Hyperinflation and "Modern Monetary Theory" - a conundrum

 

In our study of inflation on this blog, we've examined hyperinflation in the Weimar Republic in some depth.  We've also referenced, in passing, hyperinflation in other countries such as Zimbabwe, Venezuela, etc.  I recently came across a very interesting article examining hyperinflation in then-Zaire (today the Democratic Republic of the Congo) in the 1990's.  Here's an excerpt.

The Zairian economy had managed to stay afloat during decades of kleptomania, nepotism, and military spending by Mobuto and his cronies due to Western Aid and high prices for the various minerals mined in the Eastern Congo basin. Beginning around 1990, the combination of the collapse of the Soviet Bloc, falling copper prices, and deeper administrative ineptitude buffeted the economy. 

As Gerard Prunier, French journalist and author of the excellent Africa’s World War:  Congo, the Rwandan Genocide, and the Making of a Continental Catastrophe, explains:

From sickly, the Ziarian economy turned terminal . . . Because imports remained at a fairly high level for some time while exports declined, the external debt had risen to $12.8 billion by 1996, representing 233 percent of GDP, or 924 percent of export capacity . . .

Perhaps the most preoccupying effect of this collapse was the quasi-disappearance of the monetary system. With inflation rate that the IMF calculated at an average of 2,000 percent during the 1990s, prices shot up in an insane way.

The Zairian consumer prices index moved from 100 in 1990 to 4,130 in 1992 to just under 2,000,000 in 1993. Prunier continues:

The government started to print money as fast as it could, simply to keep a certain amount of fiduciary currency irrigating the economy. Bills were printed in ever higher denominations and put into circulation as fast as possible, and their rapidly shrinking real purchasing value would then wipe them off the market in a way that make even the German hyperinflation of the 1920s look mild . . . In December 1992 the system finally imploded: the Z 5 million bill was refused by everybody and had a zero life span. The government then tried to force it through by paying soldiers’ salaries [with the inflated bills] but the army rioted when its money was refused in the shops.

So far it reads like one of the many hyperinflations throughout history. But then things get interesting. Mobuto, in a panic, demonetized the zaïre and issued the new zaïre, with an initial exchange rate of 1 new zaïre = 3,000,000 old zaïre.

A nation issuing new currency to attempt to staunch a inflationary hemorrhage is nothing new; Brazil did the same thing in the 1990s. However, the new zaïre suffered from the same hyperinflative tendencies as its predecessor except that in certain areas of Zaire, the old zaïre resurfaced and began to be used again as a medium of exchange.  For instance,

Kasai refused the new currency and kept using the old one, which regained a certain value simply by not being printed anymore.

In other words, even though the government and its central bank ruled that the old zaïre was without value and the full faith and credit of the Zairian government backed the new zaïre, the only currency with any value was the old zaïre — and the value had nothing to do with any fiat issued by the government, but instead the understanding of a sector of the population that because the old zaïre was no longer being printed, it could act as a reasonably safe store of value.

Finally, by 1994, the financial sector was operating entirely with foreign currencies.  Meanwhile, Prunier reports,

As for the Congolese population . . . its tax burden increased out of all proportion, reaching a punishing rate of 7.5 percent of GNP outside the oil and mining levies.

The case of the zaïre is provides strong anecdotal evidence discounting the fiat currency-obsessed Modern Monetary Theory (“MMT”).

. . .

The question MMT simply cannot answer is what happens when, due to monetary and fiscal gymnastics, the consumer simply stops trusting or using the currency. The Zairian central bank could not tax the populace enough to reduce “aggregate demand,” and its attempts to force a new currency on the populace immediately failed. Meanwhile, the older currency, which the government had specifically disavowed, was given value by the people — at least for awhile. Under MMT tenets, this should not have happened; indeed, it should be impossible. And yet, it happened all the same.

There's more at the link.

This, of course, is the fundamental flaw in Modern Monetary Theory.  MMT advocates believe they can arbitrarily dictate the amount of fiat currency that should be issued, and that people - the economy as a whole - will simply accept this diktat and use the money accordingly.  Unfortunately, people know full well that something without any underlying value is basically worthless.  Just because an economist or bureaucrat or administrator says that a computer-generated dollar is as good as one produced via economic activity doesn't mean that it's true.  The people of Zaire were wise to that, and savvy American consumers are wise to it today.

It's all very well to promise "pie in the sky", as MMT does:  but sooner or later people want to see, and touch, and smell, and taste the pie.  When a picture of a pie turns out to have none of those attributes whatsoever, they'll look for their real pie elsewhere.

Peter