1+1+1+1+1 = -79,600,000,000

We all have a few perceptions in our lives. When I say India, different people will have things that pop into their heads. It might be the characteristics of a young and growing economy, or the match that we lost a few days ago, or the traffic. A couple different things would pop up when I say the United States. But what is the first thing that comes to mind when I say Zimbabwe? Surely not the fact that they missed qualifying for the World Cup twice in a row. When I hear Zimbabwe, I immediately think about two things: Robert Mugabe and hyperinflation. Even though Mugabe had a lot of interesting stories that we can discuss, I am going to stick to hyperinflation. 

One of the worst types of inflation that an economy can face is hyperinflation. As the name suggests, Hyperinflation is used to describe situation where prices of all goods and services rise uncontrollably over a defined time period. In other words, it is extremely rapid inflation. Generally, inflation is termed hyperinflation when the rate of inflation grows at more than 50% a month. Hyperinflation generally occurs when there is significant rise in money supply that is not supported by economic growth. Let me put forth an equation for you. 

   

M stands for the money supply. 

V stands for the velocity or the exchange of money. 

P represents the prices. 

Y represents real GDP 

This equation should always be balanced. When M rises or the money supply in the economy rises, the following right-hand side should experience growth as well. Either the prices should rise or the real GDP. Consider the RBI policy on interest rates. When Mr. Shaktikanta Das announces either an increase or a decrease in interest rates, he is basically playing with the M on the LHS. If he increases the interest rates, M goes down as the supply of money goes down, and hence the RHS experiences a decrease in terms of either a decrease in P (prices of goods and services) or Y (real GDP). When this equation does not balance out, we face severe consequences, and hyperinflation is one of them. The increase in money supply is often caused by the government printing and injecting more money into the domestic economy or to cover budget deficits. When more money is put into circulation, the real value of the currency decreases, and prices rise.

 

Hyperinflation quickly devalues the local currency in foreign markets as its relative value in comparison to the other currency drops. This situation will drive holders of the domestic currency to minimize their holdings and switch to a more stable currency. In an attempt to avoid paying higher prices tomorrow, individuals typically begin investing in durable goods such as equipment, machinery, jewelry, etc. In situations of prolonged hyperinflation, individuals will begin accumulating perishable goods. However, the practice causes a vicious cycle: as prices rise, people accumulate more goods, in turn creating higher demand for more goods and further increasing prices. If hyperinflation continues unabated, it nearly always causes a major economic collapse. I wish someone had enlightened Zimbabwe about this. The Zimbabwean currency would have been in circulation instead of wearing a batch of suspended currency.

A decade ago, during the financial crisis, Zimbabwe recorded the second highest incidence of hyperinflation in history. The country's inflation rate for November 2008 was a staggering 79,600,000,000% (essentially a daily inflation rate of 98%). The price in Zimbabwe nearly doubles every day. Goods and services would cost twice as much each following day. With the unemployment rate exceeding 70%, economic activities in Zimbabwe virtually shut down and turned the domestic economy into a barter economy. It was like reliving the Stone Age for the residents of Zimbabwe.

The cause of hyperinflation in Zimbabwe was attributed to numerous economic shocks. The national government increased the money supply in response to rising national debt. An increase in the domestic money supply decreases the debt but devalues the currency, leading to a vicious cycle. The rise in money supply wasn't supported by a rise in output and exports, leaving the above-mentioned equation imbalanced. Hyperinflation in Zimbabwe spiraled out of control, causing a foreign currency to be used as a medium of exchange instead of the Zimbabwean dollar. Even Mugabe was to blame for the hyperinflation in Zimbabwe. He kept on printing the currency in order to distribute "Free Bees" to gain votes. I guess nothing good is ever free. As usual, the citizens are the ones who pay for these economic collapses, and the rich are always untouched.

 

  

THE CONSEQUENCES: 

A. People weren't able to afford basis goods:  The country had worst of both worlds - prices rising faster than wages and incomes. People become "poverty billionaires". It was no good having a salary of one billion dollar if a loaf of bread cost two billion dollars. 

B. No credit available: The entire financial system become undermined, banks closed and were unwilling to lend any more. Due to the rising prices, the value of debt could be soon wiped out. But this meant business and individuals had no access to credit. 

C. Menu cost: With inflation almost doubling through the day, anyone who received money had to exchange into foreign currency or spend straight away. Bus commutes were one price in the morning, and much more expensive on the way back. People had to spend time adjusting prices, but more importantly get rid of Zimbabwean currency as soon as you received it. 

D. Lost savings: Anyone with savings lost everything unless they were able to exchange with foreign currency. Even people with assets and property often saw the value shrink. Foreign currency controls make it very hard to take money out of the country. 

E. Damage to business confidence: The extent of hyperinflation and fall in output disrupted normal economic activities and saw Zimbabwe GDP shrink. It affects investor for a long time. 

I believe Mugabe once blamed inflation on "greedy businesses" demanding price rises. This encouraged him to set up price control. But, as mentioned, these have been ineffective in preventing inflation. Other Mugabe supporters have tried to blame inflation as a "Western import". Although this assertion was rather bizarre given that inflation is relatively low in western economies. 

 

Finally, in 2009, the government of Zimbabwe abandoned printing the Zimbabwean dollar entirely. This implicitly solved the chronic problem of a lack of confidence in the Zimbabwean dollar and compelled people to use the foreign currency of their choice. Since then, Zimbabwe has used a combination of foreign currencies, mostly the US dollar.