Taking A Page Out Of The Bank Of Zimbabwe Playbook

Includes: FXE, UDN, UUP, YCL
by: Bespoke Investment Group

Remember back in 2008 and 2009 when the stock market of Zimbabwe was regularly the top performing market in the world? There were several days when the country's benchmark stock index was up by more than 100%. Who wouldn't want that type of return?

The primary reason for the staggering nominal returns in Zimbabwe's stock market was due to the fact that the Zimbabwe Dollar was in free fall. Actually, free fall may actually be too tame of a description. In fact, at its peak in November 2008, the monthly rate of inflation in Zimbabwe peaked at 79,600,000,000%. After taking that rate of currency depreciation into account, the rise in Zimbabwe's equity market was still not enough to keep up with the hyperinflation. Obviously, the rate of inflation that Zimbabwe saw was not sustainable. Ultimately, Zimbabwe abandoned its currency altogether in January 2009, and if you go to the website of the Zimbabwe Stock Exchange, the website is "under maintenance." Needless to say, it didn't end pretty.

There is no official hyperinfaltion going in the developed world today, but looking at the currencies of some of the G-7's best performing countries this year shows that the Bank of Japan (BoJ) and Bank of England (BoE) may at least be borrowing a little bit from the playbook of the Bank of Zimbabwe (BoZ). Also, some would argue that the U.S. Federal Reserve already started borrowing from the BoZ a few years ago.

The chart below shows the performance of Japan's Nikkei 225 and Great Britain's FTSE 100 stock indices since the start of the fourth quarter. These are two of the developed world's best-performing stock markets this year. Since the start of October, the FTSE 100 is up by more than 11%, while the Nikkei 225 is up 29.3%.

Now, let's look at the currencies of each country over the same time frame. As shown in the chart below, the British pound has seen its value decline 5.3% relative to the dollar since the start of October, while the Japanese yen is down by 16.8%. In any environment, these would be considered large moves, but when you add the fact that the integrity of the dollar hasn't necessarily been strong, the decline in these currencies is even more dramatic.

Even after accounting for the declines in both currencies, the stock markets of Great Britain and Japan are still up in dollar terms (although by a much smaller degree). So far in 2013, though, a much larger share of each index's "gain" is directly attributable to currency depreciation. The FTSE-100 is up 8.52% in nominal terms, but after adjusting for the decline in the British pound, the index is only up 2.22%. For the Nikkei, even more of 2013's gains are currency related. On a nominal basis, the Nikkei is up 10.32%, but in dollar terms the gain is a relatively meager 2.17%. In both cases, the impact of the weaker currencies has been realtively benign, but as countless examples throughout history suggest, these types of policies often don't end pretty.