Reasons for Redenomination

When a country experiences extreme inflation, or hyperinflation, like Germany after WWI, former Soviet republics in the 90’s, and Zimbabwe in the late 2000’s, the people suffer immensely. When a currency is worth so little, like the First Zimbabwean Dollar which, at one point, was equal to 10^-16 USD, meaning even a loaf of bread cost billions, those who saved money in the currency lose all their savings and those who earn money are no longer able to buy anything with it. So, what is a country to do when their money becomes practically worthless? Often, countries turn to a process called redenomination, sometimes multiple times. In countries dealing with hyperinflation, the only bills that get used (if any) are only the highest value bills, sometimes worth billions of a certain currency. Redenomination takes advantage of that. In this process, a country creates a new currency which is a few times more valuable than the old currency. It is usually larger by a factor of ten to some power or, sometimes, an integer times ten to some power. This allows the government to essentially ignore the last few zeros of the old currency to convert them to the new. A notable case of this is, again, Zimbabwe. The First Zimbabwean Dollar was replaced by the second Zimbabwean Dollar, which was 1000 times as valuable. Unfortunately, inflation continued and, two years later, the 2nd dollar was replaced by the 3rd, which was 10,000,000,000 times as valuable, and later by the fourth, which was one trillion times as valuable. Some countries, however, choose to anchor their new currency to a hard currency, a strong, globally traded currency like the USD, Euro, or Japanese Yen, which means the government has to make the new currency larger by a factor that may not necessarily be an integer. Brazil did this in 1994 when they converted their cruzeiros reais to the Brazilian Real, which was larger by a factor of 2750 and linked to the USD.

Redenomination isn’t only used for inflation, it also occurs when nations change currency, like many members of the EU, when they switched to the Euro but, in cases of inflation, it has some unique advantages. When the country’s currency is unstable, the workforce is less reliable since they don't know if the opportunity cost of working at a factory is worth it, since the wages could be worthless soon. This makes such a country an undesirable trading partner and an unreliable producer of goods. By stabilizing their currency, the workers are able to trust that the work they do will be equal to the utility they receive from goods they will be able to purchase. This country is now able to encourage other countries to trade with them, taking advantage of the free market and comparative advantage. Stabilizing the currency allows the country and its possible trading partners to maximize production. As we learned, if countries focus on what they have a comparative advantage in, the largest amount of products can be produced. Thus, a stable country that makes a good trading partner is much more efficient in its production of goods than an unstable country suffering hyperinflation.