Revaluations vs Redenominations

The heart of the Vietnam dong scam and the reason so many Americans seem to be “investing” in this collapsing currency can be found in their failure to distinguish between a currency revaluation and a redenomination. In this week’s post I will be explaining the reality of both and the reasons why neither will make you rich. 

 

Redenomination

Last week I discussed a key characteristic of money that is necessary to make it a generally accepted medium of exchange - its function as a store of value. However, another fundamental characteristic is that it must be a convenient unit of account. That is to say it shouldn’t take a bag full of $100 trillion bank notes (and possibly a degree in maths) to buy a loaf of bread, as was the case in Zimbabwe in the 1980s (Chibber, et al., 1989). 

While Vietnam is not quite as bad as Zimbabwe in this regard, it still has a rather high maximum note quantity of 500,000 dong.

  

To combat this problem and restore this key characteristic of money, the citizens of Vietnam informally knock three zeros off the end of prices quoted. So something that costs 500,000 dong will simply have a price tag of 500. In effect they are changing the face value of their currency without affecting its underlying value. 

When this is done formally by a government, taking in 500,000 dong notes and replacing them with 500 dong notes, it is known as a currency redenomination. The key thing to note is that the value of the old 500,000 dong note and the new 500 dong note are identical on the open market (or black market as is the case in Vietnam).

The Mythical Revaluation

The online sellers of this currency are deliberately misleading buyers with some kind of get rich quick scheme, by implying that this redenomination is the same thing as a revaluation. The naive buyers are paying a huge premium to own millions of dong with the belief that when/if the Vietnamese government formally redenominated their currency by knocking three zeros off, that the value of their holdings would be 1,000 times greater – making them millionaires overnight!

In an actual revaluation the underlying value of the currency does change, so it would be possible to make some form of profit. However, if the Vietnamese government wanted to revalue/appreciate the dong against the dollar it would have to heavily intervene in the market using foreign reserves to maintain the new rate. It is well known that Vietnam's foreign reserves are too low to have the credibility to do this without provoking further capital flight or in an extreme case, even a speculative attack.

The only revaluation that the Vietnamese central bank may implement would be a devaluation – to realign the official and black market rates and to promote exports. In the event of a devaluation, anybody who “invested” in the dong will take a loss. 

In fact Vietnam devalued their currency three times against the US dollar between 2010 and 2011. Not only will holding the dong not make you rich overnight, it will make you highly likely to lose an average of 10% if another devaluation were to take place. 

References:

Chibber, A., Cottani, J., Firuzabadi, R. & Walton, M., 1989. Inflation, Price Controls, and Fiscal Adjustment in Zimbabwe, Country Economics Department: The World Bank.