By Lazarus Nyagumbo.
London. (News of The South) – In recent days, there’s has been an escalation in the discussion of topical monetary issues, in particular optimal and relevant currency to adapt and use in circulation among Zimbabwean economic agents (individuals, households, businesses, social media and main stream media). There is a notable size of the population who advocate and believe that re-dollarization is the most plausible way forward and an equal number of economic agents suggesting a full-blown return of the ZW$. Both sides are putting forward a spirited argument for and against these two notable views. However, most of the arguments are based on self-interests or a lack of an understanding of what is money, what are the determinants of currency value and a general appreciation how an economy works?. In this article, following several requests from Zimbabwe and Diaspora community, I will explore some of these questions with a view to improve the body of knowledge, understanding, application, analysis and evaluation of Zimbabwe’s macroeconomic and monetary system.



The History of Money, Gold Standard.
During mediaeval early days of money, gold coins were used as a medium of exchange (to pay for goods and services). The money had intrinsic value. Overtime, with a rise in the volume of goods and services produced in domestic and international trade markets there was a need for notes and coins. According to Pettinger (2009) “the gold standard was a way to fix the value of money by allowing them to be converted into a certain amount of gold. This gave people faith in the new ‘paper money’. For example, in United Kingdom (1717) fixed £1 to 113 grains (7.32 g) of fine gold”.

Throughout the nineteenth and early twentieth century, other countries including Zimbabwe also adopted the gold standard. They set their currency at a certain level against gold. Managed exchange rates were very stable and only fluctuated after an agreed adjustment.

What were the advantages of Gold Standard?

To begin with, advantage of the gold standard was that the amount of gold was relatively stable. It means that governments couldn’t print money and create inflation. It also created confidence in the financial system. Furthermore, it created stability in exchange rate and certainty for international trade. Also, exporters knew they couldn’t rely on devaluation to improve competitiveness, encouraging firms to cut costs and increase productive efficiency.

The Mini Collapse of Gold Standard.



To a larger extent, the costs of the First World War (WW1, 28th July 1914 – 11th November 1918) were so great that countries abandoned the gold standard in order to have the ability to print more money and pay for the war. This led to inflation which persisted after the war, the time-lag effects. However, when WW1 ended, countries returned to the gold standard. In the early 1920s, defeated allied powers like Germany, Hungary and Austria couldn’t pay their war reparations denominated in gold. Germany had to print a lot of money causing the famous hyperinflation, The Great Depression.

However, a return to the gold standard meant UK exports were too expensive causing falling demand for UK manufacturers. In the 1920s, because of the gold standard, the UK experienced deflation and a prolonged period of high unemployment (even before the Great Depression). On the other hand, the US dollar was undervalued, this contributed to a boom in US economy which led to the credit bubble and stock market crash of 1929. In the 1930s, the Great Depression caused many to leave the gold standards and allow their exchange rate to devalue. The UK left in 1931. After the Second World War (WW2), Britain had depleted its gold reserves in paying for the war; a return to the gold standard was not practical.

The Birth of Bretton Woods System.

However, to guard against the inflationary potential of floating exchange rates and Central Banks with the power to print money, the Bretton Woods system was set up. The Bretton Woods Agreement is the landmark system for monetary and exchange rate management developed at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire, USA from July 1 to July 22, 1944. In simple terms, this was a fixed exchange rate system where countries pegged their currency to the dollar and the US fixed the price of gold at $35.

The Demise of Gold Standard & Bretton Woods System 1970s.

Notably, the gold standard led to macroeconomic problems for the productive sectors in most economies, for example UK manufacturing sectors faced uncompetitive exports leading to lower aggregate demand and economic slowdown. It was unsustainable and a floating exchange rate mechanism was introduced whereby the value of the domestic currency will be determined by market forces of demand and supply. However, the gold standard has many drawbacks because of its ability to create deflationary pressures e.g. which harmed the UK economy in the 1920s. Inflation or deflation could be created by variations in production of gold. In recessions, monetary policy became ineffective because governments cannot increase the money supply (can’t suddenly increase the amount of gold but it’s easier to print more paper money or electronic money, quantitative easing).




The Bretton Woods System of fixed exchange rates encouraged speculative attacks on the currency.

However, some economists and late Col. Gadaffi argued that we should revert to the gold standard to protect against inflation and the power of Central banks to inflate away debt which benefits governments (USA benefit from USD being used as a global reserve currency) and those with debts but destroys the income of savers.

The Present Day Fiat Money:
In most modern day economies, money is called fiat money, meaning it is accepted as money because a government says that it’s legal tender, and the public has enough confidence and faith in the money’s ability to serve as a store of value (savings or investment) or a medium for purchasing power both in domestic and international markets.
A fiat system is based on a government’s mandate that the paper currency e.g. ZW$, USD, £, ZAR, Bond Notes it prints is legal tender for making financial transactions. Legal tender means that the money is backed by the full faith and credit of the government that issues it. In other words, the government promises to be good for it.
Fiat money is the opposite of commodity money or gold standard, which is money that’s based on a valuable commodity. Once upon a time, gold, silver, copper, salt, peppercorns, tea, giant stones, embellished belts, shells, alcohol, cigarettes, cannabis, candy, cocoa beans, cowries and barley, furs and other animal products were used as commodity money preceding the current fiat system.
Why other fiat currencies are stronger than others? How does a country’s gold reserve impact its currency? Why is China buying tonnes of gold and meanwhile trying to become an international reserve currency like the US Dollar?

Christopher Byrd (2015) suggested that gold reserve or lack thereof can affect the value of a nation’s currency if that currency is not backed up by a hard asset, that is, if it is a fiat currency. There is a temptation for nations to spend beyond their means (domestic debt), which is beyond what goods or services produced in the domestic economy to warrant having that currency. If nations print money that is not backed up by anything other than what is purchased with it, the value of that money is weakened the more of it that is printed, a currency depreciation. The over printing of fiat currency can in fact lead to hyperinflation where more and more of the currency is needed to be printed in order to purchase goods, inflation-causing-inflation.



The positive effect gold can have on a nation’s currency is that if it is the foundation of that currency (that is the backing for that currency) it helps curb overspending because it is understood that the currency can always be swapped for its value in gold (or silver). If the gold or silver is not in the country’s vaults the money becomes worthless or certainly of less worth and inflation occurs. At present, no country’s currency is backed by gold ever since the collapse of the gold standard.

However, because China perceives instability in the world standard US fiat dollar and the enormous debt that has been accumulated by the US, much of it owed China, China does not see much chance of its loans to the US ever being paid back. Instead it seems it has decided on a self-preserving path of offering the yuan as an alternative global reserve currency to the US dollar and one that will be backed by gold. It has therefore been accumulating large quantities of gold at low prices and building up its gold reserves. Interestingly, this is at a time when the West has been selling away much of its gold in its mistaken belief in the soundness of Keynesian economic theory. The BRIC (Brazil, Russia, India & China) nations are coming up with a banking system that will act as an alternative to the World Bank and IMF where transactions will be made in yuan and not the US dollar. This will have a significant impact on the Western banking system unless western nations also became members of the new alternative New Development Bank (NDB, https://www.ndb.int/) and are willing to trade in yuan instead of or as well as in dollars.

Gold is generally considered a safe haven rather than an investment. Gold is also seen as a threat to the value of the fiat US dollar and for this reason Central Banks and the Fed have been doing everything in their power to prevent a rise in the value of gold or Col. Gadaffi’s Gold Dinar substitute to USD reserve currency.

The western banks have the means of hedging large contracts back and forward on the commodities market and thus control the price of gold. This is, of course, illegal but the western monetary regulatory authorities ignore the malpractice (corruption) because gold is a direct threat to the dollar. These trades are supposed to be backed by physical gold and silver but if you sum total the number of gold and silver contracts in existence there is far more paper gold and silver than the actual physical metal itself in the world. When delivery is called the banks are forced to pay off in dollars not in the precious metals which they don’t have.



In the Zimbabwean context, some commentators are suggesting that the country must build up notable gold reserves before the full-blown introduction of ZW$ in line with BRIC’s sentiments. To some extent they are correct, but the gold standard regime collapsed long back. After all gold has many pertinent industrial uses such as “78% of the gold consumed each year is used in the manufacture of jewellery”, H. M. King (Geology.com, 2017). Also, gold is highly valued and in very limited supply, it has long been used as a medium of exchange or money (coinage, bullion, currency backing). The most important industrial use of gold is in the manufacture of electronics because it is the highly efficient conductor that can carry these tiny currents and remain free of corrosion. Electronic components made with gold are highly reliable. Gold is used in connectors, switch and relay contacts, soldered joints, connecting wires and connection strips. Furthermore, computers’ edge connectors used to mount microprocessor and memory chips onto the motherboard and the plug-and-socket connectors used to attach cables all contain gold. In addition, gold is used in dentistry because of its superior performance and aesthetic appeal. Gold alloys are used for fillings, crowns, bridges, and orthodontic appliances. Gold is used in dentistry because it is chemically inert, nonallergenic, and easy for the dentist to work.
Given the above competing uses of gold, a Zimbabwean return to gold standard or reserves is not the first best solution to the current macroeconomic and monetary challenges facing the economy. In my view, its not about which currency Zimbabwe must use, any currency is plausible and effective especially the ZW$ when it is supported by thriving robust productive sectors producing goods and services. When the Zimbabwe’s economy produce goods and services to satisfy domestic and international market demand, then the demand for ZW$ will rise, gaining value and in the process earning the elusive forex including USD, Yaun, £, ZAR etc. However, ZW$ prior to Cde Chinamasa’s January 2009 multicurrency or dollarization regime introduction, was facing huge pressure from domestic and external currency attacks culminating in higher inflation and currency depreciation. The dollarisation came as a relief to mitigate such currency attacks and stabilise prices. Now, the great question maybe has dollarisation succeeded or been effective?

Zimbabwe Currency Substitution – Dollarisation or Sterlingisation, Multicurrency Regime:

Pettinger ( 2014) define currency substitution as when a country uses another currency without any official backing and without a Central Bank – instead of using its own currency.
For example, Panama and Zimbabwe uses the US Dollar as part of its currency. Jersey uses Sterling unofficially too.
The advantage is that a country like Panama and Zimbabwe get to use a currency which has a stable value and international respect. The disadvantage is that it has little control over monetary policy and doesn’t have a Central Bank to act as lender of last resort to print money during periods of illiquidity. Also, you lose the ability to devalue the exchange rate as per the requirements of the obtaining macroeconomic fundamentals and objectives. This results in the domestic central bank’s monetary policy incapacitation and ineffective.
Does it matter if Zimbabwe doesn’t have a lender of last resort?
Some economists argue that having no central bank encourages and motivates banks to act more responsibly and avoid taking on excess risks (reduce moral hazard issues).




A central bank is important in any economy especially during a recession, we have seen how OECD central banks galvanised global support and coordination of Quantitative Easing to redress the deep and stubborn unprecedented 2007-09 Global Financial Crisis. Most of these countries’ central banks electronically created/printed more money to stimulate aggregate demand and aggregate supply to steer their economies towards economic recovery and growth. This is the advantage forgone by Panama and Zimbabwe by adapting dollarisation or multi currency regime. This might be the rationale for the full-blown return of ZW$.
The Inherent Shortcomings of Dollarisation:
Dollarisation was a brilliant move to mitigate hyperinflation and ZW$ currency attacks.

“Instead of deliberately supporting the sustainable productive sectors with just found dollarisation at the time of GNU, the finance minister slept on the job and supported a rise in imports of dead capital and consumption goods. Culminating in excessive USD bleeding out of ZW monetary transmission mechanism or system, leakages. If the leakages is continuous, logically the USD BOREHOLE will eventually dry up, here we are?

It’s not about which currency is good or bad for ZW, no? It’s a very wrong way of understanding the underlying and underpinning determinants of currency value?

Any currency stability is backed domestic production of goods and services culminating in its demand in domestic and global markets. A rise in demand for ZW exports will lead to a firming and strengthening of ZW currency whilst a wanton unabated import imports demand rise will result in the free fall of ZW currency.

Before any talks about which currency, I think we need to talk about production production boosting exports and reducing imports”, TLN Economics (2018).

Similarly, according to Hon Kamba (2018) “it is evident that the wider use of the US dollar had its own costs, which include loss of competitiveness, as the dollar is over-valued, capital flight and externalisation. Proponents of de-dollarisation point to these economic woes in support of that or any other currency other than the greenback. However, the attainment of a smooth transition to de-dollarisation must go alongside a well-organised and realistic economic recovery programme that focuses on increased productivity in the real sector to enhance a wide range of economic diversification. Without such, all efforts will be doomed as the currency will quickly depreciate towards worthlessness. Injection of more bond notes under the current macroeconomic conditions may drive the economy towards a more single currency in the form of bond notes, which is prone to rapid depreciation and fuelling inflation, with dire economic and social consequences”.

Consumer economy vs Producer Economy: Which one do you prefer and why?
Capital goods and consumer goods are classified based on how they are used. A capital good is any good deployed to help increase future production like property, plant and equipment, or PPE. Consumer goods are any goods that are not capital goods; they are goods used by consumers and have no future productive use.



Economists and businesses pay special attention to capital goods because of the role they play in improving the productive capacity of a firm or country. In other words, capital goods make it possible to produce at a higher level of efficiency.
Dollarisation in Zimbabwe promoted and encouraged a consumer economy whereby most of the economic activities are based on consumptive imports such as used cars, groceries, clothes, etc because with USD in hand, they could buy anything from anywhere. However, sustainable steady economic recovery, growth and development, low stable inflation, low unemployment (job creation) and a favourable balance of payments (BOP) can only be achieved through a sound producer economy, where economic activities are mainly based on production, made in Zimbabwe goods and services.

The Chinese way is a classic example. I recommend Zimbabweans and policy makers to find time to read “Out of The Rabble by Dr David Chiweza”, an illuminating book.
Based on Zimbabwe’s past forty-five years of experience, Chiweza, a resident of Zimbabwe, relates his nation’s economic fortunes to markets and establishes that all emerging economies have leveraged monopolistic domestic markets to overtake advanced economies. He sheds light on the causes of Zimbabwe’s infamous economic crisis and details an industrialisation blueprint with universal strategies that have catapulted underdog nations to succeed against the odds. It can be found on
https://www.iuniverse.com/Bookstore/BookDetail.aspx?BookId=SKU-000579881 .
In an illiquidity crisis, a country has no ability to print or create money if it is operating under dollarisation regime. This could lead to higher treasury bills or bond yields and pressure to pursue austerity, government spending cuts. For example, in 2010 countries like Italy, Portugal and Spain had relatively low levels of government borrowing (at least compared to UK) but with markets concerned at the absence of a domestic central bank to create or print liquidity – countries saw rising bond yields and a pressure to cut government spending because European Central Bank (ECB) controls the printing of the euro.
Furthermore, dollarisation causes an inability to devalue domestic currency. With dollarisation a country has no ability to devalue. If the country becomes uncompetitive (eg ZW exports relatively more expensive than competing economies), it will be stuck with an overvalued exchange rate (USD) – leading to lower exports and BOP current account deficit. This has been a major problem for Zimbabwe, Panama and Eurozone periphery countries who have needed to pursue internal devaluation to restore competitiveness.
What is more, is that dollarisation may lead to Capital Flight.
Another concern over ‘Adaptive Dollarisation’ is – would foreign shareholders be willing to take on the greater risk of securing ZW bank lending? Given the recent history of Barclays Bank Zimbabwe, etc OFAC fine, foreign shareholders may be less attracted to hold shares in ZW banks when there is greater risk and no lender of last resort.
To what extent does Panama provide a model for Zimbabwe?
Dollarisation may have been successful for Latin American countries like Panama but there are many differences between their economy and a Zimbabwe economy, which is seeking international re-engagement following Zidera Act 2001 (amended 2018) at the behest of misguided opposition MDCA..

Way Forward: factors that influence ZW$ exchange rates and its stability.
For those advocating for the immediate return of ZW$, here are some factors to consider before the full-blown re-introduction of domestic currency:
Inflation
If inflation in the ZW is relatively lower than elsewhere, then ZW exports will become more competitive, and there will be an increase in demand for ZW$ to buy ZW goods. Also, foreign goods will be less competitive and so ZW citizens will buy fewer imports, saving forex leakages. Therefore countries with lower inflation rates tend to see an appreciation in the value of their domestic currency.

Interest rates
If ZW interest rates rise relative to elsewhere, it will become more attractive to deposit money in the ZW. You will get a better rate of return from saving in ZW banks. Therefore demand for ZW$ will rise. This is known as “hot money flows” and is an important short-run factor in determining the value of a currency. Higher interest rates cause an appreciation and cutting interest rates tends to cause depreciation.
Speculation
If speculators or currency attackers believe the ZW$ will rise in the future, they will demand more now to be able to make a profit. This increase in demand will cause the value to rise. Therefore movements in the exchange rate do not always reflect economic fundamentals but are often driven by the sentiments of the financial markets. For example, if markets see news which makes an interest rate increases more likely, the value of the ZW$ will probably rise in anticipation.



Change in competitiveness
If ZW goods become more attractive and competitive this will also cause the value of the exchange rate to rise. For example, if the ZW has long-term improvements in labour market relations and higher productivity, good will become more internationally competitive and in long-run cause an appreciation in the ZW$. This is a similar factor to low inflation.
Relative strength of other currencies
In 2010 and 2011, the value of the Japanese Yen and Swiss Franc rose because markets were worried about all the other major economies – US and EU. Therefore, despite low-interest rates and low growth in Japan, the Yen kept appreciating. In the mid-1980s, the Pound fell to a low against the Dollar – this was mostly due to the strength of Dollar, caused by rising interest rates in the US.
Balance of payments
A deficit on the current account means that the value of imports (of goods and services) is greater than the value of exports. If this is financed by a surplus on the financial/capital account, then this is OK. But a country which struggles to attract enough capital inflows to finance a current account deficit will see depreciation in the currency. (For example, current account deficit in US of 7% of GDP was one reason for depreciation of dollar in 2006-07). UK current account deficit reached 7% of GDP at the end of 2015, contributing to the decline in the value of the Pound.
Government debt
Under some circumstances, the value of government debt can influence the exchange rate. If markets fear a government may default on its debt, then investors will sell their bonds or treasury bills causing a fall in the value of the exchange rate. For example, Iceland debt problems in 2008, caused a rapid fall in the value of the Icelandic currency.
Some governments attempt to influence the value of their currency. For example, China has sought to keep its currency undervalued to make Chinese exports more competitive. They can do this by buying US dollar assets which increases the value of the US dollar to Chinese Yuan.
Economic growth/recession
A recession may cause depreciation in the exchange rate because during a recession interest rates usually fall. However, there is no hard and fast rule. It depends on several factors. During this period 2007-09, the value of Sterling fell over 20%. This was due to:
• Restoring UK’s lost competitiveness. The UK had large current account deficit in 2007
• Bank of England cut interest rates to 0.5% in 2008.
• The recession hit UK economy hard. Markets expected interest rates in the UK to stay low for a considerable time.
• Bank of England pursued quantitative easing (increasing the money supply). This raised the prospect of future inflation, making UK bonds less attractive.
Foreign Currency Reserves (Forex Reserves).
This is the amount of foreign currency reserves that are held by the Central Bank of a country. In general use, foreign currency reserves also include gold and IMF reserves. Also, people may take into account liquid assets that can easily be converted into foreign currency. The most common currency for holding foreign currency is the dollar with 64%, the Euro is increasing its share and now accounts for 26%.
Reasons for Holding Foreign Currency Reserves
• Influence the exchange rate. With large foreign exchange reserves, a country can target a certain exchange rate. For example, suppose China wanted to increase the value of its currency the Yuan. China could sell it’s dollar reserves to buy Yuan on the foreign exchange markets. The increased demand for Yuan would appreciate the Yuan. Actually, the Chinese have been trying to keep the Yuan undervalued by selling Yuan and buying Dollars. This is why China has so many Dollar reserves. In a fixed exchange rate, foreign currency reserves can play an important role in trying to keep a target exchange rate.
• Act as a Guarantor for Liabilities such as External Debt. If a country holds substantial foreign debt, holding foreign currency reserves can help to give more confidence in the country’s ability to pay. If countries have dwindling foreign currency reserves, there is likely to be deterioration in a country’s creditworthiness.
Who decides the quantity of foreign currency reserves?
The number of foreign currency reserves will be decided by the Central Bank / Government depending on current exchange rate / monetary policy? For example, in the Bretton Woods system, countries tried to maintain a certain level of foreign currencies to be able to protect the value of a currency. In a floating exchange rate, there is less need to hold foreign currency for protecting against speculative attacks. Often an increase in foreign currency reserves may simply reflect a large current account surplus and a desire to prevent the currency appreciating too much. By buying foreign currency the domestic currency is kept lower than it would otherwise have done.
Problems of Foreign Currency Reserves
Foreign Currency Reserves are rarely sufficient to target a certain exchange rate.
If speculators sell heavily, then a currency will fall despite the best efforts of a Central bank. e.g. the UK lost billions trying to protect the value of Pound when it was in the Exchange Rate Mechanism in 1992. Eventually, the UK authorities had to admit defeat and devalue the pound.
Inflation Erodes Value. The problem with holding foreign currency reserves is that they can lose their value. Inflation erodes the value of currencies not fixed against gold (fiat exchange rates). Therefore, a Central Bank will need to keep buying foreign reserves to maintain the same purchasing power in markets. Also, there may have been many better (higher yielding uses of the capital).
Lose Money on Currency Changes. In theory, a Central bank can make money through the appreciation of other currencies it holds. However, many Central Banks have been losing money through the long-term decline in the value of the dollar. This particularly applies to China who has over $1900 billion of foreign reserves, mostly held in dollars.
It is therefore, not a very straight forward scenario in which Zimbabwean economic agents (individuals, households, firms, government, city and rural councils) find themselves in. The macroeconomic situation requires a clear understanding of the underlying fundamentals that requires our united and diligent actions as a people of Zimbabwe whilst outsiders can only help.

Lazarus Nyagumbo (TLN Economics 2007) is currently Head of Economics Department UK & Zanu PF UK & Europe Political Commissar, former Stanbic Banker and Economic Assistant Researcher at SARDC. Disclaimer: the views expressed in this articles are his personal economist thinking.




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