Kill Central Bank to Fix Inflation in Zimbabwe

This article appeared in The Times on July 13, 2008.

The hallmark of Zimbabwe's economic collapse is hyperinflation.The most recent official inflation figure is for February 2008: awhopping 165000% year-on -year.

But in June, inflation was unofficially about 2.5-million percent ayear. Not surprisingly, the Zimbabwe dollar has lost more than99.9% of its value against the US dollar during the past year.

Zimbabwe's hyperinflation is destroying the economy, pushing more of its inhabitants intopoverty, and forcing millions of Zimbabweans to emigrate. Between 1997 and 2007, cumulativeinflation was nearly 3.8-billion percent, while living standards fell by 38%.

The source of Zimbabwe's hyperinflation is the Reserve Bank of Zimbabwe's money machine. Thegovernment spends, and the RBZ finances the spending by printing money.

The RBZ has no ability in practice to resist the government's demands for cash. Accordingly, theRBZ cannot hope to regain credibility any time soon. To stop hyperinflation, Zimbabwe needs toimmediately adopt a different monetary system.

Central banking is the only system that has ever created hyperinflation and instability inZimbabwe.

Any one of three alternatives can rapidly slash the inflation rate and restore stability and growthto the economy.

The first is "dollarisation" — replacing the discredited Zimbabwe dollar with a foreign currency,such as the US dollar or the rand.

The second is a currency board. Under such a system, the Zimbabwe dollar would be crediblebecause it would be fully backed by a foreign reserve currency and would be freely convertibleinto the reserve currency at a fixed rate on demand.

The third is free banking — allowing commercial banks to issue their own private notes and otherliabilities with minimum government regulation.

Any one of these systems, or a combination of them, could be implemented immediately, withoutpreconditions, and would therefore quickly put an end to hyperinflation and produce stable money.

Financial liberalisation is a vital companion to dollarisation, free banking, or a currency board.

With the elimination of hyperinflation, the rationale for price controls and foreign exchangecontrols no longer exists. Both should be prohibited.

Other forms of "financial repression", including interest rate ceilings, the forced purchase of government bonds, minimum reserve requirements for financial institutions, and the compulsoryallocation of credit to favoured borrowers, should also be prohibited.

This liberalisation would permit the free flow of capital to and from Zimbabwe. It would alsoincrease the return on savings and reduce the cost of capital, removing major impediments toeconomic growth and improved living standards.

Such has been the experience of other countries that have ended financial repression.

In Zimbabwe, the depreciation of assets has been exceeding investment for some time, resultingin capital consumption and the atrophy of the nation's plant and equipment. In addition, thecombination of hyperinflation and price controls has wiped out much of the country's stock ofworking capital.

The quickest way to replenish capital stock is to import capital. To accomplish this, stable moneyand a liberal financial regime are prerequisites.

Prior to the introduction of central banking to then Southern Rhodesia early in the 20th century,the country had a rich monetary experience in which a free banking system and a currency boardsystem performed well.

It is time for Zimbabwe to adopt one of these proven monetary systems and discard its failedexperiment with central banking.

Steve H. Hanke

Steve H. Hanke is a professor of applied economics at Johns Hopkins University in Baltimore and a senior fellow at the Cato Institute.