Tag: Central banks

Is Zimbabwe Now on the Gold Standard?

Image of “someone in Zimbabwe holding the new ZiG currency” generated by ChatGPT 4o.

The classical gold standard lasted from 1880 until the outbreak of World War I in 1914 disrupted the global financial system. Under the gold standard, countries stood ready to redeem their paper currencies in gold and many business contracts contained “gold clauses” that allowed the receiver of funds to insist on being paid in gold. The countries shaded in yellow in the following figure were on the gold standard at the beginning of 1914.

After World War I, the United States remained on the gold standard but the very high inflation rates during and immediately after the war made it difficult for most European countries to resume redeeming their domestic currencies in gold. The United Kingdom didn’t return to the gold standard until 1925—seven years after the end of the war—at which time several other countries participated with the United Kingdom and the United States in what was called the gold exchange standard. In this system, countries fixed their exchange rates against the U.S. dollar and the British pound and held their international reserves in either pounds or dollars. By fixing the value of their currencies against the dollar and the pound—which were both convertible into gold—the currencies effectively fixed the value of their currencies against gold.  The gold exhange standard ended in 1931 when, as the result of financial problems caused by the Great Depression, the United Kingdom stopped the convertibility of pounds into gold. The United States stopped the convertiblity of dollars into gold in 1933. (We discuss the gold standard in the online appendix to Macroeconomics, Chapter 18 and Economics, Chapter 28, and in Money, Banking, and the Financial System, Chapter 16, Section 16.4).

In 1944, near the end of World War II, several countries meeting at Bretton Woods New Hampshire agreed to fix the exchange rates between their currencies. Under the Bretton Woods system, the United States agreed to convert U.S. dollars into gold at a price of $35 per ounce—but only in dealing with foreign central banks. U.S. citizens continued to be prohibited from redeeming dollars for gold. The central banks of all other members of the system pledged to buy and sell their currencies at fixed rates against the dollar but not to exchange their currencies for gold either domestically or internationally. As can be seen, the Bretton Woods system was not actually a gold standard because no members of the system allowed their currencies to be freely convertible into gold. The difficulty of keeping exchange rates fixed over long periods led to the collapse of the Bretton Woods system in 1971. (We discuss the Bretton Woods system in the places referenced at the end of the last paragraph.)

Although over the decades there have been various proposals to return to the gold standard, it seems unlikely that the United States or other high-income countries will ever do so. Current day advocates of returning to the gold standard often mention the check the gold standard can place on inflation because the size of a country’s money supply is limited by the country’s gold reserves. In the United States and most other high-income countries the central bank attempts to regulate the inflation rate by controlling short-term interest rates. In lower-income countries, central banks are often not able to act independently of the government. That has been the situation in the African country of Zimbabwe, which has frequently experienced hyperinflation—that is, rates of inflation exceeding 50 percent per month. The inflation rate in 2008 reached a staggering 15 billion percent. As a result, most people in Zimbabwe lost faith in Zimbabwean currency and instead used U.S. dollars for most buying and selling.

That most of the currency in circulation in Zimbabwe is U.S. dollars causes two problems: 1) The supply of available U.S. dollars is limited—so much so that some businesses carefully wash dollars to try to prolong their usability; and 2) few U.S. coins are available, making it difficult for businesses to make change for purchases that aren’t priced in even dollar amounts. Some businesses give customers change in the form of candy or other small food items. The government has made several attempts to resume printing Zimbawean dollars but has had trouble getting consumers and businesses to accept them.

In late April, the Zimbabwean tried a different approach, introducing a new currency, the ZiG, which is short for Zimbabwe Gold. The new paper currency is “backed” by the government’s gold supply, which has a value of about $185 million U.S. dollars. We put the word “backed” in quotation marks because the government isn’t backing the ZiG in the way that governments backed their currency during the period of the classical gold standard. Under the gold standard, paper currency was freely convertible into gold, so anyone wishing to exchange currency for gold was able to do so. The ZiG isn’t convertible into gold. The government is backing the currency with gold only in the sense that it pledges not to issue more currency than it has gold. In other words, the government is essentially promising to put a limit on the total value of the ZiG currency it will issue. Zimbabwean governments have made similar promises in the past that they have ended up breaking.

In its first weeks, the ZiG was having trouble finding acceptance among consumers and businesses, despite efforts by the government to require most businesses to accept it. An article in the Financial Times quoted the owner of a grocery store in the capital of Harare as stating that he won’t accept the ZiG because “My business is alive because I stick to the US dollar.” Similarly, the web site of the BBC quoted the owner of a market stall as saying that “Everything, absolutely everything, is still in US dollars.”

As we discuss in Macroeconomics, Chapter 24, the key to the acceptance of any paper currency is that households and firms have confidence that if they accept the paper currency in exchange for goods and services, the currency will not lose much value during the time they hold it. Without this confidence, currency can’t fulfill the key function of serving as a medium of exchange. In Zimbabwe, as a post on the web site of the World Economic Forum puts it: “It remains to be seen whether the new ZiG can gain the confidence of the public and become a stable local currency, which would allow officials to regain control over monetary policy.”

The Surprising Effect of Weight-Loss Drugs on Monetary Policy in Denmark

Novo Nordisk production facility in Denmark (Photo from Bloomberg News via the Wall Street Journal.)

Like most other small European countries, imports and exports are more important in the Danish economy than in the U.S. economy.  In 2022, imports were 59 percent of Danish GDP and exports were 70 percent. In contrast, in 2022 imports were only 16 percent of U.S. GDP and exports were only 12 percent.

The Danish company Novo Nordisk makes the weight-loss prescription injections Ozempic and Wegovy. Because these and related pharmaceuticals are the first to result in significant weight loss among patients, demand for them has been very strong. (Note that some researchers believe that is not yet clear whether long-term use of these drugs might have side effects.) Demand has been so strong that Novo Nordisk’s market cap—the total value of its outstanding shares of stock—is now larger than Denmark’s GDP. According to the Wall Street Journal, Novo Nordisk now has the second largest market cap in Europe, behind only luxury good manufacturer LVMH Moët Hennessy Louis Vuitton

Most of Novo Nordisk’s customers are outside of Denmark, so to buy Ozempic or Wegovy, these customers much exchange their domestic currency—for example, euros, U.S. dollars, pounds, or yen—for Danish kroner. This increase in demand, increases the value of kroner relative to dollars, euros, and other currencies. (We discuss the effects of changes in demand and supply of a currency relative other currencies in Macroeconomics, Chapter 18, Section 18.2, Economics, Chapter 28, Section 28.2, and Essentials of Economics, Chapter 19, Section 19.6.)

Denmark has been a member of the European Union (EU), since the EU’s formation in 1991. But it is one of two EU countries (Sweden is the other) that has retained its own currency rather than using the euro. Because most of Denmark’s trade has traditionally been with other countries in the EU, the Danmarks Nationalbank, Denmark’s central bank, has pegged the value of the krone to the euro. Pegging makes it easier for Danish firms to plan because they know the prices their goods and services will sell for in eurozone countries. In addition, Danish firms that borrow in euros know how much in interest they will be paying in kroner. Finally, if the krone rises in value against other currencies, prices of imported goods and services will increase, raising the Danish inflation rate. (We discuss currency pegs in Macroeconomics, Chapter 18, Section 18.3, and Economics, Chapter 28, Section 28.3.) Inflation is a significant concern in Denmark because, as the following figure shows, the inflation rate reached 10.1 percent in October 2022. Although by July 2023, the inflation rate had decline to 3.1 percent, that rate was still above the Nationalbank’s inflation target of 2 percent.

Source: Statistics Denmark, dst.dk.

To keep the the krone pegged against the euro, the Nationalbank has to reduce the demand for the krone. The key tool that a central bank has to reduce demand for its country’s currency is interest rates. If the Nationalbank keeps interest rates in Denmark below interest rates in eurozone countries, investors will demand fewer kroner in exchange for euros. Accordingly, the Nationalbank as kept its key monetary policy rate below the corresponding rate set by the European Central Bank. In August the ECB’s policy rate was 3.75 percent, whereas the Nationalbank’s corresponding policy rate was 3.35 percent.

It’s unusual even for a small country that its central bank has to take steps to respond to a surge in demand for a single product. But that was the situation of the Danish central bank in 2023.

Sources: Joseph Walker, Dominic Chopping, and Sune Engel Rasmussen Wall Street Journal, August 17, 2023; Matthew Fox, “America’s Favorite Weight Loss Drugs Are Impacting Denmark’s Currency and Interest Rates,” finance.yahoo.com, August 18, 2023; Christian Weinberg, “Novo’s Value Surpasses Denmark GDP After Obesity Drug Boost,” bloomberg.com, August 9, 2023; Tom Fairless, “European Central Bank Raises Rates, Says Pausing Is an Option” Wall Street Journal, July 27, 2023; and “Official Interest Rates,” nationalbanken.dk.