Last week, neither huge bubble in the street market for US dollar banknotes nor its subsequent bursting when the Reserve Bank of Zimbabwe declared that US dollars could no longer buy goods and services in Zimbabwe were unexpected.
This is because this market is not what many people assume, the “real” market that sets the “real” exchange rate between the US dollar and the Zimbabwe dollar. It never has been that market and never will be.
That market is, at present, the interbank market where willing sellers of foreign currency, earned through exports, can sell their retained holdings to those who need to import goods and services. That exchange rate remained remarkably constant throughout the first four days following the announcement of the end of the multi-currency system. The interbank market tells us what an importer is prepared to pay for a US dollar.
The street market, which many wrongly call the parallel market, is something quite different. It tells us what someone is prepared to pay for a US dollar banknote, with no questions asked. The street market is basically fed with remittances sent by Zimbabweans in the Diaspora to their relatives back home through Western Union and similar money transfer agencies.
The buyers have been a very varied group, but all wanting physical US banknotes for their range of reasons. A core group have been the cross-border traders. They cannot get allocations from the banking system so have to buy on the street. They have been joined by people wanting banknotes to feed their debit cards to order stuff on the Internet or send money to relatives outside Zimbabwe. Finally, there were those who wanted to smuggle money out of Zimbabwe, making illegal capital transfers.
In recent months, other hitherto small groups of buyers have expanded rapidly. First, there are those who were forced by some Zimbabwean suppliers to pay in US dollars, the creeping dollarisation of the economy that the RBZ was determined to end when it announced its raft of measures on Monday. This group had possibly become the major buyers and the group that pushed the exchange rate up so high.
Then there were those who reckoned, with inflation driven by the exchange rate, and with reasonable blocks of RTGS dollars or bond notes handy that they could buy US banknotes to pay for goods and services later, in some cases weeks later, and the costs of buying the notes, the gap between buy and sell rates, would be less than the price rises in the interim. Perhaps. But they put pressure on the market.
Finally, there were those who reckoned they could make money through dealing, buying on one day, stockpiling the cash at home and then selling later at a profit. With the rapid rises in rates seen in June there are stories that people were actually borrowing money to engage in this business. In effect, they were manipulating the market and creating self-fulfilling prophecies.
All this extra pressure created what is known as a bubble, when the price of the underlying product, in this case a US dollar banknote, is way above what a rational value assessment would suggest was the real price. Such bubbles are common. One of the earliest and most famous was in Dutch tulip bulbs. Even modern sophisticated economies have seen bubbles in share prices or housing. And when the bubble bursts a lot of people are suddenly a lot poorer, with money actually being destroyed.
In any case, because the street market for foreign banknotes was not a real market setting value, a large bubble could form and, with a suitable jolt, this would burst. Which is what happened this week. And as is usual in bubbles, the selling pressure grows as holders of the overpriced item suddenly have to liquidate to save as much as they can and, in this case, to buy some Zimbabwe dollars to buy things like food. Few Zimbabweans are going to weep over speculators losing money.
If nothing else the bubble and its bursting should have the positive effect of getting that conceptual change through, that the street market was not a currency market, but rather an item market, the item being a foreign banknote, and that the interbank market, which is now dealing in three quarters of Zimbabwe’s export earnings, is the real currency market setting the real value of the Zimbabwe dollar in terms of foreign currency.
The idea that vendors sitting on pavements can set a currency’s value was always a little odd, when you think about it, and as these vendors were being in turn managed by manipulators and speculators there was very little reality to justify the faith in the street value. And those who do want foreign banknotes can now start using the bureaux de change, revitalised by the Reserve Bank to provide a safe and regulated market for
the legitimate users of the old street markets.