. . . Is full dollarisation the answer?
Clive Mphambela —
Following a decade of instability and hyperinflation spanning 1998 to 2008 that resulted in the decimation of financial assets and the eventual demise of the Zimbabwe dollar, Zimbabweans have recently been haunted by a sense of déjà vu. The wide spread loss of value resulted in dented confidence in the financial system. These fears seem to have been revived of late and the recent behaviour of prices in the goods market as well as share prices on the Zimbabwe stock exchange rekindled feelings of trepidation amongst Zimbabweans and indeed foreign investors. It is now common cause that if one tries to buy a property in the suburbs, a motor vehicle, domestic capital goods or even groceries down town, you can be asked to pay in US dollars.
Government’s response to the market movements was rather quite surprising. Firstly, the movements in these key market variables were merely dismissed as the result of the illegal, speculative, mischievous agenda setting behaviour of a few misguided elements bent on disrupting the economy.
The authorities responded by issuing threats to the market, and in some cases, government even proceeded to cause the arrest of several people, who were accused of either trading in currency, hoarding bonds notes or both. Most of these accused persons were subsequently acquitted. What are the lessons to be drawn from all this in this short summary?
Lesson One: The Laws of Economics are called “Laws” for a reason. They must be obeyed, or at the very least, it must be understood that they cannot be broken without consequence.
Lesson Two: Liquidity (money) is very timid. Money is easily scared. The bond notes policy was not clear and crisp and left people guessing all the way.
Lesson Three: The best policy changes must be made, early, swiftly and usually without warning. The Reserve bank took too long between the announcement of the change in currency rules and the eventual implementation leaving a lot of room and scope for the market to position itself against the policy proposals.
Lesson Four: Policy interventions must be seen by the market to make sense through the positive reinforcement by the policy makers and not merely though legal force. Legal force rarely prevails over market forces. And the value of money or currency depends on perceptions and factors usually beyond the scope or capacity of the issuer. It is common knowledge that in many jurisdictions, people are prepared to pay more than the face value of one US dollar to lay their hands on one US dollar.
One of the main reasons why the wheels have rapidly come off as far as bond notes are concerned is that whilst the intentions of the central bank were good and well justified, the introduction of the bond note tended to turn a blind eye on substantial economic fundamentals.
Save for a declaratory note via a directive, which was later supported by legislation, there was no sound economic basis or other credible argument advanced for Bond notes to be pegged at par with US dollars. The central bank simply took a legalistic view. If we say bond notes are one to one with the US dollar, so be it!!!
Well markets are markets and in the long run (which in this case came very quickly), the market simply found its own equilibrium. In fact, as soon as bond notes hit the streets, not even the issuing authority itself was able to trade-in its own bond notes in exchange for US dollars on demand.
Value is a creature of the market and cannot be legislated. The legalistic position taken by the central bank was simply erroneous and seemed to assume irrationality on the part of the market. It presupposed by design, that the central bank was smarter than everyone else; and that markets would be incapable of determining the appropriate risk and ascribing the appropriate value to the bond notes. Well the market have always proven to be a far more arrogant and effective platform for allocating risk and price, time, capital or labour than any single institution can be.
Save only to the extent that there was a desperate need for a medium of exchange for the common citizen, there was no nationalistic motivation accompanying the rapid acceptance of the bond notes when they were introduced, but the currency was offloaded onto a market which was desperate for utility value in the exchange process. The lack of intrinsic value of the bond note has never been in dispute. It was just a question of time before market forces stopped allowing essentially unbacked fiat money to pass on as real US dollars.
In fact, it would have be extraordinary that people would continue to happily accept bond notes, which are a physical representation or abstraction of the digital currency we now commonly refer to as RTGS money, that is being generated by the Reserve bank of Zimbabwe as being nominally valuable as US dollars, whose characteristics and methods of generation are vastly different.
Secondly, real money is timid. The operation of Gresham’s Law in the context of the bond note versus the US dollar was never going to be avoidable. Gresham’s Law is a monetary principle economics which states that “bad money will drive out good money”, whenever there are two forms of “money or currency” in circulation, which are regarded at law as having similar nominal or face value, but differing intrinsic values, the money considered more valuable will be substituted systematically in transactions and will soon disappear from circulation, leaving the less valuable currency as dominant in circulation.
This is precisely what has happened. Upon introduction, Bonds notes began to drive out US dollars from the market, and as quickly as hard currencies disappeared into people homes, pillows, safes and mattresses, RTGS and mobile money soon took over, also driving out bonds notes from circulation. This is because the market ascribes different utility values to all these forms of payment and hence applies different discount rates in the exchange process. This explains fully the existence of multiple tier pricing system that has been the subject of policy debate.
Let me conclude today’s discussion with a disclaimer. The import or intent of my analysis, is not to denigrate or to attack the policies of the central bank, but merely to point out the inherent downsides of the bond notes, which in large part are merely indicative of how deeply embedded in our psyche, the general view is, that in the short to medium term, our economy is no longer determined by our own contextual factors.
We must accept that Zimbabwean’s have increasingly become global in their economic outlook and now have a predisposition towards accepting the economic systems and realities of those countries that they admire, including the United States of America, whose currency we should as a necessity, stubbornly hold on to if we are to fix our own economy to a point where the sins of the past 15 years are forgotten.
Without doubt, the current foreign currency liquidity challenges can only be resolved in the short term through enhanced access to lines of credit, sustained growth in inward remittances; portfolio investment flows and grants and in the medium to long term , through the growth of exports, which themselves are a function of greater investment and productivity.
In this regard there is urgent need to review the negative costs and uncertainty that has been visited on the economy by the introduction of Bond notes. The instrument, which had the dual purpose of stimulating exports and ameliorating cash shortages, seems to have had the unintended consequences of inadvertently driving hard currency out of circulation through the operation of normal laws of economics.
As a result we have seen further dislocations in the macro-economic environment, manifesting as a resurgence in harmful parallel market activities fuelled by speculation. There is need for Government to immediately institute measures to restore the integrity of the multi-currency system in order for confidence to return. Strong consideration should be given to the growing sentiment that Bond Notes should be demonetised without delay. The brief experiment with partial dollarisation is bringing us more hurt and pain that we can bear.
From the foregoing there is a logical basis to argue that we somehow need to reverse some of the effects that have resulted from the materialisation of the export incentive in the form of bond notes. The optimal way to obtain currency stability in our case no longer seems to be the pursuit of an elusive and somewhat unsustainable peg between the local dollar and the real dollar. The better option is to abandon the local currency (bond note) completely in favour of the exclusive use of the US dollar (or another major international currency, such as the rand). This is known as full dollarisation.
The main reason the country should do this is to reduce country risk, thereby contribute to the provision of a stable and secure economic and investment climate. Zimbabwe is already in transition and full dollarisation may perhaps avert the effects of devastating inflation which we have experienced before. By deciding to use the foreign tender, individuals and institutions investors will be protected against possible devaluation of the local dollars and the country’s economic climate will become more credible, and since our markets will be therefore insulated, the possibilities of speculative attacks on either the local currency, property and or capital market will virtually disappear.
This diminished risk should, in-line with the policy thrust of the new government, encourage both local and foreign investors to invest their money in the country, boosting liquidity and preserving the value of savings in the banking system and the capital market. Further, the fact that an exchange rate differential will no longer be an issue should help reduce interest rates on foreign lines of credit, impacting local cost of credit. As things stand, borrowing offshore is quite risky and costly as lenders are smart enough to realise that lending hard currency into an environment with bond notes exposes the borrowers to exchange rate risks.
The writer is an economist. The views expressed in this article are his personal opinions and should in no way be interpreted to represent the views of any organisations that the writer is associated with.