eBusiness Weekly
Central bank cannot buy time for Government much longer
Chris Chenga
Economic observers are at their most obsessive at the time leading up to and immediately soon after policy statements. Naturally, Reserve Bank of Zimbabwe governor Dr John Mangudya has been under the spotlight leading up to his Monetary Policy Statement and he will surely remain so in the next few days.
But what are credible observer expectations, of him and the central bank that he leads?
Exactly what do observers expect from the central bank and behind those expectations, which commentary — whether complimentary or critical — is warranted of the central bank’s policy actions?
It is necessary to raise this narrative aimed at the observer because in many instances, it seems fashionable to vilify certain institutions, yet on misguided expectations of the actual sphere of influence belonging to those institutions.
Throughout economic history, and perhaps since the inception of the first central bank in 1609 in Amsterdam, governments have had a mischievous tendency resorting to use central banks as instruments for financial engineering; financial engineering for short term fixes of welfare and productivity challenges that are actually under the influence of governments themselves.
More often than not, these short term fixes have ended up proving to be pernicious, with prolonged difficulties left on unsuspecting citizens.
Typically, governments have actively postured to portray the financial calamities which befall citizens as the fault of central banks, and perhaps to this day, observers of central banks are now accustomed to weigh more emphasis on central banks than what is actually warranted. Well, we shouldn’t give into the charade.
The most important character in any government is its management and discipline with credit. Central banks are institutions that create this credit. This is the fundamental relationship which should be understood in observing monetary policy.
Sound management and discipline of credit by governments should grow an economy. By using the credit created by central banks to improve productivity in the making of goods and services, governments should ultimately stimulating better welfare for citizens. Poor management and ill-discipline of credit leads to lowering productivity and depressed citizen welfare.
Central banks use financial engineering to create credit for governments, for example the credit financing that the Government of Zimbabwe has been using. It is not just here; currently central banks in the UK, China, US, EU, and other developed economies hold a fifth of their government debt at over $15 trillion. This is more than any time before in history.
Central banks can purchase bonds or financial securities from governments to create credit.
They could choose to create credit within the financial sector by adjusting interest rates and lending practices.
The act of printing money itself is another form of credit creation (hence the promissory clause printed on bank notes).
It is from this perspective, where central banks’ prime duty is to create credit in an economy, that the Reserve Bank of Zimbabwe has done a relatively good job considering the government it has had.
A national debt of over $7 billion, in a $14 billion economy, means there should hardly be any credit in our economy.
For example, this is why there has been huge growth in the micro-financing segment of credit in our economy. It is indicative of depressed credit capacity passed down from government level to regular citizens.
So, even under such constraints the RBZ has been able to create some credit in the economy. This is where observers need to look.
Granted, some of the credit creation practices by the RBZ have been distasteful, fundamentally, the central bank’s responsibility is to ensure availability of credit — almost at all costs.
The choices it has to do this are derived from government’s level of management and discipline. For instance, by the debt assumption bills, deficit financing of government budgets, or debt buy up in ZAMCO, the RBZ has to socialise the burden of bad management and poor discipline of government onto all citizens.
It is not accurate to make Mangudya culpable for the ethical perception of these decisions. Credit has to be found somewhere. It is unfortunately inherent in the manner in which central banks function, that they carry a high exposure to agency theory; where credit creation seems to benefit undeserving entities at the expense of citizens. In most cases, as per governor Mangudya’s case, central banks have no choice but to utilise financial engineering of this nature to form that credit in the short term.
In his MPS on Wednesday, to the disgruntlement of many bank account holders, Mangudya said that bond notes will remain in circulation into the foreseeable future. Again, this surrogate currency is a means of credit creation in a situation where the Government of National Unity could only attract US dollars, but afterwards, government that failed to sustain productivity and welfare to retain US dollar in our economy.
It is important to understand that USD inflows are a form of credit into our economy, and bank balances denoted in respective countries are only as valuable as the credibility of respective governments.
The value of bank accounts in Zimbabwe was not sustained by any sound management and discipline of credit by government. It is that simple an explanation.
Governor Mangudya used bond notes as credit creation to fill that gap. The choice was between the uncertainty of losing unknown value of account balances, or having a surrogate currency that upheld some semblance of value in the short term?
Arguably, this is what good central banks should actually do; formulate policy that creates chances for redeeming credit potential in an economy, irrespective of who gets an undeserving leg up or the bank account holders short-changed by loss of parity currency value.
Central banks have to create short term credit, which are windows of opportunity for governments to get their act together. This is where I believe observers should focus on as it relates to the RBZ.
We should comprehend that the current central bank administration is tasked to, and pursuing the creation of credit in the economy under serious productivity and disciplinary pressures from government.
Writing on this predicament faced by central banks, Scottish economist and Controller General of the Finances of France, John Law wrote in 1716 “I maintain, that an absolute Prince who knows how to govern, can extend his credit further and find needed funds at a lower interest rate, than a Prince who’s limited in his authority.
In credit, supreme power must reside in only one person. . .” He meant this advice for the Duke of Orleans for as long as there is a credit crisis at governmental level, such as that faced in Zimbabwe at present; decisions on credit creation are constrained to the one agency, which is the central bank, and hose decision are not popular.
Accordingly, Zimbabwean stakeholders need to shift focus from the central bank, and start pressuring government to attend to its credit crises, as unresolved, it is continuously constraining credit creation by the central bank, leading towards a bubble backed by little productivity and wealth.
Governor Mangudya himself has honestly indicated that with the bulging electronic credit, in the form of RTGS balances, government needs to start “sweating” that credit to improve productivity and increase citizen’s hard wealth.
He has also been consistent in stating that bank account balances losing parity to USD can only re-emerge in value with increased exports that reclaim productivity confidence to attract USD into the economy.
As fearful investors move money into stock markets and other asset classes as witnessed last year, this is merely inflationary value without any fundamental improvement in the productivity of those companies and assets.
Unfortunately, as opposed to a dire circumstance where there is no credit at all in the economy, the RBZ can only continue to create credit, which is a bubble, until government reforms to a point where management and discipline of that credit inspires real productivity and wealth.
For more in-depth comprehension on this notion of credit, I recommend observers of monetary policy to watch a video called “The Economic Machine” by Ray Dalio, founder of Bridgewater Associates.
