To: Students of Supply-Side University
From: Jude Wanniski
Re: Monetary Policy in Africa
The great pleasure of teaching comes when you realize your students have learned. There are no quizzes or examinations at SSU. You either learn the material and demonstrate the practical use of it, or you donít. For today's lesson, Iím calling upon a magna cum laude graduate of Supply-Side University, Cedric Muhammad, the perfect example of just such a student. He is the 28-year-old publisher of Blackelectorate.com, a web site we continue to recommend highly. Cedric examines the currencies of three African countries to provide a brilliant analysis of the liabilities of Africa's current attachment to both fixed and floating exchange rates. He goes on to solidly outline the steps by which the continent's debilitating monetary policy may be overcome, opening the way to robust non-inflationary economic growth and Africa's integration into the global economy. It is because of his participation in Supply-Side University and absorption of its lessons over the years that he now is so well-equipped to get his arms around Africa's monetary policy. We have seen nothing anywhere else that matches the incisive, theoretically solid and practically applicable effort made here by Cedric. This exposition below originally appeared on his website August 22, 2000 and can also be found in his archive at: http://blackelectorate.com/archives/082200.asp
The Failure of Africa's Monetary Regimes
August 22, 2000
There is no greater argument to end Africa's current attachment to floating and pegged currency regimes than the current condition of three of her currencies: the Ghana cedi, Zimbabwe dollar and CFA Franc. All three currencies are in serious trouble and all three currencies demonstrate that African nations, in their rush to independence, never successfully addressed a basic step in nation building: establishing currency stability.
It broke my heart yesterday to see the condition into which Ghana has fallen. In such bad shape that she now needs $300 million in emergency "capital inflows" from the IMF, World Bank and private institutions. And why? Because her currency has lost almost 100% of its value, in just this year.
Over the weekend I was saddened to learn that fuel and electricity could not be paid for in Zimbabwe because she too, lacked foreign currency and her creditors and trade partners would not accept her battered currency, the Zimbabwe dollar, which the government recently devalued by 31%. And of course the country has turned to the IMF, World Bank and private institutions in order to attract foreign currency "capital inflows. "
Both countries argue that once they attract foreign currency that their local domestic currencies -- Ghana's cedi and Zimbabwe's dollar -- will strengthen.
Both countries will be sadly mistaken.
Currencies do not get their strength from the outside in, they get them from the inside out. But in order to pay some pressing bills and win the favor of foreign investors, both countries turn toward the West for an emergency loan, rather than inward, in an effort to strengthen their currencies.
And in the process they elevate the urgent over the important.
Then we look at the CFA Franc, which continues to move erratically while loosely tied to the French franc and thus, indirectly to the euro. As we wrote earlier in the year in ďThe CFA Franc and Africa's Monetary Dependence,Ē the CFA Franc will not benefit from such a weak and blind tie to the monetary policy of Europe. If for no other reason than the continent's currency woes, the nations of Africa have to seriously reconsider their current approach to monetary policy. The days of floating exchange rates like that in Ghana, and the pegged exchange rates in Zimbabwe and the CFA franc nations have to come to an end. Neither floating nor pegged exchange rates work well in economically developing countries.
Floating regimes tend to not work because developing countries have weak monetary authorities, a history of monetary instability, and are struggling to stamp out corruption, and there are rarely rules imposed on the growth of base money. Pegged exchange rates tend to not work because they require a monetary authority to simultaneously manage an exchange rate and monetary policies. A much stronger monetary regime with less susceptibility to political whims is needed.
The countries that dot Africa's landscape, including South Africa -- which is busy with a fruitless exercise known as "inflation-targeting" -- should seriously consider dollarization or "euroization"; or a fixed exchange rate regime -- either a currency board, or a continent-wide, pan-African gold standard.
Under a currency board an African nation would have its currency tied to the U.S. dollar at a fixed exchange rate and the only purpose of the African central bank would be to guarantee that exchange rate. Each day, the local central bank would have to make public its balance sheet and prove that it had at least 100% backing in foreign currency for its local currency.
Under a currency board, Ghana's central bank would not be able to print additional cedis and Zimbabwe's central bank could not print additional Zimbabwe dollars unless it received another U.S. dollar to back them.
A currency board, if firmly tied to a gold-price rule, would work far more effectively than the loose peg that the CFA Franc countries have had to the French franc. Under the CFA Franc regime, central banks have only had to maintain a 20% foreign-exchange cover and have had to deposit 65% of their foreign-exchange holdings with the French treasury. The system is not as transparent as a currency board and also has provisions that make it prone to the accumulation of huge external debts and the involvement of the IMF and World Bank, as countries still must attract foreign "capital inflows."
With a currency board firmly tied to a dollar-gold price rule, a central bank in Africa would tie its currency to the U.S. dollar at a fixed exchange rate, which it would maintain every day but it would only do so if the dollar-price of gold stayed within a certain range. This would enable the African nation to determine whether U.S. monetary policy itself was unstable.
In Ghana, it would work like this: the Ghana government would decree that it would officially honor and maintain a fixed exchange rate of 3000 cedi to 1 U.S. dollar. But it would stipulate that it would only do so if the dollar-gold price stayed within the range of say, $270 and $300 per gold ounce. Why? Because if the dollar price of gold went below $270 it would send a signal that the U.S. dollar was becoming too valuable relative to gold -- a sign of a monetary deflation that could depress world commodity prices. And if the dollar price of gold went above $300 per ounce, it would be a signal that the dollar was becoming less valuable relative to gold -- a sign of a monetary inflation that could inflate world commodity prices.
Ghana would be foolish to follow U.S. monetary policy into either an inflation or deflation just because its currency was fixed to the U.S. dollar. Watching the dollar gold price ensures that a currency board arrangement brings to Africa the best of U.S. or European monetary policy and not the worst.
The emphasis on the gold price cannot be understated as it is the nations such as those in Africa, that make their living from the earth and from the export of commodities. The dollar price of gold is the leading indicator of the future movement of world commodity prices. If the African nations had been watching the price of gold in 1996 and 1997, they would have known that the drop in the price of gold was a signal that the world was headed for a deflation and that commodity prices would soon be falling. And a currency board with a gold-price rule would have allowed the CFA Franc nations to avoid their dramatic devaluation in 1994.
Under a currency board, there would be no more need for repetitive emergency infusions of foreign exchange like both Ghana and Zimbabwe need today -- and which come with the heavy price tag of IMF and World Bank conditions. In the situation in which Ghana and Zimbabwe find themselves today, they will be forced to make major policy concessions just for the sake of an emergency loan to pay outstanding bills to creditors and trade partners who will only accept foreign currency, largely because the local currency is losing more and more of its value each day.
And part of the reason that these currencies are losing value, under their current monetary regimes, is that the central banks of these nations are printing money with no discipline or regard for a standard. They also are not taking consideration of the actual velocity of money in circulation. When the actual demand for a local currency has dropped, one finds that African central banks are still printing more and more money. They increase the supply of the currency when the demand for it has dropped. What they should be doing is decreasing the supply of the currency at the same time that they increase the demand for the currency. Increasing the demand for a currency can be accomplished by lowering marginal tax rates and cutting taxes on capital and by reducing regulatory burdens that discourage production and entrepreneurial activity.
In countries where corruption is so great and the trust level between the people and their leaders is so low, an African nation should consider dollarization or "euroization." Under this regime an African nation or group of African nations would stop issuing its local currency and make the U.S. dollar or euro legal tender inside of the country. This would allow the African nation to import the benefits of good monetary policy from abroad and would dramatically decrease central bank corruption and mismanagement, as there effectively would be no more monetary policy in the country.
The net effect of this monetary regime would be that it would virtually end the foreign exchange crises that Ghana and Zimbabwe are undergoing today which would help to eliminate the dependency of African nations on the IMF and World Bank.
While African nations couch their dealings with the IMF and World Bank in lofty economic terms, their relationship with the multilateral institutions is no different than that of a desperate debtor and a loan shark. The IMF and World Bank supply the credits necessary for African countries to obtain the foreign exchange necessary to pay their delinquent bills with creditors and trading partners. They use the IMF and World Bank to get emergency cash and this process has nothing to do with the principles of economic development.
African leaders and opposition groups know this but continue to lie and cover up the loan shark reality by telling their citizens that dealing with the IMF and World Bank are "necessary steps in order to improve the economy." They promise their people pie in the sky while the IMF and World Bank extract concessions from the government for the sake of quick cash. And to make matters worse, opposition groups to corrupt African governments use the IMF and World Bank aid to get leaders that they do not like out of power.
These opposition groups run and show the IMF their economic agenda, get its approval and then run all over the world to Western countries guaranteeing that they will open the doors to foreign investment if these Western countries will just help them get their "corrupt" leader out of power. Then, once these opposition groups themselves are in power, another competing opposition group rises and uses the IMF and World Bank to get the new government out of power. This scenario has been repeated a countless number of times in Africa with neither the government or opposition groups generating economic growth.
The only things they generate are dashed hopes among the electorate. By embracing effective monetary policies, African countries can take a firm non-partisan step toward political reform, peaceful succession, and the end of many forms of corruption. Dollarization and currency boards, if done properly, would allow these countries to get from under the grip of the IMF and World Bank, which take advantage of these countries' dependency upon foreign exchange.
Both dollarization and currency boards should be used as transitory monetary regimes as countries work toward the ultimate: a pan-African, continent-wide common currency backed by gold. Africa has the GDP, population, land mass and access to gold necessary to create a monetary regime that would be totally independent of the West. Forming a common currency and defining its value in terms of a weight of gold would virtually guarantee monetary stability and a competitive currency that could eventually become the strongest in the world.
Shortly after its inception, a pan-African currency could be on equal footing with the dollar and euro and would allow the continent to quickly move into the most profitable areas of the global economy like financial intermediation and high technology. It also would speed Africa's development of its manufacturing and service sectors.
A common currency defined in terms of gold would provide the stable environment necessary for the marriage of labor and capital inside of African nations and it would release the latent capacity, talents and skills of the African people as the rewards for risk-taking and innovation would no longer have to include a premium for inflation or deflation. Businesses could plan their activities for days, weeks, months and years in advance without having to worry about their currencies depreciating or the government devaluing the currency.
An African currency defined in terms of a weight of gold, would provide a clearly defined unit account by which all people could measure their units of labor, a necessary prerequisite if a currency is to fulfill its function as a medium of exchange between people and nations. It also would provide the foundation for the human-centered economy that the African people are crying out for.
African nations must come to terms with the failure of their monetary policies and embrace monetary regimes that promote currency stability, trust and economic growth. Its track record, up to the present, has been a dismal failure.
The people deserve much better than they have received.