What Zimbabwe Can Teach You About Inflation – Introduction
Zimbabwe is a country few people think and talk about. Yet, Zimbabwe is a country that provides a good lesson on Economics. The country is located in the Southern part of Africa and is one of the largest producers of platinum and other minerals. Yet, it is one of the poorest countries on earth. Under the previous leader – Robert Mugabe – the country took land from the white settlers and distributed it to the native Africans. Since the natives did not have a lot of experience in agriculture, the whole process led to the disruption in the sector. This led to shortfall of foreign exchange funds as the United States put in place sanctions on Mugabe. To deal with this situation, the president ordered large scale printing of local currency.
By printing the currency, the country’s inflation rate increased because the printed currency did not have any value. In June 2008, the country’s inflation rate reached a peak of 79,600,000,000% in November 2008. With the condition worsening, the country was forced to abandon the worthless currency. Afterwards, the country pegged its currency to the US dollar but then abandoned it after the 2013 election. In its place, the country put in place the so-called bond notes.
Today, the country will start another regime of Real Time Gross Settlement (RTGS), which is now the official currency. However, this has been rubbished by experts who view the RTGS notes as being worthless.
The Zimbabwe situation is the best way to explain what inflation is and why it matters in the world of finance. The central banks are created to be independent from political interference because of the short-sightedness of the politicians. This is because politicians usually look at the next election. As such, most politicians usually favor a low interest regime.
In monetary policy, central banks look at a number of factors when deciding on the ideal interest rates. When inflation rate is very low, the banks usually lower interest rates to stimulate the inflation. It stimulates inflation by making capital more affordable. When there is a high inflation rate, the central bank reduces interest rates. This helps reduce the spending appetite of the people and companies. The main goal of the central bank is to ensure that there is a slow growth in inflation and reduce very high inflation rates. In the developed countries, the target inflation rate is usually 2%.
The authorities and investors look at a number of data that help them determine the inflation rate. The first one is the CPI (Consumer Price Index). This is a measure of how the prices of goods rose in a given period. The core CPI is calculated in a similar way to the CPI but it removes the volatile food and energy products.
The other measure of inflation is retail sales. This is a measure of the performance of the retail sector. A high retail sales number is usually a sign that inflation is growing.
Another measure is the unemployment rate. The Philips curve says that when the unemployment rate declines, it leads to a higher rate of inflation. This is so because more people are employed, it leads to more purchases. However, this does not always work. For example, Japan has continued to experience a period of low inflation despite of the low unemployment rate.
Other measures of inflation are the consumer surveys and the manufacturing and industrial performance. As a trader, you should view high inflation rate from a country as being an indication of an upcoming rate hikes, which favors its currency.