Does existing debt at a fixed rate in local currency really just functionally disappear? What about variable rate loans – do rates get up in the 100s or 1000s? Do all new lending activities cease, or are they issued in a different currency? Do credit cards stop working? And how is all this money entering the economy? If, in the example of bolivia, the bolivar is losing 99% of its value in less than a year for multiple years, then are employers re-calibrating salaries like every week?
In: Economics
Yes, if a currency is subject to hyperinflation, then debts owed in that currency quickly become effectively worthless.
Some institutions try to stay on top of this by keeping interest rates locked with the inflation rate, but this becomes untenable fast, the true inflation rate can move a lot faster than any central bank is even able to measure it.
Variable rate loan contracts will specify some terms under which the interest rate can change, but usually the contract terms don’t simply allow the lender to decide on a new interest rate whenever they feel like it. It’s common for such loans to update based on the prime rate either monthly or annually, which might be way too slow to recoup the value lost. So if inflation is moving fast enough, they’re generally out of luck.
For those who hold debt at fixed rates, yes, in a hyperinflationary environment, the debt is functionally depreciated to insignificance. But new debt in the local currency is incredibly hard to come by, and households and businesses start to hoard and basically get rid of cash as fast as they can. Governments almost inevitably target exporting companies and force them to convert their foreign currency earnings into domestic currency at some unrealistic exchange rate. This essentially kills the goose that lays the golden eggs.
In this kind of environment any kind of business that relies on anything but the shortest supply chain cannot do business. Their suppliers cannot hold on to prices because the raw material supplier is raising prices. So all forms of sophisticated industry (essentially the higher value add ones) perform badly leaving only really simple ones like mining, farming and basic food production.
Of course, the next page will be imposing capital controls, price controls and subsidies (to placate the masses). Favored parts of the government (ie the ones holding the guns) will be given access to privileged prices. Rationing occurs to prevent hoarding etc. This is, of course, immensely destructive to private enterprise. Everyone wants to work for the government (who can print money). Private firms simply go out of business because they can’t adjust prices fast enough to cover increasing wage demands. The only employers left will be ones that the government supports.
Yes, debt burden gets reduced by inflation. In countries where high levels of inflation or currency fluctuation happen, large ticket items typically financed are priced and transacted in stable currencies like Dollars. So even if Mexico uses Peso as their currency, buying a may take place in U.S. dollars.
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