Zimbabwe: Best Performing Stock Market in 2007?

CNBC and other stock market tabloids are notorious for making simplistic linkages between the stock market and gross domestic product (GDP). They tell us that any event that stimulates GDP growth inevitably drives stock prices up, and any event that hurts GDP growth pushes stocks down.

Since the largest share of GDP is consumption, consumer demand becomes the all-important figure driving growth. When the consumer gets too excited, the Fed must step in to cool them down with interest-rate hikes. When the consumer isn't spending, Fed interest-rate cuts stimulate demand.

The tragedy currently occurring in Zimbabwe completely contradicts this sort of logic. Zimbabwe is in the middle of an economic disintegration, with GDP declining for the seventh consecutive year, half what it was in 2000. Ever since President Mugabe's disastrous land-reform campaign (an entire article in itself), the country's farming, tourism, and gold sectors have collapsed. Unemployment is said to be near 80%.

Yet something odd is happening.

The Zimbabwe Stock Exchange (the ZSE) is the best performing stock exchange in the world, the key Zimbabwe Industrials Index up some 595% since the beginning of the year and 12,000% over twelve months. This jump in share prices is far in excess of increases in consumer prices. While the country is crumbling, the Zimbabwean share speculator is keeping up much better than the typical Zimbabwean on the street.

CNBC logic fails to explain the coincidence of a rising ZSE and collapsing GDP because it entirely ignores the monetary side of the economy. At this point Austrian economics makes its contribution to our story. According to Austrian Business Cycle Theory (ABCT), the peak-trough-peak pattern that economies demonstrate is not their natural state, but one created by excess growth in money supply and credit. New money is not simply parachuted to everyone equally and at the same time — it is sluiced into the economy at certain initial "entry points." From these entry points, a number of initial goods are bought by recipients of new money causing a rise in price for these initial goods relative to other goods.

Because entrepreneurs react to this observed but unjustified change in the structure of prices by investing their capital, misallocation occurs. As money-supply growth continues and prices become more contorted, more and more ventures are undertaken that would not be undertaken in a regime without money-supply growth. When, for whatever the reason, money supply finally contracts, the artificial strength in prices that encouraged unprofitable ventures is removed, prices collapse, and large numbers of ventures go bankrupt. Thus we have the recession part of the business cycle, the simultaneous failure of many firms at the same time.

If, as the Austrian theory states, money enters the economy at certain points, it is likely that a nation's stock market will become a prime beneficiary of any monetary expansion. Fresh money enters the economy first through banks and other financial entities who may invest it in shares, or lend it to others who buy shares. Thus stock prices rise relative to prices of things like food and clothes and will outperform as long as this monetary process is allowed to continue.

This is what we are seeing in Zimbabwe. With the country suffering from Mugabe's catastrophic policies, increasingly the only means for the government to fund itself has been money-supply growth. This has only exacerbated the economy's problems. The flood of new money that authorities have created has caused the existing value of money in circulation to plummet, i.e., the prices of all sorts of goods to explode, some rising more than others.

As prices become more misaligned, basic decision-making abilities of normal Zimbabweans are impaired and the day-to-day functioning of the economy deteriorates. Perversely, all of this has forced the government to issue even more currency to make up for budget shortfalls and to buy support. At last measure, the country's consumer price index was rising (i.e., the purchasing power of currency declining), at a rate of 1,729% a year.

The ZSE is growing some three times faster than consumer prices. This relative outperformance versus general prices is a result of stocks being a chief entry point for the flood of newly created money. Keep Zimbabwean dollars in your pocket, and they've already lost a chunk of their value by the next day. Putting money in the bank, where rates are pithy, is not much better. Investing in government bonds is the equivalent of financial suicide. Converting wealth into foreign currency is difficult; hard currency is scarce, and strict rules limit exchangeability.

As for capital improvements, there is little incentive on the part of companies to invest in their already-losing enterprises since economic prospects look so bleak. Very few havens exist for people to hide their wealth from the evils created by Mugabe's policies. Like compressed air looking for an exit, money is pouring into shares of ZSE-listed firms like banker Old Mutual, hotel group Meikles Africa, and mobile phone firm Econet Wireless. It is the only place to go. Thus the 12,000% year over year increase in the Zimbabwe Industrials.

Our Zimbabwe example, though extreme, demonstrates how changes in stock prices can be driven by monetary conditions, and not changes in GDP. New money gets spent or invested. In Zimbabwe's case, because there are no alternatives, it is stocks that are benefiting.

This sort of thinking can be applied to the stock markets in the Western world too. Though western central banks have not been printing nearly as fast as their Zimbabwe counterpart, they do have a long history of increasing the money supply. It forces one to ask how much of the growth in Western stock markets over the preceding twenty-five years has been created by a vastly increasing money supply, and how much is due to actual wealth creation. Perhaps stock prices have increased faster than goods prices for the last twenty-five years because, as in Zimbabwe, Western stock markets have become one of the principal entry points for newly printed currency.

John Paul Koning