Zimbabwe: An Example of Global Inflationary Bias?

``The financial press sometimes criticizes Federal Reserve policy, but the validity of the fiat system itself is never challenged. Both political parties want the Fed to print more money, either to support social spending or military adventurism. Politicians want the printing presses to run faster and create more credit, so that the economy will be healed like magic- or so they believe.”-Congressman Ron Paul of Texas, The Federal Reserve Monopoly over Money

WE have always argued that markets remain irrational (especially over the short-term) more than we can remain solvent. Because I’ve lately quoted Keynes a lot (based on momentum and NOT on Demand management through government intervention), I have been misconstrued to have turned into a Keynesian cheerleader. No, momentum does not equate to cheerleading nor does it signify my tergiversation from our free market principles to the Keynesian philosophical dogma.

Despite the present developments, risks have not abated and in fact as the IMF pointed out in its recent Global Financial Stability Report, they have been enhanced, the Reuters quotes the IMF, ``Global economic conditions have been supportive of a benign financial environment, but underlying risks and conditions have shifted somewhat since ... September 2006, and have the potential to weaken financial stability.”

Yet, we have been ingrained to think or made to believe by textbooks or by mainstream analysts or by the media that stock market performances are reflective of the performances of corporations or of a nation’s GDP growth. Or simply, a country’s economic progression defines its relative returns with regards to stock market investing or is it?

Figure 5: Mises.org: Zimbabwe: Best Performing Stock Market in 2007?

According to John Paul Koning, the Zimbabwe Stock Exchange is shaping out to be the best performing stock index in the world up about 595% year to date, and get this, a whopping 12,000% (TWELVE THOUSAND PERCENT) in over 12 months see figure 5!

Yet, Zimbabwe’s economy has rapidly deteriorated over the years due to policies adopted by its tyrant ruler Pres. Robert Mugabe. The Economist Intelligence Unit shows Zimbabwe’s GDP calculated in Billions of US dollars based on Purchasing Power Parity (PPP) at $25.04 billion in 2002 to $21.13 billion in 2006 or a nominal decline of over 15% over the past 5 years!

The reason Zimbabwe’s stock market has been zooming is due to its hyperinflationary state (Germany’s Weimar 1920s experience relived!). Its degenerative economy and its lack of access to financing have led its incumbent government to undertake excessive money printing in order to preserve its powers.

And excessive production of money has reduced its purchasing power of its currency so great that consumer price index have jumped by an astonishing 1,729% a year! Imagine losing the value of your currency by the day!

Now of course, the lack of opportunities under such hyperinflationary landscape has alternatively made its stock market as the ONLY safehaven from the evaporating value of the country’s currency.

John Paul Koning elaborates (emphasis mine)

``According to Austrian Business Cycle Theory (ABCT), the peak-trough-peak pattern that economies demonstrate is not their natural state, but one created by excess growth in money supply and credit. New money is not simply parachuted to everyone equally and at the same time — it is sluiced into the economy at certain initial “entry points”....

``If, as the Austrian theory states, money enters the economy at certain points, it is likely that a nation's stock market will become a prime beneficiary of any monetary expansion. Fresh money enters the economy first through banks and other financial entities who may invest it in shares, or lend it to others who buy shares. Thus stock prices rise relative to prices of things like food and clothes and will outperform as long as this monetary process is allowed to continue.”

``As prices become more misaligned, basic decision-making abilities of normal Zimbabweans are impaired and the day-to-day functioning of the economy deteriorates. Perversely, all of this has forced the government to issue even more currency to make up for budget shortfalls and to buy support. At last measure, the country's consumer price index was rising (i.e., the purchasing power of currency declining), at a rate of 1,729% a year.”

In other words, contrary to the public’s expectations, monetary process contributes to the conditions of the financial markets and not just changes in GDP.

And it is in this regards where we have frequently commented that the appearance of peculiarities (rampaging asset prices amidst deteriorating fundamentals) in the behavior of the global financial markets may actually reflect such inflationary tendencies...but on a benign scale relative to the Zimbabwe’s experience.

Possible symptoms as price misalignments or distortions, rich valuations, record low yields, low volatilities, record low credit spreads, expanding global imbalances and rampant signs of speculation (private equity, mergers and acquisition and exploding hedge funds) on a backdrop of gradually rising consumer prices indices can be viewed as affectations of such monetary processes to the financial markets in contrast to other preconceived theories as the Global Savings Glut, Lack of Investment or dearth of supply of investible instruments.

So when we declare that momentum favors today asset classes, or otherwise seen as “cheerleading”, our premise originates from the perspective where surging money and credit expansion or simply inflationary manifestations have been MADE conducive for the financial sphere to expand its tentacles behind and in support of today’s structurally asset dependent economies.

In the prescient words of Hyman Minsky, ``An understanding of the American economy requires an understanding of how the financial structure is affected by and affects the behavior of the economy over time. The time path of the economy depends upon the financial structure.”

I guess this should apply not just to the American economy but to the global economy as well.