How Zimbabwe’s ‘bad’ bond notes are driving out ‘good’ U.S. dollars

Proving Gresham’s Law, Zimbabwe has introduced an increasingly worthless parallel currency to counter a shortage of U.S. dollars, writes Barry Wood.

Source: How Zimbabwe’s ‘bad’ bond notes are driving out ‘good’ U.S. dollars – MarketWatch Dec 6, 2016

Bad money drives out good, according to Gresham’s Law, dating from 16th century England. Sir Thomas Gresham, money manager for Queen Elizabeth I, argued that, if two coins with the same nominal face value simultaneously circulate, the one with the most gold will be hoarded while the less valuable coin will be used.

Who would have guessed that in our time this medieval axiom would be tested — of all places — in Zimbabwe, the once rich, now impoverished land in southern Africa.

Zimbabwe is ruled by 92-year-old Robert Mugabe, who traveled last week to Cuba for the funeral of his friend Fidel Castro who died at age 90. In 2008 under Mugabe, Zimbabwe recorded the world’s highest rate of inflation. As prices rapidly escalated — rising multiple times daily — the central bank issued progressively larger denomination Zimbabwe dollars. That process culminated with the issuance of a 50 trillion note.

With the economy in chaos, a reformist finance minister, Tendai Biti, was named. He abolished the Zimbabwe dollar and adopted the U.S. dollar DXY, +0.06%  as the country’s currency. Hyperinflation was halted and for a few years the economy began to recover.

But in recent years the commodity boom that had held up the prices of Zimbabwean mineral exports went bust. There was a devastating drought and the U.S. dollar soared against the currency of South Africa, Zimbabwe’s major trading partner.

Unable to issue its own currency, Zimbabwe ran out of money and deflation took hold. Cash is in such short supply that civil servants, police and military, are seldom paid on time. For months there have been restrictions limiting what can be withdrawn from cash machines. Then cash machines were seldom open and people lined up overnight in hopes of getting some of their savings from the banks.

Aware of a deepening crisis, for several months Zimbabwe’s central bank told citizens that it would issue “bond notes,” a temporary expedient to alleviate the cash shortage. Ordinary people, remembering hyperinflation, protested. The bond note proposal was ridiculed as a back-door method of reintroducing the discredited Zimbabwe dollar.

On Nov. 28 as Mugabe jetted off to Havana, the bond notes were finally released. They had been secretly printed. The $2 bond notes are theoretically exchangeable for $2 in U.S. currency. The government says the notes are backed by a hard-currency loan from a multilateral bank based in Cairo. The small denomination bond notes are sprinkled among U.S. dollars in the cash machines that are working.

The words “bond note” is on the red banner near the top.

Last week money changers reappeared on the streets of Harare, Zimbabwe’s capital. Despite harassment from police the bond notes in some places trade at a hefty discount.

Gresham’s Law appears to be kicking in. In places where the official rate is honored people are using bond notes while holding back their U.S. dollars.

The government says it will issue $12 million of bond notes in coming weeks.

So far there have been few surprises. Some shopkeepers applaud the notes, saying they are helping overcome the cash shortage. Others call bond notes a desperate move by a failing state.

Zimbabwe is in desperate straits. Hard times and economic mismanagement prompted a third of its population to flee. Between 1997 and 2008 the economy shrank by 50%. Payroll accounts for 85% of government spending. Unemployment is as high as 80%. International agencies say 33,000 children need immediate attention for malnutrition and that 4 million Zimbabweans are food insecure.

International agencies are prepared to help. Efforts are being made to pay off Zimbabwe’s large foreign debt and the country’s arrears to the International Monetary Fund have been cleared.

A major problem is that President Mugabe has not named a successor and the ruling party is divided as to who will take over upon his demise.

Barry D. Wood is a journalist based in Washington who writes frequently about southern Africa’s economy.

COMMENTS

WORDPRESS: 10
  • comment-avatar
    nelson moyo 5 years ago

    Sir Thomas Gresham’s ( 1519-1579) law of currency is about to be tested in Zimbabwe :–
    Gresham’s law states that any circulating currency consisting of both “good” and “bad” money (both forms required to be accepted at equal value under legal tender law) quickly becomes dominated by the “bad” money. This is because people spending money will hand over the “bad” money rather than the “good” ones, keeping the “good” ones for themselves. Therefore the bad money (bond notes) will drive out the good money(US dollars) and a US dollar will become extinct inside Zimbabwe.
    To summarise – In Zimbabwe a US dollar and a soon to be issued ZW Bond note are equal value according to the Reserve Bank of Zimbabwe and Doctor John ‘Bond’ Mangudya.
    The market place of Zimbabwe and the world is being tested to see if GRESHAMS LAW of CURRENCY is still valid after 400 years

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    Morty Smith 5 years ago

    Drought and exchange rates have nothing to do with the shortage of cash. To state the problem in these terms is to buy the ZANU lie at the outset. There is no real money in circulation because the government has taken it.

    That which is still in private hands is being hoarded because soon this will be the only money that is worth anything at all and may be the difference between starvation and survival.

    The bond notes are peripheral to the situation. The bits and bytes in the banks will inflate very nicely without the need of physical notes. Greshams Law will apply even without the actual printed notes.

    Bad money is irredeemable treasury bills and any other paper that is issued by the ZANU government. There will be another collapse and then we will be back to 2009 again .

    • comment-avatar
      Jimus Beanus Erectus 5 years ago

      Well done @Nelson Moyo ! You managed to re-write exactly what the news item delivers. You must be proud of yourself…
      What exactly were you trying to achieve with your time ? Besides stating the obvious ?

  • comment-avatar

    What was the reason for the Air Mugabe 767 flight that departed Harare yesterday at around 4pm to LUANDA, Angola and returned to Harare at around 2.30 AM that same night??????????????????????????

    • comment-avatar
      nelson moyo 5 years ago

      ANGOLA – one of the most corrupt countries on the planet. Comrade Fidel Castro of course helped the regime in power there in the 1960’s and 70’s.
      The President of Angola Dos Santos daughter is one of the worlds richest people – Isabel dos Santos is worth about 3 billion US dollars – 99 per cent of Angolans do not have any money at all.
      So to answer your question HOMO ERECTUS it must be for some nefarious activity connected with the corrupt President Mugabe and diamonds maybe – Angola washes/ markets diamonds for Zimbabwe on occasions

  • comment-avatar
    Miike 5 years ago

    So that’s where they were printed !

  • comment-avatar
    TJINGABABILI 5 years ago

    IT ALWAYS DOES!

  • comment-avatar
    Doris 5 years ago

    And furthermore Government departments are refusing to accept bond notes in exchange for a Permanent Resident stamp to be put into foreign passports. Immigration at Linquenda House are now demanding your life history plus $100 in American money, for the privilege of being allowed to be called a Permanent Resident.

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    Mazano Rewayi 5 years ago

    That ‘bond notes’ are a circus is accepted by all, including the government. All they have achieved is divert the nation’s attention from the main issue – how do we put things right? Ideas have a tendency to become reality when they are discussed often, openly and sincerely. So instead of theorizing on the merits and demerits of ‘bond notes’ why not shift to practical thoughts that might contribute to our salvation. For example, how to organise for the outcome we want in 2018; how to give the govt their own medicine by paying every official bill using the bond notes. It’s time to talk about our future and the actions required to secure it at every opportunity instead of reacting to the diversionary tactics of the men in power now. Let’s not allow them to set the agenda for national discourse anymore. Just a village boy’s thoughts.

  • comment-avatar
    Ngoto Zimbwa 5 years ago

    Good thoughts there Mazano.
    Unfortunately, with the know-it-all Zimbo, we are going to have as many opinions on this one as our population.
    Just a thought on 2018, without electoral reform and a proper open voter’s roll, putting aside zanu’s rigging machine, it will remain pie in the sky.