How do countries end up with worthless currency? Like countries who’s dollar bills lie on the ground or are burned for warmth because it has no purchase power anymore

Question

How do countries end up with worthless currency? Like countries who’s dollar bills lie on the ground or are burned for warmth because it has no purchase power anymore

In: 174

Answer 1

I see comments that say things like “they print too much money.” We have to be careful here. “Print” (mostly) does not mean physically making some metal coin or paper bill.

There are plenty of ways to create new money without printing a single new bill. There are lots of details, but in the spirit of ELI5, most of them boil down to one of two ways.

1. The government simply decides that there is more money, usually to pay off its own debts. There will be lots of technical steps and theory, but at the end of it all, the government made an explicit decision to, say, double the amount of money in the system.
2. The government wants to encourage growth. This will speed up how fast people earn and spend money. This is often called “velocity”. The higher the velocity, the more money the system has. Let’s say we both have a dollar. I give you a dollar to make a bracelet, and you give me a dollar to make a hair brush. Now we both still have a dollar *plus* goods that are each worth a dollar. Now imagine we do this 4 times instead of just once in the same amount of time. It’s like we each had 4 dollars to spend instead of just 1.

Either way, if the amount of money in the system gets ahead of how much is actually being produced, the value of the money starts to drop to compensate.

Additionally, once this type of inflation starts to take off, everyone expects that it will remain and will start demanding more money for their goods and services as well as trying to spend the money they have as fast as possible. The smart 5 year old will realize that this is only going to increase the velocity even more, which is part of why we got in this mess.

If nothing is done, inflation might begin to feed on itself, eventually becoming hyperinflation where money is losing value faster than you can spend it.

At this point, the printed bills cannot possibly keep up with the drop in value. And at some point, the incremental value of burning the money for heat is higher than the printed value.