Description
The report describes the reasons of hyperinflation in zimbabwe in detail.
ZIMBABWEZIMBABWE CRISS – The Hyperinflation Episode THE HYPERINFLATION EPISODE
Table of Contents
Inflation and Hyperinflation ................................ ................................ ................................ ............... 3 History of Zimbabwe................................ ................................ ................................ .......................... 5 Road to hyperinflation and dollarization ................................ ................................ ............................ 6 1997 to 1999: Political vulnerability and economic breakdown................................ ...................... 6 2000 to 2003: Land reform and destruction of the production base................................ ............... 7 2004 to 2007: Pseudo-Keynesian economics................................ ................................ .................. 8 Impact on Economy ................................ ................................ ................................ ........................... 9 Loan Sanctions by IMF ................................ ................................ ................................ ..................... 10 Monetizing the Fiscal Deficit ................................ ................................ ................................ ............ 11 Revaluation of Zimbabwean Dollar ................................ ................................ ................................ .. 12 Impact of Revaluation................................ ................................ ................................ ...................... 13 Challenges and Policy Options after Hyperinflation................................ ................................ .......... 14 Possible Approaches to Hyperinflation................................ ................................ ............................. 15
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Inflation and Hyperinflation
Inflation is an increase in the overall level of prices or decrease in the value of money. Inflation is caused by: yan imbalance between the money supply and the goods and services in an economy yand/or when confidence in the currency is eroded.
Inflation is always and everywhere a monetary phenomenon. ²Milton Friedman, A Monetary History of the United States 1867-1960 (1963) Hyperinflation Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. A working definition (definitions vary from 100% p.a. for 3 years to 50% a month) is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a.
Where Pt = P0 (1+r)t P0 = Current Price Pt = Price after time t r = inflation rate Possible indicators of hyperinflation: yThe general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain the purchasing power. yThe general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that foreign currency. ySales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short. yInterest rates, wages and prices are linked to a price index and the cumulative inflation rate over three years approaches, or exceeds, 100%.
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Hyperinflationary Models Confidence Model: Some events or series of event cause the people to lose confidence o then money issuing authority. Because of this, people prefer either keeping goods or money of some other nation. The suppliers start charging premium for their products which is much higher than the actual price. To overcome this, the best policy is changing the backing of the currency by issuing a new currency. Monetary Model: The money issuing bodies start printing money (not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money) to pay the debts or to cover costs coming up because of social unrest or war. When businesses perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency's value. The money issuing authority must then accelerate its expansion to cover these prices, which push the currency value down. Seigniorage & Hyperinflation Seigniorage is the revenue the government gets from printing new money. SE = M/P
Seigniorage Laffer Curve Seigniorage Laffer Curve shows the relationship between steady state inflation rate and Seigniorage revenue. It indicates that Seigniorage revenue must rise for a while and then fall again as inflation rises. Therefore there is an inflation rate that produces a maximum amount of Seigniorage with a stable rate of inflation. Above that rate, it is possible to collect more Seigniorage only if inflation rate is increasing.
Hyperinflation can be experienced when the government face a greater need of Seigniorage to finance its increasing fiscal deficit and after the Seigniorage maximizing inflation rate is reached. Above that rate, the curve indicates that revenue decreases.
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History of Zimbabwe
In 1980, the new nation of Zimbabwe rose as Rhodesia gained independence from the British Empire. Rhodesia had long been considered the jewel of Africa as it was rich in fertile farmlands and raw material such as gold and chromium. The rule of law was secure as much of the population trusted the police and believed in equitable treatment in the courts. With low crime, strong banking, a sophisticated manufacturing base, and booming tourism; real GDP growth averaged a strong 4.3%. Prior to independence, Rhodesia had been administrated by Great Britain during the late 19th century¶s Race for Africa as part of the British South Africa Company. The Colony of Southern Rhodesia was created in 1923, granting self-rule to the white colonists, while leaving blacks disenfranchised. Rhodesia enacted the Land Apportionment Act in the year 1930, forbidding land ownership for blacks outside of tribal reserve areas. During that time, the British built an agricultural empire in the colony, developing one of the most sophisticated water delivery systems in Southern Africa. With only 7% of the land, Rhodesia had 86% of the area¶s dams and 93% of the reservoir surface area at the time of independence, serving an agricultural sector that was the backbone of a thriving economy: strong enough to feed all of its seven million people and export the rest to the world. Around 70% of the Rhodesia¶s vast farmland had been run by about 4,500 white farmers who produced cash crops such as tobacco and cotton. These white-owned farms supported: ya flourishing banking sector yloaning funds for machinery, seeds, tools ymost importantly, the water delivery system. The farms employed some 350,000 black workers and provided money for local schools and clinics. With the Zimbabwean dollar replacing the Rhodesian dollar at par and trading for US$1.59, the economic future looked bright for the fledgling democracy of Zimbabwe. That is, until Robert Mugabe came to power. In 1960¶s, Mugabe became prominent and became the Secretary General of the Zimbabwe African National Union ± a militant organization that fought the British in the Rhodesian Bush War throughout the 1970s. In a nation where there was only 1 white for every 22 blacks Zimbabwe, hadn¶t seen blacks in a position of power until 1979 ± and then only in lower ministerial positions. The ZANU (Zimbabwe African National Union) fought this inequitable bi-racial rule side by side with the Zimbabwe African People¶s Union ± comrades in arms united only by their desire to expel the British from their country. Once that end had been achieved, the two groups had divergent philosophies about the governance of the country: Mugabe¶s group had Maoist beliefs, while the ZAPU (Zimbabwe African people¶s Union) was Marxist. When the war concluded in 1979, Mugabe was hailed as a national hero, and won election to the post of Prime Minister in the first election following independence. Since then, the two opposing groups have been embroiled in a bitter civil war for control of the nation, with Mugabe¶s ZANU retaining control through force, intimidation, and outright murder. Elections are held from time to time; the results are usually rigged by the ruling ZANU¶s. In 1987, the position of Prime Minister was abolished, with Mugabe seizing new powers relegated to the position of Executive President of Zimbabwe and effectively becoming Dictator. While Rhodesia¶s white-owned farms thrived, as a result of the Land Apportionment Act some 840,000 black farmers were crowded into eroded and over-farmed land unconnected to the irrigation grid, producing corn, groundnuts, and other staples. This land was without title, and squabbling over land rights between villagers was rampant. As part of the Lancaster House Agreement ± the nation¶s independence agreement with Britain ± the subject of land redistribution was blocked until 1990. Mugabe sought to institute land reform, with the goal of redistributing the white-owned farms to black farmers. The nation¶s constitution forbade the seizure of land without proper compensation, and the electorate rejected a 1999 referendum to amend the constitution to allow it.
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Road to hyperinflation and dollarization
1997 to 1999: Political vulnerability and economic breakdown
In August 1997, approximately 60,000 war veterans were granted ZWD 50,000 each (approximately USD 3,000 at the time) plus a monthly pension of approximately USD 125 per month outside the budget. The payouts amounted to almost three percent of GDP at the time and this had the immediate effect of inflating the budget deficit at the end of 1997 by 5 percent from5 the 1996 levels. Concerns were raised pertaining to the financing side of the transaction in view of an already precarious fiscal position, and on that basis in September 1997, the World Bank temporarily withdrew a USD62.5 million standing credit line for the balance of payments support until the government had demonstrated that the payments would not result in a higher than the projected 8.9 percent budget deficit in the 18 months leading to December 1998. As an ad hoc decision, the government had intended to accommodate the gratuities payment through tax increases in the 1998 budget but countrywide protests orchestrated by the trade unions forced the government to backpedal and resolve to monetization of the transaction.
The second populist decision followed in November 1997 when the president, Mugabe, announced plans to compulsorily acquire white-owned commercial farms, again without elaboration on the financing side of the transaction. This had the immediate effect of giving investors a perception of an ensuing precarious fiscal position and consequently there were spontaneous and concerted runs against the currency from the money and capital markets. The climax of these events was on 14 November 1997 when the Zimbabwean dollar crashed and l st 75 percent of its value against theo USD on a single day, on what is now known as ³Black Friday´ in Zimbabwean economic history. The stock market also plummeted and the index was down by 46 percent by day end from the peak August levels. The central bank had to intervene and raise interest rates by six percentage points within that single month. The exchange rate continued to depreciate uncontrollably, thus the 1997 financial and currency turbulence set the stage for a long and potentially long slump in the real economy.
In September 1998 the president agreed to send 11,000 troops under the SADC protocol, to the Democratic Republic of Congo (DRC) to back the discredited leader, Kabila, who was under attack by Rwandan and Ugandan backed rebels. This act was simply the utilization of national military by the political elite for private financial gain as it emerged that the Zanu PF bigwigs had been promised mineral concession in the DRC. A letter written by the finance ministry to the IMF seeking funds puts the funds to finance the war at USD 1.3 million per month in 1998 or 0.4 percent of GDP and in 1999 when additional troops were deployed at USD 3 million per month or at 0.6 percent of GDP (IMF, 1999). The country could not spare forex outlays of such magnitude and this consequently weakened the currency, again with pernicious effect on price stability. There was intense pressure on the currency and in a bid to increase the flows of foreign currency which were dwindling at precariously low levels, the central bank reintroduced widespread import controls and banned foreign currency accounts. This decision was futile as in the first quarter of 1999 the central bank, had to devalue the currency by 50 percent to trade at USD1: ZWD38 from USD1: ZWD25
The aforementioned events marked a period in which the inept handling of government expenditure instigated investors to lose confidence in the currency with the consequence that they ran away from it thereby putting a pressure on the exchange rate, which fuelled infl tion througha the increase in the prices of import. Thus a characterization of inflation in this first period is that it was of a cost-push nature.
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2000 to 2003: Land reform and destruction of the production base
The president¶s rhetoric on confiscation of white-owned farms was elevated to the next level in early 2000, when war veterans, who courtesy of the gratuities, were now the paramilitary wing of the ruling Zanu PF party, started invading white-owned farms as part of an elaborate scheme by Zanu PF to terrorise people to vote for it in the parliamentary election in July 2000. The government delineated the parameters of its land redistribution policy embodied in the fast-track land reform programme under which 300,000 households and 51,000 black commercial farmers would be apportioned the previously white-owned commercial farmers. As a result of the upheavals on the farms, agricultural output fell dramatically from the level of 18 percent of GDP in 2000 to 14 percent of GDP in 2002 (World Bank, 2008).
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Export proceeds from tobacco declined from USD612 million in 1999 to USD321 million in 2003.
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The government could not service its multilateral debts obligations and as a result in October 2000, the World Bank suspended any extra lending to Zimbabwe und the IBRDer and IDA facilities due to non-payment of over six months (World Bank, 2000). On the other hand the government could not import essential raw materials and fuel as a result of the declining forex inflow, which further fed into falling production with the result that by 2004, total foreign currency earnings from the export of goods and services had declined to less than half the 1996 peak of USD3,169 million (World Bank, 2008). In purported retaliation to the perceived deterioration of human rights conditions in the country, the European Union imposed sanctions against the country, after Mugabe had ejected a Swedish election observer before the 2002 elections. Under the terms of the sanctions, the European Union suspended budgetary support to Zimbabwe and terminated financial support for all projects except those in direct support of the population.
According to this analysis the major driver of inflation in this period was the shrinkage in aggregate supply sparked by the fall in the agriculture, which then spread to other sectors of the economy. The shrinkage in aggregate supply would ceteris paribus, trigger price increases which ignite the price-wage spiral.
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2004 to 2007: Pseudo-Keynesian economics
On 1 December 2003 a new governor, Gono was appointed to head the central bank. The battle against inflation, which now stood at 263 percent on a year on year basis at the end of 2003, became Gono¶s first priority. He undertook money-targeting framework as the monetary policy strategy and consequently set up a µFramework for Liquidity Management¶, which was to contain money supply growth to levels consistent with inflation targets. The interest rate was the operational target and it was raised acutely in the first quarter of 2004, reaching a peak of 5,242 percent annually in March 2004. Inflation which had soared from about 20 percent in December 1997 to a peak of 623 percent in January 2004, decelerated sharply from March to around 130 percent at the end of 2004 (RBZ, 2007). The high real interest rates and an increasingly overvalued official exchange rate was also putting pressure on domestic producers and exporters, and in a move to bail out the ailing industries, the central bank started engaging in quasi fiscal activities. The quasi-fiscalactivities went beyond the operational realm of a normal central bank and had the effect of undoing the ephemeral achievements in the inflation battle and firmly set course for the drive towards hyperinflation. At the height of these quasi-fiscal activities, money (M1) was increasing at the rate of 66,659 percent annually in 2007 and this feed to demand pull inflation during this period. The ravaging inflation standing at over 1000 percent meant that the people had to carry large sums of currency to conduct the simplest of transaction and on 1 August 2006, the Zimbabwean dollar was replaced by a new Zimbabwean dollar exchanging at a ratio of 1000:1 and it was subsequently devalued against the USD. A transition period of 21 days during which both currencies co-existed was given and thereafter the old notes ceased to be legal tender.
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Given the cosmetic nature of the reforms, there was no sign of reces in inflation and Zimbabwes formally entered hyperinflation in March 2007 when month-on-month inflation reached 50.54 percent and year-on-year 2,200 percent (RBZ, 2007). This period thus, marked the country¶s accelerated drive towards hyperinflation fuelled by the central bank¶s quasi-fiscal activities meant to fund the political campaigns of an unpopular ruling regime. In terms of economics, the characterization of inflation in this period is therefore of a demand pull nature
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Impact on Economy
y y Financial investors fled the country, concerned that other businesses may go the way of the farms, with foreign direct investment falling 99% between 1998 and 2001. Since there were no more land titles, there was no collateral for bank loans, causing dozens of banks to collapse. The farmland lost an estimated three quarters of its value between 2000 and 2001, amounting to $5.3B in losses. The collapse of the farmland led to widespread famine and, since it no longer had any owners, the prized irrigation system was dug for scrap, some being melted for coffin handles ± one of the few growth industries left in the country.
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As figure shows, agricultural production declined sharply, with 2005 output being only slightly above 1992 ± one of the worst drought years on record. For years afterward, Mugabe used this drought to explain the drop-off in production. Real GDP followed agriculture, as could be expected in a primarily agrarian economy. In 2007, it returned to the level it had been at independence 27 years earlier.
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Loan Sanctions by IMF
y Following the drought of 1992, the government of Zimbabwe began receiving loans from the International Monetary Fund. Repayment of these loans had been relatively steady until 2000, when the confiscation of farms and the subsequent slowdown of production caused the government to fall behind in its payments. In response to the deteriorating political and economic situation in Zimbabwe, President Bush signed into law the Zimbabwe Democracy and Economic Recovery Act of 2001, enacting sanctions against the nation by instructing the US Treasury and US members of international financial institutions to oppose the extension of any loans to Zimbabwe. The IMF declared Zimbabwe ineligible to access Fund resources and suspended the remaining payment support. Mugabe and the government of Zimbabwe have repeatedly cited these sanctions as the primary cause of their economic collapse. In 2004, due to their inability to repay the loans, Zimbabwe was expelled from the IMF, and repayments effectively ceased (IMF).
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Monetizing the Fiscal Deficit
y In the first few months of 2000, the Mugabe government began an aggressive moneyprinting campaign with ZW$30B, hoping to use the newly-minted money to purchase foreign currency to pay the IMF arrears, as well as to fund massive amounts of government spending. Monetary production remained relatively linear until a veritable explosion in 2000, flooding the monetary supply and causing hyperinflation the likes of which hadn¶t been seen since Weimar Germany in the 1920s. As the quantity theory of money ± and common sense ± tells us, the result of this excess printing with GDP in decline was that the value of the Zimbabwean dollar collapsed exponentially. As a result, the cost of living skyrocketed in tandem with the monetary supply. In the thirty years of independence, the cost of living has increased by a factor of 97,072,150,785.138%, and 2,152,473,377.841% since January of 2000. (For comparison, the United States CPI has increased 274.68% since 1980 and 126.69% since January of 2000.)
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Estimates vary to the extent of this hyperinflation, as measuring such a behemoth has become all but impossible. In November of 2008, prices were doubling every 24 hours. The calculation of the CPI in Zimbabwe is an extremely precarious endeavor, as many of the goods in the basket are nowhere to be found. Supermarket shelves once full of meat, grain, and supplies have become completely empty. Residents of Zimbabwe have taken to substituting whatever is available for the disposable goods they once purchased: instead of using newspapers for fire kindling, residents use the abundance of worthless banknotes; instead of using toilet paper, residents have again taken to banknotes. As a result of increasingly worthless bills, Mugabe¶s government has been printing ever larger denominations. In 1980, denominations of 2, 5, 10, and 20 dollars were printed, with the addition of a $50 banknote in 1994 and a $100 note in 1995. When inflation started becoming problematic, $500 notes were introduced in 2001 a $1,000 in 2003.nd When inflation started becoming systemic, denominations up to $100,000 were introduced in 2006 ± and by July, these were trading for less than US$0.20 on the black market. When inflation started becoming endemic, the central bank of Zimbabwe issued a $10,000,000 bill in January of 2008 ± at the time insufficient to buy a hamburger in a Harare restaurant. It was followed by a $100,000,000,000 note in July of 2008 (Zimbabwe introduces), and a $100,000,000,000,000 bill ± the world¶s first ± in January of 2009. At
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the time of its issue, it was worth about US$30 (Zimbabwe rolls) ± a stark contrast to the $1.59 the Zimbabwean dollar was worth at independence ± and no cash register on the planet is capable of ringing up so many zeroes.
Revaluation of Zimbabwean Dollar
y In August of 2006, Mugabe¶s government undertook the first of several redenomination of the Zimbabwean dollar, removing three zeroes: ZW$1,000 was now ZW$1. At the same time, Mugabe¶s government pegged the exchange rate at ZW$250, though this lagged behind the parallel rate of 550. In July of 2008, the government redenominated the dollar once again, this time removing ten zeroes, followed by the removal of another 12 zeroes seven months late.
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Impact of Revaluation
As one might imagine, Mugabe¶s monetary policies have been devastating for the people of Zimbabwe.
Unemployment: 80% (#3 in the world)
Literacy Rate: (above 15 years) %91.4
Life expectancy at birth: 44 years
Population below Poverty Line: 80%
Public Debt: 218% of GDP
20 %increase in under-five mortality since 1990 .
Human Development Index: 146th of 178
Limited support to the country¶s orphaned and vulnerable children, with 79 per cent not receiving any form of external assistance. yThe country, once a net exporter of grain and considered the ³breadbasket of Africa´, has been reduced to a nation where the highest denominated bill is insufficient to buy a loaf of bread. The situation in Zimbabwe can be considered an experiment ± an outrageously expensive one ± in reverse. The quantity theory of money: In one broad incompetent swoop, Mugabe has proven nearly every macroeconomic theory posited since Smith. y
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Challenges and Policy Options after Hyperinflation
Following a decade of economic decline and hyperinflation during 2007±08, Zimbabwe¶s economy has started to grow. The nascent economic recovery has been supported by a significant improvement in economic policies, but important policy challenges and significant vulnerabilities remain to be addressed. In late 2008, hyperinflation led to abandonment of the Zimbabwe dollar in transactions and de facto widespread dollarization. The official recognition of the demise of the Zimbabwe dollar took place in February 2009, when authorities established a multicurrency system. Under this system, transactions in hard foreign currencies are authorized, payments of taxes are mandatory in foreign exchange, and the exchange system largely is liberalized. Since the abolition of all surrender requirements on foreign exchange proceeds on March 19, 2009, there has not been a functioning foreign exchange market for Zimbabwe dollars. Bank accounts denominated in Zimbabwe dollars (equivalent to about US$6 million at the exchange rate of Z$35 quadrillion per US$1) are dormant. Use of the Zimbabwe dollar as domestic currency has been discontinued until 2012. While five foreign currencies have been granted official status, the U.S. dollar has become the principal currency. Budget revenue estimates and the budget expenditure allocations for 2009 were denominated in U.S. dollars, and the subsequent budget for 2010 was also denominated in U.S. dollars. For noncash transactions, the market is exhibiting a strong preference for the U.S. dollar: banks estimate that some four-fifths of all transactions are taking place in U.S. dollars, including most wage payments. Furthermore, stock exchange trading takes place in U.S. dollars, the payments systems operate in U.S. dollars, and the banking system and the Reserve Bank of Zimbabwe (RBZ) maintain accounting in U.S. dollars. In cash transactions, the U.S. dollar is the currency of choice, but the rand is prevalent in the South of the country, and it also circulates in the rest of the country, in particular coins. Wider circulation of the rand is prevented by South Africa¶s capital account control. Currencies other than the U.S. dollar and the rand have limited circulation in Zimbabwe.
The multicurrency system has provided significant benefits. In particular, it fostered the remonetization of the economy and financial reintermediation, helped enforce fiscal discipline by precluding inflationary financing of the budget, and brought greater transparency in pricing and accounting after a long period of high inflation. As a result, the price level in U.S. dollars declined during 2009, while the economy started to recover. The multicurrency system also poses a number of challenges. First, prices and wages are usually agreed and quoted in U.S. dollars, while South Africa is Zimbabwe¶s main trading partner and country of origin of capital inflows. Movements in the U.S. dollar/rand exchange rate therefore have considerable effects on Zimbabwe¶s competitiveness and international investment position. Second, shortages of small-denomination U.S. dollar banknotes and coins pose difficulties for retailers. Third, some politicians have expressed concern that loss of the national currency and seigniorage is an undesirable erosion of sovereignty and monetary independence. The government considers the multicurrency monetary regime a temporary arrangement until 2012 at least. Therefore, the pros and cons of maintaining the multicurrency regime indefinitely are not discussed. Despite the remaining challenges, the multicurrency regime could continue to operate with certain improvements until a new regime is chosen. The necessary improvements include aligning legislation, including the RBZ Act, with the prevailing practice of use of multiple currencies, making exchange controls more transparent, and faciltating the supply ofi coins, possibly with an agreement with South Africa. Zimbabwe has been experiencing a fragile recovery since early 2009. The jump start in growth has so far been consumption-led, but Zimbabwe¶s export sector, in particular mining, could potentially recover quickly and provide much needed fiscal revenues to a cash-strapped government with large external obligations. Zimbabwe continues to run large current account deficits financed by short term and volatile capital inflows and accumulation of arrears. Zimbabwe is in debt distress: external debt²of which about 64 percent corresponds to external arrears²is projected to be about 151 percent of GDP by 2015.
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Possible Approaches to Hyperinflation
The quickest way to stop hyperinflation in Zimbabwe is to replace central banking with a new monetary regime. This would instill confidence in the currency. In Zimbabwe¶s historical experience with a variety of monetary systems, only central banking has produced hyperinflation. Similarly, throughout the world, hyperinflation has been a phenomenon linked to central banking or its close cousin, the direct issue of currency by a government¶s treasury. During the transition, real interest rates have often been punishingly high, and long-term loans in local currency have been difficult to obtain. As a result, economic growth has been relatively slow, general living standards have remained stagnant, and the scourge of poverty has spread. For replacing the central bank with some other monetary regime Zimbabwe has 3 options available -
1) Dollarization 2) Currency board 3) Free banking
These options are not mutually exclusive. For example, a currency board system could be combined with official dollarization, as in the monetary systems of Lesotho, Namibia, and Swaziland.
Dollarization:
1. Unofficial When individual holds foreign currency, bank deposits or notes to protect against the inflation in domestic currency. Zimbabwe was already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. Zimbabwe is already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. 2. Semi-official Under semiofficial dollarization, foreign currency is legal tender and may even dominate bank deposits, but it plays a secondary role to domestic currency in paying wages, taxes, and everyday expenses such as grocery and electric bills. Unlike officially dollarized countries, semiofficially dollarized ones retain a domestic central bank or other monetary authority and have corresponding latitude to conduct their own monetary policy. 3. Official Official dollarization could be based on, for example, the South African rand, the U.S. dollar, or the euro. If Zimbabwe used the rand, it could negotiate a profit-sharing agreement such as Lesotho and Namibia now have, and which Botswana and Swaziland formerly had. Under these agreements, South Africa shares the profit (seigniorage) it derives from issuing currency, according to estimates of how many rand notes (paper money) and coins are in circulation in the partner country.
Free banking system
A completely free banking system has no central bank, no lender of last resort, no reserve requirements, and no legal restrictions on bank portfolios, interest rates, or branch banking. Free banking systems existed in nearly 60 countries during the 1800s and early 1900s. In general, these systems were relatively stable, issued currencies convertible into gold or silver at fixed exchange rates, and were not purveyors of inflation. Zimbabwe had free banking from the time its first bank was established in 1892 but it was replaced by currency board in 1940. Currency board
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Zimbabwe had currency board in 1940. A currency board is a monetary institution that issues notes and coins. A currency board¶s monetary liabilities are fully backed by a foreign reserve currency (also called the anchor currency) and are freely convertible into the reserve currency at a fixed rate on demand. The reserve currency is a convertible foreign currency or a commodity chosen for its expected stability. a currency board holds low-risk, interest-earning securities and other assets payable in the reserve currency. A currency board holds reserves equal to 100 percent or slightly more of its notes and coins in circulation, as set by law. Financial liberalization With the elimination of hyperinflation, the rationale for price controls and foreign exchange controls no longer exists. Both should be prohibited. Other forms of ³financial repression,´ including interest rate ceilings, the forced purchase of government bonds, minimum reserve requirements for financial institutions, and the compulsory allocation of credit to favored borrowers should also be prohibited. This liberalization would permit the free flow of capital into and out of Zimbabwe. It would also increase the return on savings and reduce the cost of capital in Zimbabwe, removing major impediments to economic growth and improved living standards.
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doc_100543026.pdf
The report describes the reasons of hyperinflation in zimbabwe in detail.
ZIMBABWEZIMBABWE CRISS – The Hyperinflation Episode THE HYPERINFLATION EPISODE
Table of Contents
Inflation and Hyperinflation ................................ ................................ ................................ ............... 3 History of Zimbabwe................................ ................................ ................................ .......................... 5 Road to hyperinflation and dollarization ................................ ................................ ............................ 6 1997 to 1999: Political vulnerability and economic breakdown................................ ...................... 6 2000 to 2003: Land reform and destruction of the production base................................ ............... 7 2004 to 2007: Pseudo-Keynesian economics................................ ................................ .................. 8 Impact on Economy ................................ ................................ ................................ ........................... 9 Loan Sanctions by IMF ................................ ................................ ................................ ..................... 10 Monetizing the Fiscal Deficit ................................ ................................ ................................ ............ 11 Revaluation of Zimbabwean Dollar ................................ ................................ ................................ .. 12 Impact of Revaluation................................ ................................ ................................ ...................... 13 Challenges and Policy Options after Hyperinflation................................ ................................ .......... 14 Possible Approaches to Hyperinflation................................ ................................ ............................. 15
2
Inflation and Hyperinflation
Inflation is an increase in the overall level of prices or decrease in the value of money. Inflation is caused by: yan imbalance between the money supply and the goods and services in an economy yand/or when confidence in the currency is eroded.
Inflation is always and everywhere a monetary phenomenon. ²Milton Friedman, A Monetary History of the United States 1867-1960 (1963) Hyperinflation Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. A working definition (definitions vary from 100% p.a. for 3 years to 50% a month) is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a.
Where Pt = P0 (1+r)t P0 = Current Price Pt = Price after time t r = inflation rate Possible indicators of hyperinflation: yThe general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain the purchasing power. yThe general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that foreign currency. ySales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short. yInterest rates, wages and prices are linked to a price index and the cumulative inflation rate over three years approaches, or exceeds, 100%.
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Hyperinflationary Models Confidence Model: Some events or series of event cause the people to lose confidence o then money issuing authority. Because of this, people prefer either keeping goods or money of some other nation. The suppliers start charging premium for their products which is much higher than the actual price. To overcome this, the best policy is changing the backing of the currency by issuing a new currency. Monetary Model: The money issuing bodies start printing money (not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money) to pay the debts or to cover costs coming up because of social unrest or war. When businesses perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency's value. The money issuing authority must then accelerate its expansion to cover these prices, which push the currency value down. Seigniorage & Hyperinflation Seigniorage is the revenue the government gets from printing new money. SE = M/P
Seigniorage Laffer Curve Seigniorage Laffer Curve shows the relationship between steady state inflation rate and Seigniorage revenue. It indicates that Seigniorage revenue must rise for a while and then fall again as inflation rises. Therefore there is an inflation rate that produces a maximum amount of Seigniorage with a stable rate of inflation. Above that rate, it is possible to collect more Seigniorage only if inflation rate is increasing.
Hyperinflation can be experienced when the government face a greater need of Seigniorage to finance its increasing fiscal deficit and after the Seigniorage maximizing inflation rate is reached. Above that rate, the curve indicates that revenue decreases.
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History of Zimbabwe
In 1980, the new nation of Zimbabwe rose as Rhodesia gained independence from the British Empire. Rhodesia had long been considered the jewel of Africa as it was rich in fertile farmlands and raw material such as gold and chromium. The rule of law was secure as much of the population trusted the police and believed in equitable treatment in the courts. With low crime, strong banking, a sophisticated manufacturing base, and booming tourism; real GDP growth averaged a strong 4.3%. Prior to independence, Rhodesia had been administrated by Great Britain during the late 19th century¶s Race for Africa as part of the British South Africa Company. The Colony of Southern Rhodesia was created in 1923, granting self-rule to the white colonists, while leaving blacks disenfranchised. Rhodesia enacted the Land Apportionment Act in the year 1930, forbidding land ownership for blacks outside of tribal reserve areas. During that time, the British built an agricultural empire in the colony, developing one of the most sophisticated water delivery systems in Southern Africa. With only 7% of the land, Rhodesia had 86% of the area¶s dams and 93% of the reservoir surface area at the time of independence, serving an agricultural sector that was the backbone of a thriving economy: strong enough to feed all of its seven million people and export the rest to the world. Around 70% of the Rhodesia¶s vast farmland had been run by about 4,500 white farmers who produced cash crops such as tobacco and cotton. These white-owned farms supported: ya flourishing banking sector yloaning funds for machinery, seeds, tools ymost importantly, the water delivery system. The farms employed some 350,000 black workers and provided money for local schools and clinics. With the Zimbabwean dollar replacing the Rhodesian dollar at par and trading for US$1.59, the economic future looked bright for the fledgling democracy of Zimbabwe. That is, until Robert Mugabe came to power. In 1960¶s, Mugabe became prominent and became the Secretary General of the Zimbabwe African National Union ± a militant organization that fought the British in the Rhodesian Bush War throughout the 1970s. In a nation where there was only 1 white for every 22 blacks Zimbabwe, hadn¶t seen blacks in a position of power until 1979 ± and then only in lower ministerial positions. The ZANU (Zimbabwe African National Union) fought this inequitable bi-racial rule side by side with the Zimbabwe African People¶s Union ± comrades in arms united only by their desire to expel the British from their country. Once that end had been achieved, the two groups had divergent philosophies about the governance of the country: Mugabe¶s group had Maoist beliefs, while the ZAPU (Zimbabwe African people¶s Union) was Marxist. When the war concluded in 1979, Mugabe was hailed as a national hero, and won election to the post of Prime Minister in the first election following independence. Since then, the two opposing groups have been embroiled in a bitter civil war for control of the nation, with Mugabe¶s ZANU retaining control through force, intimidation, and outright murder. Elections are held from time to time; the results are usually rigged by the ruling ZANU¶s. In 1987, the position of Prime Minister was abolished, with Mugabe seizing new powers relegated to the position of Executive President of Zimbabwe and effectively becoming Dictator. While Rhodesia¶s white-owned farms thrived, as a result of the Land Apportionment Act some 840,000 black farmers were crowded into eroded and over-farmed land unconnected to the irrigation grid, producing corn, groundnuts, and other staples. This land was without title, and squabbling over land rights between villagers was rampant. As part of the Lancaster House Agreement ± the nation¶s independence agreement with Britain ± the subject of land redistribution was blocked until 1990. Mugabe sought to institute land reform, with the goal of redistributing the white-owned farms to black farmers. The nation¶s constitution forbade the seizure of land without proper compensation, and the electorate rejected a 1999 referendum to amend the constitution to allow it.
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Road to hyperinflation and dollarization
1997 to 1999: Political vulnerability and economic breakdown
In August 1997, approximately 60,000 war veterans were granted ZWD 50,000 each (approximately USD 3,000 at the time) plus a monthly pension of approximately USD 125 per month outside the budget. The payouts amounted to almost three percent of GDP at the time and this had the immediate effect of inflating the budget deficit at the end of 1997 by 5 percent from5 the 1996 levels. Concerns were raised pertaining to the financing side of the transaction in view of an already precarious fiscal position, and on that basis in September 1997, the World Bank temporarily withdrew a USD62.5 million standing credit line for the balance of payments support until the government had demonstrated that the payments would not result in a higher than the projected 8.9 percent budget deficit in the 18 months leading to December 1998. As an ad hoc decision, the government had intended to accommodate the gratuities payment through tax increases in the 1998 budget but countrywide protests orchestrated by the trade unions forced the government to backpedal and resolve to monetization of the transaction.
The second populist decision followed in November 1997 when the president, Mugabe, announced plans to compulsorily acquire white-owned commercial farms, again without elaboration on the financing side of the transaction. This had the immediate effect of giving investors a perception of an ensuing precarious fiscal position and consequently there were spontaneous and concerted runs against the currency from the money and capital markets. The climax of these events was on 14 November 1997 when the Zimbabwean dollar crashed and l st 75 percent of its value against theo USD on a single day, on what is now known as ³Black Friday´ in Zimbabwean economic history. The stock market also plummeted and the index was down by 46 percent by day end from the peak August levels. The central bank had to intervene and raise interest rates by six percentage points within that single month. The exchange rate continued to depreciate uncontrollably, thus the 1997 financial and currency turbulence set the stage for a long and potentially long slump in the real economy.
In September 1998 the president agreed to send 11,000 troops under the SADC protocol, to the Democratic Republic of Congo (DRC) to back the discredited leader, Kabila, who was under attack by Rwandan and Ugandan backed rebels. This act was simply the utilization of national military by the political elite for private financial gain as it emerged that the Zanu PF bigwigs had been promised mineral concession in the DRC. A letter written by the finance ministry to the IMF seeking funds puts the funds to finance the war at USD 1.3 million per month in 1998 or 0.4 percent of GDP and in 1999 when additional troops were deployed at USD 3 million per month or at 0.6 percent of GDP (IMF, 1999). The country could not spare forex outlays of such magnitude and this consequently weakened the currency, again with pernicious effect on price stability. There was intense pressure on the currency and in a bid to increase the flows of foreign currency which were dwindling at precariously low levels, the central bank reintroduced widespread import controls and banned foreign currency accounts. This decision was futile as in the first quarter of 1999 the central bank, had to devalue the currency by 50 percent to trade at USD1: ZWD38 from USD1: ZWD25
The aforementioned events marked a period in which the inept handling of government expenditure instigated investors to lose confidence in the currency with the consequence that they ran away from it thereby putting a pressure on the exchange rate, which fuelled infl tion througha the increase in the prices of import. Thus a characterization of inflation in this first period is that it was of a cost-push nature.
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2000 to 2003: Land reform and destruction of the production base
The president¶s rhetoric on confiscation of white-owned farms was elevated to the next level in early 2000, when war veterans, who courtesy of the gratuities, were now the paramilitary wing of the ruling Zanu PF party, started invading white-owned farms as part of an elaborate scheme by Zanu PF to terrorise people to vote for it in the parliamentary election in July 2000. The government delineated the parameters of its land redistribution policy embodied in the fast-track land reform programme under which 300,000 households and 51,000 black commercial farmers would be apportioned the previously white-owned commercial farmers. As a result of the upheavals on the farms, agricultural output fell dramatically from the level of 18 percent of GDP in 2000 to 14 percent of GDP in 2002 (World Bank, 2008).
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Export proceeds from tobacco declined from USD612 million in 1999 to USD321 million in 2003.
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The government could not service its multilateral debts obligations and as a result in October 2000, the World Bank suspended any extra lending to Zimbabwe und the IBRDer and IDA facilities due to non-payment of over six months (World Bank, 2000). On the other hand the government could not import essential raw materials and fuel as a result of the declining forex inflow, which further fed into falling production with the result that by 2004, total foreign currency earnings from the export of goods and services had declined to less than half the 1996 peak of USD3,169 million (World Bank, 2008). In purported retaliation to the perceived deterioration of human rights conditions in the country, the European Union imposed sanctions against the country, after Mugabe had ejected a Swedish election observer before the 2002 elections. Under the terms of the sanctions, the European Union suspended budgetary support to Zimbabwe and terminated financial support for all projects except those in direct support of the population.
According to this analysis the major driver of inflation in this period was the shrinkage in aggregate supply sparked by the fall in the agriculture, which then spread to other sectors of the economy. The shrinkage in aggregate supply would ceteris paribus, trigger price increases which ignite the price-wage spiral.
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2004 to 2007: Pseudo-Keynesian economics
On 1 December 2003 a new governor, Gono was appointed to head the central bank. The battle against inflation, which now stood at 263 percent on a year on year basis at the end of 2003, became Gono¶s first priority. He undertook money-targeting framework as the monetary policy strategy and consequently set up a µFramework for Liquidity Management¶, which was to contain money supply growth to levels consistent with inflation targets. The interest rate was the operational target and it was raised acutely in the first quarter of 2004, reaching a peak of 5,242 percent annually in March 2004. Inflation which had soared from about 20 percent in December 1997 to a peak of 623 percent in January 2004, decelerated sharply from March to around 130 percent at the end of 2004 (RBZ, 2007). The high real interest rates and an increasingly overvalued official exchange rate was also putting pressure on domestic producers and exporters, and in a move to bail out the ailing industries, the central bank started engaging in quasi fiscal activities. The quasi-fiscalactivities went beyond the operational realm of a normal central bank and had the effect of undoing the ephemeral achievements in the inflation battle and firmly set course for the drive towards hyperinflation. At the height of these quasi-fiscal activities, money (M1) was increasing at the rate of 66,659 percent annually in 2007 and this feed to demand pull inflation during this period. The ravaging inflation standing at over 1000 percent meant that the people had to carry large sums of currency to conduct the simplest of transaction and on 1 August 2006, the Zimbabwean dollar was replaced by a new Zimbabwean dollar exchanging at a ratio of 1000:1 and it was subsequently devalued against the USD. A transition period of 21 days during which both currencies co-existed was given and thereafter the old notes ceased to be legal tender.
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Given the cosmetic nature of the reforms, there was no sign of reces in inflation and Zimbabwes formally entered hyperinflation in March 2007 when month-on-month inflation reached 50.54 percent and year-on-year 2,200 percent (RBZ, 2007). This period thus, marked the country¶s accelerated drive towards hyperinflation fuelled by the central bank¶s quasi-fiscal activities meant to fund the political campaigns of an unpopular ruling regime. In terms of economics, the characterization of inflation in this period is therefore of a demand pull nature
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Impact on Economy
y y Financial investors fled the country, concerned that other businesses may go the way of the farms, with foreign direct investment falling 99% between 1998 and 2001. Since there were no more land titles, there was no collateral for bank loans, causing dozens of banks to collapse. The farmland lost an estimated three quarters of its value between 2000 and 2001, amounting to $5.3B in losses. The collapse of the farmland led to widespread famine and, since it no longer had any owners, the prized irrigation system was dug for scrap, some being melted for coffin handles ± one of the few growth industries left in the country.
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As figure shows, agricultural production declined sharply, with 2005 output being only slightly above 1992 ± one of the worst drought years on record. For years afterward, Mugabe used this drought to explain the drop-off in production. Real GDP followed agriculture, as could be expected in a primarily agrarian economy. In 2007, it returned to the level it had been at independence 27 years earlier.
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Loan Sanctions by IMF
y Following the drought of 1992, the government of Zimbabwe began receiving loans from the International Monetary Fund. Repayment of these loans had been relatively steady until 2000, when the confiscation of farms and the subsequent slowdown of production caused the government to fall behind in its payments. In response to the deteriorating political and economic situation in Zimbabwe, President Bush signed into law the Zimbabwe Democracy and Economic Recovery Act of 2001, enacting sanctions against the nation by instructing the US Treasury and US members of international financial institutions to oppose the extension of any loans to Zimbabwe. The IMF declared Zimbabwe ineligible to access Fund resources and suspended the remaining payment support. Mugabe and the government of Zimbabwe have repeatedly cited these sanctions as the primary cause of their economic collapse. In 2004, due to their inability to repay the loans, Zimbabwe was expelled from the IMF, and repayments effectively ceased (IMF).
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Monetizing the Fiscal Deficit
y In the first few months of 2000, the Mugabe government began an aggressive moneyprinting campaign with ZW$30B, hoping to use the newly-minted money to purchase foreign currency to pay the IMF arrears, as well as to fund massive amounts of government spending. Monetary production remained relatively linear until a veritable explosion in 2000, flooding the monetary supply and causing hyperinflation the likes of which hadn¶t been seen since Weimar Germany in the 1920s. As the quantity theory of money ± and common sense ± tells us, the result of this excess printing with GDP in decline was that the value of the Zimbabwean dollar collapsed exponentially. As a result, the cost of living skyrocketed in tandem with the monetary supply. In the thirty years of independence, the cost of living has increased by a factor of 97,072,150,785.138%, and 2,152,473,377.841% since January of 2000. (For comparison, the United States CPI has increased 274.68% since 1980 and 126.69% since January of 2000.)
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Estimates vary to the extent of this hyperinflation, as measuring such a behemoth has become all but impossible. In November of 2008, prices were doubling every 24 hours. The calculation of the CPI in Zimbabwe is an extremely precarious endeavor, as many of the goods in the basket are nowhere to be found. Supermarket shelves once full of meat, grain, and supplies have become completely empty. Residents of Zimbabwe have taken to substituting whatever is available for the disposable goods they once purchased: instead of using newspapers for fire kindling, residents use the abundance of worthless banknotes; instead of using toilet paper, residents have again taken to banknotes. As a result of increasingly worthless bills, Mugabe¶s government has been printing ever larger denominations. In 1980, denominations of 2, 5, 10, and 20 dollars were printed, with the addition of a $50 banknote in 1994 and a $100 note in 1995. When inflation started becoming problematic, $500 notes were introduced in 2001 a $1,000 in 2003.nd When inflation started becoming systemic, denominations up to $100,000 were introduced in 2006 ± and by July, these were trading for less than US$0.20 on the black market. When inflation started becoming endemic, the central bank of Zimbabwe issued a $10,000,000 bill in January of 2008 ± at the time insufficient to buy a hamburger in a Harare restaurant. It was followed by a $100,000,000,000 note in July of 2008 (Zimbabwe introduces), and a $100,000,000,000,000 bill ± the world¶s first ± in January of 2009. At
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the time of its issue, it was worth about US$30 (Zimbabwe rolls) ± a stark contrast to the $1.59 the Zimbabwean dollar was worth at independence ± and no cash register on the planet is capable of ringing up so many zeroes.
Revaluation of Zimbabwean Dollar
y In August of 2006, Mugabe¶s government undertook the first of several redenomination of the Zimbabwean dollar, removing three zeroes: ZW$1,000 was now ZW$1. At the same time, Mugabe¶s government pegged the exchange rate at ZW$250, though this lagged behind the parallel rate of 550. In July of 2008, the government redenominated the dollar once again, this time removing ten zeroes, followed by the removal of another 12 zeroes seven months late.
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Impact of Revaluation
As one might imagine, Mugabe¶s monetary policies have been devastating for the people of Zimbabwe.
Unemployment: 80% (#3 in the world)
Literacy Rate: (above 15 years) %91.4
Life expectancy at birth: 44 years
Population below Poverty Line: 80%
Public Debt: 218% of GDP
20 %increase in under-five mortality since 1990 .
Human Development Index: 146th of 178
Limited support to the country¶s orphaned and vulnerable children, with 79 per cent not receiving any form of external assistance. yThe country, once a net exporter of grain and considered the ³breadbasket of Africa´, has been reduced to a nation where the highest denominated bill is insufficient to buy a loaf of bread. The situation in Zimbabwe can be considered an experiment ± an outrageously expensive one ± in reverse. The quantity theory of money: In one broad incompetent swoop, Mugabe has proven nearly every macroeconomic theory posited since Smith. y
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Challenges and Policy Options after Hyperinflation
Following a decade of economic decline and hyperinflation during 2007±08, Zimbabwe¶s economy has started to grow. The nascent economic recovery has been supported by a significant improvement in economic policies, but important policy challenges and significant vulnerabilities remain to be addressed. In late 2008, hyperinflation led to abandonment of the Zimbabwe dollar in transactions and de facto widespread dollarization. The official recognition of the demise of the Zimbabwe dollar took place in February 2009, when authorities established a multicurrency system. Under this system, transactions in hard foreign currencies are authorized, payments of taxes are mandatory in foreign exchange, and the exchange system largely is liberalized. Since the abolition of all surrender requirements on foreign exchange proceeds on March 19, 2009, there has not been a functioning foreign exchange market for Zimbabwe dollars. Bank accounts denominated in Zimbabwe dollars (equivalent to about US$6 million at the exchange rate of Z$35 quadrillion per US$1) are dormant. Use of the Zimbabwe dollar as domestic currency has been discontinued until 2012. While five foreign currencies have been granted official status, the U.S. dollar has become the principal currency. Budget revenue estimates and the budget expenditure allocations for 2009 were denominated in U.S. dollars, and the subsequent budget for 2010 was also denominated in U.S. dollars. For noncash transactions, the market is exhibiting a strong preference for the U.S. dollar: banks estimate that some four-fifths of all transactions are taking place in U.S. dollars, including most wage payments. Furthermore, stock exchange trading takes place in U.S. dollars, the payments systems operate in U.S. dollars, and the banking system and the Reserve Bank of Zimbabwe (RBZ) maintain accounting in U.S. dollars. In cash transactions, the U.S. dollar is the currency of choice, but the rand is prevalent in the South of the country, and it also circulates in the rest of the country, in particular coins. Wider circulation of the rand is prevented by South Africa¶s capital account control. Currencies other than the U.S. dollar and the rand have limited circulation in Zimbabwe.
The multicurrency system has provided significant benefits. In particular, it fostered the remonetization of the economy and financial reintermediation, helped enforce fiscal discipline by precluding inflationary financing of the budget, and brought greater transparency in pricing and accounting after a long period of high inflation. As a result, the price level in U.S. dollars declined during 2009, while the economy started to recover. The multicurrency system also poses a number of challenges. First, prices and wages are usually agreed and quoted in U.S. dollars, while South Africa is Zimbabwe¶s main trading partner and country of origin of capital inflows. Movements in the U.S. dollar/rand exchange rate therefore have considerable effects on Zimbabwe¶s competitiveness and international investment position. Second, shortages of small-denomination U.S. dollar banknotes and coins pose difficulties for retailers. Third, some politicians have expressed concern that loss of the national currency and seigniorage is an undesirable erosion of sovereignty and monetary independence. The government considers the multicurrency monetary regime a temporary arrangement until 2012 at least. Therefore, the pros and cons of maintaining the multicurrency regime indefinitely are not discussed. Despite the remaining challenges, the multicurrency regime could continue to operate with certain improvements until a new regime is chosen. The necessary improvements include aligning legislation, including the RBZ Act, with the prevailing practice of use of multiple currencies, making exchange controls more transparent, and faciltating the supply ofi coins, possibly with an agreement with South Africa. Zimbabwe has been experiencing a fragile recovery since early 2009. The jump start in growth has so far been consumption-led, but Zimbabwe¶s export sector, in particular mining, could potentially recover quickly and provide much needed fiscal revenues to a cash-strapped government with large external obligations. Zimbabwe continues to run large current account deficits financed by short term and volatile capital inflows and accumulation of arrears. Zimbabwe is in debt distress: external debt²of which about 64 percent corresponds to external arrears²is projected to be about 151 percent of GDP by 2015.
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Possible Approaches to Hyperinflation
The quickest way to stop hyperinflation in Zimbabwe is to replace central banking with a new monetary regime. This would instill confidence in the currency. In Zimbabwe¶s historical experience with a variety of monetary systems, only central banking has produced hyperinflation. Similarly, throughout the world, hyperinflation has been a phenomenon linked to central banking or its close cousin, the direct issue of currency by a government¶s treasury. During the transition, real interest rates have often been punishingly high, and long-term loans in local currency have been difficult to obtain. As a result, economic growth has been relatively slow, general living standards have remained stagnant, and the scourge of poverty has spread. For replacing the central bank with some other monetary regime Zimbabwe has 3 options available -
1) Dollarization 2) Currency board 3) Free banking
These options are not mutually exclusive. For example, a currency board system could be combined with official dollarization, as in the monetary systems of Lesotho, Namibia, and Swaziland.
Dollarization:
1. Unofficial When individual holds foreign currency, bank deposits or notes to protect against the inflation in domestic currency. Zimbabwe was already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. Zimbabwe is already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. 2. Semi-official Under semiofficial dollarization, foreign currency is legal tender and may even dominate bank deposits, but it plays a secondary role to domestic currency in paying wages, taxes, and everyday expenses such as grocery and electric bills. Unlike officially dollarized countries, semiofficially dollarized ones retain a domestic central bank or other monetary authority and have corresponding latitude to conduct their own monetary policy. 3. Official Official dollarization could be based on, for example, the South African rand, the U.S. dollar, or the euro. If Zimbabwe used the rand, it could negotiate a profit-sharing agreement such as Lesotho and Namibia now have, and which Botswana and Swaziland formerly had. Under these agreements, South Africa shares the profit (seigniorage) it derives from issuing currency, according to estimates of how many rand notes (paper money) and coins are in circulation in the partner country.
Free banking system
A completely free banking system has no central bank, no lender of last resort, no reserve requirements, and no legal restrictions on bank portfolios, interest rates, or branch banking. Free banking systems existed in nearly 60 countries during the 1800s and early 1900s. In general, these systems were relatively stable, issued currencies convertible into gold or silver at fixed exchange rates, and were not purveyors of inflation. Zimbabwe had free banking from the time its first bank was established in 1892 but it was replaced by currency board in 1940. Currency board
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Zimbabwe had currency board in 1940. A currency board is a monetary institution that issues notes and coins. A currency board¶s monetary liabilities are fully backed by a foreign reserve currency (also called the anchor currency) and are freely convertible into the reserve currency at a fixed rate on demand. The reserve currency is a convertible foreign currency or a commodity chosen for its expected stability. a currency board holds low-risk, interest-earning securities and other assets payable in the reserve currency. A currency board holds reserves equal to 100 percent or slightly more of its notes and coins in circulation, as set by law. Financial liberalization With the elimination of hyperinflation, the rationale for price controls and foreign exchange controls no longer exists. Both should be prohibited. Other forms of ³financial repression,´ including interest rate ceilings, the forced purchase of government bonds, minimum reserve requirements for financial institutions, and the compulsory allocation of credit to favored borrowers should also be prohibited. This liberalization would permit the free flow of capital into and out of Zimbabwe. It would also increase the return on savings and reduce the cost of capital in Zimbabwe, removing major impediments to economic growth and improved living standards.
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