The Sunday News
Dr Bongani Ngwenya
Preamble:
WHEN the Government introduced bond notes on 28 November 2016 the monetary authority, that is the Central Bank, informed the nation that the surrogate currency was meant to facilitate the planned five percent export incentive bonus scheme and help curb the illegal externalisation and leakages of the US dollar from the economy.
This was done in a bid to encourage companies to export their products in order to earn the country more foreign currency.
Ironically, the bond notes were introduced at the time the country was beginning to experience serious cash shortages.
The introduction of the surrogate currency was received with mixed reactions; with some convinced that the liquidity crisis was going to be alleviated, while others dismissed the surrogate currency as a fallacy.
Worth noting at the time of the introduction of the bond notes was the persistent negative inflation experience that the economy was going through, which had started from the last quarter of 2014, closing that year at -0,21 percent, and continued throughout 2015 at an average monthly rate of -2,4 percent.
This negative inflation spiral continued into 2016 and marginally decreased to -1,57 percent until the introduction of the bond notes in November 2016. This phenomenon effectively turned the country’s economy into deflation as the liquidity problem and unemployment continued rising. The reality is that had the deflation continued it would have caused another severe economic meltdown of its own kind.
The dark side of deflation:
The simple understanding of deflation is that of an experience of the overall price levels decreasing so that inflation rate becomes negative. It is the opposite of the inflation. The question is, doesn’t deflation make us better off because things are cheaper?
One might think that a general decrease in prices is a good thing because it gives consumers greater purchasing power. To some degree, moderate drops in prices of certain products, such as food or energy, do have some positive effect on consumer spending.
A general, persistent fall in prices, however, can have severe negative effects on growth and economic stability. Prices may be falling, but the amount of money we have to spend is also likely to be falling. When there are falling prices, this often encourages people to delay purchases because they will be cheaper in the future.
In particular, it can discourage consumers from buying luxury goods or non-essential items, e.g. flat screen TVs because consumers could save money by waiting for the luxury goods to be cheaper. Therefore, periods of deflation often lead to lower consumer spending and lower economic growth.
However, this in turn, creates more deflationary pressure in the economy. Certainly, this kind of fall in consumer spending was a feature of the Zimbabwe experience of deflation over the period 2014-2016 of falling wages and increasing unemployment.
The Zimbabwe’s deflation experience was associated with economic recession and not compatible with economic growth, and also caused by a reduction in money supply (liquidity crunch) or reduction in credit availability were basically the reasons for the deflation in the economy.
As the economy continued to be affected by the reduction in money supply, because of the inability to control the supply of the multi-currencies, consumer spending did not only fall in consumption of luxury goods, but also in consumption of essentials and basic goods as the cash crisis continued to bite.
The deflation was also a result of reduced investment spending by Government (failure to stimulate aggregate demand) and individuals leading to a problem of increased unemployment due to slack in demand. Naturally deflation occurs in and after periods of economic crisis such as the recession that culminated into the hyperinflation experience of 2008. When an economy experiences a severe recession or depression, economic output slows as demand for consumption and investment drop.
This leads to an overall decline in asset prices as producers are forced to liquidate inventories that people no longer want to buy following a fall in aggregate demand. Consumers and investors alike begin holding onto liquid money reserves to cushion against further financial loss.
As more money is saved, less money is spent, further decreasing aggregate demand. At this point, people’s expectations about future inflation are lowered, and they begin to hoard money. Why would you spend a dollar today when the expectation is that it could buy effectively more stuff tomorrow? And why spend tomorrow when things may be even cheaper in a week’s time? As production slows down to accommodate the lower demand, companies reduce their workforce, increasing unemployment.
These unemployed individuals may have a hard time finding new work during a recession and will likely deplete their savings to make ends meet, eventually defaulting on various debt obligations such as mortgages, car loans, student loans and credit cards.
Despite the many serious costs of deflation, the right kind of deflation could be beneficial to the economy. The right kind of deflation involves lower prices through increased productivity and better technology resulting from increased efficiency and lower costs of production.
None of all these were the cause of the deflation experience in our economy over the period 2014-2016. The argument is, when the surrogate currency was introduced in November 2016, the negative trend and direction of the inflation changed to positive inflation trends that have continued from that time to date.
In their effort to keep the overall price levels stable and avoiding situations of severe deflation or inflation, central banks may infuse a higher money supply into the economy to counter-balance the deflationary impact. A little bit of inflation is good for economic growth, that is, around two to three percent a year. Since the introduction of the bonds notes the highest inflation experience has been 3,52 percent in January this year, which had increased from 3,46 percent in December 2017 and 2,97 percent in November 2017.
This significant increase in inflation during the festive season was caused by the unscrupulous basic commodities retailers who sought to maximise their profits over the festive season. While it may be true that there were other factors that caused the reversal of the negative prices during the period in review, the million dollar question is, was it by default or by design that the introduction of the surrogate currency tamed the deflationary phenomenon in the economy.
To a certain extent the introduction of the surrogate currency could be attributable to this notable positive effect on the economy, most likely by default and certainly not by design. In conclusion, it is a pity that the surrogate currency, however, has failed to solve the cash crisis in general.
The argument is that with the right economic fundamentals on the ground, the introduction of a real currency would have turned around the economic misfortunes for the better. That’s food for thought.
Dr Bongani Ngwenya, currently based at the University of KwaZulu-Natal as a Post-doctoral Research Fellow. He can be contacted on [email protected]
