All around the entrepreneur, prices are rising. This means that the prices of the entrepreneur’s factors of production are rising as well. When consumers approach him with large bundles of money in their hands, he must raise his prices as well.
However, not all prices are being raised at the same times in the same amounts. The prices for the entrepreneur’s factors of production might be rising much faster than the entrepreneur can raise his prices. The opposite could be true as well. Is the increase of costs over revenue a product of hyperinflation or are his products truly unprofitable? The entrepreneur has no way to know. He could change his production, or he could wait and hope that prices will stop rising so quickly for the factors of production that he needs.
The difficulties here should be apparent. When the value of money is constantly changing, it makes determining profit and loss very difficult. As the hyperinflation accelerates and prices change more and more quickly, determining profitability, as well as the logistical issues of transporting and accounting for large sums of money, becomes increasingly difficult, bordering on impossible.
Experience during the Weimar Republic’s hyperinflation in 1922-23 attests to the difficulties of the entrepreneurs. Adam Fergusson in his “When Money Dies” states:
“In the month following May 20 [of 1923], the price of an egg rose from 800 marks to 2400; of a litre of milk from 1800 to 3800, of a kilo of milk from 2400 to 6600, of pork from 10400 to 32000…Tradesmen could not know how to establish prices, and often simply shut up shop.” (Fergusson 142)
As the rate of inflation continued to increase, businesses were eventually compelled to stay open by the government for fear that they shut down. Fergusson says:
“Business had become virtually impossible, and shopkeepers who kept going were subject to a new ordinance – promulgated on October 22 – compelling them to keep their shops open and to offer goods in exchange for marks.” (Fergusson 197)
Businesses may resort to foreign currencies to try to restore a sense of stability and make calculation of profit and loss feasible again. Philip Haslam and Russell Lamberti, writing about the hyperinflation in Zimbabwe in 2008, recorded that:
“As the Zimbabwe dollar became less useful to trade with, people found substitutes. The government had banned the use of foreign currency, under pain of arrest, and made it illegal to record transactions in anything other than Zimbabwe dollars. Despite this, many continued to receive foreign currency from their offshore relatives.” (Haslam and Lamberti 168)
While calculation of profit and loss is difficult enough under conditions of hyperinflation, the government can make the situation even more difficult. This can be done through price controls, nominally inflicted to try and curb the inflation the government itself is promulgating. The Zimbabwean government, during their hyperinflation crisis in 2007-8, did just this. Haslam and Lamberti write:
“Hyperinflation pushed retailers to bankruptcy. As store owners raised prices to stay in business, the government fought back with price controls in warlike fashion. The Price Control Commission was set up to regulate prices. Hundreds of store owners were arrested for trying to stay in business, being accused of ‘profiteering’.” (Haslam and Lamberti 126)
While we can understand why hyperinflation would make the job of the entrepreneur quite difficult, what makes it so destructive for society as a whole? It is because when the functions of both profit and loss are inhibited, the entire system of production and its method for allocating resources is paralyzed.
Entrepreneurs always are looking to make a profit. This occurs when their revenue is greater than their costs. However, both revenue and costs carry greater implications. The revenue of a business is a function of the degree to which consumers value the goods or services sold. If they value it very highly, revenue will be relatively higher. If they do not value it highly, revenue will be relatively lower. Either way, it reflects that valuations of the consumers.
Costs carry a similar significance. The factors of production that an entrepreneur bids for are also desired by other entrepreneurs. There are often many entrepreneurs bidding for the same resources, but have plans to utilize those resources in very different ways. A market price is reached according to the supply of the factor in question and the demand for that factor. Some entrepreneurs, those willing to pay highly enough, receive the factor, while those who with less to pay do not receive the factor.
When we view revenue and costs together, they both act in tandem. Revenue comes in from the sale of goods or services. The entrepreneur then uses this revenue, representing the value which consumers place on his goods or services, to buy factors of production to continue making those goods. However, he can only bid for factors to the extent that he has been paid by consumers to do so. Thus, if the consumers were to value his goods or services less, he would be left with less money with which to buy factors.
This applies for every entrepreneur that is bidding for factors. Thus, every entrepreneur is going to the market for factors with the money given to him by the consumers. If an entrepreneur’s goods or services are valued relatively lower than other goods, he may not have enough revenue to buy factors to continue producing his goods. In this case, his costs would be exceeding his revenue and he would be taking a loss. He would be priced out of the market, and other entrepreneurs will receive factors that he did not.
It is through this mechanism that resources are allocated to entrepreneurs based on the wishes of the consumer. Entrepreneurs receive income from consumers, and take that income to the factor market to purchase factors. If they have enough revenue from consumers to buy factors, they will be making profit, or at least breaking even. If not, they will be taking a loss. Entrepreneurs will move into lines of production where profit can be made, which will be those that best satisfy the consumer, and move out of lines of production where losses are taken, which will be those that do not satisfy consumers. It is in this way that the functions of profit and loss carry the society-wide implication of allocating resources to the wishes and desires of consumers.
This is the mechanism by which resources are allocated out among entrepreneurs according to the wishes and desires of the consumers. However, under hyperinflation, as we showed above, this entire mechanism goes awry. When entrepreneurs cannot calculate, there is no way for this allocation process to operate efficiently. Without a method for calculation, there is no method for resources to be allocated according to the dictates of the consumers.
At the point at which calculation is impossible, many businesses will simply shut down. This is attested to by Fergusson above. Fewer and fewer goods come to market. This results in the shortages of basic necessities that are associated with the specter of hyperinflation. Fergusson relays this sentiment well at the end of his work on German hyperinflation when he states:
“In war, boots; in flight, a place in a boat or a seat on a lorry may be the most vital thing in the world, more desirable than untold millions. In hyperinflation, a kilo of potatoes was worth, to some, more than the family silver; a side or pork more than the grand piano. A prostitute in the family was better than an infant corpse; theft was preferable to starvation; warmth was finer than honour, clothing more essential than democracy, food needed more than freedom.” (Fergusson 256)
It is this destruction of business that makes the impairment of economic calculation so intolerable. All other effects of hyperinflation: uncertainty about the future, logistical problems of dealing with ever-higher prices, etc. could all be theoretically tolerable in the long run. However, once the entrepreneur is unable to fulfill his task of bringing goods and services to market according to the wishes of consumers, hyperinflation must be ended or modern society itself will perish.
Ludwig von Mises states in Human Action: “What economic calculation requires is a monetary system whose functioning is not sabotaged by government interference.” (Mises 223-224) Hyperinflation is the greatest actualization of the government’s power to interfere. Likewise, when the government exercises this power to its greatest extent, it will wreck the greatest magnitude of destruction. Economic calculation is the lifeblood of an economy, and thus, of the material means of society. Without it, nations will rot from within.
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