To Explain Zimbabwe’s Inflation – The Hypervelocity Of Money

Zimbabwe is finding out that getting rid of the idiot autocrat – Mugabe – doesn’t mean that everything will now be economically peachy. That requires sensible and reasonable economic policy which those who replace the idiot autocrat – Mugabe – may or may not enact. That is, as ever, it’s economic policy which determines economic outcome. The country has raging hyperinflation again, the result of those economic policies which lead to hyperinflation – whichever idiot is running economic policy, autocrat or not.

There is though something that should be said about this level of inflation. We usually say that there’s inflation, a general increase in the price level, then there’s hyperinflation, which is a general increase in the price level of more than 50% per month. This isn’t a formal definition, just a useful enough dividing line between the two. Somewhere around and about this level, this hyperinflation, perhaps above it, is something of a step change though, where we might be more accurate to call this not inflation of any kind, but instead the hypervelocity of money. This insight originally came from Frances Coppola and any misunderstandings in it are mine. As well as some of the explanation of it being mine.

The background here is our old friend, the money thing.

MV=PQ

The quantity of money times the velocity of its circulation equals prices times quantity. Those last two referring to goods and services out in the economy. So, normally we model V as being static. Money changes hands, each piece of money gets used, at a stable rate. Sometimes it doesn’t, which is how we explain quantitative easing – the simplest mental model of which is that V fell, meaning that either P must, meaning deflation, or Q must, meaning recession or depression. So, increase the amount of M, each bit of money is being used less often but we’ve more of it thus disaster averted. Note this isn’t quite accurate but it’s a useful mental model to have floating around the synapses.

But, normally V is stable, meaning that it’s changes in M which drive inflation/deflation. Government prints lots of money to spend, a la MMT, and inflation will show up. Even the MMT folks agree with this, that’s why tax should rise to reduce the inflation by reducing that amount of money around.

OK, so, what’s this hypervelocity then?

So prices began rising and panic quickly set in as some, remembering the economic crash a decade earlier, went to spend their money before they feared it would lose all its value.

That is. Again, this isn’t wholly accurate but it’s a useful method for cramming the point into our poor little mammalian brains. Sure, inflation is because more money, hyperinflation is because lots more money, but truly vast inflation is because of the hypervelocity of money. People realise that holding that cash means they’re losing it, day by day. So, they go spend it now. On anything. Anything at all. Any physical object that might retain real value over time, unlike the pieces of paper. This of course drives inflation ever higher as you can see from the equation. So it becomes not a daily loss of value in the paper but an hourly one, driving ever more frantic attempts to spend it now, now, now.

There’s no useful example of a currency that has recovered from this. Every rescue has come from the creation of a new currency which is believably fixed to something else which is of real value. Or at least credibly limited in the amount that will be issued. The Rentenmark being a good example, what stabilised the Weimar hyperinflation. There was a tax roll, rents upon land owed to the government. No more money would be printed than could be backed by that revenue. The inflation died immediately – in that currency that is. It’s necessary to break the belief in that hyperinflation which is leading to that hypervelocity of money.

Essentially, once people are willing to keep cash in their wallets for a week, instead of spending it the moment they get it, then you’ve won. Quite how Zimbabwe is going to do that is unknown but it is what needs to be done. They’ve reached the point where it’s the velocity of money which is the problem, not the quantity of it so much.