Free banking, a radical idea to get around the lack of foreign coins in Zimbabwe

Jun 30, 2011

Resorting to foreign currencies as everyday legal tender brought an end to Zimbabwe's hyperinflation, but what does the country do about the fact that the economy is now subject to the whims of foreign monetary authorities? Until the country has its own currency again, this is a question that cries out for an answer.

David Beckwith writes in a blog post in March, "While dollarization is tied to the ending of hyperinflation, it could also impose a straitjacket on the economy. One solution would be to allow a free banking system in Zimbabwe, where the U.S. dollar remains the reserve currency but banks are allowed to issue their own notes and coins that would be backed by the dollar."

A few weeks ago there was talk of replacing the US dollar as the country's reserve currency with gold reserves, but no one seems to have taken this idea seriously and it appears to have died a natural death.

With no local legal tender, a lot of the functions of a central bank to control the amounts in circulation and its value relative to other currencies obviously no longer exist. This is part of why the Reserve Bank of Zimbabwe is downsizing and laying off a big chunk of its staff.  

Beckwith's suggestion, however, is not so much to do with this larger implication of adopting a foreign currency as legal tender. What he has in mind is the more basic problem of there not being enough small denominations of the foreign currency in use for day to day requirements, an issue whose frustrations all Zimbabweans are keenly familiar with. The lack of US dollar-denominated coins means people making purchases are often given their small change in the form of sweets or vouchers towards their next purchase. Or even more confusingly, the change is given in South African Rand coins or Botswana Pula coins, which are in greater circulation and more widely recognised in Zimbabwe than US coins.

Some months ago there was talk of the central bank buying coins from the US treasury to solve this problem, but nothing came of it.

Beckwith links to another article that explains how 'free banking' would work. George Selgin, the interviewee who defines it says he means "banking without any special government regulations or restrictions. Like free trade, it’s an ideal concept. It doesn’t refer to any specific or actual banking system. My own ideal version of free banking would have no special requirements for note issuance. Private banks would be able to issue their own notes on the same basis as they create demand deposits."

So then, just on the basis of this loose definition we can safely conclude that 'free banking' is an idea that would be extremely unlikely to work in Zimbabwe!     

Trust by Zimbabweans in the country's banking system remains at a very low ebb after many saw their bank deposits and life savings wiped out primarily by hyperinflation, which cannot be blamed on the banks. But the haughty way the banks dealt with their customers in the admittedly first-ever-for-the-country chaotic situation won them no friends. The banks were overwhelmed by the demands of trying to serve their customers in such an environment, and a lot of the public resentment over the hyper-inflationary period was aimed at and remains with the banks.

Then there are the post-hyperinflation scandals which have plagued several of the plethora of new banks that have arisen in the last several years.

So just as confidence in the Zimdollar sunk to an all time low, confidence in the banking system in general in Zimbabwe is too low at present for there to be any trust in a system in which each bank could issue its own currency. Lord have mercy, the free for all that would be!

Selgin's system is based on a system of no banking regulation, while many in Zimbabwe are worried that there is not enough regulation of the banking system at present. This is both because the country does not have its own currency as the instrument of banking/monetary regulation, but also because the central bank is just not adequately resourced. Given the countless dodgy schemes to make a quick dollar that Zimbabwe's economic implosion has spawned, in banking and many other sectors, it is hard to imagine free banking working.

Beckwith also adds the important protective caveat that each issuing bank's 'currency' would have to be backed by US dollar reserves. In theory this should mean that the bank can not just print paper at will, the problem that made the country's inflation balloon out of control in the first, but in practice...   

Nice idea, but not in Zim, not now!

Beckwith's free banking suggestion is an interesting one, but for now Zimbabweans are probably safer and much better off just dealing with the daily frustrations of getting their change in bubblegum and boxes of matches.


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