Dollarization and Re-Dollarization

Dollarization may have been the best thing to happen to Zimbabwe since independence. This is not because the state of dollarization is desirable (it is actually detrimental in the long term), but that the actions a government has to take to get out of it are. 

What is it?

Dollarization (also known as currency substitution or currency pegging) is when a nation pegs its currency against another (i.e. the dollar) or completely adopts that other currency as legal tender. This is ideally a short to medium-term state. It is normally implemented to save economies that are on the verge of collapse because the local currency there has lost its function as a store of value and its characteristics of limited supply and acceptability. These casualties are associated with hyperinflation. Some nations that have dollarized before are Ecuador and El Salvador.

Hyperinflation is a result of fiscal indiscipline. A direct result of government printing too much money. Therefore, inflation and hyperinflation can only be caused by a government since no one else has the legal right to print money.

“Inflation is always and everywhere a monetary phenomenon” – Milton Freidman, Nobel Laureate (Economics)

When to De-Dollarize and Re-introduce a Local Currency

Once dollarization has achieved its goal of stabilizing the economy and re-igniting production, it then eventually becomes necessary to de-dollarize so that a nation can have a currency that appreciates and depreciates according to its own trade balance and not that of the U.S.A. (or whatever country it may have pegged its currency to). This will then increase exports and reduce imports if it had a trade deficit and vice versa if it had a trade surplus. However, a key condition needs to be met: The country that wishes to de-dollarize must have built sufficient foreign currency reserves so that it can support its new currency and ensure convertibility. Without doing this, a country will go back to square one as hyperinflation will return. All of the nations that have failed to de-dollarize have done so due to poor fiscal and monetary discipline.

The Zimbabwe Story

In 2009, the nation dollarized because hyperinflation had rendered the Zimbabwean Dollar useless. This brought about stability within the economy and growth. In 2011 under the guidance of former Finance Minister Tendai Biti, Zimbabwe recorded the world’s highest GDP growth rate (15.4% against a global growth rate of 3.15%). However, the trade deficit began to expand but this would be fixed by the successful re-introduction of a local currency. This essentially took place in 2016 with the announcement of the Bond note which was said to be an export-incentive whose purpose was to increase exports. (Note: economic data has shown that the Bond note had little to no effect on exports). This was a for all intents and purposes, a Zim dollar with a fancy name. This would not be a bad thing at all if adequate foreign currency reserves to back it up were in place. Unfortunately – there were little if any at all. Why the government did this shamelessly illogical act is up for speculation. As a result, the Bond note (and consequently its sibling, the RTGS dollar) rapidly began to lose value on the market as it had no legs to stand on. De-Dollarization has failed and in response, the economy is naturally re-dollarizing as businesses seek to protect themselves from hyperinflation. 

“Inflation is taxation without legislation.” – Milton Freidman

Just like the Zim Dollar which would be recklessly printed and have zeroes slashed at will without any foreign currency to back such monetary profligacy, the bond note/RTGS is rapidly headed to the currency grave. The only hope for its salvation is strict fiscal and monetary discipline.

To successfully de-dollarize, a government that is not known to live within its means will have to do so or face failure, again. Henceforth, this article opens with the sentence: “Dollarization may have been the best thing to happen to Zimbabwe since independence. This is not because the state of dollarization is desirable but that the actions that a government has to take to get out of it are.”

“Governments never learn. Only people learn.” – Milton Friedman