Monday, May 8, 2017

Three-tier pricing

Americans and Canadians take for granted that fact that while a multiplicity of dollar brands circulates in our respective nations, a dollar is always equal to a dollar. In the U.S.'s case, whether it be a VISA card, paper money issued by the Federal Reserve, or a deposit created by a either a big bank like Wells Fargo or a tiny one like Wisconsin Bank & Trust, a retailer will (almost always) accept each of these monies at the same rate.

Compare this to Zimbabwe where a phenomenon called three-tier pricing has emerged over the last few months. Retailers have begun to charge customers three different prices for goods and services depending on the brand of dollar being used: a paper U.S. dollar price, another in "plastic money" (i.e. local U.S. dollar-denominated bank deposits transferable by debit card), and the last price in terms of relatively new parallel paper money called bond notes.

To better illustrate three-tier pricing, here is a photo of a Zimbabwean store sign:

You can see that the list of goods being sold is denominated in U.S. dollars, bond notes, and "swipe" i.e. plastic money. Under three-tier pricing, those who pay with U.S. dollars get the lowest price while anyone who pays with plastic money faces the highest price. For instance, the item labelled Kingsize (cigarettes maybe?) retails for $9 in U.S. banknotes, $9.50 in bond notes, and $10 in plastic money. Given these rates, the shop estimates that a US$100 bill is worth $105 in bond notes and $111.11 in deposits.

These rates are generous. There are reports (see here, here, and here but there are many more examples) that bond notes and plastic money often trade at discounts as deep as 20-30% to U.S. dollars.

Three-tier pricing may seem odd, but it is actually the market's natural response to a breakdown in the fungibility, or substitutability, of various types of money. While plastic money and U.S. paper money used to be perfect substitutes (i.e. they traded at par) from 2009-2015, over the last twelve months the quality of plastic money has rapidly deteriorated relative to U.S. paper dollars as it has become increasingly apparent that a bank deposit is a claim on the Zimbabwe government rather than on an actual U.S. dollar. Needless to say an IOU issued by the Zimbabwe government is not a very good claim to own.

As for bond notes, a paper dollar look-alike originally issued by the central bank at the end of November 2016, they were supposed to be pegged 1:1 by equivalent U.S. dollars held in accounts at an international development bank, the African Export Import Bank. But this promise has proven to be a dubious one as the peg has not held. In this context, three-tier pricing is a way to recognize the  fundamental breakdown in fungibility by rewarding users of the highest quality medium, U.S. banknotes, with the most advantageous price, and penalizing users of the lower quality mediums--bond notes and plastic money--with less advantageous prices. (To see why bond notes are worth more than plastic money, see the appendix below).

This panoply of prices is quite embarrassing to President Robert Mugabe and his cronies as it makes the government look weak. They are trying to put an end to three-tier pricing by forcing retailers to set one universal price for goods. To this effect, recently-passed legislation says:
Retailers and wholesalers shall sell any particular product for the same price irrespective of the mode of payment and desist from multiple pricing of goods on account of mode of payment (cash, Real Times Gross Settlement (RTGS) and Point of Sale or a combination of any two or more of them).

For the avoidance of doubt, retailers and wholesalers shall not charge any premium for the sale and purchase of their wares on the basis of mode of payment. Similarly any cash or quantity discount shall, in accordance with best practice, be granted in the normal course of business and not on the basis of the multiple pricing system.
The penalty for not accepting cash and plastic money at par is up to seven years in jail.

By forcing retailers to accept all brands of money in Zimbabwe at par, Mugabe is interfering with the market's natural response to a breakdown in the relative quality of different monies. His actions will inevitably set off a specific set of responses dictated long ago by Gresham's law: if the government specifies the exchange rate at which money must be accepted by the populace, then the good, or undervalued money will be chased out by the bad, or overvalued money.

We know from its relative position in the three-tier pricing mechanism that plastic money is Zimbabwe's worst money. By requiring retailers to accept the two paper monies--U.S. dollars and bond notes--at par with the inferior money, plastic, Mugabe is forcing retailers to dramatically undervalue paper currency. As per Gresham's law, Zimbabwean shoppers who own U.S. dollars and bond notes will prefer to hoard and/or export them rather than spend them at artificially undervalued rates, using only plastic money to buy things. Thus the bad chases out the good. Media reports concur with this prognosis. U.S. paper money, which had already started to disappear back in November when bond notes were declared legal tender, is all but impossible to find. And now bond notes are getting more elusive too.

To try and fix the very problem it has created, the Reserve Bank of Zimbabwe--the nation's central bank--has initiated a whistle-blowing campaign against cash hoarders. Good luck with that; cash is very easy to hide. If the authorities really want to end cash hoarding, they should re-legalize three-tier pricing. With the market sorting mechanism reestablished, the true value of cash will once again be recognized and banknotes will flow back into the market. Of course, these prices will only bring back the premium on U.S. dollars, making it terribly obvious to all how poorly the government's credit is esteemed by the market. Unfortunately, this is exactly why three tier pricing is unlikely to be legalized. This situation won't have a happy ending.


I had been meaning to include the following bits in the main body, but on second thought decided to put them into an appendix. What follows is a quick history of how each of the three tiers has developed.

First Tier

As readers will probably remember, a hyperinflation of the local currency finally ended with the populace spontaneously adopting the U.S. dollar in 2008. Deposits denominated in the local currency became worthless with banks only offering U.S. dollar deposits to their customers. Since then, Zimbabwean prices have been mostly been in set in terms of dollars.*

Second Tier

In 2016 a two-tier system emerged when U.S. banknotes and "plastic money" ceased being fungible (bond notes had not yet been created). The nation's central bank--the Reserve Bank of Zimbabwe (RBZ)--reopened for business sometime after the nation had dollarized. It began to offer U.S. dollar accounts, or IOUs, to local banks for the purposes of settling interbank payments, later forcing them to keep a certain amount of money on deposit at the RBZ. In theory, these IOUs were supposed to be fully backed and convertible into genuine U.S. dollars, a promise that has proven to be a tenuous one as the RBZ has been rationing access to U.S. dollars since early 2016.

This has left local banks in the lurch. Stuck with a bundle of more-or-less inconvertible RBZ IOUs, they now lack the resources to meet their depositors' U.S. dollar redemption requests. As a result, a nationwide bank run developed in early 2016 which led to the imposition of strict withdrawal limits. Ever since then, long queues at ATMs have been a perpetual phenomenon as bank customers, desperate for cash, wait--often overnight--to withdraw their quota of U.S. banknotes.**

With redemption now impeded, U.S. dollar deposits had effectively been decoupled from U.S. cash. By mid-2016 a black market of sorts had developed in which cash, the superior money, now traded at a premium to deposits, or plastic money. To cope with this lack of fungibility, retailers came up with an ingenious workaround; they began to set a cash price and a "plastic money" price, the cash price being lower.

Any retailer that did not set a lower price for U.S. dollars would not be able to "lure" U.S. dollars out of customers' pockets with the proper market reward. And without U.S. dollars, it would be difficult to import products from overseas to sell to customers.  An alternative strategy to two-tiered pricing is to simply require U.S. dollars only, like here:


But this single-tier pricing strategy inconveniences customers with bank accounts and may attract the disapproval of authorities.

Third Tier

The third tier emerged when the RBZ introduced its own parallel issue of U.S. dollar banknotes, called bond notes, at the end of November 2016. This parallel currency currently comes in $1, $2, and $5 denominations, although the RBZ had earlier promised to introduce higher denominations.

In its initial announcement, the government had promised that bond notes would be fully backed and redeemable in genuine U.S. dollars provided by an international development bank, the African Export Import Bank. But this redemption promise is not being kept [source]. Those who want to redeem bond notes for U.S. banknotes have found that they face the same hurdles as those who want to redeem deposits. Thus, just as deposits have been decoupled from U.S dollars and fallen to a discount, so have bond notes.

Although deposits and bond notes are both inferior imitations of the U.S. dollar they do not themselves trade at par with each other, bond notes being valued at a premium to plastic money. My guess is that this has to do with the fact that, till now at least, the supply of bond notes has been kept to ~$120 million, with the government reportedly unwilling to issue more. [source] Given the fact that many Zimbabweans do not have bank accounts and only transact with paper, the limited amount of bond notes that has been created is insufficient to meet the nation's demand for cash. So there is a scarcity premium built into the price of bond notes.

* Some prices were also set in rand, the South African currency
** The other way of emptying one's bank account, wiring dollars overseas, has likewise been constricted as foreign exchange is tightly rationed by the central bank.


  1. If commerce payments move to bank deposits then that does not seem to be at odds with the purpose of the legislation if that purpose is to reduce the amount commerce in dollar bills.

    1. If that was there goal, they've done a good job of leveraging Gresham's effect. One wonders how they'll try to control the next step in the Gresham progression: inflation.

  2. At some point we need to establish exactly why the Zimbabwe issued currency is so difficult to stabilize.

    I hesitate to use Modern Monetary Theory to support a logical reason, but I think that Zimbabwe has no creditable plan to stabilize the amount of money (as measured by deposits in bank accounts and currency in circulation) that is directly linked to Zimbabwe government issued debt.

    Here is one way to logically link money and monetary stability. There are other ways but this may be the easiest to understand: We can all agree that only government can legally print currency or the electronic equivalent. In that case, government has a choice of printing a limited supply or printing as much as is demanded by the public and government itself. If government decides to limit currency, currency can be as difficult to find as the rare commodity "gold".

    On the other hand, government can decide to make currency readily available, eschewing any link between currency and gold. Monetary stability (as related to a fixed reference) suffers, following a yet-to-be-discovered relationship.

    Maybe not MMT logic. Maybe just a logical extrapolation.

    1. I am not really following you Roger, but if you want to know why Zimbabwe tends to have monetary problems, you need to explore its complex history, demographics, and politics.

  3. Sorry to be so slow in following up on the original comment.

    Well, the point I am trying to make is that there is no need for fiat currency to be unstable. A willing government can make it's currency stable by controlling currency supply growth with the taxation mechanism. If desired, the stability can be made as "good as gold".

    Taxation has the ability to remove money from the money supply, removing money that was previously created when government spent money that was created by bank borrowing. To accomplish this feat, government (simply?) needs to pay-down the bonds issued when the money was first created.

    As you suggest, Zimbabwe has a history of politics that included government officials who ballooned the money supply and government debt. There seems to be no creditable effort to correlate taxation and money-paid-by-government. I would expect stability to return quickly if government began operating on a balanced budget.

    (Here is a post I wrote (about three years past) that details how taxation removes money from circulation. )

  4. Roger, you've perhaps inadvertently struck on the missing variable to all these mysteries: taxation.

    The reason plastic is valued less than the bond notes is that bank transactions cannot be hidden. Zimbabwe suffers from rampant tax-avoidance at every level of finance, so leaving a banking trail prevents sellers from under-reporting sales.

    That leakage then creates a feedback loop against the country's current accounts... bond notes and USD magically disappear from the economy. The problem is, we wave it away by calling it "cash hoarding". It's nothing of the sort.

    Notice how back in 2009 when the whole house of cards collapsed, there was a flood of USD that entered the country and created what turned out to be a short-lived economic boom? That wasn't the release of prior hoarding, as the USD was not the currency in circulation. It was unreported revenue, converted to USD on the black market at increasingly inflationary rates, being partially repatriated.

    Certainly Zimbabwe had to that point failed to generate enough export-derived revenue to run a balanced budget, which was the major driver of inflation. But the lack of discussion about the significant contribution of tax avoidance to inflation has always struck me as self-serving.

    Unfortunately, capital controls and other financial regulations put in place to mitigate this and other issues get vilified by the very same people who are guilty of robbing value from the country.

    Mugabe has his (major) flaws, but the more time passes the more I come to understand that he's not the true villain of this story.