Let the Buyer Beware

The Vietnam dong currency scam is in fact not the first of its kind. Its now heavily written about predecessor is the Iraqi Dinar scam. This week’s post will be focussed on drawing parallels between the two, by which I hope to help warn any potential future “investors”, as scammers look for fresh victims by pushing a new currency – the dong.

A common tactic for the Iraqi dinar scam was for the online sellers to greatly exaggerate real world events and how an “imminent” a positive currency revaluation would result. In the case of Iraq, this frequently involved promoting the county’s “vast” natural oil fields. The same tactic can now be seen for the Vietnamese dong. They try to push the currency by taking the victim’s attention away from chronic inflation problems and frequent devaluations, by instead exaggerating the economic impact of increasing exports and big multinational manufacturers such as Samsung setting up factories there. Please note that the dinar was on the verge of its “imminent” revaluation for the best part of a decade (and for those “investors” unwilling to accept they were scammed, it still is).

Much of the success of the dinar scam was attributed to the fact that the buyers could physically hold the fiat currency and feel the security associated with this. While this sense of security remains a debated topic for even the most developed non-asset backed currencies, in the eyes of an American buyer, it should be almost non-existent for the dong due to its illiquidity.

Even if by some miracle the dong did positively revalue, there is not a legitimate FX exchange in the United States that would touch it and even less chance that the original seller will buy it back. Furthermore, it is technically illegal to be holding it outside of Vietnam, so anybody caught “smuggling” it back in to exchange it would have the amount seized and risk arrest and imprisonment in Vietnam. Even if it was successfully smuggled back in, it would have to be exchanged at a huge discount on the black market.

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.

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.

Free Lunch Anyone?

We are told time and time again that there is no such thing as a free lunch, and nowhere is this truer than in the world of finance. Known as the “zero arbitrage condition”, it is one of the few things that most economists can agree upon. Go to any finance class in the world and you will be told that if any such opportunity does exist, it disappears almost immediately. But what if I were to tell you that it is possible to buy a currency in one country and then sell it at a 65% premium in another. Would I have your attention?

In July 2014 I was backpacking in Vietnam, where the official currency is the Vietnamese Dong. Unbeknownst to me at the time (and rather ashamedly as an MSc Finance student), this is a closed currency that follows a crawling peg with the US dollar. Officially you are only permitted to buy or sell dong within Vietnam at a current rate of approximately 21,000 dong per US dollar.

 

Through a strange series of events I ended up leaving Vietnam with a princely sum of 17 million dong in my wallet. Upon my return to Europe I discovered that the only way to sell this currency was on ebay.com which technically makes the site a black market for the currency. To my great surprise I found that the dong was trading on the site at an average rate of 12,720 dong per US dollar, representing a premium of over 65%!  

Intrigued by what I had found, I examined the seller’s history, only to find that he was indeed selling large quantities, despite the enormous premium. Not only are there numerous sellers on eBay doing this, but in fact there are entire forums focused on the merits of the dong as an "investment", as well as websites dedicated to selling the Vietnamese dong, and at even higher premiums!

So it appears that to get this elusive free lunch all you have to do is buy dong in Vietnam and then sell it in the United States. Could it really be that simple? Over the coming weeks this blog will aim to answer this question, and discover the reasons behind why so many buyers are paying such an enormous premium for an asset infamous for its depreciation. 

Ultimately I hope that this blog will help to expose what I believe can only be considered an enormous scam being run by sellers, who are praying on the financially illiterate and naive.