* Zimbabweans fear return to hyperinflation
* Security chiefs tell Mugabe to "wake up, smell coffee"
* Army said to be unhappy with new currency
* Veteran leader's authority challenged
By Ed Cropley
HARARE, Nov 25 (Reuters) - In Zimbabwe, where worthless $100 trillion notes serve as reminders of the perils of hyperinflation, President Robert Mugabe is printing a new currency that jeopardizes not just the economy but his own long grip on power.
Six months ago, the 92-year-old announced plans to address chronic cash shortages by supplementing the dwindling U.S. dollars in circulation over the past seven years with 'bond notes', a quasi-currency expected at the end of November.
According to the Reserve Bank of Zimbabwe (RBZ), the bond notes will be officially interchangeable 1:1 with the U.S. dollar and should ease the cash crunch. The central bank also promised to keep a tight lid on issuance.
After a 2008 multi-billion percent inflationary meltdown caused by rampant money-printing, many Zimbabweans are sceptical. The plan has already caused a run on the banks as Zimbabweans empty their accounts of hard currency.
Internal intelligence briefings seen by Reuters raise the possibility that the bond notes, if they crash, could spell the end of Mugabe's 36 years in charge.
A Sept. 29 Central Intelligence Organisation (CIO) report revealed the powerful army was as unhappy as the rest of the population with the new notes and had told Africa's oldest leader to "wake up and smell the coffee".
"Top security officers have told Mugabe not to blame them if Rome starts to burn," the report said.
Reuters was unable to determine the author of the report. It is also unclear if Mugabe has seen the report, whose final audience is not specified. Mugabe's spokesman did not respond to requests for comment, nor was the CIO available.
But the report offers a rare glimpse into the thinking of Mugabe's security forces - the backbone of his power - and their concerns about the implosion of what used to be one of Africa's most promising economies.
"Mugabe was openly told that the bond notes are going to cause his downfall," the report said.
The notes' first test will come in the informal foreign exchange markets on the streets of Harare.
If they fall heavily in value, they are likely to unleash an inflationary spiral that could bleed the banking system of its last few dollars and wipe out Zimbabweans' savings for the second time in less than a decade, economists say.
The same happened in 2008: powerful individuals with access to dollars at the official 1:1 rate were able to buy bond notes at a discount on the unofficial market and then convert them back to dollars at face value.
"You start with one dollar, then you've got 10, then you've got 100, then you've got 1,000 - and it's not even lunchtime," said John Robertson, one of Zimbabwe's most respected private economists.
In Harare's chaotic Road Port bus station, the main terminus for those heading to and from South Africa, Zimbabwe's biggest trading partner, some bus operators are fearing the worst.
Required to pay nearly all their expenses - fuel, road tolls and police bribes in Zimbabwe and South Africa - in hard currency cash, they are particularly exposed.
"It's like being on death row. You don't know when the hangman is going to open your cell door," said ticket-seller Simba Muchenje, pulling a wad of worthless 2008 Zimbabwe dollars from his briefcase and tossing them onto the counter.
"It's just taking us back to the bad old days."
In interviews, none of eight money-changers trading South African rand and U.S. dollars said they would accept bond notes at their $1 face value because of fears of immediate depreciation. The rand and the U.S. dollar have become Zimbabwe's currencies since the local dollar was scrapped in 2009
"The banks may say 1:1, but here we say 2:1. We can't afford to pay the same as the banks. I'm running a business, not a bank," said Patience, a 32-year-old money-changer.
Given Zimbabwe's recent history of hyperinflation, the RBZ is keen to allay fears the printing presses are about to go into overdrive, and that the bond notes are a roundabout route to a new Zimbabwe dollar.
"The introduction of bond notes does not mark the return of the Zimbabwe dollar through the back door," it said in a statement on its website.
Instead, the bank has presented the notes as a 5 percent "export incentive" - a top-up added by the central bank to the accounts of those receiving foreign exchange either from overseas remittances or via farming, manufacturing and mining exports.
They will also be backed by a $200 million "loan facility" from Afreximbank, a Cairo-based lender owned by the African Development Bank and dozens of African governments and central banks. Afreximbank declined to comment.
Given monthly exports of roughly $250 million, the 5 percent 'top-up' suggests a monthly liquidity injection of just $12.5 million, or $1 for every Zimbabwean.
In public statements, the RBZ has given assurances it will not exceed the $200 million issuance ceiling.
But it has not clarified how bond note balances will be recorded in U.S. dollar accounts, nor how ATMs will distinguish between greenbacks and bond notes when they issue cash.
"Upon withdrawal, banks have an option to pay in any one of the legal tenders," the RBZ said.
RBZ Governor John Mangudya missed a scheduled interview with Reuters and did not respond to emailed questions.
Few Zimbabweans interviewed believed the RBZ would stick to the issuance limits, especially while a large current account deficit continues to suck dollars out of the country.
After the bond notes' announcement, #ThisFlag and #Tajamuka, social media campaigns targeting the new system, drew the biggest anti-Mugabe protests in a decade before being crushed by riot police and the CIO.
Meanwhile, tens of thousands across the country queue through the night to empty their accounts the moment their pay or pensions arrive, exacerbating the liquidity crunch.
Banks have responded with daily withdrawal limits: $100 one day, $50 another, none another. Customers have no idea until the banks open their doors at 8 a.m.
"Sometimes you get to the end of the queue and there's no money," said industrial fitter Edmund Panganai, 40, outside a CABS building society branch in Harare. Every month, it takes him at least seven nights of queuing to get his hands on his pay.
In Harare, where most U.S. dollar bills are stained deep brown with grime, a crisp 2009-edition $100 note is now worth as much as $115.
Conversely, the plastic and mobile money introduced to ease physical cash shortages is depreciating, forcing vendors to charge a 10-15 percent premium.
One prostitute, who had been relying on e-wallet payment systems such as Ecocash, run by mobile firm Econet Wireless , said she and other sex workers were turning away customers without hard cash.
"Ecocash? No thank you. Dollars, dollars, dollars," said Patience, a 22-year-old working a Harare street corner. "No dollars, no fun."
Combined with unemployment at 90 percent and a government budget crunch that has seen delays in payment of state wages, the discontent is also pervading the army.
The Sept. 29 CIO report said soldiers had applauded the social media protests because they had led to an improvement in daily rations.
"Before the demonstrations government had stopped supplying them with breakfast. At lunch they were being fed with sadza (maize meal) and cabbage without cooking oil. Mugabe instructed for the army officers to be given descent meals so they will rally behind him," the report said.
Other intelligence reports from late September and early October suggested Mugabe was having doubts about the bond notes. Reuters was unable to confirm this.
"The issue of the bond notes is giving Mugabe sleepless nights," one said. "Mugabe is serious thinking of delaying the introduction of the bond until January next year."
Another report said army officers were frustrated with pay delays and withdrawal limits.
"They are very angry as they are failing to access their money from the banks and do not want to be issued with bonds," it said.
"These junior and middle-ranked officers reckon that Mugabe has failed, hence he needs to step down for new blood to replace him."
In July, veterans of the 1964-1979 liberation war that brought Mugabe to power broke ranks, accusing him of "dictatorial tendencies" and blaming him for the "serious plight" of the economy and discord in the ruling ZANU-PF party.
"We are dedicated to stop this rot," they said in a statement.
As fears over the bond notes have grown and the battle to succeed Mugabe has intensified, they have continued to flex their muscle.
"Once you go wrong with us, you automatically go wrong with the whole state apparatus," veterans leader Chris Mutsvangwa told Reuters.
The veterans enjoy warm ties with the army and security services, and want Vice-President Emmerson Mnangagwa, a former security chief nicknamed "The Crocodile", to take over from Mugabe, political analysts say. On the other side is a faction attached to Mugabe's 51-year-old wife, Grace.
Mugabe responded to the growing pressure on Nov. 19 with an address in which he admitted fallibility and gave a rare hint at retirement.
"If I am making mistakes, you should tell me. I will go," he said, before adding: "Change should come in a proper way. If I have to retire, let me retire properly." (Additional reporting by MacDonald Dzirutwe; Editing by Janet McBride)