by Alexander Czombera*
If there is one single law in economics then it is that markets tend to equilibrium. Or, to align this with Grove’s law (“Technology will always win. You can delay technology by legal interference, but technology will flow around legal barriers”), the free market will find its ways, whether in white, grey or black market. Despite of initially strong resistance of the Zimbabwean government it was market forces and not political consent that abolished central banking and legal tender laws in the South African country. Paper money of its original currency was replaced with notes from other countries, the shortage of coins was addressed by “efficient rounding”, condoms and sweets.
While inflation was mostly in double digits ever since its independence in 1980 it began to climb when the government faced high deficits and deep recessions in the early 2000s. In late 2008 it eventually reached a peak of 8.97 x 10 (to the 22nd power) percent. Prices doubled almost every day.
Because of the limited supply of foreign currencies and fixed exchange rates some people used this time to exploit arbitrage opportunities. The term burning money was coined when well-connected people in Harare exchanged their Zimbabwe Dollars into the limited supply of South African Rand at the fixed exchange rate and sold the Rand in the parallel market at a fair price.
The continuing devaluation of its own currency moved Zimbabwean citizens into other currencies, most notably Rand, Pula, US Dollar, Euro and Pound. In spite of legal tender laws these currencies became established in the regions which traded frequently with the countries issuing these currencies or having previously adopted them. It was the convenience of using them and not the mere desire to store value that moved people into other currencies. In fact, because there were no incentives to keep deposits in Zimbabwe Dollars local long-term business lending was limited to 30 days. Needless to say, businesses borrowing US Dollars were exposed to the risk of a future shortage or negative translation effects. Still, a variety of foreign currencies saved the Zimbabwean economy and was finally acknowledged for this when the government declared them a legal tender in April 2009. At this time the output was 20% of its capacity.
While the denationalization of Zimbabwean currency from its own country enabled its economy to grow it has not yet followed some Hayekian conclusions.F.A. Hayek suggested that the most efficient currencies (e.g., those that are able to build up a sufficient reputation) survive in a competitive environment. We may expect that under a free banking system one could find only one or at most two currencies prevalent in a particular region (e.g., for a population of some 13 million). Otherwise menu costs and complexity exceed the potential benefits of competing currencies. While network effects are a strong determinant for establishing currencies Zimbabwean shops often disclose prices in at least three to four currencies, whereby the selection depends on the economic connections of the local economy with other countries. Because the selected currencies have not been subject to vast daily fluctuations and arbitrage opportunities between them are limited by transaction costs this equilibrium proved to be sustainable. In fact, Zimbabwe increased its number of legal currencies up to eight (including Australian Dollar, Yuan, Rupees and Yen). It sounds familiar to say that the more players are in a market the better off is the user.
However, It should be acknowledged, that merchants have to adapt their prices as exchange rates change. Because the use of multiple currencies requires them holding more cash than they would if they traded in only one currency they reduced the usage of coins. For smaller transactions change is given in sweets and condoms. If we assume that coins have certain advantages to paper and commodity money (e.g., higher divisibility and sufficient transportability) Zimbabwe shows that bad money keeps out good money. Coins have advantages over condoms and sweets with regards to their size and durability. However, as foreign currency was brought in large denominations the country has suffered from a chronic shortage of coins. This has fostered a tradition of giving change in alternative pseudo-currencies or rebates. At the same time any coins that were used are horded. A trader rather prefers to give out condoms and sweets rather than coins if both have the same value.
Zimbabwe like many other countries faces the burden that money and banking are interconnected. Hence, it is not surprising to see that with the decline in central banking, the abandonment of strict regulatory authority and the advantages of having a lender of last resort Zimbabwean banks lost market shares. A large part of deposit accounts is with foreign institutions or their subsidiaries. Government (from stable governments) regulation or at least a good reputation and “qualified” origin seem to be desired.
What Zimbabwe demonstrates is that if people are free to choose their currency many may actually prefer governmental currencies that have a long track record of price stability and small volatility. However, the equilibrium in countries with a high exposure to global trade is found in many and not a single currency. These foster stable inflation and economic growth. Indeed, it should acknowledge that outcomes might differ if this experiment is conducted in countries with a population above Zimbabwe’s 13 million and a rather transparent economy (In 2009 only 6% of Zimbabwe’s labor force was registered as employed).
*Student at WHU – Otto Beisheim School of Management and Carnegie Mellon University; scholar at Friedrich Naumann Foundation for Freedom. German articles can be found at http://ef-magazin.de/autor/alexander-czombera.