The Big Reverse

by Meera Sanyal

  In early 1990, the zaire traded at about 300 to the US dollar, but it rapidly depreciated when the Americans withdrew support after the end of the Cold War. Hyperinflation accelerated and vast segments of the economy shut down. With the price of food beyond the reach of most of the population, there was a migration from urban areas back into the ‘bush’, where food was still available. In July 1991, Zaire Army soldiers mutinied because they had not been paid. In the weeks of looting and violence that followed, several shops and industrial establishments were destroyed. The rioting also led to the evacuation of virtually all foreign workers, including most of the country’s university professors, teaching staff at hospitals, and geologists in the vital mining industry.

  Rioting erupted again in February 1992, when soldiers discovered that the new five-million-zaire banknotes used to pay them were impossible to spend. They seized control of the parliament building and held several hundred lawmakers hostage, demanding that they order local merchants to accept the new banknotes. Hundreds, including the French ambassador, were killed.

  The 1993 Demonetization

  In an effort to prop up the economy, on 22 October 1993, Mobutu demonetized the old zaire, replacing it with the New Zaire (NZ) at a rate of NZ 1= Z3 million, with an initial parity of NZ 3 per US$ 1.

  Prof. Hughes Leclercq reports that the demonetization backfired, with ‘…soldiers refusing to accept the new notes in salary payments leading to renewed rioting. The new currency depreciated sharply, sending prices into a further sharp upward spiral. By December 1993, the NZ had depreciated to 102 per US$ 1, and monthly inflation had surged to 250 per cent, yielding cumulative price increases that exceeded 3,300 per cent during the three-month period ending in January 1994.’

  In his article in The New York Times, Kenneth Noble quotes a number of people who summed up the situation. Peter Rosenblum, a senior lawyer with the Human Rights Law Group, said, ‘Zairians are in terror of the new bills. They know that each time a new bill is introduced, the old bills become virtually worthless, and inflation takes another galactic leap.’

  Etienne Tshisekedi, Zaire’s main opposition leader at the time, called the demonetization a ‘criminal swindle and pure piracy.’ In Washington, George Moose, the Assistant Secretary for African Affairs, said at a Congressional hearing that the Mobutu government’s currency manipulations were ‘…wrong-headed and could incite a new round of pillaging and military unrest.’

  These words were to prove prophetic. As the economy collapsed, ethnic violence increased and in May 1997, Laurent Kabila, who had led a popular rebellion against Mobutu, seized power, declared himself President, and renamed Zaire as the Democratic Republic of the Congo. Mobutu fled into exile in Morocco and died four months later.

  North Korea19

  Korea, which had been annexed by Japan in 1910, was liberated in 1945 at the end of World War II. The country was divided into two zones – the North occupied by Soviet forces and the South by the Americans. As negotiations for unification failed, two separate governments were formed. The Democratic People’s Republic of Korea was established in the north on 9 September 1948, with Kim Il-sung as Premier.

  Until the 1960s, North Korea’s economic growth was higher than South Korea’s, and North Korean per capita GDP was equal to that of its southern neighbour until as late as 1976. The North Korean Won was pegged to the US$ at the rate of Won 2.16=US$ 1. The rate was reportedly set since 16 February (i.e., 2.16) was the Premier’s son Kim Jong-il’s birthday! By the 1980s, the economy had begun to stagnate and almost completely collapsed when aid from the Soviet Union stopped in 1991. In 1994, Kim Il-sung died of a heart attack and his son Kim Jong-il took over.

  In July and August 1995, floods described as being ‘of biblical proportions’ ravaged the country, causing not only the destruction of crop lands and harvests, but also the loss of emergency grain reserves, as these were stored underground. According to the United Nations, the floods of 1995 destroyed around 1.5 million tons of grain reserves. There were further major floods in 1996, and a drought in 1997. In the resultant famine (known as the March of Suffering), approximately 3.5 million North Koreans died from hunger and starvation, out of a total population of 22 million.

  After the famine, informal private markets sprung up across the country enabling an increasing number of North Koreans to feed themselves and earn a basic living by trading. The UN estimated that about half the calories consumed in North Korea in 2009 came from food purchased at private markets.

  On 30 November 2009, Kim Jong-il announced a demonetization of the Won, replacing the 1,000 notes with 10 notes. The announcement was made to foreign embassies and later carried via a wire-based radio service only available within North Korea. The government announced that an individual could exchange only up to 1,00,000 Won (an amount that would buy a 50 kg sack of rice, or less than $40, at black-market exchange rates), and any amount above that threshold would be, in effect, worthless. In response to the citizens’ immediate and widespread anger, those limits were subsequently raised to 1,50,000 Won and later to 5,00,000 Won.

  Furthermore, while the old notes ceased to be legal tender on 30 November 2009, the new Won notes were not distributed until 7 December 2009, which meant that North Koreans could not exchange any money for goods or services until that date. Most shops, restaurants and transport services shut down for the week.

  The move sparked a nationwide panic. To quell civil unrest, army bases were put on standby, and authorities threatened ‘merciless punishment’ for any person who violated the rules of the currency change.

  North Korean authorities took a second step against the markets by banning use of foreign currencies on 28 December 2009. This measure was designed to further strengthen political control over ‘black markets’ by criminalizing the unauthorized possession of foreign currency.

  The third step was the most drastic. North Korean authorities shut down general markets across the country in order to transition them to farmers’ markets. This shutdown exacerbated both inflation and the short supply of goods inside North Korea, contributing to the spread of famine conditions in various parts of the country, and resulting in starvation deaths.

  Explaining the rationale for the demonetization, Bill Powell wrote in Time magazine, ‘The government allowed black markets to proliferate this decade out of desperation, but they had grown to the point where the leadership may have begun to feel threatened. Small traders and black markets existed outside of government control, and, by definition, at some point the regime was not going to tolerate that… The breakaway, snowballing market was a threat to the regime… Under the new plan, however, the small savers who run those private markets will be stripped of much of the cash they need to run their businesses.’

  The demonetization was a failure, and the Won plummeted 96 per cent against the US dollar in the ensuing days. Lifetime household savings and the working capital of many private trader entrepreneurs were completely destroyed.

  Scott Snyder of the Asia Foundation commenting on the outcome said, ‘As social opposition to these moves began to manifest itself, the government was forced to backtrack, offering compensatory wage increases, sometimes paying workers at the old wage rates in the new currency, amounting to a 100-fold increase in money income. The result was a complete disintegration of the market, as traders, intimidated by the changing rules of the game, withheld supply, reportedly forcing some citizens to resort to barter…’

  The reopening of the markets was accompanied by a rare public apology. In a meeting with government officials and local village leaders, Premier Kim Jong-il is reported to have stated ‘…regarding the currency reform, I sincerely apologize as we pushed ahead with it without a sufficient preparation so that it caused a big pain to the people…’ and that the government ‘…will do its best to stabilize people’s lives.’

  In January 2010, the director of the Planning and Finance Department of North Korea’s ruling Workers’ Party, Pak Nam-gi, allegedly re
sponsible for the demonetization, was dismissed from his post, and was executed by a firing squad in March 2010. It was widely believed that he was made the scapegoat for the botched demonetization.

  In December 2011, Kim Jong-il died and was succeeded by his son, Kim Jong-un.

  Successful Demonetizations

  The examples above reinforce the poor outcomes from demonetization, especially when undertaken with an objective to eliminate corruption and black money. This may raise the question whether demonetizations are ever successful. And the answer is, yes!

  Demonetizations have been used most successfully to tackle hyperinflation,20 and when the value of the original currency has been so debased that it becomes worthless as a medium of exchange.

  Though the causes and triggers for hyperinflation are complex, economists believe that it is either caused by a lack of confidence – that the government or the central bank will remain solvent, or by a spiralling downward cycle of monetary expansion. In both cases, it is initially caused by large government deficits financed by reckless money creation. As people realize that their banknotes are able to purchase fewer and fewer ‘real goods’, there is a frenzy to spend them before there is a further loss of purchasing power, which further accentuates the downward spiral of loss of value.

  Such hyperinflationary episodes are often dealt with by a demonetization, redenomination or revaluation of currency, and by pegging the paper value of the new currency to a stable unit of value, e.g., gold or, in more recent times, the US dollar. However, faith in the new replacement currency rarely lasts, unless accompanied by strong fiscal and monetary discipline, and often a change in rulers or regime as well.

  The following are some of the more famous instances of hyperinflation dealt with successfully by demonetization.

  Roman Empire in the Third Century21

  As the Roman Empire extended its geographical reach, successive emperors sought to finance their military expenditures, initially by a series of increasingly unjust taxes, and, when this was no longer sufficient, by ‘debasing’ the currency.

  The silver denarius, introduced by Emperor Augustus at the end of the first century BCE, which was 95 per cent silver, had continued for almost two centuries as the medium of exchange across the Roman Empire. By the third century CE, the Roman treasury was bankrupt and successive emperors kept reducing the percentage of silver in the denarius, till it was nothing more than a bronze coin dipped in silver. Prices during this period rose by nearly 1,000 per cent in many parts of the Roman Empire.

  Emperor Diocletian finally abandoned the denarius in 294 CE. Constantine, the first Christian Roman emperor, tried to address this situation by issuing a new gold coin in 312 CE called the solidus – solid gold – which was struck 72 coins to a pound of gold. Over time, the government began collecting taxes and paying soldiers in gold, and thus the gold standard was strengthened and became the ‘real’ money of the Roman Empire.

  Emperor Constantine’s demonetization succeeded. Sadly, however, this situation did not last. While soldiers and bureaucrats were paid in gold and thus protected against the effects of inflation, the ordinary citizen had to struggle with an increasingly unjust and corrupt tax system to finance the profligacy of successive emperors. By early fifth century, the Roman Empire was in terminal decline. In the opinion of the Christian priest Salvian of Marseille, the Roman state was in a state of collapse because it deserved collapse; because it denied the first premise of good government, which was justice to the people.

  A prophetic and cautionary message for all governments!

  China During the Yuan Dynasty and from 1948–4922

  Paper currency was first introduced in China during the Tang dynasty (618–907 CE) as privately produced promissory notes, which were exchanged by merchants across the Silk Road.

  However, ‘official’ paper currency was only introduced by the Song dynasty (960–1279 CE). The first government-backed notes called Jiaozi were produced in 1024. Each issue of paper notes put into circulation was backed by the government, and could be exchanged for standard copper coins. The currency was popular especially among merchants and tradesmen as the paper notes were more convenient and much lighter to carry than strings of copper coins. By the twelfth century, paper notes were the main form of currency in China. Thanks to strict controls on the issuance of such currency, these paper notes maintained their value. Counterfeiting of paper currency was punishable by death.

  When the Mongols took over China and established the Yuan dynasty, they issued their own paper currency, called Chao. Though it was initially backed by precious metal, the Khans soon resorted to excessive printing of the Chao, to finance military expeditions. As a result, no longer backed by gold or silver, the Chao depreciated in value by almost 1,000 per cent leading to runaway inflation and ultimately collapse of the dynasty in 1368.

  The Ming dynasty that followed suspended the printing of paper money for much of their reign, using silver instead, which was brought to China by Spanish traders from Peru and Mexico. China did not revert to paper money for another 600 years until 1890, when the Qing dynasty began producing the Yuan.

  During 1948–49, China once again experienced extreme inflation, peaking in April 1949 at 5,070 per cent. The Yuan was replaced first by a gold yuan and then a silver yuan but with little success. The currency was finally stabilized by the newly installed Communist government, who issued a new currency – the Renminbi (literally, the people’s currency) in December 1948. For several years the Renminbi remained pegged to the US dollar, with tight monetary control, and, as a consequence, remained stable.

  France During the French Revolution23

  The French Revolution caused severe inflation and tax revenues declined precipitously. The problem was compounded as aristocrats had fled with vast quantities of gold and silver. The National Assembly, therefore, issued a new paper currency in 1789, called Assignat, backed by the value of confiscated properties from the Catholic Church.

  It used these to pay the interest and principal falling due on the enormous debt accumulated by the former monarch, and also on fresh debt incurred for the public work projects they had commenced in Paris, and on bread subsidies.

  However, people had little faith in this new paper currency. Compounded by an unwillingness of the masses to pay any taxes, growing civil unrest, rising prices and food shortages, several issues of Assignats were made with the result that they soon lost almost all their value. It is also believed that these were counterfeited both locally and by the British, Belgian and Swiss, exacerbating the problem.

  In February 1796, production of Assignats was officially halted. At the time, it is said that a 1,000 Assignat note could barely purchase a cabbage in the market at Strasbourg! A general demonetization of the Assignats (and the short-lived Mandats that followed) occurred in February 1797.

  When Napoleon took over as First Consul, the Germinal Law was passed introducing the new Franc. This law established the face value of the new French Franc: the coins of quarter-, half-, three-quarter-, one-, two- and five francs were minted in silver. The twenty- and forty- franc pieces were to be in gold. The weight of metal and alloy were fixed, and the unit of account corresponded identically to the actual value of the money.

  Napoleon is said to have requisitioned every silver and gold coin found during his invasion of Italy and countless treasures of the Vatican to back the new currency. He insisted that from thenceforth, soldiers, contractors and merchants would be paid only in gold, or its equivalent. Under him, France conquered most of the Continent while on the gold standard, and the Germinal Franc was to remain stable until 1914.

  Germany During the Weimar Republic24

  Emperor Wilhelm II and the German Parliament decided to fund their World War I efforts entirely by debt. When Germany lost the War, the new Weimar Republic had to not only service this debt, but also pay the war reparations. Since the reparations had to be paid in gold or hard currency, the Weimar Republic resorted to mass
printing of Marks, with which they then purchased hard currency to pay the reparations.

  This resulted in a complete breakdown in the value of the Mark and galloping hyperinflation. In the first half of 1922, 1 US dollar was worth 320 marks; by November 1923 it was worth 4.2 trillion marks.25

  The law and order situation deteriorated rapidly across the country. The galloping hyperinflation naturally placed great pressure on the state. On 9 November 1923, Adolf Hitler, leader of the Nazi party, attempted to seize power through the infamous Beer Hall Putsch and was put on trial and eventually imprisoned for treason. He used his time in prison to evolve his forthcoming political and military strategies and to write Mein Kampf. Many historians attribute his rise and success in German politics to the hyperinflationary episode of 1921–23.

  In September 1923, the Weimar Republic finally took steps to stabilize their economy. The newly appointed Chancellor, Gustav Stresemann, declared a State of Emergency. In October, the Rentenmark Ordinance was published, allowing for a new currency, the Rentenmark – equivalent to the gold linked pre-War Mark – to be issued by a new institution, the Rentenbank.

  On 13 November 1923, Hjalmar Schacht (formerly the managing director of the Darmstadt and National Bank) was appointed Commissioner for National Currency. Two days later, he stopped the printing of the old devalued Mark and the next day the first Rentenmarks began to emerge. On 20 November, the old Mark was pegged at the new Rentenmark at a trillion to one, and Germany reverted to the gold standard.

  The description of how Dr Schacht operated is fascinating. He sat in a single room which had once been used as a charwoman’s cupboard, looking on to a backyard in the Ministry of Finance. From this post he transformed the German financial system from chaos to stability in less than a week. His secretary, Fraulein Steffeck, was later asked to describe his work as the commissioner: ‘What did he do? He sat on his chair and smoked in his little dark room, which still smelled of old floor cloths. Did he read letters? No, he read no letters. Did he write letters? No, he wrote no letters. He telephoned a great deal – he telephoned in every direction and to every German or foreign place that had anything to do with money and foreign exchange as well as with the Reichsbank and the Finance Minister. And he smoked. We usually went home late, often by the last suburban train, travelling third class. Apart from that, he did nothing.’26