Venezuela – ravaged by socialist policies, corruption, and incompetence – is currently embroiled in the world’s 57th episode of hyperinflation. Since the beginning of November, the bolivar has lost 55.2 percent of its value on the black market (read: free market), worsening the situation in a country in which wheelbarrows have already replaced wallets. So, on November 30th, Venezuelan officials announced a misguided and foolhardy plan to issue larger bills in an attempt to mitigate the damaging effects of its hyperinflation.
But why is the Banco Central de Venezuela (BCV) redenominating? Because if it doesn’t, then the people are stuck. If you go to a market in Caracas today, you either need a wheelbarrow of cash or bigger bills – much bigger. So, President Maduro and the BCV hope that, by printing 20,000-bolivar notes, they can skirt around the hyperinflation problem until it goes away. And that’s a mug’s game.
In the early 1990s, Yugoslavia tried to combat its own hyperinflation by printing larger bills, and it failed horribly. Yugoslavia’s heavy inflation continued throughout the ‘90s, and the dinar was devalued 18 times between 1991 and 1999, losing 22 decimal places of value along the way. Yugoslavia’s monetary orgy finally came to an end when the Topcider mint ran out of capacity. Yugoslavia’s 313,000,000 percent monthly inflation transformed 500-billion-dinar bills into small change before the ink had dried.
Redenomination does nothing if elevated inflation levels persist – as Zimbabwe’s infamous 100-trillion-dollar note demonstrates – and Venezuela will be no different. When inflation goes to the moon, you physically cannot redenominate bills fast enough – you can only add zeroes to notes so quickly. In consequence, you are ultimately left with valueless notes with many zeroes and a "wheelbarrow problem." The issuance of higher-denomination bolivar notes isn’t the end of this episode, and it’s not the solution.
In fact, the only surefire solution is either to dump the bolivar and replace it with the U.S. dollar or make the bolivar a clone of the dollar via an orthodox currency board, in which the bolivar trades at a fixed rate with the U.S. dollar, is totally convertible with the U.S. dollar, and is completely backed by U.S. reserves.
As the Venezuelan bolivar collapses, the hype about Venezuela’s alleged hyperinflation becomes more intense. Most of the commentary is literally fantastic, suggesting that the authors are unfamiliar with the subject of hyperinflation and the arithmetic of inflation.
For example, DolarToday.com – which publishes reliable black-market exchange rate data, as well as the Johns Hopkins-Cato Institute annual inflation estimates – claims that the bolivar has depreciated by over 100 percent this month. This is wrong because DolarToday’s arithmetic is wrong. DolarToday’s mistake represents a common error. It fails to transform the bolivar-U.S. dollar exchange rate into dollars and cents. At the start of the month, the VEF/USD black market rate was 1,501.17, and as of November 29th, it was 3,744.52. The correct arithmetic to calculate the deprecation of the bolivar between those two dates is ((1/3,744.52) - (1/1,501.17)) / (1/1,501.17) = 59.9 percent depreciation.
The accompanying charts illustrate the correct arithmetic and the linkage between black market exchange rates and annual inflation rates. For Venezuela’s inflation to hit the International Monetary Fund’s (IMF) 720 percent inflation forecast for 2016, the bolivar would need to depreciate by 44 percent from today’s rate of 3,744 to 6,735 VEF/USD. Furthermore, for Venezuela to hit hyperinflation, which is an annual inflation rate of 12,875 percent, the bolivar would need to collapse by 97 percent from today’s rate to 106,565 VEF/USD.
The fog of war, coupled with the output from multiple propaganda machines, makes it difficult to determine which side has the upper hand in any conflict. In Syria, it appears from recent reportage from Aleppo that President Bashar al-Assad’s forces are getting the upper hand. But are they?
The best objective way to determine the course of a conflict is to observe black market (read: free market) exchange rates, and to translate changes in those rates via purchasing power parity into implied inflation rates. We at the Johns Hopkins–Cato Institute Troubled Currencies Project have been doing that for Syria since 2013.
The two accompanying charts—one for the Syrian pound and another for Syria’s implied annual inflation rate—plot the course of the war. It is clear that Assad and his allies are getting the upper hand. The pound has been stabilizing since June of this year and inflation has been trending downwards.
Recent reportage in the Wall Street Journal by Matt Wirz, Carolyn Cui, and Anatoly Kurmanaev states that Venezuela’s annual inflation rate is 500 percent. The authors fail to indicate the source for that 500 percent figure. Knowing that the most accurate estimate of Venezuela’s current annual inflation rate is 55 percent, I concluded that the Journal was way off and set out to determine the source for its incorrect figure. The most likely candidate turned out to be the International Monetary Fund’s (IMF) October 2016 World Economic Outlook (WEO), which contains an estimate for Venezuela’s annual inflation. This report projects Venezuela’s annual inflation to average 475.8 percent for 2016, a far cry from my current estimate of 55 percent. The IMF’s figure, though, gives the appearance of a finger-in-the-wind approach because no methodology accompanies the IMF’s October report. The 95% rule reigns – 95% of what you read in the financial press is either wrong or irrelevant.
So, how does one make an accurate estimate of inflation in countries experiencing elevated inflation levels? The Johns Hopkins-Cato Institute Troubled Currencies Project calculates reliable inflation estimates. These are based on changes in black market (read: free market) exchange rates. The principle of purchasing power parity (PPP) is used to translate exchange rate changes into estimates of implied inflation rates. When inflation is elevated, this method provides deadly accurate estimates.
Nigeria’s President, Muhammadu Buhari, and his government have lost control as Nigeria’s economic crisis sends that African nation into a doom-loop. Everyone, including the President’s wife, Aisha, knows that Nigeria is going down the tubes. But not the International Monetary Fund (IMF). As is often the case, the IMF doesn’t have a clue. The IMF’s October 2016 World Economic Outlook projects Nigerian inflation to average 15.4 percent for 2016. This number is in sharp contrast to my Johns Hopkins-Cato Institute Troubled Currencies Project’s inflation estimate for Nigeria. We estimate that the year-over-year inflation rate is currently 104.8 percent (see the chart below).
Why is the IMF so far off base? Because it is doing what it often does: it is taking the Central Bank of Nigeria’s (CBN) official inflation data at face value. That official rate averaged 14.3 percent from January to August of this year. For the IMF forecast to materialize, official annual inflation in Nigeria would need to average 17.6 percent for the September through December period. What did the latest inflation report from the Central bank of Nigeria show? According to the CBN, annual inflation was 17.9 percent in September. The IMF’s blind acceptance of the CBN’s data is a big mistake.
Driving Nigeria’s surging inflation is the collapse of its currency, the naira (NGN). Indeed, many of Nigeria’s recent economic troubles are reflected in the rapid depreciation of the naira. For over a year, the CBN held the official exchange rate at about 200 NGN/USD, with the aid of exchange controls. During this period, dollar shortages raised their ugly heads and caused foreign investment in Nigeria to deteriorate. The shortages even forced airlines to stop flights into Lagos. Simultaneously, a black market (read: free market) for foreign currency developed and the actual value of the naira deteriorated rapidly (see the chart below).
In June 2016, the CBN introduced a managed “float” and claimed that the resulting NGN/USD rate was a purely market driven exchange rate. After a massive one-day depreciation of the official NGN/USD rate, the naira has traded at about 315 NGN/USD while the black market rate plunged to over 450. The sharp contrast between official and black market rates is evidence that the CBN is spreading disinformation (read: lying) about its embrace of a free market for foreign exchange.
Reports have emerged claiming that Nigerian businesses cannot access FX from the banks officially tasked with providing it, so they are turning to bureaux de change (BDCs) and black market dealers. On October 16, 2016 the black market rates and the BDC rates were both 460 NGN/USD, and the official rate was 315 NGN/USD. The CBN brushes off the existence of the black market, claiming these rates don’t reflect the true value of the naira and only account for a small portion of FX transactions. This is nonsense. If this were true, stories of businesses struggling simply to access foreign exchange would not be so common. The CBN’s claim to embrace a purely free market determined Naira is a lie. Take what the Central Bank of Nigeria says with a grain of salt.
Nigeria is in a doom loop – one that the government and the CBN lie about and the IMF blindly repeats.
On Monday afternoon, the Central Bank of Nigeria (CBN) ended the Nigerian naira’s sixteen-month peg to the U.S. dollar, sending the naira into a freefall. The currency had been pegged at 197 naira per dollar, but as the chart below shows, it had been trading at over 320 naira per dollar for months on the black market (read: free market) and currently sits at 345 naira per dollar. At the time of writing, the naira was officially trading at 282.50 naira per dollar.
The official inflation rate for Nigeria in May was 15.6 percent. However, by using changes in the black market exchange rate data and applying the Purchasing Power Parity Theory, I calculate that the annual inflation rate implied by the free market is actually much higher – currently sitting at over 56 percent (see the accompanying chart).
A managed, floating exchange-rate regime is ill-suited for a country with weak institutions and little discipline, like Nigeria. More troubles lie ahead.
Most press reports about Zimbabwe’s fantastic hyperinflation are off the mark – way off the mark. Even our most trusted news sources fail to get the facts right. This confirms the “95 Percent Rule”: 95 percent of what you read in the financial press is either wrong or irrelevant.
When it comes to the reportage about hyperinflation, there are no excuses. All 56 of the world’s hyperinflations have been carefully documented in “World Hyperinflations”. This record is available in the Routledge Handbook of Major Economic Events in Economic History (2013) and has been available online since 2012 at the Cato Institute.
The International Monetary Fund (IMF) is the main culprit, a prominent source of the faulty data. EvenThe Economist magazine has fallen into the trap of uncritically accepting figures pumped out by the IMF and further propagating them. It’s no wonder that there is a massive gap between the public’s perception and economic reality. A gap that, ironically, The Economist reports on this week.
The Economist’s most recent infraction on Zimbabwe’s hyperinflation appeared in the May 2016 issue. The magazine claimed that the hyperinflation peaked at an annual rate of 500 billion percent. Where did this figure originate? You guessed it. That figure is buried in the IMF’s 2009 Article IV Consultation Staff Report on Zimbabwe.
In reality, Zimbabwe’s annual inflation rate in September 2008 was 471 billion percent, not 500 billion percent. More importantly, Zimbabwe’s hyperinflation peaked in November, not September. It was then that Zimbabwe recorded the second-highest hyperinflation in history: a whopping 89.7 sextillion percent. This is 179 billion times greater than the IMF’s figure.
That said, the IMF did attempt to cover its backside from questions about its hyperinflation guestimate. 2009 Article IV Staff Report on Zimbabwe states clearly that “data have serious shortcomings that significantly hamper surveillance due to capacity constraints.” Despite the red flag, The Economistcontinues to blindly propagate a figure that is neither reliable nor replicable. I stress the word “continues”.
It turns out that The Economist is a serial propagator of inaccurate IMF figures. The magazine has cited IMF’s incorrect figure of 500 billion percent before, in June 2009 and October 2015.
For accurate estimates of Zimbabwe’s fantastic hyperinflation that are used in the professional literature – estimates that are reliable and replicable – the IMF and the financial press corps should take a look at the following table from “On the Measurement of Zimbabwe’s Hyperinflation”, which was published in The Cato Journal, (2009):