Economics was defined by Prof. Oluwasanmi in his days at University of Ife as common sense made difficult by complex theories, intricate analysis and jaw-breaking formulas.
To his credit my approach in this paper will deliberately follow the message in the Professor’s definition of economics so as to simplify and logically develop a policy option largely from our Nigerian experience of currency reform and restructuring of the naira.
Let me begin by stating some facts:
– Excessive increase in money supply leads to drastic declines in the value or purchasing power of money
– The continued drift in the value of the naira is due mainly to too much of it being pumped into the economy by monetary authorities.
– Since the introduction of the Naira in 1973 money supply has expanded significantly while the value of Naira has continued to decline such that the smaller denominations (half kobo, one kobo, five kobo and twenty kobo coins) are today no more and fast forgotten. It is also true that the fifty kobo and one naira denominations are extinct, having been en-coined and left to die due to inflation
– It is no fiction that even the values of the bigger denominations have been significantly eroded raising threat level on the Naira to unprecedented levels of CRITICAL.
– It is also no longer news that various administrations, including the present one have been battling with how to restore the value or bring down the threat level. The CBN has had to introduce the N1000 note by end of 2005 as well as project turn N5 and N10 notes into coins.
– CBN under Prof. Soludo as part of its 13-point reform agenda tried to restructure the nation’s currencies-the first at the time in 22 years (1984) when the last restructuring of the naira took place. The Governor (Soludo) himself gave average number of years in which a currency should be restructured as Eight years.
– By the end of (2006) CBN restructured and re-issued N50, N20, N10 and N5, using the vanishing technology do double the lifespan of our currencies, hence claimed to have reduced the cost of production by 50 percent. The same CBN under Prof. Soludo pushed for the redenomination of the Naira sometime in 2007/2008 but failed to do so because both the Nigerian people, Political Class and government officials were not properly sensitized.
– CBN has turned full circle under a new leadership and seems to have abandoned the Soludo approach in favour of continuing the old practice of introducing higher denominations of its currency while encoining the lower denominations. It is therefore not surprising that the CBN has yet again proposed higher denomination of N5,000 and to encoin lower ones’.
This paper sees no better time to contribute towards the adoption of the most effective currency reform option for Nigeria. But first, I will state more facts:
a. The Federal Government and indeed monetary authorities have tended to rely heavily on the traditional contractionary monetary and fiscal policies to address inflation and restore some value to Naira by reducing the quantity of it that is in circulation. Remember CBN’s “STABILISATION GUERRILLA MONETARY WARFARE”?
b. Above method has not proved very effective in restoring the value of the Naira as prices have continued to rise at a faster or lower rate. More so, such policies tend to exert adverse effects on the growth of real output and employment by reducing the amount of funds available for investment purposes.
These problems, amongst others, no doubt informed CBN’s determined effort to find a lasting cure albeit using orthodox intentions and strategies.
Our proposed option seeks to circumvent the shortcomings of monetary and fiscal contraction policies of CBN. The plank of our argument is based on the fact that FIAT money has no intrinsic worth in itself but its value depends on what has been assigned to a unit of it by the government or monetary authorities at the time of its inception. We therefore, humbly believe that it is possible to restore the purchasing power of the Naira using Crude quantity theory of money.
We will show how drastic reductions in money supply can be achieved in such a manner that all prices cascade down-wards in the same direction and proportion as money supply. Thus, restoring the purchasing power of money without exerting any adverse effects on the level of real output and employment. First let’s briefly go through the conventional methods of Currency Reform as a refresher.
Conventional methods of currency reform
The following are some of the known conventional methods that a country can use to reform its payment system:
A. Dollarization:
– This refers to the use of foreign currency, usually the US dollars or in recent times the Euro for real financial transactions in a country.
– It is a devise adopted to sanitise or stabilise a nation’s ailing economy..
i. Full dollarisation:
– When a country abandones it own currency and officially adopts for example the US dollar as its legal tender, it is said to have fully dollarized.
– Example of fully dollarized economies include Ecuador, El-Salvado and Panama. Countries that dollarized and de-dollarized include Mexico, Isreal, Poland, Slovenia and Bosnia Herzegovina.
– Dollarisation is only appealing to countries with close links to the USA.
– Dollarisation provide a means for ‘importing’ monetary stability but limit the scope for domestic control over monetary and fiscal policies.
ii. Partial dollarisation:
– This occur when a country retains its own Currency, but also allows payments and transactions to be carried out for example, freely in US dollars. Partial dollarization is more wide spread.
– Examples of partial dollarization include some countries in Latin America, Asia, Africa and the European transition economies.
B.? Common currency
– This is the use of a single supper national currency by member countries of a monetary union and usually managed by a supranational central bank.
– Examples include the European Union (EU), which introduce the Euro as its common currency in 1999 and became legal tender in 12 EU countries in 2002. The French speaking countries in Central and Western Africa have at a point in time used the CFA franc as their common currency since 1984. The Economic Community of West Africa States also plans to introduce the ECO as its common currency.
– Common currency is more successful where there is an already high level of Inter-union trade, with a well diversified and structurally complementary production and export base.
– Common currency like with dollarization provide the means for importing monetary stability, but limit the scope for domestic control over monetary and fiscal policies.
C. Introduction of higher denominations:
– Whenever the value of money has been significantly eroded by inflation, the practice in some countries, e.g. Nigeria, is to introduce higher denominations of the currency and turn the remaining lower denominations into coin.
– For example, over the years, the initial 1/2K, 1K, 5K, 10K and 25K Nigerian coins are long extinct, hence, the 50K and N1 notes were turned into coins to replace them.
– These were quick to disappear and responsible for the move to turn the N5, N10, N20 and N50 notes into coins to retain coinage in the Nigerian payments system. The CBN introduced N1000 note in 2007.
– Example of countries that have introduced higher denominations and turned the lower notes into coins include:
• Ghana, where the 20, 000 cedi note was the highest denomination.
• The 60-year-old CFA Franc common currency used by the French speaking Central and West African countries had 10, 000 CFA Franc notes as the highest denomination.
• In the advanced world, countries such as Japan have up to 500 Yen in coin denomination
– The existence of very high denominations often reflects a history of ambitious monetary policy regimes, which may or may not have yielded the desired results. For example, in the case of Japan such a regime is evident in the strength of its economy. On the other hand, high denomination epitomises weakness of the economies of less developed countries.
– The introduction of higher denominations does not bring back into effective circulation the smaller denominations that have disappeared. Instead, it usually turns more notes into coins.
– Most currencies that have high denominations usually have high exchange rates, high average prices and low value of money. In other words, this method does not restore the past value of money.
The Nigerian experience in currency restructuring:
– In 1973 the Naira was first introduced to replace the British West Africa Pound Sterling.
– A fixed exchange rate of N2 to ?1 was used to exchange the two currencies.
– This exchange was also used to convert all prices, all accounts and other nominal magnitudes from Pound sterling to the naira currency.
– To achieve this, all accounts were multiplied by an Index of 2 to convert them to the naira currency.
– In April 1984, the Federal Government changed the colours of four denominations of naira notes. This was the last time an attempt was made to restructure the naira.
Proposed scheme to restructure Nigeria’s currency:
– The proposed scheme essentially reverses the old procedure adopted by Nigeria in 1973, but this time, instead of using multiplication of an index, the procedure will be through a process of deflation or division, using a fixed index of conversion.
– The new proposal will also show that changing the colours and design of money along side the above process of deflation can be done in a manner that value of the Naira is effectively restored.
– The method revolves around the selection of an index (as done in 1973) which captures the magnitude of the decline in currency value with which all the denominations of a weak currency, all Accounts and all nominal magnitudes are to be deflated.
– Just as the index of 2 was used in Nigeria in 1973, any index can be used to achieve the same objective regardless of its mode of computation as long as the index used equally multiply or divide the money supply and all prices, as well as account s expressed in money terms. The effect in so doing is only on nominal values leaving the real economic variables intact.
– In other words, it can only increase or decrease the nominal money supply and all prices, but has no essential effect on real output and employment in the short-term. In the long-term, it can be used to accelerate the growth of real output and employment in the economy.
– The index adopted in the proposed scheme will depend on the perceived extent of the decline in the value of money.
– For example public opinion in Nigeria puts the purchasing power of the present N100 as the equivalence of only N1 years ago.
If this is accepted for example, it means that all denominations of the Naira and all economic magnitudes expressed in monetary terms (prices of goods and services, Salaries and wages, savings, wealth, value of landed property, all accounts expressed in naira terms etc) are to be equally deflated ( divided) by this index when changing from old to new naira currency.
Transfer of purchasing power through currency redenomination
This scheme to restore the value of money involved:
– Transfer of purchasing power from higher denominations of the present currency say N100 whose value has considerably declined to a lower denomination of new currency, say N1.
– The value of new N1 note will now be legally defined as the equivalent of N100 of the present currency that is proposed for withdrawal from circulation.
– The effect is that whatever good or service the present N100 can purchase; the new N1 should be used to purchase it.
– All denominations of money and all monetary magnitudes will be deflated by the adopted index of 100 when converting from old to new currency.
*purchasing power in terms of the proposed new currency.
Money supply and price
The effect of indexing and deflating the Naira on money supply and prices using the index of N100 for example are:
– The monetary authorities will drastically reduce money supply by as much as 99 percent, leaving only 1 percent of pre-change level while maintaining the same level of economic activities as before.
– Using the same index of 100 on all other economic magnitudes, all prices in the economy would also automatically fall by 99 percent and retain only 1% of their former levels.
– All goods and services would immediately cascade downwards in proportion with the reduction in money supply in true quantity theory manner.
– While the scheme affects the general price level, it is neutral on rate of inflation.
– The reason is that only changes in money supply in the conventional monetary policy manner affects the rate of inflation and/or rate of change in real output and employment in the economy.
Income and consumption:
The effects of indexing and deflation on incomes or salaries and wages, savings or wealth generally are as follows:
– A multi-millionaire who has N182 million is converted to N1.82 million in new currency.
– A worker who earns N53, 625.00K per month is converted to N536.25K in new currency.
– An individual whose savings is N450, 000 in present currency is automatically converted to N4, 500 in new currency.
– A landed property worth N30 million in present currency is converted to N300, 000 in new currency.
* In real terms, the two amounts in old and new currencies are equal since? they command the same purchasing power.
* The scheme has neutral effects on real demand and supply, or consumption and production of actual goods and services.
– The scheme only gives an alternative indication of the real incomes or real wealth of people, without reducing in real terms.
Some important clarifications:
(a) Cost of producing money will reduced since reduction in money supply from this scheme implies substantial reductions in the costs of printing and minting currency notes and coins.
(b) Effects on real variables is nil. The scheme as suggested has neutral effects on the real variables in the economy just as was the case in 1973.
– The scheme is also neutral on bank rates, interest rates and profit margins, etc.
– The scheme is also neutral on real demand and supply of actual goods and services, both within the domestic economy and international trade.
(c) Monetary and Fiscal policies
– The scheme provides greater scope for enhancing monetary and fiscal policies (if needed).
– A 99 percent reduction in money supply as demonstrated using the index of 100 percent to deflate on currency will take even the most reckless governments’ decades to return to its pre-change levels.
(d) Exchange rate:
– The present relatively stable exchange rate of about N158 to the US dollar will remain stable at the exchange rate of N1.58 to the dollar in terms of the new naira currency.
– The above will not necessarily change the present pattern of importation and exportation, hence will not on its own adversely affect Nigeria’s balance of payments position.
(e) Plan to introduce the ECO (ECOWAS common currency)
– The scheme can be used to bring about significant convergence in the internal and external values of the currencies of ECOWAS member countries.
– Facilitate comparability of the exchange rate of the ECO to the US dollar or EURO.
Conclusions:
– The method of restructuring the denominations of the naira in such a manner that their values are effectively restored constitute a viable alternative to the currency strategy adopted by the CBN.
– The CBN’s strategy increasingly introduce higher currency denominations and convert more notes into coins without restoring the lower denominations that have disappeared.
– Our proposal makes it possible for the CBN to restore the value of all denominations of the naira and bring back into effective circulation all lower denominations that have disappeared.
– Our proposal will greatly increase the prospects of achieving the goals of currency reform and government economic policies.
– Our proposal to convert from old to new naira currency is very simple to comprehend. With effective public enlightenment, Nigerians will understand the conversion procedure as was done in 1973.
– Ghana did it and it is working.
— Ndanusa is an economist and? former director-general of the Securities and Exchange Commission (SEC)