Dollarisation is a simple monetary arrangement which the political classes have contrived to misunderstand, and consequently, Zimbabwe, which never actually completed the process of dollarisation, unwittingly abandoned it and in its place brought about what I term a “dollar-exchange regime”.
Joseph Noko,Financial analyst
So deep-seated is the misunderstanding of dollarisation, there is the absence of an awareness of a misunderstanding. Under dollarisation, one uses another country’s currency, the central bank is reduced to a strictly regulatory body, there is no independent exchange rate and, more broadly, no independent monetary policy and one gains low inflation, monetary credibility and stability.
Today, Zimbabwe has an activist central bank, its own rapidly depreciating and still overvalued currency, soaring inflation, monetary instability and low levels of credit. As early as 2011, I argued that dollarisation was incomplete and badly done and that crisis lay ahead and today I argue that we have de-dollarised into a new monetary arrangement that is doomed to fail and that we are headed once again toward a re-dollarisation process few still understand.
The first feature in defining a state as dollarised is that it uses a foreign unit of account, and foreign notes. Zimbabwe began the process of de-dollarisation with the adoption of Statutory Instrument 133 in October 2016, which allowed for the issuance of bond notes at par value with United States dollars and used them as the basis for all financial transactions. When in March 2017, parliament promulgated the Reserve Bank of Zimbabwe (RBZ) Amendment Act, the break-up of the dollarisation regime was final. A state cannot be dollarised if its unit of account is domestic.
In the last 150 years, there have been about 100 instances of dollarisation across the world and, apart from Honduras, which had a small and unimportant local issue, no dollarised country had issued its own currency in tandem with the foreign currency used as its “anchor currency”, until Zimbabwe.
Bond notes, the currency without a name — and make no mistake, this is a currency, because currency is nothing more than money in actual use — are the unacknowledged currency of the land. The government has insisted it will not issue a currency until “fundamentals” are in place, even though bond notes are, functionally, a currency. Much as Switzerland has Swiss francs but allows for payments in euros, Zimbabwe has bond notes, but allows payments through a variety of currencies. This is the extent of the “multicurrency regime”. This has led many to believe we are still dollarised or that de-dollarisation is recent. Somehow Zimbabwe de-dollarised without any deep thinking or planning and without government stopping to address the issues that made Zimbabwe’s dollarisation process a very unique failure. Some speak of re-dollarisation without understanding not only how we de-dollarised, but what full and functional dollarisation is.
What confuses many about bond notes is the broad attempt to disguise them as United States dollars-by-another-name, and the fact that they are not convertible outside Zimbabwe because the government did not officially recognise them as the currency of the land. Yet this does not change that bond notes are money, are currency.
The history of de-dollarisation is grim. Going through our extensive database on dollarisation, it is clear to me that countries that have de-dollarised have largely experienced monetary instability and their currencies have depreciated sharply against the currency they formerly used. Cuba, for example, which in the early 20th century used the US dollar, began de-dollarisation with a Cuban peso that was at par with the US dollar.
Today, the black market rate is 26 Cuban pesos to every one US dollar. Needless to say, the official rate is 1:1. Of those countries that have successfuly de-dollarised, they are largely oil-rich Middle Eastern countries which had used the Indian rupee. The present crisis is nothing other than the effects of de-dollarisation. That the government seems eager to pursue a full national currency in three to five years flies in the face of 150 years of data.
De-dollarisation nearly always triggers rising inflation, a hoarding of foreign currency, a sell-off of the domestic currency, speculative attacks on the local currency, and the kinds of general panic we are beginning to see. Either the government is ignorant of this, or has once again placed nationalist politics ahead of empirical economics.
The dollar-exchange regime
Zimbabwe’s dollar-exchange regime has comprehensive exchange controls and no market where private parties can freely trade foreign currency. The Bank Use and Promotion Act makes it illegal to trade bond notes at less than par with the US dollar.
At the heart of the system is the identification of bond notes and US dollars at a 1:1 peg. Bond notes are not convertible at market rates and the monetary authorities, through the vast expansion of issuance of Treasury Bills, as well as through issuance of bond notes, can sterilise the market, which is to say, they can intervene to
offset the effect of changes in demand for US dollars on the supply of the domestic monetary base, or vice-versa.
Given the illegality of converting bond notes at below par, there is a perverse incentive to trade on the black market made worse by the expansion of the monetary base by the RBZ. The value of a currency cannot simply be determined by an act of parliament; there is no “command economy” possible, it is a matter of confidence and belief and if the market lacks confidence in a currency and believes its worth to be much lower, then that is what the value of the currency is. Furthermore, if the market believes that the monetary authorities cannot defend their peg, then that currency is open to speculative attacks on open markets, or, in our case, on the streets. To attack foreign currency dealers merely ignores the fundamental weakness of bond notes; it is to blame fleas
for feasting on a carcass.
A simple model of the dollar-exchange regime that Zimbabwe is under looks something like this:
Money US dollars
↑ Bond notes
↑ RTGS balances and other deposits
By “money” we are referring to a means of final settlement and by “credit” we mean a promise to pay money. What is money at one level of the system is credit from the standpoint of the level above. When buying tomatoes at the market, bond notes are money, when holding US dollars, they are less than money, rather, they are a weakening promise to pay the par value in US dollars. Similarly, when making an RTGS payment, one is trading a promise, that, one can get one’s money in bond notes. Securities are promises to pay bond notes over some time horizon in the future.
Bond notes are, we are told, “backed” by US dollars through an Africa Export-Import Bank (Afreximbank) facility, in the sense that Afreximbank holds US dollars as reserve, but that does not mean that bond notes represent US dollars or are at the same hierarchical level as US dollars. They are still promises to pay whose credibility relies on the Afreximbank facility.
The device of seeking an external backer means the system has a split central bank with the function of supporting the currency exercised by Afreximbank. Reserves are important: what it means is that, when a currency falls in value, the central bank can sell its reserves of foreign currency, that is, buy the domestic currency, so that the price of domestic currency rises against that of foreign currency. In this instance, however, it seems Afreximbank holds reserves aside on behalf of the Reserve Bank, but these reserves are not put to market to stabilise bond notes, rather, they seem to exist as a kind of insurance whose terms are a matter of the greatest secrecy, making them irrelevant in defending the peg.
The panic a fortnight ago which ensued after Finance minister Mthuli Ncube essentially admitted that bond notes are not, in effect, US dollars-by-another-name. The announced measures to segregate foreign currency accounts (FCAs) balances from bond-denominated RTGS balances only abated when he then announced the extension of a US$2 billion facility from Afreximbank to further bolster bond notes. The system thus has this contradiction: that keeping it alive demands acknowledging reality and yet it cannot survive without being blind to it.
The credibility of the promise is paramount and reserves of instruments that lie higher up in the hierarchy are meant to enhance credibility.
RBZ governor John Mangudya presented a monetary policy statement on October 1 which clearly discriminated between bond notes — once touted as an “export incentive” by the RBZ so successful its governor said he would resign if they failed — and US dollar balances. The statement shows a failure to not only implement dollarisation correctly, but to correctly diagnose today’s problem: the absence of what in dollarisation literature is called “financial dollarisation”. As bond notes fall in value, Thiers’ Law that good money chases out bad, will re-assert itself and the economy will re-dollarise. Yet, given the near-total ignorance on dollarisation, we are likely to see the same problems I outlined in 2011: cash and liquidity shortages, higher-than-normal bank risk, a failure to converge with the market of the anchor currency, higher-than-normal inflation, etc. This, then, is a rudimentary description of the dollar-exchange regime, which is defined largely by a pegging of bond notes as being at par with the US dollar. This creates a conflict with the market when the market exchange rate is different from the regime’s exchange rate, because one cannot merely define a peg and illegalise economic reality.
The battle is lost
My contention is that the basis of the system is untenable: the peg is indefensible because the monetary authorities lack the firepower to fight the market, the credibility of the system is extremeley low and Zimbabwe lacks the qualities needed to maintain a successful peg.
The coming budget may enact swingeing cuts on the labour force, wages, government programmes and the like, but that is a matter of political will, and the government may not have the stomach for that, meaning the government will be forced to continue to build up debt to fund its spending, driving down the price of bond notes and pushing up inflation.
A question many have is: “How much are bond notes actually worth?”, in other words: “What is the correct exchange rate?” A simple way to calculate this is to compare the price of a good that is identical and sold on different markets. The Old Mutual Implied Rate does this by comparing the price of shares in a single company, Old Mutual, traded on the Zimbabwe and London stock exchanges. As I write, the Old Mutual Implied Rate is at 5,1907. In other words, though the system is built on the assumption that bond notes are equivalent to US dollars, bond notes are overvalued by over 500%. This implies that even the black market rate, which as I write, is at US$1:$3,4, overvalues bond notes.
Exchange rate pegs collapsed in many countries in the 1990s, from the failure of Mexico’s peg in December 1994 or to the sharp devaluations in East Asia in 1997-1998, in Russia in August 1998, and in Brazil in January 1999, the collapse of unilateral exchange rate pegs often brought with it acute financial and macro-economic crises. This is not to suggest all pegs fail, but to outline the difficulties inherent in maintaining a peg.
Maintaining a peg comes at a cost: rather than allowing the market to adjust the exchange rate gradually, imbalances build up, and speculators see a window of opportunity and attack the currency. The RBZ has gradually re-asserted itself over the last few years, but because of the absence of foreign reserves, cannot defend the peg, meaning imbalances will continue to build up.
There is not enough flexibility in the system for a peg to work. In Hong Kong, for example, wages are adjustable to defend the hard peg. This leaves building up huge foreign reserves as another option, as Saudi Arabia and China have done. Saudi Arabia has enough reserves to cover 48 months of imports. The Guidotti-Greenspan rule states a country should hold liquid reserves equal to its foreign liabilities coming due within a year, but clearly that is not going to happen.
In a pegged regime, it is vital that the pegging country sets a monetary policy that always appears to currency traders to be consistent with the pre-announced conversion rate. To my mind, this implies that for every dollar of bond money, there is a dollar of American money for them to be true to their intent as “surrogate currency”. The old gold standard was built on a relationship with gold that all the currency in the land was redeemable for gold.
Secondly, the best way to uphold the commitment to the peg is to run a monetary policy that is similar to that in the anchor country in terms of inflation rates and credit expansion. Again, the government over the last few years has run an inflationary budget at a time when the US government has reduced its footprint in America and where inflation has been in decline.
A pegging regime is more resistant to speculative attack if banks and other institutions hold an amount of foreign-exchange reserves that is at least as great as the quantity of short-term debt that is denominated in foreign currencies. Taiwan, for example, was largely immune to the Asian crisis of 1997-1998 due to its large holdings of foreign exchange reserves.
In short, the Zimbabwean government simply does not have the firepower to defend the overvalued bond notes and the dollar-exchange regime it has established.
The system is self-contradictory, built on the lie that bond notes are US dollars-by-another-name and yet vulnerable because of the effects of de-dollarisation to a build-up of imbalances and shocks and, given the direction of policy, the system is likely to collapse and be replaced by a wave of re-dollarisation.
Noko is a data scientist specialising in financial institutions, a published economist, consultant on economics to companies seeking to navigate through dollarisation and author of Dollarisation: The Case of Zimbabwe (June 15, 2011) in the Cato Journal, Vol. 31, No. 2, 2011, among many other journal articles.