June 01, 2023 - 6 min read
The road to currency credibility will take time after decades of reduced economic output, overspending, and episodes of hyperinflation.
The Reserve Bank of Zimbabwe announced that they will offer a gold-backed central bank digital currency to investors and individuals in the country. This comes after the Zimbabwe dollar has dropped by more than half in the last year, falling to about 2,200 ZWL to 1 USD. Of course, many people ditch the local currency at every opportunity, with some estimates reporting that 76% of trade in the country is settled in US dollars.
Issuance is set to be rolled out in two phases. During phase one, individuals can acquire wallets and convert their physical gold into digital tokens. In phase two, tokens will be tradable for P2P and B2B purposes, and can be exchanged for gold at international market prices following the 180 day vesting period. As of mid-May, $14bn of the tokens have reportedly been sold.
To get some context on the situation, some history is in order first. Of course, Zimbabwe’s hyperinflation episode is widely recognized as one of the most severe in recent history. The causes are primarily due to unrealistic fiscal and monetary policies, as well as political and social instability, not to mention corruption which will hardly have any statistics tracking this metric.
However, a combination of land reforms and heavy borrowing destroyed the nation’s agricultural productivity, and transformed it into one obligated to fund its operations via debt and external aid – which almost always comes with political strings attached. It also leads to economic distortions in which local vendors and merchants find it hard to gain traction. How did things go bad in the first place, though?
Zimbabwe’s land reform program began in 2000, and was known by the name Fast-Track Land Reform Program, and was perhaps the most controversial policy measure of Robert Mugabe’s presidency. The program was heavily criticized by human rights groups for forcibly evicting farmers from their lands with little to no compensation.
Prior to these reforms, much of Zimbabwe’s best farmlands were owned by a few farmers descended from European settlers. Though these farmers made significant contributions to Zimbabwe’s economy, the ostensible goal of the land reform program was to seize control of capital resources owned by European descendants and give them to other people based on local ancestry. The justification for this was that doing so would rectify historical injustices resulting from the preceding years of European colonization on the continent.
However, the program didn’t pay much attention to farming skills or allocate land based on merit, expectations of future gains, logistical realities, or other such metrics. In fact, much of the prime farming real estate ended up in the hands of Mugabe’s family, friends, and top members of the ZANU-PF party. The abrupt transfer of productive land from experienced to inexperienced farmers, combined with a lack of support for new farmers, led to a sharp drop in agricultural productivity.
Ironically, the support that was being allocated for new farmers became an immediate drag on the government’s expenditures, as subsidies and other aid programs were suddenly in higher demand than ever before. This was devastating to Zimbabwe’s budget, as agriculture had previously been one of its most productive economic sectors from which the government could fund itself as opposed to being a net loss following Mugabe’s reforms.
President Mugabe dispatched Zimbabwe’s army to participate in the Second Congo War in 1998, and participated all the way through 2002, which proved to be extremely costly. Some estimates even place government expenditures in the hundreds of millions of dollars with some tallying costs amounting to $1 million per day at the height of the war. Perhaps this could be sustained if productivity was roaring away back at home, but as we just covered- this wasn’t the case anymore.
In 1997, in response to protests and demands for compensation for their roles in the armed forces, President Mugabe granted generous, unbudgeted payouts to thousands of war veterans and their families. The government also employed a rather large civil service whose salaries made up a significant portion of government expenditure. Paying these wages with regular increases to alleviate complaints over the soaring inflation further inflated the government’s deficits.
Furthermore, the government attempted to support the new farmers of the land reform program by various means, including subsidies and price controls. Of course, these were largely wasted or troublesome to enforce, leading to further economic and political strain. Without a productive economy to generate real wealth, the government was left with few choices but to create more paper currency and send it out into circulation as fast as possible.
Without the usual tax revenues from a productive agricultural sector, the government really fired up the money printers to fund its deficits, with hyperinflation becoming clearly pronounced around 2004. To demonstrate the extent of currency debasement which took place, consider this: by 2008, Zimbabwe’s hyperinflation peaked at a rate of 89.7 sextillion percent per month according to the Cato Institute. The situation was so dire that prices were doubling every day.
In response, the Reserve Bank of Zimbabwe issued 100 trillion Zimbabwean dollar notes to reduce the amount of paper that even basic transactions would require. Unsurprisingly, this only exacerbated the problem. Eventually, the government finally abandoned the Zimbabwean dollar in favor of a dollarized system. Since public trust was low, people still opted to use other currencies, and black market rates quickly diverged from the official conversion rates offered by banks.
By 2019, the government had reintroduced a new Zimbabwean dollar, effectively ending the multi-currency system, but inflation problems persisted. Zimbabwe continues grappling with high inflation and the challenges of restoring confidence in its local currency to this day. This is essentially how they came to offer a gold-backed CBDC.
First of all, a key prerequisite to regain trust is to demonstrate sound financial management, which includes both responsible management of fiscal and monetary policy that adheres to a limiting metric. Without budgetary changes paired with productivity gains in the real economy, it is difficult to imagine that the gold would remain in the treasury long enough to be redeemed. This is the key to controlling inflation, after all.
This could in part be achieved by establishing a clear mandate to heavily control the growth in the money supply which corresponds to economic productivity, and is free from political interference. Furthermore, using gold to back the currency would help – though it is not sufficient all alone.
This is where the concept of time comes into play for Zimbabwe’s gold-backed CBDC. If people can freely convert their currency into physical gold, then we can expect that trust will be restored after enough time has passed and the central bank’s prudence is demonstrated with a degree of longevity.
Skeptics, on the other hand, worry that the CBDC is great for press releases, but fails to address the nation’s underlying economic woes. While we can’t expect major changes to take place overnight, only time will tell if Zimbabwe’s gold-backed CBDC will bring about meaningful change for the future of the country.
Perhaps it will be an example to follow for its neighbors also developing CBDCs like Zambia and Mauritius. The other major CBDC already in use is the eNaira in Nigeria. While the eNaira was off to a slow start in terms of adoption, the phasing out of cash and new digital welfare program has really accelerated the process more recently.
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