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Stop the money presses
Nothando Ndebele
May 03, 2007

There is inflation, high inflation and then there is hyperinflation. The first one is acceptable, the second worrying and the third is a nightmare.

Zimbabwe falls in the latter camp. Hyperinflation, put simply, is very high inflation. A country is usually classified as having hyperinflation when the monthly inflation rate is greater than 50%. Latest data shows inflation at 2 200% for March, up from 1 594% in January.

What this means is that goods that cost $100 this time last year now cost $1 829. In most developed countries inflation runs at under 4%.

High inflation is caused by "too much money chasing too few goods". Hyperinflation is an exacerbated state of high inflation usually resulting from a rapid growth in the supply of paper money.

This usually occurs on the back of governments financing their expenditures via the country's printing press -- or the central or Reserve Bank. The printing press produces reams of new cash to fund expenditure such as foreign debt repayments or wages for a bloated civil service workforce.

It's a vicious circle. The government's printing pushes up the supply of money in the economy, which leads to competition for goods that, in turn, pushes up the price of those goods.

To cover expenditure for the same quantity of goods, the government has to print more money, which leads to higher prices as people rush to buy goods today to avoid paying higher prices tomorrow. This accelerated demand pushes prices up even further and so the circle continues and hyperinflation prevails.

The victims of hyperinflation are people whose income levels cannot keep up with the rise in prices of goods and services. The government's means of financing its expenditures becomes an added "tax burden" to people -- their purchasing power falls at the expense of the government.

Other beneficiaries of hyperinflation are speculative suppliers of goods. If you have a warehouse full of inventory, delaying sales will allow the seller to recoup higher prices from consumers. Hyperinflation periods are often accompanied by periods of civil unrest.

Zimbabwe is not the first country to suffer from hyperinflation. Germany went through a period of hyperinflation after World War I. More recently, Bolivia experienced severe hyperinflation that peaked around 12 000% in 1985.

However, both Germany and Bolivia conquered the beast and restored stability to prices and the economy. In Germany, the government created a new unit of currency whose value was directly linked to tangible assets, in this case gold. The new unit could be converted to gold on demand. This restored value in the currency and gave people faith that the government was committed to halting the supply of money.

I doubt this would be sufficient in Zimbabwe today with the current leadership -- people have lost faith in the government. In addition, it is unlikely that the government has sufficient gold reserves to back the currency.

Zimbabwe may have to go the Bolivian route -- shock treatment under a new government. The Bolivian government removed all price controls and simultaneously froze payrolls to curb expenditure. The first policy removed incentives for speculators in the market and thus led towards a normalisation on the supply side (no more hoarding of inventories).

The latter ended the need to keep printing money -- simply put, the government made a pledge to live within its means.

This could work in Zimbabwe. Most people realise that the current state of affairs is unsustainable. However, we should not under-estimate the extent of the social shock involved. Initially, there could be a worsening in inflation as the instigated price controls have kept the prices of basic commodities such as oil well below black market rates.

The combination of higher prices and zero wage growth would curtail demand swiftly, which would result in a stabilisation of prices. Unfortunately, people, especially low-income earners, would bear the brunt of these economic adjustments.

To alleviate these adverse effects, the government should simultaneously adopt policies to boost the level of forex in the country and stimulate growth of the economy.

These include, but are not limited to, reviving the agricultural and manufacturing sectors, which are not only important for domestic consumption needs, but also generate much-needed foreign exchange.

Bottlenecks and impediments to trade need to be addressed, especially in terms of duties and tariffs. This will help lower the end cost of goods in the country, which should also help with price stabilisation.

Reviving the tourism sector would also boost foreign exchange reserves and stimulate job growth.

However, none of the above is likely to be sufficient to sustain price stability if the government does not refrain from living beyond its means. Given that Zimbabwe is currently running a budget deficit in excess of 40% of GDP, there will have to be large rationalisation of government departments -- and this could begin with the army.

On the income side, better tax collection will afford the government more flexibility on expenditures.

We would like the Zimbabwean finance minister to one day be faced with the same problem as his South African counterpart, Trevor Manuel, of significantly higher than expected tax revenues resulting in headaches of how best to spend it all. And how better to spend it than on socio-economic programmes financed by the government, which has not had to print a single note for any of it.

*Nothando Ndebele, an economist, is head of research at Renaissance Specialist Fund Managers of South Africa and a founding partner in the firm

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