If it's true that bad money can drive out good, then the reverse can happen too. Witness Zimbabwe, which as recently as July 2008 was experiencing inflation at an annual rate of 231 million percent. This February inflation clocked in at a 3% annual rate, thanks to an experiment in U.S. dollarization that has achieved what price controls never could. There's a broader monetary lesson here.

When the country became independent in 1980, the Zimbabwe dollar was worth about $1.25. Inflation rose steadily by double digits under Robert Mugabe until the late 1990s, by which time his land confiscation from white farmers had crippled food production. To continue funding the government?and its debts?in the face of plummeting tax revenue, the Reserve Bank of Zimbabwe cranked up its printing presses, and inflation rose to triple digits by 2001.

By the end of 2008, consumer prices were nearly doubling from one day to the next. The government in Harare tried price controls, which merely exacerbated the shortages caused by Mugabe's expropriations. And the government periodically redenominated the Zimbabwean dollar, scribbling out zeroes by fiat, to little effect. In January 2009 it introduced the Zimbabwe 100 trillion dollar note, worth about $30.

Reserve Bank Governor Gideon Gono declared then that "the Zimbabwe dollar will not be overtaken by any other currency, formally or otherwise, now or at any point in the future." Except it already had. For years businesses had made many products available only in U.S. dollars or South African rands.

By April 2009 the government had stopped resisting, legalized the use of foreign money, and suspended the Zimbabwe dollar. The move essentially abandoned an independent monetary policy, but Zimbabwe's citizens could suddenly maintain their assets in currencies they could trust. Inflation began to fall to rates consistent with U.S. central bank policy.

The Zimbabwe economy has started to show other signs of life, such as store shelves that are full again. According to the IMF, economic growth hit 5.9% last year and is projected at 4.5% this year, after a decade of contraction. With a stable currency, more citizens can now earn enough to buy what they need, and even save money that might not instantly lose its value.

In nearly all other respects, Zimbabwe's business climate remains a nightmare. Property rights, investor protections and contract enforcement remain negligible, to say nothing of Harare's ongoing political repressions. To compound Mugabe's disastrous brand of "black empowerment," the government is making noises to implement the "Indigenization Act," which would require foreign mining companies to cede 51% of their shares to a sovereign wealth fund.

Trust Uncle Bob to demonstrate that there is much ruin in a government. But Zimbabwe's successful experience with dollarization reminds us again of Milton Friedman's point that inflation is always and everywhere a monetary phenomenon. Sound money?a means of exchange that people trust?is essential to economic growth. Dollarization has given Zimbabweans a chance to eke out a living despite the continuing depredations of their political leaders.

Source: The Wall Street Journal,

Posted by IAMES