Zimbabwe Shouldn't Be Printing Banknotes Again

A Zimbabwean washes U.S. dollars, from NPR Planet Money

Here's a surprising development.

Zimbabwe, a dollarized nation, is on the verge of issuing its own $2, $5, $10, and $20 banknotes. Here is is the central bank's press release. Let's back up a bit. Zimbabwe suffered one of the worst hyperinflations in history during the 2000s thanks to awful policies by the government. Citizens were so fed up that they spontaneously dropped the Zimbabwe dollar in late 2009, the U.S. dollar being recruited as media of exchange and unit of account and the South African rand serving a backup role as small change.

Since then the rand has been steadily moving to the background in Zimbabwe monetary affairs:

Currency utilization levels in Zimbabwe [source]

Another change is that last year Zimbabwe re-entered the world of monetary production by minting its own 1, 5, 10, 25, and 50 cent coins, otherwise known as bond coins. At the time I was in favor of bond coins because Zimbabwe was following the blueprint set by dollarized nations like Panama and Ecuador. These nations mint their own small change to complement Federal Reserve-printed dollar banknotes, and for good reason. Coins are heavy while not being particularly valuable, which means that shipping costs are prohibitive. As a result, local banks prefer to import paper dollars, the ensuing coin shortages that develop making it difficult for locals to engage in basic transactions.

While I was a fan of bond coins, I don't like the Reserve Bank of Zimbabwe's decision to print bond notes. It departs from the dollarization blueprint--neither Panama nor Ecuador (or any other dollarized nation that I know of) have chosen to get into the business of printing notes. Panama in particular is a highly successful dollarized nations, so if Zimbabwe wants to depart from the Panama model one would expect it to have a very good reason for doing so.

John Mangudya, head of the Reserve Bank of Zimbabwe, says that he wants to get back into the note-printing game thanks to a "shortage of U.S. dollars" that seems to be bedeviling the nation. Since March, line-ups have developed at ATMs all over the country as people try to withdraw U.S. dollar cash. This is true, the local press is full of articles on banking queues. Strict limits have been placed on the amount of cash that Zimbabweans can withdraw from their accounts.

I'm skeptical of Mangudya's dollar shortage story. There is a very simple process whereby a dollar shortage in a dollarized nation is remedied. Zimbabwean farmers, desperate to get their hands on U.S. dollars, will reduce their selling prices for tobacco and cotton, two important cash crops with flexible prices. Gold miners will do the same. The moment Zimbabwean crop and gold prices fall below the international price arbitrageurs will bring dollars into Zimbabwe to buy cheap these goods for shipment overseas. Since cash crystallizes a large amount of value in a small volume, handling costs are very low--unlike coins. Domestic commodity prices need only deviate by a small wedge from the international price before arbitrage is profitable and U.S. paper currency flows back into the country. Unless the government is interfering with this process, I can't see it taking more than a week or two for markets to rectify a dollar shortage.

Zimbabwean authorities are notorious for tampering with Zimbabwean industry--this may be short-circuiting the simple process I've just described. If so, why introduce bond notes to fix the problem when the underlying cause is silly government rules preventing cross-border markets from functioning?

On the other hand, if the government hasn't been preventing this process from playing out then Zimbabwe doesn't have a genuine dollar shortage. Lineups at ATMs may simply be the result of an insolvent banking system. Zimbabwe is currently battling a slowdown in growth as commodity prices fall. The U.S. dollar's rise over the last year or two has reduced the nation's competitiveness. This slowdown may be taking a toll on banks. However, wads of newly-imported U.S. dollar bills or freshly-printed bond notes can't fix a sick banking system.

So Mangudya's reason for departing from the Panama model seems like a poor one to me, one made worse by the fact that the same nutcase who destroyed Zimbabwe's monetary infrastructure in the previous decade, Robert Mugabe, remains in power. Bond coins were one thing, but bond notes give Mugabe much more latitude to engage in monetary mischief.

How much mischief? Many Zimbabweans are worried that the introduction of bond notes will bring about a repeat of the hyperinflationary 2000s. I'm not as worried as them. The U.S. dollar not only circulates as Zimbabwe's medium of exchange but also serves as its unit of account. The fact that prices across the nation are expressed in terms of the dollar affords Zimbabweans a significant degree of protection from Mugabe. If bond notes are to be introduced, they may very well circulate along with U.S. dollars as a medium of exchange but they will not take over the unit of account role. A nation's unit of account, like its language or its religion, is a set of rules and standards that, once adopted, is not easily changed. In the same way that society is locked-in to using the QWERTY keyboard, it gets yoked to using a certain language of prices.

This means that if the bond note turns out to be a sham and begins to inflate, Zimbabwean prices--expressed in U.S. dollars--will stay constant. Instead, the exchange rate between the U.S. dollar and bond notes will bear the burden of adjustment, bond notes falling to a discount to dollars. Because this leaves the price level unaffected, the process of adjusting to a bond note collapse would be far less burdensome to Zimbabweans than the hyperinflation of the 2000s. The move might even backfire and cause Mugabe significant embarrassment since a bond note discount could not be blamed on anything other than his own incompetence.

Even if the bond notes can never do as much damage as Zimbabwe dollars did in the previous decade, the fact remains that there is no rational for issuing them. Let the market work its magic as it does in Panama and solve any cash shortage problems. The decision to return to paper money is a particularly insensitive one given the fact that many citizens' livelihoods were destroyed by Mugabe's Zimbabwe dollar hyperinflation. Zimbabweans are right to be upset over the bond note; it's a shame that Mangudya, having so ably brought the bond coin idea to fruition, is now promoting a regressive idea.