Hyperinflation in Zimbabwe - Essay Example

?Insert Insert Grade Insert Insert Hyperinflation in Zimbabwe Introduction Inflation is a situation where the value of the country’s currency goes down leading to an increase in prices of products, increase in bank lending rates and other effects that comes with devaluation of a country’s currency. Hyperinflation is the extreme of inflation. Inflation is common in all economies while hyperinflation rarely occurs. Zimbabwe is the first and currently the only country that has experienced hyperinflation in the 21st century (Hanke and Kwok 353). This paper discusses what brought about hyperinflation in Zimbabwe and defends the argument that hyperinflation in Zimbabwe could only be solved by replacement of the Reserve Bank of Zimbabwe with another monetary regime. Origin of inflation in Zimbabwe Two major events precipitated inflation in Zimbabwe and that is, involvement in Congo civil war in 1998 and the land expropriation of 2000. The Zimbabwe government entered into war on the side of Zaire’s dictator Laurent Kabila without having budgeted for the war, without any reserves for the war or any arrangements to raise the funds. The land expropriation program of 2000 saw the government forceful take 4,500 farms from white settlers and give it to war veterans and politicians (Coomer and Gstraunthaler 312). This led to reduction in foreign investment from 400 million US dollars in 1998 to a mere 30 million in 2007. The productivity of the land was also reduced by half between 2000 and 2007. This government policies also led to imposition of sanctions by the IMF, US, UK and EU. The government in order to win public confidence provided initiatives such as purchase of farm inputs for the farmers who had been given land. The farmers also used the land as securities for securing loans. This unforeseen expenditure compounded with the four year expenditure in Congo war led the Reserve bank of Zimbabwe to adopt inflationary policies such as printing more money and employing more staff. This led to devaluation of the Zimbabwean dollar and the central bank responded by printing more money and even increasing the face value. This is the origin of hyperinflation in Zimbabwe. By March 2007 the inflation rate in Zimbabwe was 2,200% while by October 2008 it rose to 3,840,000,000,000,000,000%! (Noko 347). Hyperinflation led to lose of value of the Zimbabwe dollar. Wealth was lost within months as millionaires were no longer wealthy. The prices of commodities went up leading the government to regulate the same (Federal Reserve Bank of Dallas 11). This led producers to opt for other markets which led to an acute shortage of various products. The industries were dissolved, unemployment was at the highest level, poverty escalated and some citizens fled to other countries. The next section gives methods through which this hyperinflation could be solved. Solutions to Zimbabwe’s Hyperinflation Hyperinflation was brought about by the practices of Reserve Bank of Zimbabwe. Replacing the Reserve Bank of Zimbabwe is a sure way of ending hyperinflation (Hanke1 23). Some countries such as Angola have contained their high inflation rates without replacing their central bank through change of policy. The question is why could this be implemented in Zimbabwe? This could not be adopted in Zimbabwe because from historical perspective policy change has never checked inflation in Zimbabwe. Moreover, all over the world hyperinflation has been linked to the issue of currency by the central bank or the concerned country’s treasury. Central banks can easily end inflation as they fuel them. One of the sure ways is to stop the printing of currency. This solution reduces money in circulation and contains hyperinflation, but it is a long process because it takes time for the central bank to regain its lost credibility. During this time interest rates on loans normally escalate and it is very difficult to get a long term loan because there is less money in circulation. This could be injurious to the Zimbabwean’s who are already impoverished by the effects of hyperinflation. It could lead to more suffering because the value of the money has already gone down and yet there is less in circulation, citizens purchasing power will substantially reduce. Therefore, the surest way that could contain hyperinflation in Zimbabwe is replacing the central bank with another currency regime. There are three options in replacing the Reserve Bank of Zimbabwe with another monetary regime. The options include currency board, free banking and official dollarization. Any of this options or a combination of two or all the three will ensure currency stability and bring to an end hyperinflation in Zimbabwe. There is also a forth option of Zimbabwe gaining membership into South African rand’s common monetary area. However, this option would not be proposed here because it requires much political negotiations that would take a lot of time. This would not be appropriate for Zimbabwe, which is in critical economic crisis. Dollarization refers to a situation where a country uses a foreign currency most commonly the US dollar alongside or as a substitute to its local currency (Hanke2 8). Unofficial dollarization occurs mainly in countries with high inflation rates where citizens opt to convert their money in foreign currency to guard against the devaluation effects of inflation. Zimbabwe could be said to be unofficially dollarized because the citizens hold sterling pounds, US dollars, South African rand and other foreign currencies as a measure against inflation currency depreciation effects. Official dollarization occurs where a country adopts a foreign currency as a substitute to its local currency. This currency becomes an accepted medium for settlement of payments. Official dollarization in Zimbabwe could involve the use of the South African rand, the Euro or the US dollar as a substitute to its local currency. There is also semi official dollarization in that the foreign currency is an accepted medium of settlement of payments but plays a secondary role to the local currency. In this case, it could be proposed that Zimbabwe transits from unofficial dollarization to official dollarization. The currency to be used should also be carefully evaluated. For example, the choice of the dollar; this is a relatively stable currency, widely accepted and less susceptible to inflation. The second option would be the Euro, which is also a stable currency but less popular than the US dollar. The third option would be the South African rand which the strongest currency in the South African region in which Zimbabwe is part. Moreover, South Africa is Zimbabwe’s greatest trading partner. However, adoption of the South African rand would mean South Africa shares in the profits Zimbabwe gets in the issuance of currency. It could be argued that Zimbabwe adopts the US currency because it is a more stable and popular currency. It does also not come with many obligations. With the dollar, the inflation rates will go down, the circulation of the currency will be determined by the balance of payments and the bank lending interest rates would go down. Free banking is where private commercial banks issue currency and other liabilities with little regulation. In a completely free banking regime there is no central bank, no control on bank interest rates, and no regulation on bank portfolios or existence of a lender of last resort. Free banking existed in about 60 countries during the 19th and early 20th century. Such economies were stable and no evidence exists that such systems perpetuated inflation. Zimbabwe operated with free banking since the establishment of its first bank in 1892 up to 1940 when it was replaced by a currency board. The banks by then issued pounds sparingly to ensure balance of payments. This was a relatively stable system and was only replaced because the government wanted to share profits from the issuance of currency. Free banking will establish competition among various banks in the country. The less efficient banks will be thrown out of business. This will only leave large efficient banks to issue currency. The banks will also be at liberty to issue any currency such as the South African rand, the dollar or the Euro. With such a situation, the currency will stabilize and inflation will be contained. However, this option leaves the discretion of determination of the suitable banking system in the hands of citizens rather than the government determining for them. The third option of replacing the Reserve Bank of Zimbabwe is by establishing a currency board. A currency board is a monetary institution that is mandated to issue currency. The monetary liabilities of the currency board are backed by foreign reserve currency. This foreign reserve can be converted to currency reserve when need arises at a fixed rate. This is meant to ensure monetary stability. The currency board replaced the Zimbabwe’s free banking in 1940 and during the time it was in operation it was not associated with inflation. The currency board regulates the money that is in circulation. It does not create reserves for commercial banks but it expects them to create their own reserves. Therefore, the money supply is determined by the market forces. This will go along way into regulating the money supply in the Zimbabwean economy. Conclusion All these options could help contain inflation in Zimbabwe. It can be done through one option, a combination of two or all the three. Although they have remarkable differences, it is important to note that they are likely to bring about a reduction in inflation in Zimbabwe. Change in policy in the Reserve Bank of Zimbabwe could take a long time and it would be too costly to the already ailing economy. Works Cited Coomer, Jayson and Gstraunthaler, Thomas. The Hyperinflation in Zimbabwe. The Quarterly Journal of Austrian Economics, Vol. 14, Issue 3 (Fall 2011), pp. 311-346 Federal Reserve Bank of Dallas. “Hyperinflation in Zimbabwe”. Globalization and Monetary Policy Institute 2011 Annual Report. 2011. Web. May 17, 2013 < http://www.dallasfed.org/assets/documents/institute/annual/2011/annual11b.pdf> Hanke, Steve and Kwok, Alex. On the Measurement of Zimbabwe’s Hyperinflation. Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), pp. 353-365 Hanke1, Steve. “How to kill Zimbabwe’s hyperinflation”. Global Dialogue. 2008. Web. May 17, 2013 < www.cato.org/articles/how-kill-zimbabwes-hyperinflation.pdf> Hanke2, Steve. Zimbabwe: From Hyperinflation to Growth. Cato Journal, Issue 6(June 25, 2008) Noko, Joseph. Dollarization: The Case of Zimbabwe. Cato Journal, Vol. 31, No. 2 (Spring/Summer 2011), pp. 339-365 Read More