Hyperinflation is defined as a very high and often accelerating rate of inflation. When a country experiences hyperinflation, the results are typically disastrous. This chart shows the hyperinflation of the German Mark in 1923.
Some inflation is typically the sign of a healthy economy. Inflation signals a rise in the general cost of goods in a specific currency. As long as inflation can be stable in a low to moderate range, an economy and currency can function normally. In the US, the Federal Reserve has set 2% as its inflation rate target to help sustain growth.
Hyperinflation is when the inflation rate rises rapidly over a short period of time. In this event the prices of all goods increase, which quickly erodes the value of a currency. Because of this, people lose confidence in the currency, and switch to using more stable currencies. In modern times this equivalent has been the US dollar.
The reasons behind hyperinflation are numerous. The most typical example though is due to governments increasing currency creation (ie. printing more money) to finance budget deficits. The increase in money supply leads people to get rid of their holdings in that currency, thus increasing the money supply even further. This exact scenario is what happened to the German Mark in 1923 under the Weimar Republic.
Hyperinflation of the German Mark in 1923
Germany faced staggering reparations in the aftermath of World War I. The Treaty of Versailles required them to make payments to the allies in gold or foreign currency in specified amounts. Germany’s gold reserves were depleted from financing WWI and thus had to make payments via foreign currencies.
Prior to this the German Mark had already seen significant devaluation. In 1914 (prior to the war) one US dollar was worth ~4 marks. By June 1921 this had risen to ~63 marks per dollar. June 1921 was when the first reparation payment was due. From this moment on, the currency spiraled out of control.
Just 4 months later the marks value had been cut in half to ~124 marks per dollar. A little over a year later in January 1923, 6,890 marks were worth one dollar. By the end of 1923, 3.43 billion marks equaled one dollar. The mark became so volatile that prices on restaurants menus would change mid meal. In some cases, Germans used the marks as kindling for their fires, as this was cheaper than using the Mark to buy wood.
Eventually, a new currency was introduced in 1924 to help stabilize prices and the German economy. Though the hyper-inflationary period was over, the trauma experienced by German citizens would have lasting effects. This legacy would eventually lead to World War II.
Source: UC Santa Barbara