Sobering Lessons on Hyperinflation from Zimbabwe

by Michael Checkan

[Investment U Editor’s Note: Many of our long-time readers will remember our old friend and colleague Michael Checkan at Asset Strategies International, Inc. A specialist in precious metals and foreign currencies, today he takes a look at a unique “hyper-inflationary” economy and the havoc it plays on foreign currencies.]

With the U.S. Government printing money like never before, the whispers of inflation float over the currency and bond markets. In fact, inflation has dropped to almost nothing after hitting a high of 5.6% in July of last year. Within the past two weeks, the Fed created one trillion dollars out of thin air. Apart from left or right wing rhetoric, this is reality.

History has taught us that governments can take a perfectly good piece of paper, put some ink on it, and make it totally worthless.

It happened in Hungary in 1946, Argentina in 1988 and today in Zimbabwe.

Since entering the foreign currency and precious metals business in the 1960’s, I’ve seen it happen more than a few times. But extreme examples of currency devaluation are rare. It can be compared to a slow motion train wreck you just can’t keep your eyes off.

Today, Zimbabwe looks to take its place in history with the most corrupt government and devalued currency for the record books. Apart from being just another economic disaster and newspaper headline, we can learn something from these extreme examples of central banks gone wild and why inflation is so important.

What is Hyper-Inflation?

I saw hyper-inflation first hand when I visited Argentina in 1988. At the time, their government was using the Austral as their currency and inflation was running at 387.7%.

Afterward, the currency name was changed to the Peso and eventually the hard or new Peso. Visiting last year, I still found a questionable government dealing with political, economic and social unrest. Unfortunately, currency devaluation is just one of their issues.

You can expect to see more changes in their currency in the years ahead.

Inflation is the rising cost of daily goods and services - usually based off the Consumer Price Index. There’s a humorous quote that says, “With inflation, everything gets more valuable except money.” But it’s a great way to explain why inflation needs to be managed. Hyper-inflation is simply runaway inflation.

Imagine a $2.00 gallon of milk spiking to $775.40 within a year - like in Argentina, 1988.

That’s no April Fool’s joke.

Some inflation is necessary for individuals to see a reason for investing their money. If your dollar was going to be worth a dollar “tomorrow,” you would be less inclined to risk it in an investment. Inflation eats away at purchasing power.

Central Banks and governments have a number of other tools at their disposal to influence inflation, but their main tools are to shrink the money supply and raise interest rates. On average the United States sees inflation at around 3-4%.

Argentina’s troubles are nothing compared to the state of Zimbabwean currency.

“The death knell for the Zimbabwean dollar came as it does for currencies in all hyper-inflationary markets. That is, people just refuse to use the money. It really is a nuisance. So it just disappears on you,” said Steve H. Hanke, a professor of applied economics at Johns Hopkins University.

Officially, Zimbabwe’s monthly inflation is an unfathomable 231 million percent.

And while outrageous, that figure may be far too small. In November, the last time reliable data was available, Hanke calculated it at 79.6 billion percent and proclaimed Zimbabwe “second place in the world hyper-inflation record books.” Currently, the largest note in circulation is a $100 trillion note.

Hyper-Inflation & The Zimbabwe Banknote - Collecting Funny Money

My good friend David, who also deals in banknotes and coins says, “The situation with the Zimbabwe banknote is complicated because the new notes so rapidly become worthless it seems the Central Bank does not produce as many. In any case I’ve managed to accumulate some and I am constantly working at it. You are aware that last August after getting up to 100 billion they started the new currency. The new currency has now had a short life. It is now being replaced with the “new” new currency. I saw on the web site of the Reserve Bank of Zimbabwe the new, new, new banknotes. The only question is how long it will take before they get up to a quadrillion?”

Of course in these situations there’s always profit to be made. In this case, it’s exploiting the value of the physical coins and the value of the hyper-inflated notes.

“I happen to have a lot of one-cent coins from a few years back. The basic idea is to go to the bank with a 100 billion dollar note and request the 10 trillion 1 cent coins. Because the coin weighs about two grams, one would expect to receive 20 trillion grams of coins, which is 20 billion kilos or 20 million tons. The coin is made of steel with a copper coating. That is a lot of metal.”

It’s a physical impossibility for Zimbabwe to make good on their printing presses’ obligations in coins. From a far worse perspective, they are destroying their economy and global investment interest.

David tells me the Zimbabwean banknotes may be monetarily worthless, but they do have collector value. Some currency collectors are rushing to pick up as many of these “super-notes” as possible.

How many Americans can say they’ve held a 100 trillion dollar note? I prefer to think that a “trillionaire” should reach that status because of hard work and luck, not because their government can’t keep its hands off the printing presses.

It’s a sobering lesson on the dangers of too much money.

Comments

[Mad Hedge F...:]

It's happening here too. All of the high grade paper used by the US Treasury to print money is bought by one firm, Crane & Co., which has been in the same family for seven generations. Last year the Feds printed 38 million banknotes worth $639 million. Although they have seen the recession cause the velocity of money to decline, recent reflationary efforts have spurred a big increase in demand for paper for $100 dollar bills. The US first issued paper money in 1861 to finance the Civil War, and Crane has been supplying them since 1879. The average life of a dollar bill is 21 months. Who said no one was doing well in this recession? M1, or notes and coins in circulation, is already exploding. Is this a warning of an imminent jump in inflation?

Apr 02 07:15 AM

[kelm:]

Hyperinflation will be much harder on the US and Britain than on many other nations. We are at the top of the food can with respect to our use of electronic means of commerce and farthest removed from any form of barter. We are also more indebted which should be interesting when no one can pay off any debt due to wages lagging and high unemployment. As you say though, it starts, much like the credit crisis, as a slow motion train wreck. I don't know that Americans can really prepare the way one living elsewhere could though. Our society is very fragile in that regard.

Apr 02 10:40 AM

[henarl:]

People in Zimbabwe are used to living, 12 to a family, with their livestock in the same mud hut with a dirt floor and only eating maybe three times a week, drinking from a mud puddle and bartering for everything. They're still surviving (mostly) under these conditions.
People in the U.S. are used to living three or four to a family in a suburban McMansion with big screen TVs, granite counter tops, three late model vehicles in the garage, eating three big meals a day along with imported wine and paying for it all with a credit card.
Americans will have a tough time surviving with hyperinflation.

Apr 02 12:06 PM

[silver-bug:]

Hmm.. good article. Talking about converting paper to coins, that makes a lot of sense in a hyper-inflationary scenerio, although the banks will not be able to honor it. The way China and India (mainly China) are developing infrastructure and building more housing for the increasing city dwelling populations, the commodity boom will catch on momentum and drive up the prices of raw materials used for construction, including metals. I would exchange dollar bills for pennies and nickels since you get the most amount of metal that way.

Apr 02 12:38 PM

[fireball:]

looks like we learned the lesson very well ad are now on our way down that path. the ultimate change, the ultimate fairness. got gold? got silver?

silverbug
i heard a rumor that nickels are about to be debased. have you heard anything?

Apr 02 02:47 PM