HomeAnalysisLoathed bond notes will drive out good money

Loathed bond notes will drive out good money

The chief root of Zimbabwe’s recurring monetary problems is the age-old belief in the superstition that by excessive printing of money then lasting economic prosperity and possibly full employment could be achieved. It is the kind of voodoo economics which monetary economists have battled with for ages.

Colls Ndlovu,Economist analyst

The propensity for more and cheaper money is an ever-present political force which central banks have never been able to overcome, notwithstanding their alleged independence. A central bank is independent only to the extent that it satisfies the whims and caprices of the governing political powers. A central bank’s independence is therefore conditional.

It is an incontrovertible truism that the present multicurrency system has managed to single-handedly cure the country of the scourge of hyperinflation, reducing it from the hitherto unspeakable billions of 2008, down to the present sub-zero percent as at September 2016.

Against the backdrop of the foregoing, the question which arises is: what will be the impact of the introduction of bond notes into the multicurrency system, and, in particular what will be the effect of the Reserve Bank of Zimbabwe (RBZ)’s decreeing that the said bond notes should rank pari passu (ie equivalent) with the nominal quid pro quo US dollars?

The obvious answer on the impact of introducing bond notes into the system is that this will cause inflation to increase at exactly the same rate that these bond notes will be supplied. So if the authorities become too overzealous and excessively print the bond notes and push them into the system through salaries, payments on contracts, inter alia, the repercussion of that action will be the emergence of hyperinflation. Financial strife and severe liquidity shortages in terms of the other concurrent currencies will be experienced. Prices will start rising at exactly the same rate at which the bond notes are being increased.

As Professor Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon caused by excessive printing of money.” The reason why Zimbabwe’s inflation rate has remained at about zero percent since dollarisation is that the monetary authorities could not print money. Now with the bond notes, they can.

Ordinarily, there is nothing wrong with a country introducing its own currency. But Zimbabwe’s circumstance is extraordinary. This is a country which printed its own money until its value depreciated to absolute zero. The adverse effect of decreeing that the bond notes should rank pari passu with the nominal quid pro quo US dollars is that the bond notes will eventually drive US dollars and other concurrent currencies out of the Zimbabwean financial system. Zimbabwe will then begin to experience acute shortages of foreign currencies and the pain will be much worse than what is obtaining now. The dreaded black market will return with even more vengeance than before. The issue here is that notwithstanding the RBZ’s decree that the bond notes will exchange for one-to-one to the US dollar, the market knows only too well that in real terms, a bond note is not worth the same as the US dollar. Immediately after its introduction, we will begin to see a divergence in the valuation of the two currencies with the spread between their values widening exponentially over time.

By introducing the bond notes at a prefixed exchange rate of 1:1 to the US dollar, the RBZ is setting Zimbabwe for the so-called Gresham’s Law, that is to say, bad money driving out of circulation good money. Gresham’s Law occurs where the government fixes the exchange rate between the two currencies. As circumstances change, currency movements occur due to market conditions and, of course, one currency will become overvalued while the other becomes undervalued because of this artificial fixing of exchange rates. The undervalued currency then disappears from circulation as the market tends to horde it and only use it for special transactions. Fixing the US dollar at 1:1 to the bond note undoubtedly has the effect of undervaluing the US dollar. Consequently, the US dollar will disappear from the Zimbabwean financial system.

The foregoing then raises another fundamental question as to what can Zimbabwe do to avoid this imminent US dollar liquidity shortage as the dictum of Gresham’s law certainly points to the fact that it will disappear from circulation?

Zimbabwe can still avoid this potential double-edged knife (disappearing US dollars and hyperinflation) by not fixing the exchange rate between the US dollar and the bond note. Let the value of the bond not be dictated by the heartless market forces just like its peers within the currency basket. Then consumers will be free to choose which currency they want. In that way, the US dollar will not necessarily disappear. Inflation will not increase dramatically as consumers will punish the currency that gets excessively printed by refusing to accept it if they sense that its value is depreciating. Just like what occasionally happens to the South African rand within the Zimbabwean markets when consumers tend to reject it when they perceive its value to be depreciating. The authorities can avert the disaster before it occurs by allowing the bond note’s value to be subject to the vagaries of the market forces rather than fixing its exchange rate.

If the US dollar disappears, then the country’s problems could quintuple. Firstly, bond notes are not internationally tradable. International clearing agencies like Euroclear, Visa, Mastercard, among others, will not allow the bond notes into their platforms, let alone clear them at a rate of 1:1 to the US dollar. Zimbabwe will be stuck with an illiquid and non-convertible currency. These characteristics alone are enough to doom the bond note and condemn it to the doldrums even before it is launched.

To make a bad situation worse, tourists will find Zimbabwe to be a very expensive destination as the pricing will be denominated in a rapidly depreciating currency (the bond note in real terms) on the basis of which tourists will be required to settle their bills in US dollar equivalent.

By way of an example, because the market knows that the bond note is not equivalent to the US dollar in intrinsic terms, the hotels will charge more money in bond note terms, and, wittingly or unwittingly, tourists will be expected to pay the exact amount but in US dollars unless of course the tourists would conspire with the black market currency traders and exchange their US dollars to bond notes at the correct market rate prevailing in the parallel market. Suffice to say that at the black market, one US dollar could be fetching upwards of 100 bond notes.

Currency valuation distortions will set in and businesses will start creating artificial shortages as a ploy to push prices up in bond note terms.

Some crank out there may argue and say, but there is some US$200 million that has been secured to back the introduction of bond notes. Such an argument is a hard sell because currency markets work on the basis of trust. The question that would arise is, exactly where is this US$200 million? Has it been drawn down? Has it been promised?
When exactly will it be drawn down and why? The fact of the matter is that once the market’s perception or misperception is that the bond note will be excessively printed, nothing can stop its value from depreciating, not even a billion ounces of gold backing it, let alone an opaque and obscure alleged line of credit which consumers have tardy and skimpy information about.

In conclusion, therefore, the introduction of bond notes will have an inflationary effect. The prefixing of its exchange rate will result in the proverbial bad money driving out good money. However, the monetary authorities can still ameliorate the potentially adverse repercussions of the introduction of the bond notes through doing away with its fixed exchange rate of 1:1 to the US dollar and allow its value to be dictated by market forces like the other currencies within the approved basket.

Ndlovu, formerly with the South African Reserve Bank, was winner of that institution’s highest honour, The Governors Gold Prize, in 2014.

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