Rethinking currency reforms in Zim

IMAGINE the cohort of people who serve Zimbabwe, many of whom are approaching or have just approached pensionable age, or have retired. Do they have a pension? What value will it have? Dololo (nothing)!

Juniours
Marire
economist

A currency is an important economic institution which, if optimally instituted, should, amongst other things, promote economic freedom, lower transaction costs, preserve value of people’s savings and pensions. I present a currency regime that I have been thinking about — private currencies. The only economic activity that has, in modern times, never tasted forces of competition is currency issuance. How has the Zimbabwe government fared on maintenance of stable currency over time?

The three panels above demonstrate that the Zimbabwean government has never been good at defending the value of the Zimbabwean dollar since 1980.
Significant currency erosion has been a perennial constitutional malfeasance. The Zimbabwean dollar lost its value significantly and by October 1997, a month before the disaster of November of 1997 when government printed money to pay war veterans hefty gratuities, a Zimbabwean dollar (ZW$1) could buy what 5,83 cents of 1980 could buy (left panel).

In contrast, the value of the currency (the US$ in this case, see middle panel) was quite stable between February 2009 and October 2016. Unscrupulous pricing of goods at the advent of dollarisation explains the decline in the value of the United States dollar but the deflation that ensued in 2010/2011 saw the recovery of the real value of the US dollar within Zimbabwean borders.

With the introduction of the bond note in November 2016, underpinned by a promise not to expropriate people’s US dollar deposits and a promise to use a 1:1 parity for the bond to the US dollar, continued stability (near constancy) of the value of the bond was maintained between November 2016 and June 2018 (see right panel).

After elections of July 2018, the real value of the bond note crashed. In July 2018, one bond note could buy what 96 cents could buy in November 2016, but by January 2019 ZW$1 (bond) could only buy what 60 cents could buy in November 2016, almost halving of real value in about two years.

Money is no different from other economic goods. Competition improves the real quantity and quality of money. The removal of government monopoly over currency and opening up to private currency competition would be a competitive mechanism of disciplining our inflation-tolerant monetary authority.

The case for currency competition is justified on grounds that, first, there is ease of exit from a badly performing currency since barriers to entry and exit are non-existent for currency issuers and holders. Second, the effect of a small policy-induced inflationary monetary shock is amplified and would cause the price level to rise much faster in the currency of an ill-disciplined issuer than it would if all currency issuing banks had expanded money supply by the same magnitude.

To appreciate this, prices have been rising significantly in the bond note/RTGS relative to how they have been behaving in United States dollar, a currency issued by another. And we know its achievements and weaknesses.

At a more general level, the competition amongst currencies need not be confined to currencies issued by nations only as the multicurrency regime was, but also private currencies issued from within the country by private banks. In this case, a country’s currency could find itself competing with private domestic currencies as well.

Currency competition provides the hardest monetary restraint on currency issuers because of three automatic limiting mechanisms to errant behaviour. Assuming a redeemable privately issued bank note back by top foreign currency, firstly, the larger the banked public, the greater would be the loss of the underlying asset to other banks as one bank engages in loose money creation.

Secondly, the larger the clientele base of any currency issuing bank, the greater the likelihood that its clients would engage in interbank transactions, the result of which would be more claims from other banks for it to redeem its currency by the underlying asset.

Thirdly, the extent of the banking public’s confidence and trust in the bank is a severe limiting mechanism. Any act of indiscipline, sooner or later, will be discovered with severe consequences of bank runs as punishment that would drive that bank out of existence.

Trust and confidence are central to the stability of the value of a currency. Competition among currencies is envisaged to impose monetary discipline on a currency issuer because any act of cheating the public would be immediately captured by the competition mechanism and punished accordingly through the dumping of that currency.

If the central bank, too, has its own currency in the market, then it can, as usual, perform its other monetary policy functions, with some modifications. The constraint on the central bank now is that if it cheats, economic agents immediately dump its currency from their currency portfolios and hold privately issued currencies.

Where a country has had governments whose monetary governance behaviour is unconstrained by economic agents’ expectations, the competitive private issuance of currency is preferable. Such is the case in Zimbabwe.

In this system, good money will drive out the bad. But, how will the central bank discharge one of its crucial roles of promoting price stability? In this system there is no general price level, but there is a price level specific to each currency. Issuers who are inflation-tolerant will be observed to have higher money supply growth rates, higher inflation rates in their currencies and their currencies will tend to have weaker exchange rates in the market.

In this system, the central bank will have to manage price stability in terms of its own currency. In any case, the price levels will automatically evolve with relative changes in equilibrium money supplies for each currency.

The level of strategic interdependence among currency issuers will result in a very stable price level for each currency and the distribution of these currency-specific price levels will tend to have a mean that converges to the latent general price level for the economy, which is not measurable. The sketchy proposal is not without objections, many of which I cannot discuss today.

First, some might argue that such a system would generate hyperinflation as profit maximising currency issuing banks would supply currency up to the point where price equals marginal cost equals zero.

Second, other objectors might say that such a system makes equilibrium prices and exchange rates indeterminate and that it is inherently unstable. The problem with the major objection is that it fails to distinguish between the price of obtaining money (which is inversely related to the price level) and the opportunity cost of holding money, which are entirely different. The argument of indeterminate prices is reasonable, but is taken care of since there will be currency-specific price levels and exchange rates.

The argument about inherent instability of private currency markets is taken care of in the system proposed since the system does not preclude government’s responsibility to regulate and supervise the monetary system and also to supply its own currency. Instead, the system requires sufficient government presence as a regulator, designing and implementing market-enhancing rule systems. If a credible “policy rule” is design and enforced, a currency market of privately issued currencies would achieve efficient allocation.

In the future a sequel will be issued on the ideas I have about this reform strategy.
Dr Marire is a lecturer in economics at Rhodes University. — j.marire@ru.ac.za or Twitter: @IreJuniours. These weekly New Perspectives articles are co-ordinated by Lovemore Kadenge, immediate past president of the Zimbabwe Economics Society . — kadenge.zes@gmail.com or mobile +263 772 382 852.