via Bulawayo24 NEWS | Zimdollar versus the multicurrency system by Colls Ndlovu 28 October 2013
The ongoing debate within Zimbabwe’s financial markets about the possible return of the now-defunct Zimdollar serves to further destabilise the country’s still fragile economy in general, and the financial sector in particular. Bagfuls of hot air have been spent over debates around the merits and demerits of resuscitating the dead but dreaded Zimdollar (a currency whose last kicks reduced a whole generation of people to abject poverty and sordid misery). What is significant here is that the debate seems to be steeped more on political rhetoric than a genuine desire for economic revival.
Firstly, most of the so-called experts on monetary issues have failed to come up with critical appraisal of what the return of the Zimdollar might mean for the “green shoots” of economic activity that are showing everywhere within the country’s financial fabric. The possible return of the Zimdollar has to be juxtaposed with the multicurrency system and proper inferences be drawn as to which one is beneficial to the country.
Some deluded analysts have even made even weirder suggestions that the return of the Zimdollar be linked to gold alleging that this will be akin to returning to the gold standard monetary regime, forgetting that the miserable failure of the gold standard was precisely due to the fact that during crisis times, countries ignore the supposed policy of linking the value of the currency with gold. In practical terms the linkage remains on paper. The market immediately senses the asymmetrical illusionary link between the currency and the gold thereby triggering systemic financial instability.
The question which arises is: what is wrong with the single currency? For example, why are members of the single currency Eurozone (.e.g. Greece, inter alia) the only ones bearing the brunt of the debt crisis? Why is it that nations like Zimbabwe that have opted for multicurrency systems experiencing the lowest inflation and good economic growth? The answer is that there is the question of asymmetry within the Eurozone. On the one hand, Germany and other stable sovereigns want to restrict money supply while the debt-stricken ones like Greece urgently need money for their survival. This has given rise to a dichotomous scenario, an asymmetry scenario.
Germany of course, like Zimbabwe recently, experienced catastrophic hyperinflation during the second world war and is therefore always and everywhere dogmatically opposed to any monetary policy relaxation. Germany law makers are very skeptical of the central banks’ so-called quantitative easing (i.e. euphemism for printing excess money).
If such countries had their own national currencies, then it would have been easy for them to extricate themselves out of debt via the printing press. The risk here is that if the printing press is left in the hands of a reckless monetary regime, this could have dangerous hyperinflation-inducing repercussions (e.g. Zimbabwe recently).
From the foregoing, new questions arise: Did the European countries make misconceived ill-judgments by adopting the single currency? Were these countries wise to decommission their own currencies in favour of the Euro? Would it not have been better for them to denationalise their currencies and use them simultaneously and severally across their borders without any restrictions? Shouldn’t they have adopted a multicurrency system, i.e. invariably using currencies of all member countries without restrictions within their borders and across their borders? After all is the freedom of choice not what capitalism is all about, i.e. freedom of choice even on currencies?
It is curious and interesting to note that to answer the aforementioned questions, Zimbabwe seems to offer a perfect microcosm or case study of what the Eurozone could have done. On this, it is noteworthy that Zimbabwe is peerless in the drive towards the implementation of multicurrency system in an orderly and systematic manner. Zimbabwe’s adoption of the multicurrency system (simultaneous and several use of numerous currencies) offers an elaborate example of what the Eurozone could have done.
They should have adopted the multicurrency system (simultaneous and several use of each country’s currency) by allowing their individual currencies to function freely as legal tender within the Eurozone member countries, while allowing market forces to dictate their valuations so that errant members who print excessive money could be punished by the “invisible hand”. Had this happened in Europe, the likes of Greece and Italy would not have been allowed by the markets to borrow beyond their means. Moreover, the multicurrency system as applied in Zimbabwe has shown that it is the best way to control inflation.
Zimbabwe today probably has the lowest inflation rate in the world. Because inflation is always and everywhere a monetary phenomenon caused by excessive money supply, in a typical multicurrency system (as in Zimbabwe) the markets will quickly sense any currency that is being excessively supplied and consumers will reject it out-rightly with contempt.
It is perhaps curious that Zimbabwe is currently being used by leading advocates of multicurrency systems as a living proof that the system does work. A number of economists also use Zimbabwe as a reference point for their theories on the benefits of multicurrency systems. One such economist is Prof Steve Hanke of Johns Hopkins University in the US. Former US Republican presidential candidate, Congressman Ron Paul, a perennial critic of the US Federal Reserve System (advocating for its dissolution) uses Zimbabwe as an example of a sovereign country that has no central bank that prints money or implements monetary policy. The Reserve Bank of Zimbabwe serves as a de jure central bank, but de facto, there is no central bank that prints money and conducts monetary policy in Zimbabwe.
In the 1970s, Nobel-prize winning Austrian economist Prof FA Hayek argued persuasively for the freedom of currency choice and denationalisation of money. He argued that the doctrine of free markets theory should be extended to the freedom of choice on currencies. It is a tribute to Prof Hayek that Zimbabwe’s former acting finance minister, Mr Patrick Chinamasa introduced the multicurrency system and also outlawed the system of exchange controls as well as price controls. This is one area where Zimbabwe can lead the world notwithstanding its numerous other self-inflicted problems. The multicurrency system has worked wonders in terms of curbing inflation and stabilising the economy.
The Eurozone will remain a very unstable and dangerous (to the financial system) group of countries for ages and the markets will never trust this single currency union in our lifetime. As for Zimbabwe, it has something that works and must keep it and take a lead in helping others (ironically the Eurozone) to overcome their self-inflicted financial abyss.
Against the backdrop of the foregoing, a microscopic analysis of Zimbabwe’s adoption of the multicurrency system and a critical appraisal thereof is necessary. Because dollarisation entails the de jure abandonment of a country’s own currency and ipso facto the de facto adoption of another country’s currency, generally the U.S. dollar as its legal tender. Zimbabwe seems to have wittingly or unwittingly taken dollarisation to another level altogether, i.e. the adoption of a multicurrency system wherein a multiplicity of currencies are officially accepted as legal tenders in transactions.
The joint and several use of numerous currencies inclusive of the US$, the GBP, the Rand and the Pula is a phenomenon that is bespoke to Zimbabwe in the global financial history. Hitherto, other countries (eg. Argentina) have generally dollarised but the extent of their dollarisation had been limited to the adoption of the US$ per se while their local currencies were either pegged to the dollar or generally ignored by the markets due to the extent of their depreciation.
Zimbabwe is the only country that has unequivocally adopted the multicurrency system under free market conditions, notwithstanding the government’s propensity to stifle freedom of economic activity.
The use of the multicurrency system tends to eliminate the risk of exposure to sudden, sharp devaluation of currencies since consumers are free to switch from one currency to the other with relative ease. This results in competitiveness on the part of the country and hence may reduce the risk premium attached to its international borrowing. A country using multicurrencies enjoys a higher level of confidence among international investors. Interest rate spreads on borrowing tends to be much lower compared to what a country’s peers pay for similar borrowing. Competitiveness induces more foreign direct investment and economic growth. Certainly the ongoing infatuation with Zimbabwe by foreign investors is a case in point.
Some analysts have previously stated that multicurrency systems were not suitable for developing economies, arguing that free floating currencies risk excessive exchange rate volatility. However, the multi-currency system has worked without any disruption except some alleged shortage of liquidity at certain times. But liquidity must be earned, in other words, money does not just fall like manna from the sky. The level of liquidity that is found in Zimbabwe is commensurate with the level of economic activity in the country. Injection of excessive liquidity can trigger a financially adverse feedback loop.
It must be emphasised that for dollarization to work, it must be not only be permanent, but must also be seen to be so, in fact and in appearance. Money by its very nature is susceptible to volatility. By being a medium of exchange and a store of value, money is invariably a subject of endless scrutiny and speculation. Lenin once remarked that “the best way to destroy the capitalist system is to debauch the currency.”
Zimbabwe has previously tried to peg its own currency against major currencies but such a misguided policy failed miserably. The success of any currency regime whether dollarised or not is ultimately dependent on sound fundamentals underlying such an economy. This must be read to include the rule of law which is the bedrock of any free market economy. The free market economy thrives on the integrity and validity of contracts, and, legal certainty in case of contractual disputes.
The multicurrency system on its own is not a source of stability if underlying policies are unsound. However, it is an incontrovertibly indubitable fact that the multicurrency system when judiciously adhered to, can eliminate the possibility of excessive printing of money and restricts budget deficits to an economy’s ability to borrow in dollars or the currencies that are operational within the borders of that sovereign.
It must be pointed out however that dollarisation (multicurrency system) is not without risks. Former US Federal Reserve chairman, Alan Greenspan once warned that while the US$ currency circulating in a country like Zimbabwe is indeed credibly backed by the full might and credit of the U.S. government, any US dollar deposits made in countries like Zimbabwe or other US dollar-denominated claims are subject to the whims and caprices of the domestic government that could, “…with the stroke of a pen abolish their legal status.” This assertion is very significant because it explains why deposits placed with domestic banks are a source of vulnerability for investors since they could lose their money should authorities decide (on political expediency, as they regularly and recklessly keep alleging that they might bring back the Zimdollar) to outlaw the multiplicity of currencies.
US dollars deposited in banks within such political environments generally tend to sell at a discount to dollar currencies that are in circulation (a US dollar in your pocket is worth more than your US dollar that has been deposited with a bank) . The foregoing explain why US$ denominated interest rates in such a country like Zimbabwe tends to rise dramatically if persistent fears of the possibility of dedollarization keep lurking within investors’ perceptions. Therefore, Zimbabwe needs to manage such fears by assuring investors that the multicurrency system is here to stay. As stated above, Zimbabwe must do so in fact and in appearance. In street lingo, it must walk the talk.
In conclusion, it is now an established truism that the use of multicurrencies stabilises a country’s financial system. De-nationalisation and de-monitisation of the local currency eliminates the possibility of a sharp depreciation of the national currency. The risk of currency volatility triggered by the vagaries of uncertainty and fears of currency depreciation and capital flight are mitigated.
Because dollarisation tends to be accompanied by lower inflation, a dollarised country might also strengthen its financial institutions and create positive sentiment towards investment, both domestic and international. Consequently, the Zimdollar should never be returned, not in our lifetime. The present multicurrency system is best for the country.