An asset-backed currency not ideal for Zimbabwe

I would like to talk about the raging debate about the reintroduction of the Zimbabwean dollar. It is imperative that Costs and Benefits are laid on the table and an objective decision be made. These Costs and Benefits should be undisputed facts on the ground for us to reach an objective conclusion. Our understanding of the situation should be coherent for us to be competent enough to be authoritative on these issues. I note RBZ Governor Dr Gono has been ferocious in his defence of the Zim dollar. The Gold Standard may seem appealing but Dr Gono made several premises that do not hold in our economy. Although a new currency is a national heritage and a sense of pride, the benefits are overstated. An asset-backed currency poses the following primary problems:

1. In one of his interviews in the press Dr Gono said ‘The existence and stability of a country’s national currency is defined and dictated by the barometer of economic activity in the economy’. The quantity of his asset-backed currency will be directly linked to the volume of minerals mined and therefore the level of mining activity in the country. If we look at the nature of mining, which is capitalistic in nature, there is weak correlation between the level of mining in our country and level of production in the other real sectors of our economy. Therefore the amount of currency dictated by the levels of production of the mining industry will not be in sync with the activity of the other real sectors of the economy.

2. There is going to be instability in the foreign exchange market. A few decades ago the gold standard was favoured because it provided stability in the foreign exchange market. This was because everyone was using the gold standard and each currency was convertible to a fixed amount of gold hence the price of each currency in relation to another was constant. In our case there is an abundance of foreign currencies, which are not backed by any assets. Because of the volatility of gold prices there is going to be instability in the foreign exchange market. This is very bad for us because currencies such as the US$ tend to change their value inversely to the international price of gold because of speculative and hedging purposes. This is because gold and the US$ are reserves and if one loses value, the other one gains because when the other one loses value people will move their wealth to the other reserve hence the other reserve will gain value. As a result of this volatility if the price of a single good in US$ terms increases, it will have to decrease in ZW$ terms to fully reflect the equilibrium price at the foreign exchange market. Prices of local goods are not that volatile. This poses a pricing problem and speculators will take advantage of this situation. Ruthless retailers will rip off consumers.

3. Dr Gono needs to further explain which type of banking will be available, fractional reserve or full reserve banking. Since our current banking system uses fractional reserve banking I suppose this will continue. Fractional Reserve Banking for the Gold Standard has many problems. If RBZ money (notes and coins) is deposited in the banking system, part of it will be lent to others and deposited again in the banking system. As a result the amount of narrow ZW$ money will be more than the amount of notes and coins in the money supply. Technically the amount of ZW$ available will not be fully backed by the RBZ. This can have inflationary effects. There will be a problem when a bank is both in a financial quandary and has a systemic risk attached to it. If there was a bank run affecting that particular bank a very viable solution would be to bail out the bank. What will the central bank do if it does not have extra gold to support the release of a new currency to bail out that bank which has a systemic risk? Things will fall apart while there are watching.

4. Dr Gono talks about having ‘a sense of sovereignty in our financial affairs’. Is this the case? Surely I do not think so. Since our currency is backed up by assets whose price we don’t control, the gain or loss in value of our currency will not be directly linked to the macroeconomic variables in our country. Therefore the central bank will not be able to stabilize the currency if there is a prolonged volatility in asset prices. This will have adverse effects on our economy and again our central bank will be just watching.

                                                

These primary problems will also have some secondary effects such as inflation, acceptability, rampant speculation and artificial withdrawal of the currency from the market. There will be inflation, which the Governor perceives will be absent under his plan. If the quantity of our currency, which is linked to the minerals that we have, is more than needed to service our other real sectors of our economy, inflation in our local currency will occur. People will lose confidence in such a currency. Then people will not be willing to accept it for their various transactions. Since the value of our currency will be volatile, speculators will take advantage of this and do business.

 As I mentioned above in 2., because of instability in the foreign exchange market and inefficiencies in price changes of local goods the volume of speculative trade would increase meaning a withdrawal of our currency on the formal markets. There are generally 3 ‘demands for money’. For transactions purposes, precautionary purposes, and for speculative purposes. Mostly money is used for transaction and precautionary purposes. If precautionary tendencies increase in the economy, most of the money will be used in speculation meaning there won’t be enough money for the other demands for money. We all saw what happened with our old currency. It was awash in the market but there was not just enough money for transactions and to keep for emergencies. Most of it was kept by the money changers who are speculators. Because of pricing problems between the Rand and the US$ in Zimbabwe, the Rand has disappeared off the market and is mostly now in the hands of the currency dealers. If Dr Gono introduces an asset-backed ZW$, we will go back to the days of the notorious money changers. Therefore the ZW$ will lose its status as a fluent medium of exchange.

What the central bank Governor and his fiscal counterparts should be doing now is to straighten out the supply side. We have seen the advent of price inflation in our country when we have got a suppressed demand. With our limited financial muscle then it means our monetary and especially fiscal authorities should flex their policies to make a meaningful impact to improve the supply side and hence our efficiency levels. The efficiencies at which our businesses operate at full throttle are deplorable. Goods produced locally are more expensive than foreign produced goods plus duty. For Zimbabwe to be a regional powerhouse, we have to export quiet a lot of our products especially manufactured ones. This can only occur at the appropriate efficiency levels. Therefore when our fiscal authorities set duties they should do so in a way to encourage business leaders to operate their businesses at the appropriate efficiency levels. Although they should guard against substandard imports, their duty policy should not be solely to raise revenue.

 Then there is the problem of small change. The central bank can introduce a kind of representative currency in small denominations such as tokens or vouchers, which is backed by foreign currency such as the US$ as opposed to assets because of the problems posed by asset-backing as I highlighted above. This currency would be redeemed on demand at any bank in exchange of the foreign currency. This system would work as follows: a bank deposits foreign currency with the RBZ; the RBZ releases this currency in small denominations to the banks that then release it to the public. Redemption of the currency would work in reverse of the above. The RBZ will have to liaise with the US Federal Reserve Board to prevent any legal backlash. This locally minted money should be made legal tender only in Zimbabwe to prevent externalization of the currency.