Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Estimating the Zimbabwe hyperinflation

Hanke and Kwok have written a paper
in the Cato Journal estimating the hyperinflation in Zimbabwe in
November last year. They conclude that the monthly (not
annualized) inflation rate of 80 billion percent was the second
highest in world history (next only to Hungary in July 1946).

I was at first skeptical about the methodology that they use. Since
Zimbabwe stopped publishing inflation data during the period, Hanke
and Kwok rely on the share prices of the South African insurance and
investment company, Old Mutual, in the stock markets in Harare and
London. This involves making two assumptions:

  • that the relative price of the Old Mutual share in the two
    countries provides a reliable estimate of the exchange rate of the
    Zimbabwe dollar; and
  • the depreciation of the exchange rate is a good estimate of the
    inflation rate in Zimbabwe via purchasing power parity (PPP).

I thought that both assumptions are highly suspect for reasons that
I explain below.

We do know that, absent capital controls, the relative share price
of the same company in different countries tracks the exchange rate
very closely. This was true as early as the eighteenth century (Larry
Neal, “Integration of International Capital Markets:
Quantitative Evidence from the Eighteenth to Twentieth
Centuries”, Journal of Economic History, 1985) and
it is even more so today. Even the well known paper of Froot and Dabora
(“How are stock prices affected by the location of trade,”
Journal of Financial Economics, 1999) found problems with
the pricing of twin stocks but not the prices of the same twin in
multiple markets.

At the same time, exchange controls can play havoc with this
assumption. For example, Indian ADR prices trade at large premia to
the underlying Indian shares. The difference between Shanghai and Hong
Kong share prices of mainland China companies reflects the same
phenomenon. These examples suggest that relative prices could be off
by nearly a factor of two in the presence of stringent capital

In the kind of lawlessness that prevailed in Zimbabwe, the margin
of error is I think higher. I would not be too surprised to find a
deviation of prices by as much as a factor of ten.

The second assumption about PPP is even more suspect. Under normal
conditions, PPP does not hold up too well except over the very long
run. Lothian and Taylor needed 200 years of data to demonstrate that
PPP does hold at all (“Exchange rate behavior: The recent float
from the experience of the last two centuries,” Journal of
Political Economy,

One would hope that to the extent that PPP is held back by sticky
prices, the extreme flexibility of prices during hyperinflation would
make PPP hold better. I think there is merit in this

However, in situations like Zimbabwe, the US dollar would probably
be valued more as a store of value than as a medium of exchange. The
exchange rate is then driven by asset market considerations rather
than goods market considerations. Extreme financial repression in
which the real rate of interest on Zimbabwe dollar could be hugely
negative (approaching -100%) would make the US dollar extremely
attractive. People would then buy the US dollar not on the basis of
what it is worth now, but on the basis of what it will be worth in
future. At the same time, it is impossible for a foreigner to go long
on the Zimbabwe dollar without assuming Zimbabwe sovereign credit risk
and legal risk.

Under these conditions, I would not be surprised if the exchange
rate undervalued the local currency by a factor of ten or more. Taken
together with the earlier factor of ten for the stock price, this
implies that Hanke and Kwok could be off by a factor of 100.

Surprisingly, this would make very little qualitative difference to
the results of Hanke and Kwok. The monthly percentage rate of
inflation in Zimbabwe that they estimate is roughly 80
billion. Revising it down by a factor of hundred would bring it down
to 800 million. That is still higher than the third highest rate on
record (Yugoslavia, January 1994) of 300 million. No plausible margin
of error in the opposite direction will bring Zimbabwe within even
shouting distance of the highest recorded hyperinflation (Hungary,
July 1946) which was 4 followed by 16 zeroes.

Put differently, to push Zimbabwe down to third place, the Hanke
and Kwok estimate would have to be off by a factor of 250. Much as I
dislike the smug confidence that Hanke and Kwok seem to have in
arbitrage relationships in a society where there is security of
neither life nor property, I find it difficult to argue that the
arbitrage relationships may be off by a factor of 250.


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