(THE HERALD) End distortions on forex market
End distortions on forex marketEDITOR — Something is very wrong with the way the Zimbabwe dollar is pegged against other currencies whether on the parallel or official markets. The value of a country’s currency should be determined by what the currency purchases, such as, bread in relation to other national currencies.
For instance, one US dollar buys a loaf of bread in America. In Zimbabwe, a loaf of bread costs $7 000. Therefore, ZW$7 000 should be equivalent to one US dollar. A currency should be linked to the purchase of a staple product.
The parallel market rate of $25 000 to the US dollar is a great distortion while the official rate of $250 is unrealistic. The official rate should be pegged at the bread price of $7 000.
The same should apply with other regional currencies, such as the rand and the pula. As production of staple foods increases, the cost will come down, boosting the value of our currency.
It follows therefore that the value of the currency is determined by production.
The tendency to print money to meet the increase of the cost of products and services which is known as the cost of living, distorts the link between production of goods and the value of the country’s currency.
Therefore, the increase in production determines the growth rate of the economy which in turn increases the value of the currency.
The budget deficit comes down since more tax revenue is collected to meet Government expenditure without resorting to printing money or borrowing.
If the value of the currency is maintained by increase in production, workers would not resort to strikes if the purchasing power of their wages does not change. In the end, inflation will be kept low.
Unfortunately, the profits from these parallel market activities are not being ploughed into increased production of goods for export or for domestic consumption like maize and wheat.
Theirs is just a sellers market.
The major problem we are facing is that of low production of staple products for our domestic requirements.
There is too much consumption of foreign products which are not required to boost domestic production.
A lot of money is being used on the parallel market to fuel this unrestricted consumption of luxury goods at the expense of domestic production of staple goods and if possible, any surplus for export.
Unless the ordinary person can understand these facts of economics, the future of our children is bleak indeed.
Albert Nhamoyebonde.
Harare.
Labels: FOREX, INFLATION, ZIMBABWE
posted by MrK @ 7:55 PM
3 Comments:
I am not a trained economist by any means, and while I sympathize with the desire of the author to see fair treatment for the ZW$ in foreign exchange, I disagree with some of the premises in this article.
The US Bureau of Labor Statistics (www.bls.gov) maintains rather extensive, searchable databases on commodity prices and variation throughout the country, including breakdowns by region and population density. The April 2007 national urban average price for a one pound (453.6 grams) loaf of white bread was US$1.201, in Northeast urban areas US$1.479, in Midwestern urban areas US$1.110, in Southern urban areas US$1.087, and in the Western urban areas US$1.293. In other words, the currency equivalent of a loaf of bread varies by almost 40% within the US at any given time, and even more so over the course of a year, due to regional and seasonal variation in the cost of materials, energy, transportation, commercial real estate, competition, wages, taxes, and so on. This is why the BLS measures inflation by use of the Consumer Price Index, which combines the prices of hundreds of goods and services together using weighted averages based on surveys of what consumers actually buy with their money and how much they pay. The December 2006 CPI gives changes in the price of a loaf of bread credit for 0.246% of the total inflation measure (actual spending on bread loaves is only 0.221% of total consumer spending, so they do agree it is a relatively important price).
When one currency is exchanged for another, there is indeed an inherent assumption that the buying power of either amount of cash will be equivalent (minus the cost of the transaction itself). The stubborn and delusional insistence of the fixed official rate of US$1:ZW$250 (or US$28 for that ZW$7000 loaf of bread) does indeed result in no rational actor wanting to make such an exchange, thereby ensuring a virtual monopoly on currency exchange for the parallel market. Still the question remains, why is the rate at 1:25000 instead of 1:7000 (accepting for the moment that this is the actual "equivalent" rate)?
The author identifies several causes of price inflation in the article, such as consumption of foreign products, which must be purchased using foreign currency at some point in the supply chain. The unrestrained borrowing and printing of currency by the central bank to meet the needs of government spending, combined with budget deficits and declining tax revenues is also cited. A lack of investment in domestic production by the private sector is likewise alluded to. Inflation is not limited to the cost of bread, and may in fact be more severe for other staple items like water, energy, housing, transport, and clothing, since after all man does not live by bread alone.
A unit of currency is also a commodity, however one whose trading value is more akin to a "wheat future" than to a loaf of bread sold to a consumer. The US central bank is unlikely to be persuaded to print extra dollars simply because Zimbabweans would like to use them to purchase imported goods, the supply is carefully limited in order to control inflation. The parallel market must strike a deal to persuade a person with limited US$ to exchange them for an amount of ZW$. If the person is, for example, a tourist wishing to buy a loaf of bread that day from a market in Harare, then a rate of 1:7000 might be persuasive. However, if that person is a professional currency trader, then they are logically going to wonder if that ZW$7000 is going to buy their US$1 back tomorrow, or next month, or next year (preferably with something left over after transaction costs).
So, the reason the parallel rate is 1:25000 is, in essense, that people holding US$ (or rand or pula, etc.) believe that ZW$ will continue to decline in value over the near term, their own bellies are already full of bread, and by the time they actually want to buy something from Zimbabwe it will cost more than three times as much currency as it does now.
There is an upside available in all this, if Zimbabwe can actually export a significant amount of goods, then suddenly the parallel market exchange rate looks very attractive indeed. The National Export Strategy contains only a single paragraph on exchange rates:
"23. EXCHANGE RATE MANAGEMENT
The main focus of the exchange rate system is to address the issue of exporter viability. In order for the country to benefit from international trade, there is need to ensure viability in the export sectors of the economy. Exporters should be able to recoup the costs of production and realize a return on capital to remain competitive in the international markets. The long-term objective is to have a unified exchange rate."
Most nations seeking to maximize export income desire relatively "weak" currencies. China is widely accused of using its central bank to maintain an artificially low valuation of its currency on international markets, thereby maximizing the price competitiveness of its exports, discouraging imports, and increasing the profitability of products sold overseas rather than domestically. If you could sell your loaf of bread to an American, would you rather get ZW$250, ZW$7000, or ZW$25000 in return?
Unless the elite individuals in control of the central bank can understand these facts of economics, the future is bleak indeed.
The real question should be - what lies at the heart of these distortions?
" It follows therefore that the value of the currency is determined by production. "
That, I agree with.
" If the value of the currency is maintained by increase in production, workers would not resort to strikes if the purchasing power of their wages does not change. In the end, inflation will be kept low. "
Absolutely. Zimbabwe, Zambia, all of Africa need increases in production. They need to benefit from their own natural resources, and they need to get their arable land producing agricultural products instead of having 80% or more not under cultivation.
On the currency though. The currency (it's exchange rate) is determined by the following:
- the amount of goods and services produced in a country
- the amount of money (both physical like banknotes and coins or bonds, and theoretical, like credit) in circulation
Inflation is caused by an imbalance between the goods produced (supply), and the demand for those goods (demand), as expressed
So it is interesting to look at what the Zimbabwean government is at the basis of inflation in Zimbabwe.
Zimbabwean economy (2002):
GDP (USD) $8 billion
Exports -35% (since 2002)
agriculture (tobacco, cotton, sugarcane) 17.4%
industry 23.8%
services 58.5%
(total: 99.7%)
(source: Mbendi, http://www.mbendi.co.za/land/af/zi/p0005.htm#20 )
The economy is dependent on agricultural products such as tobacco, cotton and sugarcane and in 2002 agriculture accounted for 17.4% of GDP. GDP totaled US$8 billion in 2002 and exports have dropped by 35% since 2000.
Manufacturing is another important sector in the Zimbabwean economy and efforts are focused on textile and sugar production. Mining, primarily gold mining is also significant. Industry and services accounted for 23.8% and 58.8% of GDP respectively in 2002. The country’s tourism industry has suffered as a result of the economic and political conditions.
From the 2007 budget speech:
(Source: http://www.mofed.gov.zw/html/budget_stmt.shtm)
5. The central message from these consultations evolved
around the following challenges among others:
• Ever-increasing prices;
• Continued distortions in the pricing of key commodities
and utilities;
• Unemployment and rising poverty levels;
• Foreign exchange shortages;
• Low industrial capacity utilisation;
• Underutilised allocated land;
• Inadequate measures to deal with rising levels of
corruption in both the public and private sectors;
• Deteriorating provision of basic public services;
• Poor maintenance of infrastructure;
• Inconsistent policy pronouncements;
• Declining clarity over the role and accountability of the
key institutions of Government;
• Perceptions of lack of commitment to effectively deal with
the challenges facing the economy; and
• Increasing indiscipline.
(Actual inflation (2007 budget speech) )
Inflation Developments
63. Mr Speaker Sir, inflation remains one of the major
challenges facing our economy. Year on year inflation rose
from 613.2% in January 2006, to reach a peak of 1 204.6%
in August. In September it however declined to 1 023.3%,
before the rise to 1 070.2% in October 2006.
65. Some of the major drivers of inflation remain:
• The impact of public sector borrowing requirements,
for budgetary financing;
• Quasi-fiscal activities funded through the Reserve
Bank;
• High money supply growth;
• Corruption;
• Increase in parallel market activities;
• Foreign exchange shortages;
• Inflation expectations;
• Price distortions and behaviour of economic agents; and
• Structural supply bottlenecks.
I would really like to know the biggest single cause of inflation in Zimbabwe.
"I would really like to know the biggest single cause of inflation in Zimbabwe."
Agreed, and I have so far not been able to find a definitive source on the subject. COMESA is commissioning a study which will hopefully help to answer the question, but the results are not due until mid-August.
http://www.comesa.int/tenders/SOURCES%20OF%20INFLATION
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