Part 2 of My E-Discussion With Eddie Cross, Secretary of Economic Affairs, Zimbabwe's MDC Party

Now that the vote count is actually underway in Zimbabwe, the possibility that Zimbabwe's Opposition Party the Movement For Democratic Change (MDC) could replace the ruling ZANU-PF Party and Zimbabwe President Robert Mugabe, is more real than ever. Today we present to you part two of my discussion with Eddie Cross, the top economics official of the MDC. Mr. Cross and I are continuing our dialogue at present and BlackElectorate.com will periodically publish excerpts of our evolving economic and political discourse. We hope that this discussion has provided you with a window into Zimbabwe's elections and economic issues that you could not find elsewhere.

June 18th, 2000

Eddie:

I find it interesting that when someone lives in America and criticizes your plan according to economic principles they are an armchair critic but anyone in the U.S. who uncritically supports you is a friend that you need. Consider my critique a help to you; those who are your friends now will soon turn on you in the very likely event that you do not improve Zimbabwe's economy. You may be surprised how quickly the international community jumps off of the MDC bandwagon at the first sign of trouble. I suggest you choose your "friends" carefully. I have seen a few of them walking around in Washington D.C. and have seen how quickly they turn on a country like yours that "needs" their friendship.

Your resistance to currency stability, as I have proposed it is based upon your allegiance to bad economic theory and your desire to strengthen the position of Zimbabwe as an export country. It is obvious that you are looking to use a currency devaluation to make Zimbabwe products "competitive" abroad. But haven't you seen the disaster that results to countries from these types of currency devaluations. Debasing the currency and intentionally allowing it to fluctuate will never, ever create an environment for Zimbabwe to prosper. You point out that President Mugabe has done this but your plan gives little attention to cleaning the mess up. Your plan may actually accomplish worse things than what you accuse him of. As it is apparent that you want to devalue the Zimbabwe currency at levels way below historic norms. This would be disastrous.

Eddie, President Mugabe is borrowing money in order to make up for a short fall in tax revenues. He is financing a government deficit which this year is expected to increase from a projected 3.8% of GDP to 20% of GDP. What would you like him to do at this stage? It is pure politics that you are playing with growth of Zimbabwe's debt. You and I both know that President Mugabe's only alternative is to raise taxes on the people of Zimbabwe in order meet his budget commitments. So he has done what any other leader would do in his place, Mr. Tsivinrai included, he has chosen debt over taxation.

You are correct to point out that such action can be counterproductive as it does create inflation inside of the country but you also fail to realize that those in Zimbabwe actually need to be paid more Zimbabwe dollars in order to not lose purchasing power. And not only that, the poorest in the country need immediate help and cannot afford to have the government tell them that they won't meet basic expenditures this year. Eddie, I also believe that the Zimbabwe electorate would prefer debt to the alternative of present taxation. This is always the case in peacetime contractions like the one in Zimbabwe. Sure the Zimbabwe electorate realizes that future taxation will be necessary to pay off the bonds but they also realize that there is a potential that their political leadership will make wise decisions that will result in economic growth policies that result in more than enough tax revenue in the future, to retire the debt, if necessary. This is not to say that you don't have a valid point however, a deficit in many cases is necessary. And don't forget that in any country where the debt is monetized - where money is created by the issuance of a bond - there would be no money in circulation if there were no national debt.

The key is how well the government, through its treasury or central bank, manages the ratio of interest bearing debt (bonds) to non-interest bearing debt (money). How much non-interest bearing debt (money) that must circulate at any given time for the smooth operation of the economy is the only question that should concern the Reserve Bank of Zimbabwe (RBZ). You should consider this as you implement your planned reforms of the RBZ, some of which I think are very good. What I believe President Mugabe has failed to realize is that his increased spending financed with bonds moves virtually everyone in Zimbabwe into a higher tax bracket further increasing their burden and further increasing incentives in Zimbabwe to not work or produce. President Mugabe and hopefully the MDC, should you come to power, should be lowering tax rates to ease the burden of the people of Zimbabwe in this environment of hyperinflation. Lowering taxes also will produce another benefit that I will mention shortly.

Eddie, I must tell you that the MDC's outline for tax reform does concern me, your intention to lessen the tax burden on low-income households is very good but your plan to "widen the tax net" is doomed to fail. The hunt to nab tax evaders and force them to pay taxes hardly ever works. The point that most policy makers miss, including those in the U.S., is that people avoid paying taxes not simply because they do not want to but because they are doing business and earning an income and are using any disposable income to either survive or gamble on an "investment" vehicle that will give them a higher rate of return than simply forking the money over to the federal government. A tax code that too heavily burdens the electorate will always be evaded as citizens search for ways to earn more money or shelter more of it before they turn a dime over to the government I can assure you that much of the tax evasion taking place in Zimbabwe today could end if the right mixture of fiscal and monetary policies were implemented. You have to end inflation and lower tax rates, not just on wages but also on capital and land. This combination will result in more tax revenue than all of the law enforcement that Zimbabwe can muster. Besides you will have to pay for an army of tax collectors and their work only breeds distrust between the government and its citizens and actually has a debilitating effect on creativity and production as more and more people and corporations are forced to contend with meddlesome paperwork and regulations. If you want to do a quick study, check out Russia's efforts to cast "a wide net" for tax collection.

Your plan for a value-added tax (VAT) is a bad one as well and will ultimately hurt producers and consumers alike. And while it is less difficult to bring in than the income tax it is very difficult to administer and not easy to collect. It also represents another deterrent to production when you need it the most as it hits everyone who is part of the economic chain - manufacturers, wholesalers and retailers and finally the consumer. Eddie you mention the value added tax rate but say nothing about your sales tax rates which are at 17 %. Your decision to institute the VAT in 2001, though it exempts foodstuffs, will still hurt the same low-income consumers whose tax burdens you say you are trying to ease. You and the MDC's team should be commended for an overall intention to not raise taxes but the substitute you offer of improved tax collection will not be enough to solve your budget problems. Eddie when I say you operate from a flawed economic theory I simply mean that you place the burden for solving Zimbabwe's economic problems on cutting expenses or tax collection as opposed to the proper mixture of monetary and tax policies that lessen the burden on the Zimbabwe producer or potential producer and free capital and labor and allow them to find one another in the marketplace.

Look at the problem of the Zimbabwe companies that wish to delist from the Zimbabwe Stock Exchange (ZSE) in favor of listing in neighboring countries which wish to have their stocks listed in countries where the economies are more stable. How do you intend to handle this in the event that you come to power? Talk about an issue that impacts your foreign reserves. Eddie, if you are concerned about foreign reserves and the economic growth of your country you have to do something about this. But what would be the appropriate policy tool to use? Fiscal policy. Which part of the tax code? The capital gains tax. I suggest that you totally eliminate the capital gains tax in Zimbabwe for at least 1 year and watch capital pour into the country. But don't just stop there, look at the effect it will have on the people of Zimbabwe who will be able to earn wealth not just from their hands. Laborers can turn their disposable income and savings into investments that can earn them a rate of return in months that they could not earn in years. Reducing the capital gains tax will also help small enterprises that are desperately seeking capital and can't afford bank loans with interest rates at current levels. By eliminating or significantly reducing the capital gains tax you reward the risk of investing in these firms and circumvent the slow nature and problems that surround getting loans from the banking sector. Also Eddie, I think this will provide the ultimate compliment to your micro enterprise program. And I cannot say enough about one of your ideas.

The MDC's intentions to include employee stock ownership plans in the privatization of the state-owned agencies are brilliant. And it is just about the quickest way possible to integrate those at the bottom of Zimbabwe's economic ladder into great potential wealth. What a wonderful idea you have to produce an investor class in Zimbabwe out of the poor. It will even ease the financial burden of Zimbabwe's corporate sector as individuals will soon accept stock options in lieu of hard cash. Now, Eddie imagine what would happen if you coupled these employee-stock ownership programs with an elimination or dramatic cut in the capital gains tax. You would be helping domestic capital and domestic labor at the same time. And the added benefit is that such action would halt the flight of Zimbabwe's corporations from the ZSE and the eventual disintegration of Zimbabwe's financial markets that delisting will ultimately produce.

The Reserve Bank of Zimbabwe's (RBZ) position on this matter has been horrible thus far, actually permitting corporations to delist from the ZSE as long as 60% of the shares were maintained in Zimbabwe. A capital gains tax elimination would give struggling Zimbabwe a competitive advantage over the other nations of Southern Africa and would bring back capital that has fled the country. And don't stop there cut the capital gains tax on the sale of homes from rates currently as high as 20% to 10% and totally eliminate them for those over 60 years of age. Imagine what that would do for your Big plans for housing and your construction business. Right now the exceedingly high interest rates in Zimbabwe are stifling the real estate sector. I am aware that the government fixes the rate of interest of mortgage rates anywhere between 18% to 28% but these mortgages are limited to a small pool of bonds and in addition to this banks cannot raise money at low enough rates to increase the pool. The least that you could do, if you take over, is encourage the growth in your housing/construction business via a cut in property taxes and capital gains taxes on the sale of a home. If you count on the housing sector to become an engine of growth as you have indicated previously, why wouldn't you do this? In addition you have to cut down on burdensome regulations that hamper the property market.

Currently what sets Zimbabwe apart from say South Africa is the amount of time necessary to navigate the regulation maze that governs all transactions. The government depending upon the size of the property currently regulates the sale of houses and farms. And of course rents are regulated as well. If you are going to use construction and housing to produce the "multiplier effect" that you claim, you will have to reduce the regulatory burden as well as the fiscal burden that is weighing down the property markets. This is one half of the problem in Zimbabwe, the other, again, being the exorbitant interest rates which I will address now because it relates to the subject of monetary policy which I want to return to.

The reason that my currency ideas seem "weird" to you is because you are not looking at the issue of monetary policy from the eyes of poor people. You are not looking at it from the eyes of a poor person living inside of Zimbabwe. Rather you are looking at monetary policy from the eyes of someone trying to please foreign investors and individuals who own capital and property inside of Zimbabwe. Eddie, that may not be your intent but that comes through loud and clear in your economic vision. And of course I write what I do to not say that you are inconsiderate of the poor. Far from that, what I am saying is that your economic worldview looks at the poor first and foremost as consumers while I look at them as producers. There is a huge difference. The result is that you look for policies that will lead to the immediate filling of jobs among the Zimbabwe people and I am looking for policies that will free each person's productive capacity and allow individuals to profit from the cultivation of their talents, skills and interests and their eventual sale in the marketplace. I also am looking for policies that will enable all of the Blacks of Zimbabwe to possess capital and own real assets in Zimbabwe, the most important of which is land.

How does all of this relate to my "weird" currency ideas, as you put it? Very simply Eddie, in an inflation such as the one that you are experiencing those who own real assets are not suffering as greatly as those who own no real assets and earn an income from their labor alone. In an inflation those who own real assets, the chief of which is land are able to ride out the inflation knowing that their "wealth" and accumulated labor is safe - tied up with the value of that land as well as the future income streams that it can produce. The poor only have their accumulated labor reflected in pieces of paper. Once those pieces of paper become less valuable in terms of real assets, the purchasing power of the person of limited wealth dramatically decreases while the purchasing power of the person who owns land is maintained over time or actual increases. Take your real estate market where despite the inefficiencies of the Zimbabwe property markets, many houses have doubled in value relative to Zimbabwe dollars. Hyperinflation encourages people to move out of paper money and into hard assets, the first of which is usually land. Interestingly, house sales in Zimbabwe averaged 700 per month in 1997, 800 in 1998 and 1,000 per month in 1999. Do you see a pattern? Do you think that was an accident? Of course it isn't. In the exact same time frame in which demand for the Zimbabwe dollar was decreasing the demand for homes was increasing. That is why I am stressing to you the importance of strengthening and stabilizing the value of the Zimbabwe dollar. The more you allow paper money to lose its value relative to real assets like land you are permitting a tremendous transfer of wealth scheme that benefits land holders in Zimbabwe - and those who benefit the most in such a scenario are the 4500 white farmers in your country who don't just own land but own the most productive land. They own not just real assets but the assets that have the most productive capacity - the greatest potential to produce future income streams. It is this disequilibrium that aggravates racial tensions.

Solving your currency problem is a prerequisite to solving your land problem and even pays a dividend in race relations as it makes it very difficult for Blacks to blame their problems on whites when they have as much wealth in terms of paper and real assets and in the same proportion as Whites. Think this over. Now, you very easily dismissed the value that I placed on the price of gold but didn't tell me what exchange rate you are targeting for the U.S. and Zimbabwe dollar. If 38 Zimbabwe dollars to 1 U.S. dollar is too low and 62 Zimbabwe dollars to 1 U.S. dollar is too high what is the rate that you are looking for? Don't you realize Eddie that if you fix the exchange rate in this range that you will be locking inflation into the structure of your economy for years to come. You will be crushing those who disproportionately hold paper assets. You also will be crushing your banking sector which will be forced to accept the repayment of loans in less valuable Zimbabwe dollars than the ones that they loaned out. That's what happens in an inflation creditors are hurt and consumers lose purchasing power - everyone loses. And guess what your interest rates will take forever to fall. Eddie you have to do better than between 38 and 62 Zimbabwe dollars per 1 U.S. dollar. You have to bring the value of the currency at least back to where it was prior to 1998. You have to bring it back down to around 12 or 15 Zimbabwe dollars to every U.S. dollar and you can do it by edict though you think this is impossible.

The key to understanding how this can happen is that the value of a currency is determined by the relationship between the supply and the demand for that currency. Currently, Zimbabwe is experiencing a double whammy. The demand for the currency is drastically dwindling at the same time that the supply of the currency is dramatically increasing. You have to simultaneously do two things 1) increase the demand for Zimbabwe dollars among the people of Zimbabwe, businesses and foreign investors and 2) decrease the supply of Zimbabwe dollars. The combination will result in a strengthening of the Zimbabwe dollar relative to the U.S. dollar and real assets like gold and land. The way to increase demand for the Zimbabwe dollar is to use fiscal policy as I have suggested lower marginal income and corporate tax rates and eliminate or dramatically reduce the capital gains tax and property transfer tax rates. To decrease the supply of the Zimbabwe dollars you have to mop up excess liquidity the best way to do this is via the banking system like it is done in the U.S. via the Federal Reserve. You should consider this as you make reforms to the Reserve Bank of Zimbabwe (RBZ).

This is done in the U.S. through mandating reserve requirements and the central banks buying and selling bonds on the books of the commercial banks. This is the best way to inject and subtract liquidity. Do not rely on interest rates - just look at Japan's monetary of near 0% if you want to see how lowering interest rates is no guarantee that a dime of liquidity reaches the marketplace. Conversely raising interest rates is no guarantee that you are slowing the growth of liquidity into the system. We can discuss this further. But the manner in which the MDC empowers the central bank to take cash and bank reserves out of the system (or inject them) is of the utmost importance The reserve requirements in Zimbabwe have increased by only 50 % in the last 9 years while currency in circulation has increased by over 500%. Over the last 5 years the money measurements of M1 and M2 have increased by 500%. In the same time period - 5 years, the value of the Zimbabwe dollar fell by 500% relative to gold. This shows us that while demand for the Zimbabwe dollar stayed constant the money supply grew excessively. That is what the gold price signals - the precise point where demand and supply meet. Eddie this is what you have to understand, if you had been watching the price of gold in terms of the Zimbabwe dollar you would have known immediately that the central bank was increasing the money supply too rapidly. And you could have stopped the movement toward inflation that was inevitable. President Mugabe's central bank made the same mistake from 1993 to 1998 (1997 and 1998 in particular) that U.S. President Lyndon Johnson's central bank made from 1965 to 1968 and President Richard Nixon's did in 1971.

If the government of Zimbabwe were to announce by edict that it was tying the Zimbabwe dollar to the U.S. dollar at the rate of 15 Zimbabwe dollars to 1 U.S. dollar it could work, as long as you watched the value of the U.S. dollar relative to gold and made it clear that you would only sever the link if the U.S. dollar went outside of the range of between $270 and $300 dollars. Gold is the best measure of whether the U.S. dollar is inflating or deflating. If Thailand had been watching the U.S. dollar gold price in 1997 it would have known that it could not maintain the its peg to the U.S. dollar. The U.S. dollar gold price, which was at $360 per ounce in Jan. 1997, was at $280 one year later. This was a clear signal that the U.S. dollar was becoming too strong relative to real assets and that any currency tied to it would not be able to keep up, especially nations that export as their main source of income and especially those that specialize in gold mining. Did you ever think that there was a link between the monetary deflation signaled by the U.S. dollar and the collapse of the minerals industries in Africa - Zimbabwe included? There was one. Zimbabwe's mining industry is still hurting from what happened in 1997-1999. But if you tie to the dollar, and use the dollar-gold price signal to see where monetary policy is headed in the U.S. and to see the relative strength of the U.S. dollar relative to a real asset you will know what the central bank in Zimbabwe should do. You really have little alternative Eddie but to consider this. Tying the Zimbabwe dollar to the U.S. dollar at current levels or above them will seal in the effects of the inflation of the last 3 years for years to come as you make the losses that people suffered on paper permanent. But by decreasing the supply of the Zimbabwe dollar as you simultaneously increase the demand for it with the fiscal policies I have outlined you will see the currency appreciate in value and most importantly you will begin to see the interest rates in the banking sector fall as the premium for inflation becomes unnecessary and is dropped from bank loans. You and I both know that interest rates of well over 50% in Zimbabwe are a result of the risk of inflation being priced into loans. Yes, stabilizing the currency at pre-1998 rates will ensure that interest rates go down.

Lastly, Eddie, the economic agenda wouldn't be complete without the big question. What are you going to do about the land question? Chiefly, the fact that the majority of the Blacks of Zimbabwe live on the most unproductive land. How will you integrate them into the Zimbabwe economy as land owners of useful and productive land? Will you, in any way, redistribute the land held by the 4500 white farmers among the Black population? I have an idea that can help you solve this problem but want to know what you have already planned for the country of Zimbabwe in this critical area.

Eddie's Third Reply:

Cedric Muhammad

Monday, June 26, 2000

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