Thursday, March 12, 2015

The final chapter in the Zimbabwe dollar saga?



Here's an interesting fact. Remember all those worthless Zimbabwe paper banknotes? The Reserve Bank of Zimbabwe (RBZ), Zimbabwe's central bank, is officially buying them back for cancellation. According to its recent monetary policy statement, the RBZ will be demonetizing old banknotes at the "United Nations rate," that is, at a rate of Z$35 quadrillion to US$1. Stranded Zimbabwe dollar-denominated bank deposits will also be repurchased.

As a reminder, Zimbabwe endured a hyperinflation that met its demise in late 2008 when Zimbabweans spontaneously stopped using the Zimbabwe dollar as either a unit of account or medium of exchange, U.S. dollars and South African rand being substituted in their place. Along the way, the RBZ was used by corrupt authorities to subsidize all sorts of crazy schemes, including farm mechanization programs and tourism development facilities.

Upon hearing about the RBZ's buyback, entrepreneurial readers may be thinking about an arbitrage. Buy up Zimbabwe bank notes and fly them back to Zimbabwe for redemption at the RBZ's new official rate, making a quick buck in the process. But don't get too excited. The highest denomination note ever printed by the RBZ is the $100 trillion note. At the RBZ's demonetization rate, one $100 trillion will get you... US$0.003. With these notes selling for US$10 to $20 as collectors items on eBay, forget it—there's no money to be made on this trade. If you've already got a few $100 trillion Zimbabwean notes sitting in your cupboard, you're way better off hoarding them than submitting them to the RBZ's buyback campaign.

But this does give us some interesting data points about the nature of money. Last year I wrote two posts on the topic of whether money constituted an IOU or not. With the gold standard days long gone, central banks no longer offer immediate redemption into some underlying asset. But do they offer ultimate redemption into an asset? A number of central banks—including the Bank of Canada and the Federal Reserve—make an explicit promise that notes constitute a first claim or paramount lien on the assets of the central bank. This language implies that banknotes are like any other security, say a bond or equity, since each provides their owner with eventual access to firm assets upon liquidation or windup of the firm.

George Selgin is skeptical of the banknotes-as-security theory, replying that a note's guarantee of a first claim on assets is a mere relic of the gold standard. However, the Bank of Canada was formed after Canada had ceased gold convertibility. Furthermore, modern legislation governing central banks like the 2004 Central Bank of Iraq (CBI) Law declares that banknotes "shall be a first charge on the assets of the CBI." [See pdf]. So these promises certainly aren't relics of a bygone age. The Zimbabwean example provides even more evidence that a banknote constitutes a terminal IOU of sorts. After all, Zimbabwean authorities could have left legacy Zimbabwe dollar banknotes to flap in the wind. But for some reason, they've decided to provide an offer to buy them back, even if it is just a stink bid.

Given that banknotes are a type of security or IOU, how far can we take this idea? For instance, analysts often value a non-dividend paying stock by calculating how much a firm's assets will be worth upon break up. Likewise, we might say that the value of Zimbabwean banknotes, or any other banknote, is valued relative to the central bank's liquidation value, or the quantity of central bank assets upon which those notes are claim when they are finally canceled. If so, then the precise quantity of assets that back a currency are very important, since any impairment of assets will cause inflation. This is a pure form of the backing theory of money.

I'm not quite willing to take this idea that far. While banknotes do appear to constitute a first claim on a central bank's assets, the central bank documents that I'm familiar with give no indication of the nominal quantity of central bank assets to which a banknote is entitled come liquidation. So while it is realistic to say that the Reserve Bank of Zimbabwe always had a terminal offer to buy back Zimbabwe dollars, even during the awful hyper-inflationary period of 2007 and 2008, the lack of a set nominal offer price meant that the value of that promise would have been very difficult to calculate. More explicitly, on September 30, 2007, no Zimbabwean could have possibly know that, when all was said and done, their $100 trillion Zimbabwe note would be redeemable for only US$0.003. The difficulty of calculating this terminal value is an idea I outlined here, via an earlier Mike Friemuth blog post.

While the final chapter of the Zimbabwe dollar saga is over, the first chapter of Zimbabwe's U.S. dollar standard has just begun. Gone are the days of 79,600,000,000% hyperinflation. Instead, Zimbabweans are experiencing something entirely new, deflation. Consumer prices have fallen by 1.3% year-over-year, one of the deepest deflation rates in the world and the most in Africa. With prices being set in terms of the U.S. dollar unit of account, Zimbabwean monetary policy is effectively held hostage to the U.S. Federal Reserve's 12 member Federal Open Market Committee. Most analysts expect the Fed to start hiking rates this year, so I have troubles seeing how Zimbabwean prices will pull out of their deflationary trend. Few people have experienced as many monetary outliers as the citizens of Zimbabwe over such a short period of time. I wish them the best.

16 comments:

  1. I would think that the Zimbabwe episode is what proves backing theory wrong.

    With a gold standard world, the value of paper money depends primarily on redeemability. When redeemability is suspended temporarily, then backing is probably the least bad theory for the value of the paper money (not the gold.)

    If there is a strong commitment to some nominal anchor, then it is kind of like a gold standard. The value of paper money depends on the nominal anchor. If there is a temporary suspension, failure, or whatever it should be called when there is no explicit default, then the backing theory is probably the least bad approach.

    If the government issues the paper money, then it is the government's overall solvency that counts.

    The fiscal theory of the price level appears to be that interest bearing debt is paramount, and the obligation to keep money on its nominal anchor bears zero weight.

    Oh, and by the way, a "k percent" base money rule is approximately the same as the irresponsible print money and spend it approach in making the backing theory irrelevant.

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    1. "If the government issues the paper money, then it is the government's overall solvency that counts."

      Huh? How would the government's solvency affect the value of fiat money? Of course, if the government is *printing money* to try to become solvent, *that* affects the value of the money.

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  2. "US$0.003 cents."

    OK, what is this number supposed to mean? You have two units attached to it! The number is *either* $0.003 *or* 0.003 cents. But right now I have no idea which.

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    1. The United States is not the only country to use dollars as their currency. Just offhand I recall that Singapore, Australia, and Hong Kong also issue dollars. Sometimes it is necessary to distinguish which dollar you're talking about, so US$ is not a redundancy. I grant that in the context one would expect US$ to be the subject of discussion, but it is never a bad idea to remove ambiguity.

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  3. Money has value due to expected future use. I see no reason to expect there to be a single form of future use all money value can be reduced to/seen as anchored in.

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    1. Money has value due to expected future use, and it has future use because it is expected to be valuable. It's a circular argument, which is one of the great challenges of understanding money.

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  4. My observation is that both the Central Bank and the private sector has money to lend. The huge difference between the two sources of loans is that the Central Bank must "print" the money it loans while the private sector must first "earn" the money it loans.

    A bond issued by a borrower is nothing more than acknowledgement that the borrowed money will be returned in the future.

    Do you know if Zimbabwe had a private sector borrowing program? Or were nearly all loans issued by the Central Bank who was "printing" the new money?

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  5. You'd imagine that the value of money is based on its ability to command goods and services, so as long as someone is willing to accept it as payment it has some value. Accepting money then becomes a bet on the economy's willingness and ability to provide goods and perform services in exchange for it in the future.

    In some ways it is like the electromagnetic theory of light. Is it an electric or magnetic phenomenon, each seems to cause the other but with no original "there" present, just an eternal dance.

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    1. You would think that the fluctuations in the price of gold in recent years would get people to think more about what "value" really means. Marx had to start out Capital, Vol. 1, with a discussion of "use value" compared to "exchange value." Money is not useful for buying things because it represents something valuable, money is valuable because we can use it to buy things. Granted, fiat money requires some care in managing its issuance, but remember that commodity money (gold and silver coins) *always* had a higher face value than the price of the metal in the coins. When Spain gained large quantities of gold and silver from the New World, the result was a ruinous inflation of prices throughout Europe, but especially in Spain.

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    2. The exchange value of money makes perfect sense when trading a weeks labor for a weeks groceries, rent, gas and other items.

      The long term value of money becomes much more important when trading a years worth of effort for the start of next year's effort. I am thinking here of a wheat farm example. One year's harvest is the financial base of the next crop. Harvest is sold for money (something that has value). The money is then used incrementally throughout the year to purchase fertilizer, taxes, seed, sprays, tools, fuel, and finally, harvest expenses. A depreciating money during the year is a disaster to the wheat farmer who may run out-of-money before the next crop is mature.

      I think Zimbabwe farmers depended upon international fuel, fertilizer, and chemicals. If so, there would have been an extreme need to sell the crop for what ever currency would be stable in terms of fuel, fertilizer, and chemical prices. The Zimbabwe farmer would have a strong disincentive to sell for Zimbabwe currency which was in free-fall on the international exchange market.

      The farmer in this example would agree that money has 'exchange value' but he is also depending upon the 'store of value' aspect of money as a vitally important feature of his annual economic cycle.

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  6. Zimbabwe's situation, as horrible as it was, is unfortunately far from unique; there have been several hyperinflationary episodes in several different nations over the past 100 years (Weimar Republic, Bosnia & Herzegovina, Hungary, Yugoslavia, Armenia, Nicaragua, etc.). At the end of the day, greedy governments, reckless money printing, unrestrained spending, and dismal economic output can create a "perfect storm" for a loss of confidence in the currency. What's so terrible about it in my mind is that it is primarily the result of short-sighted monetary policy decisions, typically made by only a handful of people, yet it affects millions of people in a destructive manner. Great post, by the way!

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    1. alot of people say the 100 trillion dollar zimbabwee note is the largest ever printed, however many people are saying hungary or some other coutnry i cant recall exactly had an even larger note. its amazon to see how the price of these notes has skyrocketed. a year ago you could purchase these from amazon for a couple bucks a piece and now people are asking $70 or more for them http://buyiqd.com/collections/all/products/100-trillion-zimbabwe-unc-notes

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  7. The convertibility of money is there. When the government issues you with a tax bill of $100 it will only accept $100 of the money that it has issued as payment. One dollar of money is converted into one dollar of tax payment. Your liability to the government, and the possibility of going to jail if you don't meet that liability, is what backs the money.

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  8. The Zimbabwe Dollar was just recently cashed in by the Zimbabwe government at 0.40 cents per 100 trillion note and there's sites in the state selling these for over $70. are there not many of these around? it has to be because this item is nothing but a collectible now http://buyiqd.com/collections/all/products/100-trillion-zimbabwe-unc-notes. i bought a few back in the day as gag gifts to put in birthday cards. i think a year ago i paid like $2 with free shipping

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