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14 Aug 2022 17:45
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  •   Home > News > Business > Features

    How To Destroy Your Currency

    A colleague of mine recently returned from Zimbabwe, where he had been assisting with monitoring of the election there. He showed me a bank note and I must admit it was impressive to hold something with a value of Z$50b (that's Z$50,000,000,000!).

    Investment Research Group
    Investment Research Group
    Even more unusual was that the note carried an expiry date of December 2008. Thanks to runaway inflation of millions of per cent a year, that bank note would not even buy a loaf of bread in Zimbabwe.

    This example got me thinking about why the Zimbabwe currency has devalued so much. The reason is that the central bank has been staving off the impact of a declining economy by printing unlimited quantities of bank notes and this 'inflation' of the currency led to rising prices (this is the true definition of inflation rather than the much quoted reference to the rise in consumer prices).

    Then it occurred to me that all countries are doing the same thing to their currencies, only much slower than Zimbabwe. New Zealand increased the amount of money in circulation by around 10% in the past year and the purchasing power of that money fell by around 4%. In the past 20 years, a period when price inflation has been much lower than average, the purchasing power of our dollars has fallen by more than 40%.

    While we can hope this trend does not escalate but that cannot be ruled out given that a dollar coin is only worth what someone else is prepared to swap for it.

    This reminds me of what happened to the first attempt to offer currency that was not backed by gold or silver - so called 'fiat' currency. This was in the early 18th Century, when a British rogue by the name of John Law became involved with a French business called the Mississippi Company and later became Superintendent General of Finance for the French government.

    That meant he had control of France's finances as well as the company that was responsible for all of France's foreign trade. To stimulate demand for the new-fangled paper money - an entirely new concept for most French people - Law announced that Banque Royale-issued notes were legal tender and it was illegal to hold large quantities of coins.

    This was partly a reaction to increased demand by investors to redeem notes for coins. Such redemptions may have been a reaction to the increasing volumes of paper being issued. Some estimates put the increase value of currency in circulation during 1720 alone at around 200%.

    Needless to say, extra money in circulation without a matching increase in goods and services soon resulted in higher prices. Inflation hit an annualised high in January 1720 of 276%. Eventually, confidence in the worth of the currency fell and more and more people tried to redeem them for coins.

    When the coins ran out the company failed and many thousands of people were ruined. The final outcome of Law's grand economic experiment was that France's economy ended up virtually ruined, a far worst state than it had been a few years earlier.

    We may laugh at the naivety of 18th Century folk but the principle has not changed. If for any reason people decided they don’t trust a currency then it is doomed. If that makes you nervous, why not hold a little gold? It is the only 'true' currency that you can be sure will always be accepted.

    © 2022 David McEwen, NZCity

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