Money, Zimbabwe and the Credit Crisis

And worth nothing...

Cheque-books used to be part of the normal flim-flam one would carry around. Very few places accept cheques these days and those that do want some serious ID and confirmation that there are funds supporting your signature.

A cheque really is a license to print your own money. It’s a printing press in your pocket. You could write out hundreds of cheques, as long as people are able to cash them.

The credit bonds issued by companies are a bit like post-dated cheques. Give me the goods today and I'll pay a higher price if I can postdate my cheque to next year. So, you write out a cheque for R100 dated one year ahead, and take goods worth R80. That person can hang on to the cheque, but what happens if they also want the money now? Well, if other people are confident in that cheque being paid, then he can sell it on. Maybe he takes R85 for it. The next person sells it for R90. And so on until someone eventually decides to keep it and wait for redemption.

And that is an alternative currency. You "invented" the money when you signed the cheque. But it is still representative of real value.

The act of creating that cheque, though, does not create money in the bank to honour that cheque. You know there is a limit to how many cheques you can write. If you're confident that you'll make money to cover your post-dated cheques, then you can use them like credit. But you have to know what is being created to cover those cheques.

Where Zimbabwe went wrong is in assuming that the confidence in cheques is automatic, not hard won. They assumed that the money itself has value; that printed cash carries an absolute value.

The Zimbabwean government took seriously the claim by some left-leaning economists that the fractional reserve system, by which banks act on behalf of the central bank and lend out more money than they have as deposits, means that banks arbitrarily create cash on behalf of the rich. Their idea was to nationalise money printing and then print lots and give it to the poor instead, and themselves (for the effort).

Which is precisely like writing out cheques but having no intention of putting any value under those cheques.

Where does money come from?

Money comes from the value of people; from their effort and ingenuity and hard work and from the perception that this will continue. Money follows the people, not the people the money. Value is created, then money is printed, then the value is taxed via the money. Only when this tax is in hand, can the government spend it on their promises.

If you reverse this process, by printing money in the hope that this will create value, you get Zimbabwe.

Money, bonds, cheques, derivatives, insurance policies ... they’re all promises about value. If we believe those promises, then we will use these instruments. When confidence collapses, then it is as if no-one believes anything you say. You could put the biggest numbers you can think of on your cheques, and no-one will sell you a glass of water.

Zimbabwe has gotten to that point. They are abandoning their currency. One trillion Zimbabwe dollar notes buy nothing at all, and there is little to buy.

Zimbabwe’s currency collapsed through greed and corruption. Development economists have been hoping for a peaceful transition to majority-rule so that there could be an orderly conversion to either US dollars or SA rand.

The political bankruptcy of SADC leaders has now resulted in a disorderly conversion to an alternative currency. As Zimbabweans shift decisively towards rand, dollars or pula, they will create inflationary pressure in Botswana and South Africa.

In the wake of the credit crisis, that is the last thing our Reserve Bank should have to deal with.