A Brief History of Zimbabwe

Prior to 1980 Zimbabwe was knows as Rhodesia and was technically a colony of the United Kingdom.  In 1980 Rhodesia declared independence and called itself Zimbabwe.  The United Kingdom agreed with them and there was all sorts of pomp and circumstance around the event.  A man named Robert Mugabe was the Prime Minister after independence was declared and in 1987 became the first President of Zimbabwe.

Rudy’s Note: As you can probably gather from his long time in office, Mugabe hasn’t really been the most fair towards his competition.  In fact until 2008 elections were rigged even if anyone actually ran against him.  In 2008 Mugabe lost the election, but forced a runoff and used violence to intimidate his opponent into withdrawing from the elections.  What a great guy!

In an attempt to quell public and international outrage Mugabe agreed to put the other guy into the old Prime Minister position as a form of power sharing.  Strangely enough within months of Tsvangirai being sworn in, him and his wife were in a “car accident” that killed her and significantly injured him.  Coincidence?

At the time of independence Zimbabwe had a thriving agricultural economy augmented by significant mineral and gemstone mining operations.  While there were economic sanctions on exports prior to independence, once those were raised there was a significant economic boost exceeding 20% for several years.  By the mid 1980s the economy flattened out and overall for the decade of the 1980s Zimbabwe’s GDP grew by a little over 4%.

Ethnic  and Political Conflict Prevails…

Throughout the 1980s ethnic conflicts between whites and blacks escalated.  The constitution provided that 80% of the parliament seats would be held by blacks and the balance could be held by whites and other ethnic minorities.  In 1986 an amendment was made for that 20% to make them nominated positions instead of elected positions.

During the ’80s a form of martial law ruled, with ethnic militias and armies continuing to escalate into what eventually became a civil war.  As Zimbabwe continued to descend into single party rule health declined, with up to 25% of the population being infected by HIV.

After economic conditions triggered a series of strikes and protests by workers, students, and minorities the government continued to crack down and exert even more control.  In 1997 Mugabe began trying to redirect the anger to the white farmers which accounted for less than 1% of the population but owned 70% of the farm land in Zimbabwe.  Mugabe decided to begin forcibly redistributing that land to blacks, exiling or imprisoning the white farmers that owned the farms.

This promptly began a massive food shortage that continues today.  Not a surprising result when you take land away from those that made Zimbabwe the bread basket of Africa and handed it over to people who had no idea what to do with it.  Annual wheat production in 1990 was over 300,000 tons but it has dropped to less than 50,000 tons in 2007.  That’s production, not exports.

Rudy’s Note: Jesse Jackson commented on the forced eviction of white farmers in 2006, saying “Land redistribution has long been a noble goal to achieve but it has to be done in a way that minimizes trauma.” Don’t think this couldn’t happen here.  Land, possessions,  or money, there’s plenty of folks in this country that believe in the redistribution of wealth.

Rampant inflation begins

Throughout the 1990s inflation fluctuated between 15% and 48% according to official government numbers.  The government continued to strong arm the economy by implementing price and wage controls, running deficit spending, and actively discouraging (violence anyone?) the creation of new businesses.  In the early 1990′s the Zimbabwean Dollar (ZWD) was devalued by 40% followed by the government dropping price and wage controls in an attempt to reign in inflation and increase production.  Despite this rampant deficit spending continued which undermined any gains made by relaxing the stranglehold on the economy.   In 1999 the GDP growth went negative and it’s been there ever since.

Enter hyperinflation

Hyperinflation began in 2001 with the rate of inflation skyrocketing to 112%, capping out at over 600% in 2004.  There was a brief respite in 2004 and then inflation headed for the moon.  In 2006 the central bank of Zimbabwe kicked the printing presses into overtime and printed 21 TRILLION ZWD to pay off foreign debt, followed by another 60 TRILLION ZWD a few months later to finance a wage increase of 300% for government employees.  Conveniently none of this was budgeted.

In order to get out from under this the government decided that the current version of the ZWD was abolished and a new ZWD was issued.  A minor side note on this new currency was that in the process they somehow lost three zeroes.  In other words, the old 1,000 ZWD note was a 1 ZWD note with the new currency.  How convenient!

Proving that Mugabe doesn’t believe in Supply and Demand, in 2007 the government passed a law banning inflation.  Raising prices was now illegal and merchants who raised prices anyhow were arrested and imprisoned.  It didn’t help and inflation went from 1,281% at the beginning of 2007 to 66,212% at the end.  Wages were officially frozen and a ZWD $200,000 note was in common circulation.  Due to the price controls merchants simply stopped selling and workers stopped working.

In 2008 things got really interesting.  Since so much happened that year I’ll bullet point it.  It’s easier to read that way!

• In January inflation hit 26,470% and ZWD $10,000,000 notes were in common circulation.  They were worth about USD $4.
• In April, a ZWD $50,000,000 note was issued, worth about $1.20 USD
• In May inflation hit somewhere between 165,000% and 400,000%.  New bank notes were issued worth ZWD $100,000,000 and ZWD $250,000,000.  Ten days later the central bank issued a ZQD $500,000,000 note worth about $2 USD.
• In July the official inflation rate was 355,000% though independent estimates were 8,500,000%.  On July 4 at 5pm a bottle of beer cost ZWD $100,000,000,000.  An hour later that bottle sold for ZWD $150,000,000,000.
• On July 15th the government admitted that they were running out of paper to print money and Germany was reluctant to provide more.  The official inflation rate was now 2,200,000%.  The central bank issued a ZWD $100,000,000,000 note.
• On July 30th the government conveniently slashed 10 zeroes off of everything, so ZWD $10,000,000,000 became ZWD $1.  All old currency was now worthless.
• In November a study was released saying that annualized inflation in Zimbabwe was 89.7 sextillion percent.  I didn’t know what that number looked like so I typed it out.  That’s 89,700,000,000,000,000,000,000%.  Prices increased 6,400% between November 7th and 14th.
• In the first part of December a new ZWD $100,000,000 note was issued.  A few days later the bank was forced to issue a ZWD $200,000,000 note.  Daily cash withdrawals from banks were capped at ZWD $500,000, or about $0.25 USD.

Things continued to slide in 2009 and at this point much of the black market had moved to using foreign currency instead of the ZWD.  In early 2009 the government acknowledged this and licensed a number of retailers to officially sell goods using foreign currencies.  At this point most people refuse to accept the ZWD.  Economic production is abysmal, with unemployment rates over 95%.
On January 12, 2009 a ZWD $50,000,000,000 note was issued.  Four days later the bank announced plans to issue 10, 20, 50, and 100 trillion ZWD notes.  This was notably a gap in the series of banknote values as there was nothing between the $50 billion and the $10 trillion notes.  In February 2009 the currency was devalued yet again.  This time 12 zeroes were chopped off.

Rudy’s Note: Over the course of the economic collapse the ZWD was revalued by 25 decimal places.  If this had not happened then $1 ZWD would now be the equivalent of ZWD $10,000,000,000,000,000,000,000,000.  At some point the central banks had to place expiration dates on currency notes to keep up.

Wrapping Up

Zimbabwe is a fascinating case study, and it’s not even done yet.  Since it happened relatively recently we have a tremendous amount of data to study and learn from.  It’s critical to recognize that we MUST learn from this sort of thing to prevent it from happening to us.  The problem is that most people don’t learn from history.  Are we doomed to repeat it?  Let me know in the comments section what you think.

In the deflation article we established that deflation is an overall decline in price, or increase in the value of a given currency unit.  In other words, your dollar goes farther.  We also established that inflation is the opposite of that.  Pretty simple, right?  Your dollar buys less and less the higher inflation goes.

We generally measure inflationary rates according to one or more price indexes.  The one everyone is familiar with is the Consumer Price Index, also called the Cost of Living Index.  Other indices are useful as well when measuring inflation in narrow parts of the economy but we’ll use the CPI for the purpose of this article.  The annual inflation rate is simply the annualized percentage change in the CPI as measured by the federal government.

Inflation is bad, isn’t it?

Not inherently.  Just like deflation, inflation is not good or bad in and of itself.  In fact most economists believe that low steady rates of inflation are a good thing for an economy.  The key is that the inflation rate should stay below the growth rate of the economy at large, or the Gross Domestic Product as we call it here in the United States.  Mild inflation is also key to getting out of a depression or recession.  Mild being the key word there.

On the flip side, inflation can do some bad things.  If inflation begins to rise too high there is a natural response by consumers to spend their money on tangible durable goods before that money is devalued too much.  If you recall in the deflation article we talked about supply and demand and how it drives prices.  If consumers begin buying durable goods, prices go up as demand goes up and that has a circular effect I’m sure you can all see.

Another negative side effect of inflation is something called Cost Push Inflation.  It’s basically the concept that as consumer prices rise, employees demand more and more cost of living increases to keep up.  This is particularly negative with collective bargaining agreements like union contracts and the like which are tied to the CPI.  It can trigger a wage spiral which has the further effect of increasing the inflation rate as businesses raise prices to compensate for higher employment expense, leading to higher wages, ad inifintum.

What happens to debt in an inflationary period?

That depends on the type of debt.  A fixed interest loan, such as a standard mortgage or a contractual loan will become cheaper to pay off.  A variable interest loan will stay about the same in compensated value, but there is a real danger to variable interest rates.  The interest rate will ALWAYS rise faster and farther than your wages will.  Always.

Rudy’s Tip: Inflation adjusted interest rates on fixed interest loans are called ‘real’ rates.  It’s defined as the nominal rate minus the inflationary rate.  So if your fixed interest rate is 8% and inflation is 3% your effective rate is 5%.  If inflation jumps to 8% then you’re essentially paying no interest.  Beyond that and the bank is essentially paying you for the loan.  Funky!

What causes inflation?

Well, if you’re an economist this is where you start talking about the Quantity Theory of Money, the Velocity of Money, Currency Debasement, and other interesting things.  Since we’re in a fiat money economy we’ll limit our discussion to that.  There are really two things that matter in the long run.  The money supply and economic output.  If the supply of money increases too quickly compared to the economy at large that inevitably leads to price inflation based on the law of supply and demand.

Interest rates also play a part here as higher interest rates lead to lower inflation rates and vice versa.  This is why you see a reduction of the federal funds rate in an attempt to kick start the economy.  The theory here is that if money is cheaper to borrow more people will take advantage of that leading to more economic growth and thus higher inflationary pressure.

Great Ceasar’s Ghost!

A random final bit of information here.  I talked about currency debasement in the last section.  Debasement in its purest form is when you take a commodity currency (like a gold coin) and melt it down, then recasting the coin with a lower commodity content.  Most historians believe that debasement was one of the leading causes of the fall of the Roman Empire.  The Roman silver  denarius was 95 percent silver when introduced.  Over a one hundred year period it was debased so far that it only contained 0.5% silver.  Yowza.

Couldn’t happen here, right, since we’re in a fiat system?  Nope.  Debasement basically takes a unit of currency and reduces it’s value.  What do you think the Fed printing presses running overtime does to our currency values?

Wrapping Up

That’s it for inflation!  Conceptually pretty simple, especially after reading the deflation article I wrote.  Next we talk about Inflation Gone Wild.  Also known as Hyperinflation or Something That Keeps Rudy Up At Night.  Stay tuned!

Actually, deflation is neither good nor bad inherantly.  The causes of deflation are the REAL problem.  But I said I’d talk more about what deflation and inflation are.  I decided to write two separate posts on them, starting with deflation as I believe that we are on our way into a deflationary cycle in the United States.

Supply and Demand – A Universal Truth?

I’m going to go out on a limb and guess that most of you understand the basics of supply and demand.  If supply is constant, increased demand will increase prices.  Decreased demand will decrease prices.  If demand is constant, increased supply will decrease prices.  Decreased supply will increase prices.  Pretty straight forward!

Rudy’s Note: Yes, that’s simplified.  No, supply or demand will generally not stay constant.  The relationship is dynamic.  Nonetheless, using this simplified example helps understand it!

Everyone understands that supply and demand works on goods and services we buy all the time.  We see it in our daily lives on a regular basis.  What many people don’t understand is that money is subject to supply and demand as well.  I dabble in currency (Foreign Exchange or Forex) trading and grasping supply and demand as pertains to money is a key factor in successful forex trading.  After just a short time you can look at a chart and see the powers of supply and demand at work on money just like it works on anything else.

This is important because the prices you see in the store are not only related to supply and demand for that individual item or service but also to supply and demand for money.  Thus inflation and deflation are related to both types of supply and demand as they at their core relate directly to the general price index of goods and services in the economy at large.

Deflation vs Inflation

Everyone grasps what inflation is.  You may know it as a cost of living increase, however.  While I will have an article about inflation shortly that goes into more detail, inflation is simply a rise in price as pertains to goods and services.  This is a generalized thing and is often tracked as the average cost of living increase.

Deflation is pretty much the opposite of inflation.  It’s a general decrease in prices.  There are a number of causes and effects of deflation which I will go into shortly.  In the meantime, if you are eyeballing a $100 chain saw at Sears today, and next week it’s $80, that’s deflation.  If instead it’s $120 next week, that’s inflation.   Yes those  numbers are unrealistic and arbitrary but you get my point.

This price reduction (aka price deflation) isn’t such a bad thing if it’s for individual goods and services, but it’s a darn bad thing when it touches the entire economy.

What causes deflation?

There are generally speaking two main causes to deflation.  The first is a reduction of the supply of money or credit.  Remember I talked about supply and demand working for money too?  If the supply of money goes down, the VALUE of that money goes up.  So even if the supply and demand for that chain saw remains the same, if the value of a dollar goes up due to lower supply, the price in dollars of that chain saw goes down.  Deflated price.

Rudy’s Extra Tip: An easy rule of thumb is to recognize that in an deflationary environment your dollar will go farther the longer you hang onto it.  In an inflationary environment the longer you hang onto that dollar the less it’s worth.

The other main cause of deflation is a reduction of economic expenditure.  In other words, people stop spending money.  Back to our supply and demand scenario, if fewer people want that chain saw the law of supply and demand forces that price down.

There is another cause of deflation that is often considered good:  an increased supply of goods.  If the chain saw factory has a breakthrough in efficiency and is able to make more chain saws than they normally would, then that will force the price down as well.  This is often a good thing.

Rudy’s Mea Culpa: If you ask an economist they’ll tell you there are technically four causes of deflation:  decreased supply of money, decreased demand for goods, increased demand of money, and increased supply of goods.  I’m lumping the supply and demand changes of money together as they overall result in ‘tight money’ which means that people want more money than is available.  No, I’m not an economist.  I simplified on purpose!  I hope you don’t mind too much.

What are the side effects of deflation?

Well, there’s one big one that might look a bit familiar.  Sky rocketing unemployment numbers.  If the deflationary cause is related to ‘tight money’ or a lack of economic demand for goods and services then businesses often are forced to reduce their workforce.  This usually results in those now out of work folks spending significantly less.  As the economy continues to contract and businesses continue to reduce their work force the problem compounds.

Add into that credit defaults, wage contraction (supply and demand works for wages too!) and even lower demand for goods and services.  Resulting in more economic contraction and less free money being spent. You have the makings for an economic spiral which can lead to a major economic depression.  NOT GOOD.

Woah.  Going from deflation to depression?

Sorta.  For a deflationary environment to broadly take over and potentially turn deflation into a depression the key factor that must historically be in place is what we call a credit bubble today.  That basically means a big expansion  in the amount of available credit.  As the bubble gets bigger and bigger things look rosy and fantastic.  Nobody expects default, lenders relax standards and lend to people who have no business with loans.

Pop goes the bubble!

A bank run during the Great Depression

When you have a credit bubble forming the signs are obvious.  The cautious and smart economic thinkers will be able to see the signs clearly, but Joe Public usually doesn’t.  Eventually something bad happens in the economy that sets it all off and starts the bubble popping.

Rudy’s Extra Tip: There are two kinds of credit.  Self liquidating credit is something that is paid with interest in a short time.  Something like a business loan, or an expansion loan, etc.  This kind of loan usually adds value to the economy at large.  Non self liquidating credit is your mortgage, car loan, etc.  A loan that is there to acquire an asset or to speculate.  Basically anything that isn’t tied to direct production of a good or service.  When non self liquidating credit forms a bubble and pops, then deflation is FAR worse.  Sound familiar?

The result of this economic death spiral is a recession or depression, formally known as an economic contraction.  Bad news, Batman.

So what happens next?

The central bank steps in and adds more money to the economy.  This must be done in an intelligent fashion though, which is the key problem.  You can’t fire off a big stimulus package and increase government spending because that generally doesn’t hit the economy very well.  On the other hand, sending out a stimulus check doesn’t work either because people will just hang onto it because they need it for debt or are worried about spending it.  In any case, it doesn’t do much for the economy.  It does start causing inflation though.

The key here is to direct that money towards productive uses.  Underwriting self liquidating credit for example is a good one.  Focus on enabling people to generate real value and production for the economy.  Eventually if you inject enough money in the right way the spiral ends and things pick up.

Rudy’s Tip: If you have personal debt, get out as soon as you can.  Deflation hurts particularly bad when you have personal debt.  At very least get out of debt that carries variable interest rates.

The problem is that people often don’t do this the right way.  Enter hyperinflation which I’ll talk about later this week.

See the parallels?

I’m guessing at this point I don’t have to lay it out for you.  In this country we are in a deflationary spiral now which was caused by the credit bubble (NON self liquidating) popping.  Resulting in high unemployment, credit defaults, and the vicious circle.  We now have printing presses running overtime flooding the market with dollars.  And we’re selling more and more government debt.  Neither of which is doing anything at all to right the ship.

Right now cash is king.  The problem is that this will eventually end and we’ll see inflation kick back in.  I fear it will be a hyperinflationary environment.  Yikes.

A fine German gentleman on his way to buy a loaf of bread

This is the first example of an economic collapse situation I want to highlight.  I’ll do a couple different ones so that you, my faithful reader, will have an idea of some of the potential chaos that can happen.  Normally this would be more of a scenario but as it’s a real historic event I figured I’d lay it out in its own category.

What was the Weimar Republic?

The Weimar Republic was a parliamentary republic in Germany after World War I.  There was a constitutional convention of sorts in a town called Weimar which established this form of government to replace the imperial form of government that they had until WWI.  The Weimar Republic was formed in 1919 after the period of social and political upheaval that swept Germany during the latter stages of the war.

Internal strife tears apart the Republic

Despite best efforts to the contrary political strife continued and got even worse after the republic was formed.  Communists on one side and imperialists on the other violently opposed what the government was trying to establish.  Violence spread from the politically involved to the average citizen on the street.

Groups at the extremes of the political spectrum formed paramilitary organizations that would regularly go to war against each other.  In one case a coalition of the communists and anarchists took over the state of Bavaria and declared independence as the ‘Bavarian Soviet Republic.’  The imperialist paramilitary group came in and fought against them, effectively neutralizing the act.  On the flip side, the imperialists then occupied Berlin and put their own chancellor in power.  The legitimate government moved to a different city, calling for a general strike against the usurpers.  The new government collapsed within four days.

This back and forth between the right and the left extremes of the political spectrum continued to escalate with entire cities and states being occupied by these paramilitary organizations.  The regular army would generally act against the occupiers.

The economic picture

A 50 Million Mark bank note - Worth $1 USD when it was printed. Within a few weeks it was worthless.

As part of the Treaty of Versailles that ended World War I, Germany was required to make reparation payments to the Allies to compensate them for costs and losses incurred during the war.  In today’s dollars they were expected to pay just short of $400 Billion, and would have been making payments until 1984.  This was a significant debt owed to foreign countries.

Significant cost inflation was present in post war Germany.  Cost of living was twenty times more than it was prior to the outbreak of the war.  The political strife and violence continued to interrupt economic activity.  The reparation payments weren’t helping either.

Inflation kicks in

It was cheaper to burn the paper money for heat than buy firewood...

Immediately when reparation payments began the real value of the fiat currency plummeted.  The currency exchange in early 1921 was 1 USD to 60 Marks.  One year later the value had dropped to 320 Marks to 1 Dollar.  J.P. Morgan led a group that tried to stabilize the currency but was unsuccessful.  By the end of 1922 the Mark was down to 8000 Marks to 1 Dollar.  That’s a 16x cost of living increase in six months.  The loaf of bread you bought for 1 Mark in June would cost you 16 Marks in December.

In 1923 Germany told the Allies it could no longer afford to make the payments required under the treaty and began to default on foreign held obligations.  As a direct result, France and Belgium sent in their army to occupy the main industrial region of Germany, the Ruhr region.  By the end of January 1923 most mining and manufacturing in Germany was in the hands of the Allies who had decided to take reparations as physical goods instead of cash.

The Weimar Republic government didn’t like that too much and encouraged the workers in the region to strike and resist the occupiers passively.  These strikes lasted for eight months during which the massive industrial machine that was the Ruhr region was brought to a standstill.  No goods were being produced and little coal was being mined.  The government continued to pay the striking workers and provided other benefits.

Hyperinflation, here we come!

Since the government was out of money yet still had many obligations they fired up the printing presses and starting churning out money.  They used this new money to pay back war loans, reparations, and the like.  Businessmen used the opportunity to pay back loans with inflated currency, wages rose to keep up with inflation.  The snowball continued to tumble.

Eventually the currency had inflated too much to be tenable.  In late 1923 the government arbitrarily abolished the current ‘Papiermark’ currency and replaced it with the ‘Rentenmark’ which was based on land.  The exchange rate for the US Dollar at that point was 1 USD to 4.2 Rentenmarks.  This is great for people outside the country, but the poor citizens had to trade their Papiermarks for Rentenmarks.  Unfortunately the exchange rate there was 1,000,000,000,000 Papiermarks to 1 Rentenmark.  Remember that 1 Mark loaf of bread we started with in June of 1922?  At the end of 1923 the average guy on the street was paying 1 TRILLION Marks for that same loaf of bread.

Once the new currency was introduced and reparation payments were resumed the Allies returned the Ruhr region to Germany and things began to return to some semblance of normalcy.  Until Adolf Hilter rose to power, but that’s another story all together.

Wrapping it up

It’s a fascinating study of what happens when you have too much foreign debt, too many internal financial obligations, and too many printing presses churning out cash.  Sound familiar?

Since the cash was worthless, at least it made a good toy for the kids...