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Monday, 5 August 2013

Arbitrage during hyperinflation can be a good thing only if coupled to capital investment

Arbitrage during hyperinflation can be a good thing if coupled to capital investment

Widespread - generally illegal - arbitrage between an official forex and a parallel rate normally appears spontaneously as a result of the invisible hand of self-interest, especially in hyperinflationary countries. It was widespread in the form of "buring money" in Zimbabwe at the height of severe hyperinflation and it is now becoming widespread in Venezuela.

Arbitrage is a crude form of quantitative easing during hyperinflation. 

When the wealth created via "buring money" in Zimbabwe or illegal arbitrage currently in Venezuela without an underlying productive process, is simply used for expenses (consumption without production), then it is simply a temporary self-destructive snowball that will eventually consume the economy and may lead to Dollarization and the economic shackles that come with it.

If the wealth created via the above arbitrage were to be applied as capital investment - for example, in the source capital of new companies - which is then automatically maintained constant in purchasing power with the implementation of Capital Maintenance in Units of Constant Purchasing Power in terms of a daily index (IAS 29 Financial Reporting in Hyperinflationary Ecomies in terms of a Daily Index), the daily USD parallel rate in the case of Venezuela, then it could over time lead to economic stability and GDP growth.

The sense of easy money that illegal arbitrage during hyperinflation engenders unfortunately works against developing the economic discipline and good governance required for such capital investment to come about. It did not come about in Zimbabwe and it will not come about in Venezuela.

Nicolaas Smith Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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