Zimbabwe On A "Gold" Standard

The world champion of the money printing world, Zimbabwe, is now operating on a quasi gold standard with a largely free enterprise economy. There may be lessons to be learned by other countries from Zimbabwe's experience.

Many countries are struggling with excessive debt, i.e. debt that cannot be repaid out of income. When debt becomes excessive, it can be eliminated by bankruptcy or by an inflationary destruction of the purchasing power of the local currency. Sometimes a combination of these two options is possible.

In February 2009 Zimbabwe was the only country in the world without debt. Nobody owed anyone anything. Following the abandonment of the Zimbabwe Dollar as the local currency all local debts were wiped out and the country started with a clean slate.

It is now a country without a functioning Central Bank and without a local currency that can be produced at will at the behest of politicians. Since February 2009 there has been no lender of last resort in Zimbabwe, causing banks to be ultra cautious in their lending policies. The US Dollar is the de facto currency in use although the Euro, GB Pound and South African Rand are accepted in local transactions.

A gold standard system provides money that the politicians cannot create at will, a money that people trust to provide the usual functions of money, being a medium of exchange, a measurement of exchange and a store of value. The US$ provides all of these things in Zimbabwe. The US$ cannot be produced at will by the local Government and for the moment the US$ provides the three functions of money. The concept of the US$ as a store of value may not be valid over the longer term, but for the moment, Zimbabweans accept it as such. Thus Zimbabwe is operating under a quasi gold standard.

Price controls and foreign exchange regulations have largely been abandoned. Zimbabwe literally joined the real world at the stroke of a pen. Money now flows in and out of the country without restriction. Super market shelves, bare in January, are now bursting with products.

The Zimbabwean political situation is complicated by the fact that President Robert Mugabe is determined to stay in power. Currently there is a Unity Government where power is shared between Mugabe's ZANU-PF party and Morgan Tsvangirai's MDC. The Zimbabwean political situation is very fluid and is beyond the scope of this article.

A book by Martin Meredith titled "MUGABE: Power, Plunder and the Struggle for Zimbabwe" published by Jonathan Ball, gives a very readable account of the recent history of Zimbabwe up to 2006, which was prior to the worst of the hyperinflation. It is required reading for anyone wishing to gain a balanced understanding of what happened in that country with an emphasis on the period since Independence was granted in 1980.

There are common denominators in all hyperinflations. Generally government finances reach a point where large budget deficits cannot be financed by taxes or borrowings. The choices come down to austerity (with the government cutting back its spending) or funding the deficit by creating local currency through the printing press, leading to the inflation tax. This is always a political decision, but the line of least resistance is the printing press. Cutting government expenditures and dispensing with bureaucratic staff is anathema to most politicians.

In Zimbabwe, Robert Mugabe caused his supporters to infiltrate the army and police force. He also used Government finances as a way of funding patronage. His use of the printing press was liberal and nobody was prepared to stand up against him. This eventually led to inflation gathering momentum to the point where the armed forces got rebellious - they wanted more money. When Mugabe caved in to these demands, combined with the selling of freshly created Zimbabwe Dollars for foreign exchange, the Zimbabwe Dollar plunged.

Shortly after Mugabe was elected President in 1980, the Zimbabwe Dollar was worth more than the US Dollar. The ongoing abuse of the financial system, where Mugabe used the Reserve Bank as his own private source of funds (supplied by printing new money), eventually produced a runaway inflation. The largest bank note issued in Zimbabwe was for One Hundred Trillion Dollars and is pictured below.

The worst trauma for ordinary people during the hyperinflation was lack of food. This was due mainly to the imposition of price controls. If the real cost of production of an item was $10 and the price controllers instructed that the item could only be sold for $5, that business would soon go bankrupt if they sold at the controlled price. The result was that production and imports just dried up, hence the empty shelves in the supermarkets.

People survived by shopping in neighboring countries and relied on assistance from South Africa and the aid agencies. Companies survived the hyperinflation with great difficulty and often by ignoring laws. Although companies were left without debt post February 2009, they were also left deficient in working capital and had dilapidated plant and equipment. Regular repairs and maintenance could not be afforded. Most companies now require urgent recapitalization.

There has been a major exodus of Zimbabweans over the years, estimated at about 3 million prior to 2008. Many of these were qualified people who were subjected to Mugabe's campaign of terror. During the latter stages of the hyperinflation there was a further exodus because people were starving. Most of these people went south into South Africa. The current population of Zimbabwe is estimated to be between 10 and 12 million people, so the numbers that have fled the country are significant relative to the total population.

Current economic activity is strongly supported by remittances from Zimbabwean migrants to their families in Zimbabwe. Once the political situation settles down, it is likely that many of these migrants will wish to return to Zimbabwe. Some have already done so. Many activities that perished in the hyperinflation, such as insurance, are now starting to resuscitate.

Credit financing activities are starting to revive. Visa credit cards are once again operating successfully in Zimbabwe, others will surely follow. Banks have had both sides of their balance sheets devastated by hyperinflation and now have no lender of last resort to call on. They are understandably cautious in lending the deposits that are slowly filtering back into the system. Banks also lost much of their equity capital. Barclays Bank survived because it had 40 branches where the bank owned the real estate and had a strong parent. These properties plus some foreign currency holdings represent the equity capital on which the bank currently operates.

In a country with no debt, only assets, people and companies are under-geared. With the ultra cautious lending policies of the banks, there is a huge opportunity for foreign investors in the credit purveying industry.

There has been a sharp rise in economic activity since dollarization in February 2009. Real wages have risen substantially compared to a year ago. Whatever workers were paid in Zimbabwe Dollars during the hyperinflation bought virtually nothing. Now even the minimum wage of around $100 per month allows for basic purchases. A 10kg bag of maize meal, a staple in the local diet, costs $3.50 and lasts for two weeks. Demand for products and services are increasing rapidly. Corporate profits are rising, leading to greater tax revenues for the Government, augmented by rising VAT taxes. Greater Government revenue allows for greater Government spending.

This self-reinforcing loop will continue. The improvement in the economy will become dramatic once Mugabe leaves the scene. At that time aid agencies, NGO's, Charities and foreign governments will start injecting large volumes of funds and assistance into the country. They refuse to commit any meaningful funds while Mugabe is still the President.

With Mugabe out of the way and with the economy recovering strongly, a proportion of the Zimbabweans living overseas will return to the country bringing welcome skills and capital. Indeed foreigners will also be attracted to investing in the country in those circumstances.

It is fascinating to see how rapidly the economy is recovering. It is a great testament to what can be achieved in a free enterprise environment by the elimination of controls combined with the institution of new money that people trust. It needs to be money that their Government cannot create via the printing (or electronic) press.

The economic future of Zimbabwe is likely to be in mining, agriculture, tourism and service industries, especially those providing infrastructure and maintenance facilities. There remain many problems, not the least being chronic unemployment, but the future looks bright beyond the Mugabe horizon. The population is amongst the best educated in Africa and most people can speak English. With Zimbabwe's natural assets, there is scope for realistic optimism about the economic future, especially once the current political difficulties are overcome. The population has been brutally traumatized by the hyperinflation and the political situation. They deserve a decent change of fortune.

A very important factor in assessing the current situation is that Mugabe no longer has his own private source of funds to continue his system of patronage. The Reserve Bank can no longer be called upon to provide newly printed currency whenever Mugabe requires it. The army, police force and civil servants are paid by the Unity Government. As a consequence, Mugabe's power base must be disintegrating. He has also become very unpopular. It seems unlikely that he could win an election again, even if he managed to get his thugs to resort to intimidation. People identify Morgan Tsvangirai and the MDC with the new monetary disposition and the improved economy, while Mugabe is correctly blamed for the trauma of hyperinflation.

There is also the question of sanctions. In recent speeches Mugabe has said that it was time for sanctions against Zimbabwe to be removed. This is nonsense. It is Mugabe and 200 of his associates who are under sanction, not the country, under the Zimbabwe Democracy and Economic Recovery Act passed by the US Congress some years ago. This prevents them and their families from travelling overseas and freezes their external bank accounts.

This combination of circumstances, combined with the fact that he is 86 years old, suggests that Mugabe must be under some pressure to resign. It is a logical deduction that behind the scenes Mugabe may be attempting to negotiate a form of amnesty against prosecution. Mugabe has shown a tenacious ability to cling to power in the past, so it may be premature to write him off.

COMMENTS and CONCLUSIONS

Viewing the impact of hyperinflation at close quarters, one cannot help feeling that this is the least desirable method for eliminating excessive debt. The population has been traumatized physically, via starvation, mentally and financially. Most people did not have foreign assets or local tangible assets, so lost virtually everything. Companies survived using unusual skills, ignoring laws and protecting working capital by holding foreign currency or purchasing equities.

The alternative option for eliminating excessive debt is to take the tough political decision of austerity, allowing 'too big to fail" companies to fail and accept the unpleasant economic consequences. Excessive Government spending should be curbed. A sound currency, combined with the elimination of all rules and controls in a completely free market, will produce a much better result in the long term. If this option were adopted, the short term would likely be extremely unpleasant, possibly including an economic depression. It is doubtful whether any Government today has the courage to take this route. Sadly this implies that the world is headed down the path of currency debasement that will eventually result in a Zimbabwean situation for the elimination of debt.

Zimbabwe may yet prove to be a role model, demonstrating how rapidly a country can recover from the devastation of hyperinflation and the elimination of debt.

Alf Field

23 November 2009

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Disclosure and Disclaimer Statement: The author advises that he is not a disinterested party in that he has personal investments gold and silver bullion, gold and silver mining shares as well as in base metal and uranium mining companies. The author's objective in writing this article is to interest potential investors in this subject to the point where they are encouraged to conduct their own further diligent research. Neither the information nor the opinions expressed should be construed as a solicitation to buy or sell any stock, currency or commodity. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions. The author has neither been paid nor received any other inducement to write this article.