History of Economic Mismanagement - Part II

It is often a deceiving process to evaluate the relative stability and condition of an economy. According to Madura (2008), “The amount of consumption in any country is influenced by the income earned by consumers in that country” (p. 14). Jean Baptiste Say would have countered Madura with the proposition that the amount of relative income earned is influenced by the amount of production. In either event, international business managers’ who are intent on evaluating geopolitical risk in areas of potential foreign direct investment must understand that money is an elusive target. Prevailing interest rates, the potential for inflation, and exchange rate volatility must be considered carefully in order to establish prospective cash flows from a foreign investment.

According to Rome.info (2009), “The Roman economy suffered from inflation (an increase in prices) beginning after the reign of Marcus Aurelius.” Prior to this time, the denarius had remained a very stable currency backed by 60 grains of silver during the time of Julius Caesar. The infamous reign of Commodus (180-192) brought forth a time of superfluous spending and excess. Commodus fashioned himself a warrior and his execution of animals and prisoners in the great coliseums were amongst his favorite pursuits. According to Gibbon (1776), Commodus, “received from the common fund of gladiators a stipend so exorbitant that it became a new and most ignominious tax upon the Roman people” (p. 75). The gold and silver in the treasury soon became depleted and thus the currency began to be comprised of smaller and smaller amounts of actual value. By the time of Commodus’s murder, the denarius contained 26 grains of silver. The reduced value of this new currency caused hyperinflation and economic destabilization. Because of this devaluation, many regions would no longer accept this currency as a valid medium of trade.

In considering the effects of inflation on MNC’s, Madura (2008) asserts that, “If a country’s inflation rate increases relative to the countries with which it trades, its current account will be expected to decrease, other things being equal” (p. 34). Interest rates are similar to the money supply in their effect on prices and inflation and rates of exchange. According to Train (1985), during the hyperinflation that occurred in France around the time of the French Revolution, “As the torrent of paper poured out of the presses, specie vanished, goods were hoarded, and prices flew upward” (p. 58). As a result of the flooding of paper money into this system, its value relative to tradable goods decreased. In order to prevent this at the onset, the Assemblée of France had established an interest rate of 3 percent to attract specie from those who might otherwise question the value of paper money. The result was that a relative equilibrium was temporarily achieved as supply met demand. Greedy by the inflow of coinage, however, the Assemblée began to print money without regard to the equilibrium of supply and demand. Additionally, they reduced the rate of interest payable to zero. The result of these actions was hyperinflation and the overthrow of the French government.