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WHAT DETERMINES GOOD FINANCIAL HEALTH?
THE CASE FOR A DERIVATIVE MARKET IN ZIMBABWE (PART II)
THE CASE FOR A DERIVATIVE MARKET IN ZIMBABWE
MANAGED OR FLOAT EXCHANGE RATE—WHICH ONE IS THE BEST SUITED FOR OUR ECONOMY?
WHAT THEN? WHEN THE MEDIUM OF EXCHANGE LEAKS VALUE…
IS MARKET TIMING RELEVANT?
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published-Thu 03 Nov 2005

WHAT THEN? WHEN THE MEDIUM OF EXCHANGE LEAKS VALUE…

By: Shepherd Shambira

The previous article discussed the birth of money and the subject of inflation in simplified terms. It was noted that the concept of money was borne out of the need to facilitate trade between producers of various goods and services. That money is a medium of exchange. Money is a proxy for value and for money to be acceptable to all traders, it must have certain qualities. When money loses some or all of its key qualities, it becomes questionable as a medium of exchange. The result is that traders begin to seek for alternative ways of facilitating exchange of goods and services which they presume to be fair and just. The relationship between a currency for one country and that of other countries is depended on the volume and value of trade between the countries in question. Where a country has nothing or little output to exchange with other countries, it is likely to face challenges in securing goods and services produced outside its borders. The production of more proxies of value than actual output represented by such proxies of value gives rise to the problem inflation. This was given as a simple explanation of inflation. The simple cure for inflation was also discussed and noted to be increased production of goods and services including something for sale outside in other currencies.

The problem of inflation results in several weaknesses. For example, a hard working citizen who has produced his output and exchanged it for money as a proxy of value will stand to lose some of his buying power because the proxy of value is not a good store of value. Such consequences are surely unfair to the productive farmer who may have waited a whole year to harvest their produce for example. The other challenge which arises from inflation is that upon realizing the decline in value of money, any producer who now wishes to exchange his output will demand more proxies of value in order to cushion them from the declining buying power. This becomes a vicious cycle where the currency continually looses value. The momentum will at some stage be based on psychological expectations rather than actual facts on the ground. An element of greed and desire for security overtakes the system and all begin to demand more for everything, “just in case the value of the currency falls further”!! The problem therefore grows more due to actual issues of mismatched production and supply of proxies in addition to the crisis of expectations.

The resolution of the problem therefore has to address these two issues. The production aspect of the equation requires decisive action that triggers increased production of goods and services. On the other hand, as goods and services become available, the desire to hoard in anticipation for shortages will be quenched as no individual manages to make a profit from such practices. The expectations regarding possible hikes in prices will likely be managed as consistent and sufficient supplies of goods and services flow to the market. This is a simplified model of what may be useful in managing the relationship between the medium of exchange and the production which this medium represents. Economists prefer to base such discussions on an imaginary world where you “hold other things constant”. However, the world we live in is not an experiment and as such you can not hold anything constant while you adjust certain variables.

The question which can be asked is what then should an ordinary citizen do about the problem of inflation? There are several things which we can all do depending on our role in the economy. For example, the Brazilians and Jamaicans survived long periods of hyperinflation. One of the strategies which they used was the indexation of their currency to a common benchmark. The advantages of this approach include the maintenance of a fair distribution of wealth. One of the key problems of hyperinflation is the unfair distribution of wealth which is created by the uneven flow of currency as information moves to people at different times. For example, those who get to know of certain changes run ahead of others and therefore get unfair advantage in creating value for themselves. By the time the rest of the population get news of the changes, the privileged few would have made fortunes by taking positions. For example, when there is a change in the price of certain goods, those who are aware of the impending change may hoard the affected commodities and offload at the new price as soon as it is announced. This is referred to as the problem of information asymmetry. In the real world there is information asymmetry since not all players get access to the same information at the same time. In Brazil, the society agreed on a tripartite contract whereby the state; employers and labour agreed to a systematic formula for changes in prices, wages and taxes. The changes were linked to a mutually agreed index and this facilitated a certain level of stability. A friend of mine is negotiating with his employer to get his wage indexed to the cost of one loaf of bread per day for every month plus three shirts only!

 


 

This article is published for general investment advice and it must be noted that the price of
equities and the income derived from them can rise as well as fall. Neither First Mutual Limited nor the author shall be held liable for any losses as a result of the investment advice
contained in this article. It is important that specific investment advice is sought as each
investor’s investment will be dependent on their circumstances.

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