Tuesday, June 7, 2016

Zimbabwe Shouldn't Be Printing Banknotes Again

A Zimbabwean washes U.S. dollars, from NPR Planet Money

Here's a surprising development.

Zimbabwe, a dollarized nation, is on the verge of issuing its own $2, $5, $10, and $20 banknotes. Here is is the central bank's press release. Let's back up a bit. Zimbabwe suffered one of the worst hyperinflations in history during the 2000s thanks to awful policies by the government. Citizens were so fed up that they spontaneously dropped the Zimbabwe dollar in late 2009, the U.S. dollar being recruited as media of exchange and unit of account and the South African rand serving a backup role as small change.

Since then the rand has been steadily moving to the background in Zimbabwe monetary affairs:

Currency utilization levels in Zimbabwe [source]

Another change is that last year Zimbabwe re-entered the world of monetary production by minting its own 1, 5, 10, 25, and 50 cent coins, otherwise known as bond coins. At the time I was in favor of bond coins because Zimbabwe was following the blueprint set by dollarized nations like Panama and Ecuador. These nations mint their own small change to complement Federal Reserve-printed dollar banknotes, and for good reason. Coins are heavy while not being particularly valuable, which means that shipping costs are prohibitive. As a result, local banks prefer to import paper dollars, the ensuing coin shortages that develop making it difficult for locals to engage in basic transactions.

While I was a fan of bond coins, I don't like the Reserve Bank of Zimbabwe's decision to print bond notes. It departs from the dollarization blueprint--neither Panama nor Ecuador (or any other dollarized nation that I know of) have chosen to get into the business of printing notes. Panama in particular is a highly successful dollarized nations, so if Zimbabwe wants to depart from the Panama model one would expect it to have a very good reason for doing so.

John Mangudya, head of the Reserve Bank of Zimbabwe, says that he wants to get back into the note-printing game thanks to a "shortage of U.S. dollars" that seems to be bedeviling the nation. Since March, line-ups have developed at ATMs all over the country as people try to withdraw U.S. dollar cash. This is true, the local press is full of articles on banking queues. Strict limits have been placed on the amount of cash that Zimbabweans can withdraw from their accounts.

I'm skeptical of Mangudya's dollar shortage story. There is a very simple process whereby a dollar shortage in a dollarized nation is remedied. Zimbabwean farmers, desperate to get their hands on U.S. dollars, will reduce their selling prices for tobacco and cotton, two important cash crops with flexible prices. Gold miners will do the same. The moment Zimbabwean crop and gold prices fall below the international price arbitrageurs will bring dollars into Zimbabwe to buy cheap these goods for shipment overseas. Since cash crystallizes a large amount of value in a small volume, handling costs are very low--unlike coins. Domestic commodity prices need only deviate by a small wedge from the international price before arbitrage is profitable and U.S. paper currency flows back into the country. Unless the government is interfering with this process, I can't see it taking more than a week or two for markets to rectify a dollar shortage.

Zimbabwean authorities are notorious for tampering with Zimbabwean industry--this may be short-circuiting the simple process I've just described. If so, why introduce bond notes to fix the problem when the underlying cause is silly government rules preventing cross-border markets from functioning?

On the other hand, if the government hasn't been preventing this process from playing out then Zimbabwe doesn't have a genuine dollar shortage. Lineups at ATMs may simply be the result of an insolvent banking system. Zimbabwe is currently battling a slowdown in growth as commodity prices fall. The U.S. dollar's  rise over the last year or two has reduced the nation's competitiveness. This slowdown may be taking a toll on banks. However, wads of newly-imported U.S. dollar bills or freshly-printed bond notes can't fix a sick banking system.

So Mangudya's reason for departing from the Panama model seems like a poor one to me, one made worse by the fact that the same nutcase who destroyed Zimbabwe's monetary infrastructure in the previous decade, Robert Mugabe, remains in power. Bond coins were one thing, but bond notes give Mugabe much more latitude to engage in monetary mischief.

How much mischief? Many Zimbabweans are worried that the introduction of bond notes will bring about a repeat of the hyperinflationary 2000s. I'm not as worried as them. The U.S. dollar not only circulates as Zimbabwe's medium of exchange but also serves as its unit of account. The fact that prices across the nation are expressed in terms of the dollar affords Zimbabweans a significant degree of protection from Mugabe.  If bond notes are to be introduced, they may very well circulate along with U.S. dollars as a medium of exchange but they will not take over the unit of account role. A nation's unit of account, like its language or its religion, is a set of rules and standards that, once adopted, is not easily changed. In the same way that society is locked-in to using the QWERTY keyboard, it gets yoked to using a certain language of prices.

This means that if the bond note turns out to be a sham and begins to inflate, Zimbabwean prices--expressed in U.S. dollars--will stay constant. Instead, the exchange rate between the U.S. dollar and bond notes will bear the burden of adjustment, bond notes falling to a discount to dollars. Because this leaves the price level unaffected, the process of adjusting to a bond note collapse would be far less burdensome to Zimbabweans than the hyperinflation of the 2000s. The move might even backfire and cause Mugabe significant embarrassment since a bond note discount could not be blamed on anything other than his own incompetence.

Even if the bond notes can never do as much damage as Zimbabwe dollars did in the previous decade, the fact remains that there is no rational for issuing them. Let the market work its magic as it does in Panama and solve any cash shortage problems. The decision to return to paper money is a particularly insensitive one given the fact that many citizens' livelihoods were destroyed by Mugabe's Zimbabwe dollar hyperinflation. Zimbabweans are right to be upset over the bond note; it's a shame that Mangudya, having so ably brought the bond coin idea to fruition, is now promoting a regressive idea.      


  1. Zim's current account deficit has averaged a coronary-bursting 22% of GDP over the past 5 years, good luck ironing that out with a terms of trade adjustment on the supply side. Clearly there are extreme structural and governance problems with the economy so merely greasing the skids of commerce with liquidity-boosting measures such as these bond notes (or export notes, as authorities are now calling them) is far from what is really needed.

    As you suspect, the government will struggle to maintain an effective parity of value between the substitutes and real US dollars beyond regulatory coercion. What is likely to happen is a classic case of Gresham’s Law, whereby this substitute currency is viewed as being over-valued compared to its officially-stated value given the government’s low credibility. This will cause even more hoarding and exporting of true hard currencies. The government can of course try to enforce the utilization of its substitute, but this will only cause the over-valued substitute to be rapidly circulated and have its exchange value offered down relative to real goods, services and harder currencies.

    1. A worst case scenario is a Gresham-like one where U.S. dollars get pushed out by bond notes, opening up Zimbabwe to another potential hyperinflation.

      I don't see this developing since Gresham only kicks in if the government successfully dictates that Zimbabweans accept bond notes at the till at a fixed (and wrong) ratio to U.S. dollars. I'm not convinced the regime has the ability to enforce that kind of fix. Zimbabwean society is upset enough that it will ignore an artificial ratio, instead applying a discount to bond notes so that Gresham doesn't take hold. At least I hope so.

    2. The dollar note is more useful than the bond note as it can be used domestically and for importing. Also if the bond note is a promise to provide a dollar note, does that not make holding the actual dollar note more attractive.
      On the other hand if both notes are treated equally then inflation of the bond note could result in price inflation for payment in either note.

  2. Enjoyed the piece, thanks for explaining. Could a city/state/province do something like this in US/Canada? For example, Detroit.

    They are low on US dollars. Could they create Detroit dollars to spend on local projects? Like a parallel currency. The dollars would be accepted for all local tax payments. I'm familiar with local currency-like things during the Depression but they weren't exactly fiat. Maybe there are IRS rules against this. Have you written about something like this already?

    1. Sure, here's a post:


      It's probably doable, I think. Zimbabwe is getting help from the African Export Import Bank, which is providing a line of credit to back the notes. Without external support, it would be difficult for a bankrupt nation like Zimbabwe to issue a note that stays at par with the U.S. dollar.

  3. I can't find the link now, but I was reading an article yesterday that stated the dollar shortage was due to the government siphoning depositors' funds. So yes, the banks are insolvent. This article covers most of it: https://www.newsday.co.zw/2016/06/04/mugabe-clocks-200-000km-flying-6-months-gobbling-80m/

    1. Thanks for the link. Mugabe, such a nutcase.

  4. "Domestic commodity prices need only deviate by a small wedge from the international price before arbitrage is profitable and U.S. paper currency flows back into the country. Unless the government is interfering with this process, I can't see it taking more than a week or two for markets to rectify a dollar shortage."

    I think you're on the right track here. Whenever we hear of shortages, the first thing to look for is price ceilings. In this case, it must be a price ceiling on US paper dollars.

    Having created a shortage of US dollars, the government's next step will be to blame others for the shortage. Greedy bankers, currency speculators and hoarders, people who buy foreign goods and pay with US dollars, and so on.

    1. "Having created a shortage of US dollars, the government's next step will be to blame others for the shortage. Greedy bankers, currency speculators and hoarders, people who buy foreign goods and pay with US dollars, and so on."

      Hi Mike, the blame game is in full effect:

      "Zimbabwe’s vice president Emmerson Mnangagwa says other South African Democratic Community (SADC) countries have been raiding Zimbabwe for US dollars and they’re to blame for the cash shortages."


  5. "There is a very simple process whereby a dollar shortage in a dollarized nation is remedied... Zimbabwean farmers... will reduce their selling prices".

    Isn't there something very wrong here?
    1. If lower prices were paid by foreigners this would REDUCE Zimbabwe's dollar earnings with unchanged export volumes. Wouldn't this EXACERBATE the alleged dollar shortage?
    2. Lower prices received by Zimbabwean farmers, miners etc. would tend to reduce production, which would further REDUCE dollar earnings.
    3. Zimbabwe has almost no influence on world commodity prices in dollars. So if Zimbabwean farmers, miners cut prices, the beneficiaries would be middle men. Would this affect the alleged dollar shortage?

    1. Why are you assuming unchanged export volumes? The point of reducing prices a bit below the competitive price is to attract more purchases than normal, the seller ending up with a higher stock of U.S. dollars than they otherwise would.

    2. With export prices fixed by international factors and increasing marginal costs in farming and mining, higher production would be at a loss.
      It is unlikely that the alleged dollar shortage reduce costs or otherwise increase profitability.
      So farmers and miners are unlikely to behave in the manner you suggest.

    3. If the cash shortage problem is real, then Zimbabweans' overriding motivation will be to accumulate U.S. cash balances as quickly as possible. Being short of cash imposes very real costs on people; it is welfare reducing. Dropping prices for at least a week or two in order to attract cash will get Zimbabweans closer to their desired state, even if it means being temporarily unprofitable; the disutility of being short on cash overwhelms any decline in profits