06 August 2008

Zimbabwe Suffering Yet Again

Zimbabwe, where president Robert Mugabe recently resorted (yet again) to violence to thwart a chance at democracy, is now suffering from hyperinflation. The official figure is 2.2 million percent, but others say it is closer to 12.5 million percent.

Here's my favorite line, from a Newsday article.
"The central bank, overwhelmed by stratospheric inflation..."
Hmm, the central bank is "overwhelmed" by inflation. Let's try a simple syllogism.
1. Inflation is caused by too much money chasing too few goods--i.e., a surplus of money in the economy.
2. Central banks determine how much money is in the economy. Therefore,
3. Central banks control inflation (as Paul Volcker demonstrated so painfully, but so necessarily, in the U.S. in the early 1980s).
But the Zimbabwe bank's response? Print more money, in larger denominations. Here's more evidence they didn't take the right economics courses:
The bank attributed black market inflation to shortages of hard currency that pushed the black market exchange rate to at least 90 billion Zimbabwe dollars for a single U.S. dollar, compared to the official bank exchange of 20 billion to dollar.
Since value is based on relative supply and demand, there's no way in hell that a shortage of hard currency could reduce its value so dramatically. USD1=ZD 90,000,000,000?! The quickest way to reverse that imbalance is not to cut zeros off the currency--the classic but useless response of hyperinflating governments--but to dramatically reduce the number of Zimbabwean dollars in circulation.

The real reason goods are flowing to the black market is not because of a shortage of hard currency, but a sufeit of it. By flowing to the black market, sellers can demand payment in U.S. dollars, a far more stable currency more likely to hold its value. It's not rocket science--if you're a seller of goods, would you rather receive payment in a currency that's likely to still be worth as much tomorrow, or in a currency that's likely to be worth half as much--or less--tomorrow?

And of course the people who suffer from their government's ungodly combination of evil and stupidity are the average citizens, who've done nothing to deserve any of this.

But it could be worse, I suppose. Zimbabwean citizens could be at the mercy of a capitalist system in which Wal Mart comes into their communities and relentlessly drives prices down.


Scott Hanley said...

So what is the remedy for hyperinflation? You can't really take 99.9999% of the cash out of circulation, can you?

James Hanley said...

The remedy is to reduce the money supply. If only .0001% of the money is what's necessary to purchase all the goods in your economy, then yes you could take out 99.9999% of it.

Of course it matters not only how much you take out, but how quickly you take it out. If you take it out too quickly, you create more severe disruptions (although there's no a priori reason to think they're worse than the current disruptions), and if you take it out too slowly then you don't demonstrate credible commitment to killing inflation.

I imagine it's a Goldilocks problem--you really want to do it just right. But the short answer to your question, leaving aside specific percentages, is, "yes, you really can take a substantial amount of money out of circulation--especially when that amount is unnecessary to keep the economy running smoothly, and is so much that it distorts the market.

That is exactly what Volcker did at the end of the Carter/beginning of the Reagan presidencies--take money out of circulation (specifically, I think, they reduced M1). It caused a temporary, but painful, recession, but killed inflation.

James K said...

The best way to remove money is to push interest rates way up. It hurts like hell, but it brings things under control.