Answer by Akshat Sinha:
|
What does that mean?
Let’s revisit the basics first..
[Please skip this section if you already know how the monetary system works and what is inflation]
What’s this?
Don’t think too much.. It’s just a normal piece of paper!
Now, what’s this?
A currency note (US dollar), right?
What makes this paper different from the above piece of paper? Can’t you and I print the same fancy designs on any piece of paper and use it as currency? How is this paper worth $1 and the above one isn’t?
The answer to this lies in the simple fact that this note is backed by the government.
Look at the note closely and you will find the statement: This note is a legal tender for all debts, public and private.
Along with it you’ll find the signatures of the Treasurer of the US and Secretary of Treasury.
The government tells you it is worth one dollar and so it is worth one dollar. Nothing else! This note is not backed by anything except the government’s guarantee.
[And this is true for all the currencies of the modern world]
Does that mean everything is in the hands of the government and it can print any amount and any denomination of currency and declare it as money?
Absolutely yes.
Then what gives value to the money? On what basis does the government decide how much currency to print?
[Although I’ve answered this in detail in my answer to What is the mechanism to print currency in the country? How much currency can a country print at a time? I’ll revisit the concept in short here]
The amount of money vis-a-vis the amount of goods and services produced in the economy determines the value of the money.
Didn’t get it?
Let me make it simpler.
Suppose you have got a banana and 6 apples. If you wish to equate bananas with apples then you would say 1 banana is worth 6 apples.
If you get another banana from somewhere, what do you have now? 2 bananas and 6 apples. And, therefore, 1 banana now becomes worth 3 apples.
Moral of the story: if the bananas are increased without increasing the apple, the value of each banana will fall.
Just replace banana with currency and apples with the goods and services in the economy.
If the amount of currency in the economy is increased without the country producing enough goods and services, the value of it’s currency falls. This is called inflation and Zimbabwe experienced the worst form of it.
[The actual answer to the question starts here]
A little bit of inflation is acceptable, or rather desirable for any economy as it boosts growth. Most countries try to maintain their inflation rate at around 2%. But Zimbabwe is facing a hyper-hyper-hyper-hyper-inflation.. An inflation of 500,000,000,000%..!!!!!
How did it come to this?
It didn’t happen in a day obviously. It all started in the 1990s when presidentRobert Mugabe instituted land reforms intended to redistribute land from white landowners to black farmers to correct the ‘injustices of colonialism’. However, this turned out to be a disastrous move and started off a chain reaction. Read on to know how…
1) Many of the black farmers had no experience or training in farming. Food production started dropping sharply. Price of food began to rise. Inflation. Government had to print more money to provide subsidies to the poor for food. Further inflation.
2) The USA, the European Union and the IMF imposed sanctions upon Zimbabwe for snatching away land from the whites. Zimbabweans working abroad lost their jobs and Zimbabwean businessmen investing abroad forced to roll back their investments. Unemployment in the country increases. Government prints more money to support the unemployed population. More inflation.
3) The inexperienced farmers who lost their crops failed to repay their loans to the banks they had borrowed from. Increasing bad debts caused a collapse of the banking sector. The government had to intervene and try resurrect the banks. More money printed yet again.
By this time inflation had already reached uncontrollable levels. It had become self-perpetuating. You need more money to buy things, but the more you print it the more it loses its value. A downward spiral! The government started printing notes of higher denominations (upwards of a million Zimbabwean dollars).
By 2008, inflation had already crossed the 1 million% mark. The price of each commodity was doubling itself in just a matter of a couple of days. An egg costed 2000 bucks on a day, it costed 4000 bucks 2 days later.
When such a thing happens, people lose faith in the currency. They are not sure whether it would be worthy of anything even the next day. They go on a buying spree. They want to hoard essential items for the future since prices are sky-rocketing. This increases demand for goods. And as we know, as demand rises, prices rise!! Complete disaster.
People had to carry bagful of money to buy a loaf of bread. A cup of coffee costed trillions of dollar!
Instead of printing currencies of higher denominations, the government now decided to change the currency. The new currency (known as the 2nd Zimbabwean Dollar) had a value 10,000,000,000 (10 billion) times the earlier Zimbabwean Dollar.
in the late 90’s Zimbabwe also took part in the 2nd Congo War which proved to be another burden on its finances
If you have grasped the concept, you would be able to guess that this step won’t change things for the better in any significant way. It would only reduce the number of notes that a person would have to carry to buy a thing. Yet the government took such a step for no less than 3 times.
In 2009, a helpless Zimbabwe started allowing foreign currencies to be used within the economy. It maintained an exchange rate and allowed citizens to convert their local currency to US dollars. The exchange rate was in billions i.e. for billions of local currency, you could get a few dollars.
What’s making news now is a further drop in the value of the local currency i.e. the exchange rate for a local ZD vis-a-vis the USD has increased again, along with the announcement that the local currency would be completely discarded by September 2015.
Quoting the The Guardian:
Zimbabweans will start exchanging “quadrillions” of local dollars for a few US dollars next week as President Robert Mugabe’s government discards its virtually worthless national currency.
Zimbabweans have until September to turn in their old banknotes, which some people sell as souvenirs to tourists.
Bank accounts with balances of up to 175 quadrillion Zimbabwean dollars will be paid $5. Those with balances above 175 quadrillion dollars will be paid at an exchange rate of $1 for 35 quadrillion Zimbabwean dollars.
That leaves one option: “much more inflation,” he said. “Because this government is always going to be printing its way out of its current difficulty.”
Correction: May 5, 2006
A chart on Tuesday with an article about Zimbabwe’s high inflation rate misstated the reasons for its sharp rise and fall during 2004. The rise was caused by a flight of foreign capital, shortages and a steep increase in the money supply, not by the government’s seizure of commercial farms. The fall was caused by a rise in interest rates and an economic slowdown, not by price controls.
My prayers are with the Zimbabweans.
"Unique Facts" a blog by Akshat 