Why the Re-Introduction of the Zimbabwe dollar, Alongside the Multi-currency Framework, is a Very Bad Idea

Not too long ago, i.e. around 2010, I promised myself that I would refrain from commenting on the policies that are proposed by players in Zimbabwe's political system. However, the pronouncements that were recently made by certain constituencies have compelled me to break my self-imposed vow of silence, and, to give my own two cents on the drive to re-introduce the Zimbabwe dollar to the Zimbabwean multi-currency framework (in a bid to address the Zimbabwean liquidity crisis).

In my opinion, the re-introduction of the Zimbabwe dollar would:

• Not address the current account deficit that is causing the the liquidity crisis in Zimbabwe; it would fail to achieve its envisaged aims.
• Create shortages of foreign currency; as it would trigger leaks of foreign currency from the formal economic system to the informal economic system and foreign destinations. (Gresham's Law)
• Trigger hyperinflation.

In this blog post, I will use elements of Zimbabwe's current account to explain the rationale that underpins my assertions.

Firstly, I will explain why Zimbabwe has got a liquidity crisis. And, I will then explain the adverse consequences that the re-introduction of the Zimbabwe dollar would have.

While the topics of the current account balance and the monetary framework are indeed complex, I will try my best to simplify everything and to steer clear of unnecessary technical details.

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Illustration 1 below depicts the elements of a nation's current account that will be used to frame a discussion on Zimbabwe's liquidity crisis:

Illustration 1 (click on illustration to zoom in)

...Factor Income

As Illustration 1 shows, Factor Income is equal to Earnings on Foreign Investments minus Payments Made to Foreign Investors:
 
..Earnings on Foreign Investment

According to Illustration 2, below, Zimbabwe's stock of  investment abroad is in the USD 1,77 to 3,25 billion range:

Illustration 2 (click on illustration to zoom in) Adapted From: Index Mundi data

Zimbabwean entities, that make foreign investments, generally invest in opportunities that are domiciled in the rest of Africa. Therefore, if we assume that the performance of these investments tracks the performance of the MSCI Frontier Markets Africa Index -- which registered a -19.47% return between December 2010 and December 2011 -- the Zimbabwean 2011 Earnings on Foreign Investments figure would lie (in theory) in the USD -632.78 to -344.62 million range.
 
..Factor Income

According to Illustration 3, below, Zimbabwe's stock of foreign investment is in the USD 10.20 to 19.13 billion dollar range:

Illustration 2 (click on illustration to zoom in) Adapted From: Index Mundi data

If we assume that the performance of FDI in Zimbabwe tracks the performance of the Zimbabwean Stock Exchange (ZSE), which registered a 6.88% decline in 2011, the Zimbabwean figure for Payments made to Foreign investors in 2011 would (in theory) be in the USD -1.32 billion to -701.76 million range.

Therefore, Zimbabwe's 2011 Factor Income would (in theory) lie in the USD 357.14 million to 683.37 million range.
.

...Balance of Trade

According to Illustration 1, a nation's balance of trade can be calculated by subtracting Imports from Exports:

..Exports

According to Illustration 4, below, Zimbabwe's 2011 exports figure stood at USD 2.93 billion.

Illustration 4 (click on illustration to zoom in)

 ..Imports

And as Illustration 5, below shows, Zimbabwe's Imports in 2011 amounted to USD 4.37 billion

Illustration 5 (click on illustration to zoom in)

Hence, Zimbabwe's balance of trade in 2011 was USD -1.44 billion.


...Current Transfers


Table 1, below shows Zimbabwe's Current Transfers in 2011

Table 1 Adapted From: Zimbabwe Treasury publication

 The grand total of Zimbabwe's Current Transfers in 2011 was USD 618.32 million.


...Zimbabwe's 2011 Current Account Balance

As Illustration 1 shows, a nation's Current Account Balance is the aggregate of Factor Income, The Balance of Trade and Current Transfers.Therefore, Zimbabwe's Current Account Balance in 2011 was between USD -464.86 million and USD -138.63 million.

This current account deficit is the main source of Zimbabwe's liquidity problems and to address it, the Zimbabwean government would need to (broadly speaking):

• Take measures that would increase exports (e.g. by solving Zimbabwe's electricity crisis, which would, in turn reduce the costs of production of the firms that use inefficient diesel generators to power their plants; thus restoring the competitiveness of Zimbabwean products).
• Reduce its debt load. This would, in turn, save the foreign currency that would have otherwise been used to service foreign debt.
• Encourage people to save more money. Greater national savings would create a robust domestic capital pool for investment into the growth of Zimbabwean businesses. And, growing companies would mean less imports and more exports; which would improve Zimbabwe's balance of trade.

Further, the government of Zimbabwe could also institute policies that would bolster Zimbabwe's capital account by attracting greater Foreign Direct Investment and Portfolio investment. Such policies would have to:

• Promote the rule of law, which would give investors greater certainty that their investments would be secure.
• Foster frictionless movement of capital by reducing transaction costs and regulatory impediments.

...Zimbabwe's Proposed Currency System

The constituencies that are lobbying for the re-introduction of the Zimbabwe dollar are also lobbying for the Zimbabwe dollar to be re-introduced alongside BRICS currencies, which would create the following currency system:

Illustration 6 (click on illustration to zoom in)

...What would happen if the Zimbabwe dollar were to be re-introduced?

According to economic theory, good money has seven characteristics; Durability, Divisibility, Convenience, Consistency, Intrinsic Value, Scarcity and a Long History of Acceptance. Andrew Hoffman of Miles Franklin explains these characteristics beautifully; good money must have the following characteristics, and I quote:

1. "It must be durable, which is why we don’t use wheat or corn or rice."
2. "It must be divisible, which is why we don’t use art work."
3. "It must be convenient, which is why we don’t use lead or copper."
4. "It must be consistent, which is why we don’t use real estate."
5. "It must possess value in itself, which is why we don’t use paper."
6. "It must be limited in the quantity that is available, which is why we don’t use aluminum or iron."
7. "It should have a long history of acceptance, which is why we don’t use molybdenum or rhodium."

Using these characteristics, the elements of Zimbabwe's proposed currency system (refer back to Illustration 6) could be rated in Table 2 as follows:

Table 2 (click on table to zoom in)

As Table 2 illustrates, none of the fiat currencies in Illustration 6 have intrinsic worth; they have not had intrinsic worth since the world abandoned the gold standard.

Table 2 also shows that the following currencies have a short history of acceptance:

• The Real - was introduced in 1994 as a component of a monetary reform package that was created to put an end to thirty years of inflation.  
• The Yuan - will only become a fully convertible currency around 2015.
• The Rupee - has an exchange rate that is determined by market mechanisms. However, the Reserve Bank of India intervenes regularly in forex markets by actively trading in the USD to keep the value of the Rupee stable. This makes the currency "less than acceptable".
• The Rubble - has only been convertible since July of 2006.
• The Zimbabwe Dollar - was demonetized in 2009, and if it is re-introduced, it would have a very short history of acceptance, i.e. if the public accepts it in the first place.

If we assume that history repeats itself, the recent hyperinflationary history of the Zimbabwean dollar -- which stemmed largely from overly loose monetary policy -- demonstrates that the re-introduced Zimbabwe dollar would most likely be [1]:

• Inconvenient - lots of Zimbabwe dollars would be printed to assuage Zimbabwe's liquidity woes, and, the currency would devalue rapidly;
• Inconsistent - the central bank would have to re-issue new and smaller denominations of currency at revised values frequently (for the sake of transactional convenience).

In short, the Zimbabwe dollar would be "bad money":

There is an economic principle about "bad money" that is known as Gresham's Law; it basically asserts that "Bad money drives out good if their exchange rate is set by law." Hence, if the Zimbabwe dollar is introduced to Zimbabwe's multi-currency framework, and if its value is set by law, we can expect:

1. The Zimbabwe dollar to be the only currency in circulation; it would drive the other currencies in Illustration 6 out of the system.
2. Some of the other currencies in Illustration 6 to be hoarded [2], or; to leak outside the formal banking system and Zimbabwe [3].

This scenario is highly unlikely; Zimbabweans from all walks of life are unequivocally against the re-introduction of the Zimbabwe dollar. However, if fate is tempted, the inevitable human cost would be catastrophic.

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[1] That is, unless the value of the re-introduced Zimbabwe dollar is tied to the value of something real like gold, and; unless the central bank manages the supply of money using free market mechanisms, i.e. with no "pegs" to fiat currencies.
[2] The Rand and the Yuan would be hoarded because, according to Illustrations 4 and 5, South Africa and China are Zimbabwe's largest trade partners - thus their currencies would be needed for trade. The USD would be hoarded because Zimbabweans are accustomed to transacting in the USD, and, it would be used as the primary unit of account in the informal economy.
[3] BRIC currencies (excluding the Rand and Yuan) would be rare and infrequently traded - because they would not required for trade -- Zimbabwe doesn't trade much with Brazil and Russia -- or transacting locally . Therefore, these currencies would be underpriced, and "arbed" out of Zimbabwe's boarders.