Don't Buy Dong: Why 90 Million Vietnamese Can't be Wrong

In last week’s post I highlighted the existence of a large scale, online, black market for the trading of Dong outside of Vietnam – where American buyers of the currency were willing to pay an enormous premium to “invest” in the currency. This week I will show how irrational this is by examining why the citizens of Vietnam are willing to pay large premiums and risk large fines to take the exact opposite position.

As is the case in many other emerging market economies, Vietnam’s central bank seeks to control and maintain a stable exchange rate in order to promote trade exports. To achieve this, it uses a crawling peg with the US dollar and implements a closed currency system. 

Inflation and Overvaluation: 

However, despite the numerous devaluations of the dong by the Vietnamese central bank, the large inflation differences between the two countries have resulted in the dong being overvalued relative to the dollar - the crawling peg is simply not allowing the dong to depreciate at a fast enough pace. Average annual inflation in Vietnam between 2009 and 2012 was 12.63%, and the country even experiencing hyperinflation in the 1980’s, with inflation peaking at 774% in 1988.

Failing Currency:

Menger (1892) describes how money comes about in a barter economy without any government participation, as citizens will exchange their own goods for a more marketable good, which can subsequently be used as a generally accepted unit of exchange and a store of value. By intervening in the market the Vietnamese central bank has created an overvalued asset that is rapidly depreciating. The result is that the dong is no longer a good store of value, nor is it a generally accepted unit of exchange, as Vietnamese citizens do not wish to hold an overvalued asset. 

These citizens are abandoning the currency in favour of more marketable assets and better stores of value in the US dollar and gold. So bad is the problem of capital flight, that the Vietnamese government have imposed heavy fines for any citizens caught exchanging their dong for dollars. In addition, they have imposed large import duties on gold, due to the problem of anxious consumers and businesses hoarding gold to protect against high inflation and devaluations of the dong. 

Despite these risks, a simple walk down the streets of Hanoi or Saigon will make it clear that there is a thriving black market, in which, everyday citizens are willing to not only risk these fines, but also to pay a premium to escape the dong and get into dollars. 

So if you are considering “investing” in the dong, please at least consider the reasons 90 million Vietnamese are trying to escape it!

References:

Menger, C., 1892. On the Origin of Money. The Economic Journal, 2(6), pp. 239-55.