Thursday, 8 December 2016

Bad Money Drives Out Good - How the Bond Note will eventually wipe away the US Dollar

BAD money drives out good, according to Gresham’s Law, dating from 16th century England. Sir Thomas Gresham, money manager for Queen Elizabeth I, argued that, if two coins with the same nominal face value simultaneously circulate, the one with the most gold will be hoarded while the less valuable coin will be used.

Who would have guessed that in our time this medieval axiom would be tested — of all places — in Zimbabwe, the once rich, now impoverished land in southern Africa.

Zimbabwe is ruled by 92-year-old Robert Mugabe, who traveled last week to Cuba for the funeral of his friend Fidel Castro who died at age 90. In 2008 under Mugabe, Zimbabwe recorded the world’s highest rate of inflation. As prices rapidly escalated — rising multiple times daily — the central bank issued progressively larger denomination Zimbabwe dollars. That process culminated with the issuance of a 50 trillion note.

With the economy in chaos, a reformist finance minister, Tendai Biti, was named. He abolished the Zimbabwe dollar and adopted the U.S. dollar DXY, +0.05% as the country’s currency. Hyperinflation was halted and for a few years the economy began to recover.

But in recent years the commodity boom that had held up the prices of Zimbabwean mineral exports went bust. There was a devastating drought and the U.S. dollar soared against the currency of South Africa, Zimbabwe’s major trading partner.

Unable to issue its own currency, Zimbabwe ran out of money and deflation took hold. Cash is in such short supply that civil servants, police and military, are seldom paid on time. For months there have been restrictions limiting what can be withdrawn from cash machines. Then cash machines were seldom open and people lined up overnight in hopes of getting some of their savings from the banks.

Aware of a deepening crisis, for several months Zimbabwe’s central bank told citizens that it would issue “bond notes,” a temporary expedient to alleviate the cash shortage. Ordinary people, remembering hyperinflation, protested. The bond note proposal was ridiculed as a back-door method of reintroducing the discredited Zimbabwe dollar.


On Nov. 28 as Mugabe jetted off to Havana, the bond notes were finally released. They had been secretly printed. The $2 bond notes are theoretically exchangeable for $2 in U.S. currency. The government says the notes are backed by a hard-currency loan from a multilateral bank based in Cairo. The small denomination bond notes are sprinkled among U.S. dollars in the cash machines that are working.

The words “bond note” is on the red banner near the top.

Last week money changers reappeared on the streets of Harare, Zimbabwe’s capital. Despite harassment from police the bond notes in some places trade at a hefty discount.

Gresham’s Law appears to be kicking in. In places where the official rate is honoured people are using bond notes while holding back their U.S. dollars.

The government says it will issue $12 million of bond notes in coming weeks.

So far there have been few surprises. Some shopkeepers applaud the notes, saying they are helping overcome the cash shortage. Others call bond notes a desperate move by a failing state.
Zimbabwe is in desperate straits. Hard times and economic mismanagement prompted a third of its population to flee. Between 1997 and 2008 the economy shrank by 50%. Payroll accounts for 85% of government spending. Unemployment is as high as 80%. International agencies say 33,000 children need immediate attention for malnutrition and that 4 million Zimbabweans are food insecure.

International agencies are prepared to help. Efforts are being made to pay off Zimbabwe’s large foreign debt and the country’s arrears to the International Monetary Fund have been cleared.

A major problem is that President Mugabe has not named a successor and the ruling party is divided as to who will take over upon his demise.

Barry D. Wood is a journalist based in Washington who writes frequently about southern Africa’s economy.

Bad Money Drives Out Good - How the Bond Note will eventually wipe away the US Dollar
Source: New Zimbabwe
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