Zimbabwe - “fiat” money in action

- adapted from a report by Platinum Asset Management


Having recently visited that country he says their problems epitomise the issues of economic mismanagement and the subsequent use of the printing presses to cover the fiscal deficit¹.

The broad lessons are universal and mimic the experience of Germany in the 1920s² and Argentina in the late 1980s.

In the latter days of currency debasement, governments tend to intervene with price controls to try to offset the exploding supply of money. The populace becomes consumed in trying to arbitrage valuation discrepancies between physical assets, while property and shares are the vehicles of refuge. Capital flight is the purview of the wealthy elite and of industrialists at the cost of their operating plant that becomes rundown or obsolete. As the ever larger bundles of notes are exchanged for ever diminishing purchases, economic activity shrivels and a complete disorientation of value sets in³.  Price controls destroy companies’ working capital in the face of an inflationary crescendo but even so, in the case of Zimbabwe, one risked incarceration for removing stock from the shelves for fear of being charged with crimes against society⁴.

Trusted foreign currencies gradually took over from the Zimbabwean dollar even though it was unlawful to use anything other than the national currency. This requirement was hardly modelled by the central bank which was acting unlawfully by simply expropriating firms’ foreign exchange earnings in its desperation to meet external obligations. The end came when the populace refused to transact in Zimbabwean dollars. By late 2008 the government was forced to acknowledge that the US dollar was the principal means of exchange⁵. It is this tacit dollarisation of the Zimbabwean economy, as well as stiff sanctions against the ruling Junta, that has forced the Zanu-PF to the negotiating table.

The economic aftermath is striking; the economy now operates as though it were on a gold standard. Money supply, which comprises bank deposits and currency in circulation; US dollars, Rands, Euros and British pounds, can only grow from trade surpluses, remittances from some three million Zimbabweans abroad, foreign direct investment and foreign aid.

Businesses have lost most of their working capital from the hyper-inflation. Zimbabwean dollar bank deposits have become worthless, which in turn has the peculiar effect of expunging debt from the system but leaves the banks without a lender of last resort⁶, and an unwillingness to participate in an interbank market. Solvency concerns dictate that bank lending is now a tiny fraction of the estimated US$700 million of bank deposits. In these circumstances the economy’s growth is governed by the growth of its stock of “hard currency”. It is for this reason that an impotent President Mugabe so berates the West about sanctions. He simply cannot pay to keep himself in power via the printing press and hence his former impregnable position is now severely compromised. Top officials are earning US$300 per month and all other civil servants US$150 per month.

Businesses have been remarkably agile to adjust to the new circumstances but have an enormous backlog of capital expenditure required and very little working capital. This puts them at the mercy of imports, not from wages being too high, at 50c to $1 per hour, but because of initial scale. Employment growth will be slow and the grounding of the economy to an external peg sets up some interesting dynamics as the power sharing negotiations proceed.

The Zimbabwean market capitalisation is tiny at about US$4 billion but it may offer some interesting opportunities. The foregoing description shows a world where the central bank loses its fulcrum in an economy and highlights the assumptions we tend to take for granted! It may also have lessons for an economy that has long depended on its currency being given reserve status.

^1. Testament to this lies in the bound bundles of 100 unused Zim$10 billion notes that one is offered by hopeful street vendors for US$1-2. Admittedly the Zim$100 trillion notes are a little more difficult to come by and sell for about US$1 each!

^2. For those eager to study this subject they might seek a copy of “’The Economics of Inflation* by Costantino Bresciani-Turroni, first published in English in 1937 by George Allen & Unwin Ltd.

^3. During the hyper-inflation in Germany in 1922, the market capitalisation of Daimler was the equivalent of the price of 327 of its automobiles; in Buenos Aires, I was told of a banker having the use of a taxi for a full day for the cost of US$1 and in Zimbabwe, a drug company with 200 employees met its entire salary bill for November 2008 with the payment of the equivalent of US$1!

^4. At one stage Delta Zimbabwe calculated that it was required to sell its beer for about a quarter of a cent per bottle.

^5. Argentina explicitly linked its currency to the US dollar and Germany in 1924 reset its currency against gold.

^6. Without foreign reserves the Zimbabwe Central Bank loses its relevance. It cannot lend to the government nor the banks and nor can it set interest rates as these are set by the issuer of its currency, the US Federal Reserve Board.