Opinion / Columnist
To introduce or not to introduce domestic currency in the short run, that is the question!
11 Sep 2018 at 11:08hrs | Views
By "To be or not to be" is the manner the literary genius William Shakespeare chose to employ as an opening of a soliloquy for Prince Hamlet in the play Hamlet. "To re-introduce or not to re-introduce" is how I choose to open this article apropos of a Zimbabwean currency. I will discuss the benefits of re-introducing a domestic currency first, then look at the demerits of such a course of action and conclude with a prescription for the country in light of the pros and cons of reintroducing a domestic currency in the short run.
Domestic currency is required mainly by what I would classify into three distinct groups of economic agents, namely: the local or domestic economic agencies; foreign economic agents; and a third composite group of economic agents whose membership could be drawn from either or both of the two foregoing groups which for purposes of this discourse, I will call currency traders. Domestic economic agencies require domestic currency for transactions, precautionary and speculative purposes whereas, foreign economic agents need currency mainly for transactions and precautionary purposes (if the agents tend to be significant trading partners of the domestic economy in question). The third group is made up of those whose business it is to buy and sell currencies for a profit. These last economic agents treat currencies as stock for trading purposes.
The arguments for the re-introduction of a domestic currency in the short run appear to converge on the urgent need to have the new currency address the current liquidity constraint bedevilling the economy. Indeed, the re-introduction of a new currency would almost suddenly solve the liquidity constraint challenge that is, in the fastest ever way possible. It will act virtually like an overnight cure for a malaise that has ravaged the economy for a very long period of time. The questions that need to be posed and unfortunately answered if this approach were to be adopted include: how sustainable would that be? Would that not also usher in inflation? Would the currency be accepted generally by economic agents as is expected of money?
Introducing a domestic currency, in the short term, aids the economy through a reclamation of the lost national monetary sovereignty and the attendant national pride due to dollarization. Domestic currency embodies some kind of a national emblem. National pride tends to be trammelled when an economy has to use others' currencies. In addition, the use of foreign currencies in an economy presents some potent restrictions on the implementation and effectiveness of monetary policies. Monetary policies hinge on the ability to manipulate either the money supply or interest rates to achieve the desired outcome by monetary authorities. When monetary authorities cannot control the money supply even their ability to manipulate the interest rates is hampered hence they may in effect talk of no effective monetary policy formulation abilities. When a country is dollarized, it loses potential income through loss of seigniorage, that is, that income from printing money. The most potent demerit of dollarization in my book would definitely have to be the economy's vulnerability to external shocks. This shocks is embodied in the expression that when the owners of the currency you are using catch a cold you sneeze. This vulnerability to other governments' policies and aspirations tend to be one of the major reasons why a lot of governments do not want to stay in a dollarized environment for long than could be judged necessary. Monetary sovereignty is deemed as important as political sovereignty by governments. Central banks are also rendered unable to serve as the lender of last resort in a dollarized economy, in general, hence they are unable to curtail shocks in the banking system such as those occasioned by domestic bank failures.
The introduction of domestic currency, in the short term, also comes with it serious challenges and perhaps perils that include but are not limited to the following: exchange rate depreciation; high levels of inflation; high interest rates; reduced, if any, real economic growth; high prevalence of social vices; loss of investor confidence; as well as loss of critical human capital through massive emigration. I will explain these shortly. Allow me to digress momentarily to enable me to contextualize these challenges immediately after the detour.
Foreign currency can be earned or may emanate from: foreign investors; tourists; exports; as well as aid and loans. To earn more foreign currency, it is a no brainer that an economy ought to be working on initiatives that foster the growth of the forex drivers that I identify in the immediately foregoing sentence. There is a positive correlation between the amount of foreign currency destined for a country and the growth of any of the foreign currency drivers that I identify here. So, just as much as those working on attracting investors are busy expending their energies on initiatives towards luring investors, so should those whose business it is to attract tourists to the country be formulating ingenuities that transform the country into an instant attractive destination for tourists. Simple initiatives such as ensuring there is a sound payment system in place, bureaux de change wherein to exchange foreign currencies for domestically acceptable currencies and et cetera. The attraction of forex is not a task for the government alone. It is everyone's task. Taking the tourism forex earning head, for example: when tourists arrive in the country, it behoves every responsible citizen to make the tourist's stay in the country a memorable one for the right reasons only. The police road blocks experiences and payment systems' glitches could serve to dissuade the same tourists from coming back or could make them inform their kith and kin not to pay us a visit if they do not experience the same in neighbouring countries, for instance. With such actions on the part of the tourists, there our potential forex would have gone to waste! Our reputation attracts or scares away tourists.
For us to attract significant amounts of investment capital, we need not necessarily be offering the biggest market for the finished products of those who would want to set up shop in our country. All we need to do is to offer the best environment for those who would want to set up shop in our country. Here, we need to have robust infrastructure in place for the investor. We must always remember that the global market for the attraction of investment capital is a very competitive market. If we offer the most corrupt market, we will not attract any credible investor. If we offer the most difficult environment to do business in, we will only attract the most difficult investor. If we export primary unprocessed products we will remain primarily dependent on other economies for basic goods and services as we will not generate much forex that way. If we want to earn significant amounts of foreign currency we need to invest in technology transfer initiatives which entail bringing over those that have the technical knowhow to invest in our economy and have our own local people learn the ropes with the aim of eventually acquiring sufficient knowledge to compete on an equal footing with their erstwhile coaches in the business processes. We may not have much to say about the amount of aid and loans that we could attract presently due to our not so illustrious or rather tarnished creditworthiness. It is incumbent upon those who will be doing the negotiations this time around with those who we have offended by our failure to service our debts in time to be honest and prove with certifiable promises their commitments to honour the country's debt obligations henceforth.
To re-introduce a currency that would be generally accepted requires that the economy meets the necessary and sufficient conditions for such currency to hold its own once introduced. Economic fundamentals such as a sustainable annual growth in the Gross Domestic Product, a significantly high level of exports and a substantial amount of foreign currency reserves as well as fiscal discipline on the part of government insofar as government expenditure is concerned ought to be in place before timelines for a re-introduction of a domestic currency are pronounced. Domestic currency matters are confidence issues. Without domestic or foreign economic agents' confidence in a currency, a currency's value will be depleted instantly and incessantly.
Now let me go back to that portion of the article which I had indicated I would go back to earlier. If a domestic currency is introduced that is neither backed by gold nor by foreign exchange reserves, for example, in the absence of significant exports, the exchange rate of the domestic currency against other currencies will, ceteris paribus, depreciate. The depreciation of the domestic currency translates into higher quantities of the domestic currency that would be required for exchange into a unit of foreign currency. Let us not forget that, in our case, the foreign currency is required for importing goods and services as well! That then means more supply of the domestic currency in the forex markets. Since we assumed no significant exports, an excess supply of our domestic currency vis a vis a more or less constant demand for the domestic currency will result in a further depreciation of our domestic currency. The lower value in our domestic currency will then trigger a high level of inflation since our economy is so reliant on imports for its inputs and unfortunately finished products as well. High levels of inflation in turn will lead to high interest rates. High interest rates embargo borrowing for setting up and growth of capital investments. Little or no investment leads to reduced, if any, real economic growth. With little or no economic growth come a high level of unemployment which in turn lead to a high prevalence of social vices. With that all sorts of criminal behaviours will be conceived. Idle minds are a devil's workshop as the saying goes. Idle capacity is a crucible of these devil's workshops. Once the country has a high level of unemployment, those with key skills will emigrate to places they feel they could get decent jobs and a reasonable standard of living commensurate with their levels of skills. With the loss of human capital and the unstable social environment courtesy of the prevalence of the social vices alluded to above, investor confidence will be lost and once that is lost we are back to where we were in 2007/8 where we would need once again to dollarize!
The economy must be stabilized first, grown and earn significant amounts of foreign currency as necessary and sufficient conditions for deliberating on when to re-introduce a new domestic currency. Our national pride should currently not be focused on a pressing need for a domestic currency emblem but on achieving enviable sustainable GDP growth hence jobs. I figure the economy as a former heavy weight boxing champion who had not been feeling well for quite some time and the illness had ravaged his body leaving him emaciated and enervated. That is illustratively similar to our economy presently. To regain his lost pride, the boxer does not immediately lodge a challenge to the current heavy weight champion to a bout simply because a doctor has pronounced a clean of health on him a second ago. Rather, he embarks on a rigorous training and diet regimen and works his body and his way up to a championship bout contender level before he deems himself ready to take on the reigning champion. For now, I feel the country's focus should be to get well first (i.e. getting the economic fundamentals right as a precondition) before challenging the current champion (re-introducing a new domestic currency)!
Prosper Munyedza MSc B. Analysis & Fin. (Uni of Leicester), BSc Econ. (Hon) (Uni of Zimbabwe)
For feedback email: pmunyedza@yahoo.com
Domestic currency is required mainly by what I would classify into three distinct groups of economic agents, namely: the local or domestic economic agencies; foreign economic agents; and a third composite group of economic agents whose membership could be drawn from either or both of the two foregoing groups which for purposes of this discourse, I will call currency traders. Domestic economic agencies require domestic currency for transactions, precautionary and speculative purposes whereas, foreign economic agents need currency mainly for transactions and precautionary purposes (if the agents tend to be significant trading partners of the domestic economy in question). The third group is made up of those whose business it is to buy and sell currencies for a profit. These last economic agents treat currencies as stock for trading purposes.
The arguments for the re-introduction of a domestic currency in the short run appear to converge on the urgent need to have the new currency address the current liquidity constraint bedevilling the economy. Indeed, the re-introduction of a new currency would almost suddenly solve the liquidity constraint challenge that is, in the fastest ever way possible. It will act virtually like an overnight cure for a malaise that has ravaged the economy for a very long period of time. The questions that need to be posed and unfortunately answered if this approach were to be adopted include: how sustainable would that be? Would that not also usher in inflation? Would the currency be accepted generally by economic agents as is expected of money?
Introducing a domestic currency, in the short term, aids the economy through a reclamation of the lost national monetary sovereignty and the attendant national pride due to dollarization. Domestic currency embodies some kind of a national emblem. National pride tends to be trammelled when an economy has to use others' currencies. In addition, the use of foreign currencies in an economy presents some potent restrictions on the implementation and effectiveness of monetary policies. Monetary policies hinge on the ability to manipulate either the money supply or interest rates to achieve the desired outcome by monetary authorities. When monetary authorities cannot control the money supply even their ability to manipulate the interest rates is hampered hence they may in effect talk of no effective monetary policy formulation abilities. When a country is dollarized, it loses potential income through loss of seigniorage, that is, that income from printing money. The most potent demerit of dollarization in my book would definitely have to be the economy's vulnerability to external shocks. This shocks is embodied in the expression that when the owners of the currency you are using catch a cold you sneeze. This vulnerability to other governments' policies and aspirations tend to be one of the major reasons why a lot of governments do not want to stay in a dollarized environment for long than could be judged necessary. Monetary sovereignty is deemed as important as political sovereignty by governments. Central banks are also rendered unable to serve as the lender of last resort in a dollarized economy, in general, hence they are unable to curtail shocks in the banking system such as those occasioned by domestic bank failures.
The introduction of domestic currency, in the short term, also comes with it serious challenges and perhaps perils that include but are not limited to the following: exchange rate depreciation; high levels of inflation; high interest rates; reduced, if any, real economic growth; high prevalence of social vices; loss of investor confidence; as well as loss of critical human capital through massive emigration. I will explain these shortly. Allow me to digress momentarily to enable me to contextualize these challenges immediately after the detour.
Foreign currency can be earned or may emanate from: foreign investors; tourists; exports; as well as aid and loans. To earn more foreign currency, it is a no brainer that an economy ought to be working on initiatives that foster the growth of the forex drivers that I identify in the immediately foregoing sentence. There is a positive correlation between the amount of foreign currency destined for a country and the growth of any of the foreign currency drivers that I identify here. So, just as much as those working on attracting investors are busy expending their energies on initiatives towards luring investors, so should those whose business it is to attract tourists to the country be formulating ingenuities that transform the country into an instant attractive destination for tourists. Simple initiatives such as ensuring there is a sound payment system in place, bureaux de change wherein to exchange foreign currencies for domestically acceptable currencies and et cetera. The attraction of forex is not a task for the government alone. It is everyone's task. Taking the tourism forex earning head, for example: when tourists arrive in the country, it behoves every responsible citizen to make the tourist's stay in the country a memorable one for the right reasons only. The police road blocks experiences and payment systems' glitches could serve to dissuade the same tourists from coming back or could make them inform their kith and kin not to pay us a visit if they do not experience the same in neighbouring countries, for instance. With such actions on the part of the tourists, there our potential forex would have gone to waste! Our reputation attracts or scares away tourists.
For us to attract significant amounts of investment capital, we need not necessarily be offering the biggest market for the finished products of those who would want to set up shop in our country. All we need to do is to offer the best environment for those who would want to set up shop in our country. Here, we need to have robust infrastructure in place for the investor. We must always remember that the global market for the attraction of investment capital is a very competitive market. If we offer the most corrupt market, we will not attract any credible investor. If we offer the most difficult environment to do business in, we will only attract the most difficult investor. If we export primary unprocessed products we will remain primarily dependent on other economies for basic goods and services as we will not generate much forex that way. If we want to earn significant amounts of foreign currency we need to invest in technology transfer initiatives which entail bringing over those that have the technical knowhow to invest in our economy and have our own local people learn the ropes with the aim of eventually acquiring sufficient knowledge to compete on an equal footing with their erstwhile coaches in the business processes. We may not have much to say about the amount of aid and loans that we could attract presently due to our not so illustrious or rather tarnished creditworthiness. It is incumbent upon those who will be doing the negotiations this time around with those who we have offended by our failure to service our debts in time to be honest and prove with certifiable promises their commitments to honour the country's debt obligations henceforth.
To re-introduce a currency that would be generally accepted requires that the economy meets the necessary and sufficient conditions for such currency to hold its own once introduced. Economic fundamentals such as a sustainable annual growth in the Gross Domestic Product, a significantly high level of exports and a substantial amount of foreign currency reserves as well as fiscal discipline on the part of government insofar as government expenditure is concerned ought to be in place before timelines for a re-introduction of a domestic currency are pronounced. Domestic currency matters are confidence issues. Without domestic or foreign economic agents' confidence in a currency, a currency's value will be depleted instantly and incessantly.
Now let me go back to that portion of the article which I had indicated I would go back to earlier. If a domestic currency is introduced that is neither backed by gold nor by foreign exchange reserves, for example, in the absence of significant exports, the exchange rate of the domestic currency against other currencies will, ceteris paribus, depreciate. The depreciation of the domestic currency translates into higher quantities of the domestic currency that would be required for exchange into a unit of foreign currency. Let us not forget that, in our case, the foreign currency is required for importing goods and services as well! That then means more supply of the domestic currency in the forex markets. Since we assumed no significant exports, an excess supply of our domestic currency vis a vis a more or less constant demand for the domestic currency will result in a further depreciation of our domestic currency. The lower value in our domestic currency will then trigger a high level of inflation since our economy is so reliant on imports for its inputs and unfortunately finished products as well. High levels of inflation in turn will lead to high interest rates. High interest rates embargo borrowing for setting up and growth of capital investments. Little or no investment leads to reduced, if any, real economic growth. With little or no economic growth come a high level of unemployment which in turn lead to a high prevalence of social vices. With that all sorts of criminal behaviours will be conceived. Idle minds are a devil's workshop as the saying goes. Idle capacity is a crucible of these devil's workshops. Once the country has a high level of unemployment, those with key skills will emigrate to places they feel they could get decent jobs and a reasonable standard of living commensurate with their levels of skills. With the loss of human capital and the unstable social environment courtesy of the prevalence of the social vices alluded to above, investor confidence will be lost and once that is lost we are back to where we were in 2007/8 where we would need once again to dollarize!
The economy must be stabilized first, grown and earn significant amounts of foreign currency as necessary and sufficient conditions for deliberating on when to re-introduce a new domestic currency. Our national pride should currently not be focused on a pressing need for a domestic currency emblem but on achieving enviable sustainable GDP growth hence jobs. I figure the economy as a former heavy weight boxing champion who had not been feeling well for quite some time and the illness had ravaged his body leaving him emaciated and enervated. That is illustratively similar to our economy presently. To regain his lost pride, the boxer does not immediately lodge a challenge to the current heavy weight champion to a bout simply because a doctor has pronounced a clean of health on him a second ago. Rather, he embarks on a rigorous training and diet regimen and works his body and his way up to a championship bout contender level before he deems himself ready to take on the reigning champion. For now, I feel the country's focus should be to get well first (i.e. getting the economic fundamentals right as a precondition) before challenging the current champion (re-introducing a new domestic currency)!
Prosper Munyedza MSc B. Analysis & Fin. (Uni of Leicester), BSc Econ. (Hon) (Uni of Zimbabwe)
For feedback email: pmunyedza@yahoo.com
Source - Prosper Munyedza
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