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Tuesday, May 20, 2008

Adrift in a sea of darkness - Sohail Rabbani

The power shortage in Pakistan is a severe crisis. There is a short fall in power production and a substantial proportion of the demand can not be met. The brilliant people responsible for ensuring a steady power supply for a growing economy are busy taking cover and pointing fingers at others as they juggle with the supply demand imbalance by shutting down certain portions of the grid around the clock to ease the load on the system. But this rationing of electrical power, by pre-scheduled rolling black outs called “load shedding,” can not be a lasting solution. Something must give.

Besides being a terrible inconvenience as well as a serious retardant for the economy, this power crisis of 2008 is also an apt metaphor for the whole country. Nothing here runs on all cylinders. Systems and institutions are fundamentally dysfunctional as incompetence and corruption are rife. What we witness these days is history unfolding in real time. We are watching the breakdown of a severely stressed structure. Pakistan is literally crumbling down to its foundations. How long the ordeal will be or when it will reach climax? No one can say. Though the slow crushing grind could go on longer than one imagines today.

Disease, hunger and violence (Malthus’s ‘Pestilence,’ ‘Famine,’ and ‘War’) are upon us whether we acknowledge it or not. Our uncontrolled population growth over the past two decades has already sealed this fate. Even if we had absolutely no problems in the areas of politics, economics, inter-ethnic relations, education, health and welfare, still, global weather changes couple with the coming water shortage, by themselves, would be utterly disastrous in a few decades. But we are not a people blessed with much foresight. We don’t worry about the coming decades. If it isn’t now, it is too far in the future. We only react to what happens, and then too, only after it has already happened.

While the media are singularly focused on the antics of corrupt politicians, whose horse trading is ultimately trivial and meaningless, the real immediate nemesis for the proverbial common man is monetary inflation and the ever increasing risk of hyperinflation. Watch out.

Hyperinflation has not hit us. Not yet. It is lurking in the shadows and can be upon us before we know it. Let’s hope it never does but the signs are looking ominous. The state establishment is printing money to meet its frivolous spending.

Everyone in Pakistan should heed this warning and protect themselves if they can.

What does hyperinflation mean in common language and how if effects daily life. Let me expand on it briefly.

Imagine that the exchange value of the rupee falls off a cliff. Even against a universally sick US dollar the rupee continues to fall further in value as dishonest politicians resort to extravagant spending beyond the financial means of the government. The government issues new treasury bonds and the state bank "buys" them thus injecting more and more liquidity into the system.

If this were to go unchecked then the rupee would start losing value rapidly. Rs. 67 to one US dollar today, 76 tomorrow, 760 next week and 76,000 in six months. This is typically how currency values drop when hyperinflation hits an economy. There is no telling how far and how deep it could cut, but cut it does into the lives of people, devastating families and communities. The salary earners and pensioners are completely wiped out. Middle class vanishes. Society is only left with the rich, the poor and the utterly destitute. The whole episode is like a huge economic tsunami. It hits hard and wreaks havoc. It’s pandemonium. Then the flood waters recede and recovery begins but the aftermath is gruesome and painful for millions.

A hyperinflationary episode can last from six to eighteen months, with an aftermath of a few years. Revolutions and civil wars can erupt with episodes of hyperinflation. Supply disruptions, including vital food and fuel supplies, and harvest failures can lead to mass starvation and sporadic law and order breakdowns.

Most economics students are taught about the hyperinflation that hit the Weimar Republic of post-WW I Germany. It is very instructive to get a historical perspective.

The rise in prices destroyed the purchasing power of wages and government revenues, and the government responded to this by printing money to replace the lost revenues. This was the beginning of a vicious circle. Each increase in the quantity of money in circulation brought about a further inflation of prices, reducing the purchasing power of incomes and revenues, and leading to more printing of money.

In the extreme, the monetary system simply collapses. In Germany, people would rush out to spend the day's wages as fast as possible, knowing that only a few hours' inflation would deprive today's wages of most of their purchasing power. One source says that people might buy a bottle of wine in the expectation that on the following morning, the empty bottle could be sold for more than it had cost when full. Those with goods to barter resorted to barter to get food; those with nothing to barter suffered.

This is the way that hyperinflations happen: by a self-reinforcing vicious cycle of printing money, leading to inflation, leading to printing money, and so on. This is one reason why inflation is feared. There is always the concern that even a little inflation this year will lead to more next year, and so on. But some countries have experienced very great inflations -- 50 to 100% per year -- without ever falling into the cycle of hyperinflation, and there has never been a hyperinflation that could not have been avoided by a simple government determination to stop the expansion of the money supply. (But that assumes that those in power are honest, able and responsible; an assumption I am reluctant to make.)

Here is a brief description of that German hyperinflation episode of the early 1920s.

The worst hyperinflation in world history, so far, was not that of Weimar Republic. The absolute worst case was seen in 1993-94 in Yugoslavia. Read about it at this link: (it’s on three pages, click on next page at the bottom)

Coming back to today's Pakistan....

How do we protect ourselves against such a scenario? Well, unfortunately, most people can not do anything and are doomed to suffer immeasurable hardship. Other, who are more fortunate to begin with, can do at least five things.

One: do not hold any ‘paper asset’ (a contradiction in terms) that are denominated in the Pak Rupee. This includes cash deposits, deposit certificates, bonds of all types and even shares of many companies. Instead, convert to another form of liquidity that is not denominated in Pakistani currency. (My personal bias favors precious metals as the best form of a liquid asset.)

Sadly, if enough people panic and start doing it, that will become a self-fulfilling prophecy. But sooner or later enough people WILL panic and start doing it. You must not wait for that time and should move before the crowd does. Don’t risk getting caught in the stampede.

Two: do not accept any contractual obligation where in exchange for your goods or services today, your future payments (your income) are promised in rupees. A Big ‘No, NO’ to any such arrangement. If you are in such an arrangement presently, try getting out of it.

Three: try and pay your future obligations in rupees. If someone sells you goods or services today and is stupid enough to accept future payments in the form of Pak rupees, pin them down like a predator pins down its prey. Yes, it’s a dog eat dog world. You’d best be a big dog or at least a fast one.

Four: have the right to pay off your Pak rupee denominated obligations at any time prior to the agreed deadline without incurring any pre-payment penalties. Thus, if you have shifted out to a non-rupee liquid asset, you’ll be in a position to convert back to rupees and pay off your obligation when the rupee is at its lowest.

Five: go to your place of worship and pray that I am wrong about this one.

Sohail Rabbani, Islamabad, Pakistan, May 2008



These two articles, written in simple laymen's language, should be interesting reading for the interested and the curious...

1: Money

2: Central Banking


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