A troubled currency is one in which users have lost confidence. When users no longer think a currency will retain its purchasing power, they attempt to dump it for a stable foreign currency or commodity. As demand for the troubled currency goes down its value against stable foreign currencies collapses and prices in that area soar.
Steve H. Hanke
Jul. 27, 2013, 9:05 AM
For academics, the term “troubled currency” might be a term of art. But for people who are faced with such a currency, they know a troubled currency when they see one. Today, this is the case for millions of people around the world – most notably in Iran, North Korea, Argentina, Venezuela, Egypt and Syria.
A troubled currency is one in which users have lost confidence. When users no longer think a currency will retain its purchasing power, they attempt to dump it for a stable foreign currency (or commodities). As the demand for the troubled currency evaporates, its value vis-à-vis stable foreign currencies collapses, and prices for goods and services sold in the troubled currency soar.
As this process develops, expectations about the currency’s ability to retain its purchasing power deteriorate, and a doom loop ensues. At the extreme, doom loops can culminate in hyperinflation – an inflation rate of over 50% per month. This, however, is rare. Indeed, there have only been 56 cases of hyperinflation.
Troubled Currencies in History – The Indonesian Rupiah
The Asian financial crisis of the late 1990s gave rise to several troubled currencies. The Indonesian rupiah was one currency that entered such a doom loop. On August 14, 1997, shortly after the collapse of the Thai baht, Indonesia floated the rupiah – on ill-conceived instructions from the International Monetary Fund (IMF).
Contrary to the IMF’s expectations, the rupiah did not float on a sea of tranquility. Its value plunged from 2,700 rupiahs per U.S. dollar at the time of the float to lows of nearly 16,000 rupiahs per U.S. dollar in 1998. Indonesia was caught up in the maelstrom of the Asian crisis.
By late January 1998, President Suharto realized that the IMF medicine was not working and sought a second opinion. I was invited to offer that opinion and began to operate as Suharto’s Special Counselor. I proposed replacing Indonesia’s troubled rupiah with a stable rupiah anchored to an orthodox currency board system. On the day that news hit the street, the rupiah appreciated by 28% against the U.S. dollar (see the accompanying chart).
In a sense, the case of Indonesia was unique – the rupiah traded freely on the foreign exchange market, with a floating exchange rate. More often, severe currency problems arise under monetary systems that restrict the convertibility of their currency and/or employ a pegged official exchange rate that overvalues the currency. These circumstances typically give rise to a black market for foreign exchange, where the domestic currency is freely traded at a market-determined exchange rate.
What’s more, the Suharto government continued to publish economic data after the rupiah became a troubled currency. In many countries with troubled currencies, however, this is not the case. Indeed, regimes in countries undergoing severe inflation have a long history of hiding the true extent of their inflationary woes. Often, governments fabricate inflation statistics to hide their economic problems. In the extreme, countries simply stop reporting inflation data. Yes, official economic data from countries with troubled currencies often amount to nothing more than lying statistics and should be treated as such.
How can this problem be overcome? At the heart of the solution is the exchange rate. If free-market exchange-rate data (usually black-market data) are available, a reliable estimate of an inflation rate can be determined. The principle of purchasing power parity (PPP), which links changes in exchange rates and changes in prices, allows for reliable inflation estimates during periods of elevated inflation. Indeed, PPP simply states that the exchange rate between two countries is equal to the ratio of their relative price levels. Accordingly, to calculate the inflation rate in countries with troubled currencies, a rather straightforward application of standard, time-tested economic theory is all that is required.
Troubled Currencies Today
For the past year, I have been collecting black market exchange-rate data from various countries – namely Iran, North Korea, Argentina, Venezuela, Egypt and Syria – and using them to calculate implied inflation rates. While I have published a number of articles and blogs containing information and data on countries with troubled currencies, I have come to realize that there exists no centralized location where black-market exchange-rate and inflation data can be found for such countries.
To remedy this, I established the Troubled Currencies Project – a collaboration between the Cato Institute and the Johns Hopkins University. The Troubled Currencies Project hosts a website, regularly updated with the latest black-market exchange-rate and implied inflation rate data on countries with troubled currencies. What follows is a snapshot of the countries that the Troubled Currencies Project currently studies and a more detailed explanation of the circumstances surrounding each troubled currency.
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