Printing Money by CBL: Expansion of Money Supply or Replacement of Mutilated Notes?
In an effort to mop up excess Liberian dollar liquidity for sterilization purposes, the CBL has Conducted 11 CBL’s notes auctions and has redeemed 10 since the beginning of the auction Program in July, 2013. The total issuance during the year was L$2.8 billion with a weighted Yield of 6.51 percent.” (CBL Annual Report 2015, Page 27)
President Ellen Johnson Sirleaf is requesting Liberia’s legislature to approve the printing of bank notes. With limited or no public hearings, the Lower House recently approved the President’s request. No public explanation has been offered by the executive on why additional bank notes are needed and some members of the legislature were rumored to say the quantity and value of the bank notes are classified.
Accordingly, speculation is rife that the government of Liberia may be going beyond just replacing mutilated bank notes to issuing additional currency with the aim of increasing the money supply and gaining seigniorage revenues. According to social media supporters of the administration, the government had foregone these revenues in the growth and expansion of the Liberian economy from 2006-2012. What exactly is seigniorage?
Seigniorage is defined literally as the right of the lord to mint coins, which were typically gold, silver or other precious metals. In medieval times, this right was granted to the lords unreservedly and as circumstances dictated, the values of the coins were mostly decreased by mixing the precious metals with others, and thus inflation was introduced when more valuable coins were replaced with less valuable ones.
Today, most central banks print money, using what is generally referred to as fiat currency or paper money, with no intrinsic value, except backed by the full faith and credit of the government issuer to pay debts and other expenses such as salaries, goods and services or to propel economic expansion by investments in capital projects. The issuance of currency has costs and benefits. The benefits, which are the gains for issuing fiat currency with no intrinsic value can accrue income to central banks, which are fiscal agents for the government and these revenues are remitted to the national treasuries. Thus the term monetary seigniorage, which is gained by issuing currency.
Countries with stronger economies and well-structured financial systems print money routinely but with serious thoughts on the social costs, which are inflationary and can reduce the purchasing power of citizens and have serious economic consequences. Therefore the issuance of currency should be based on a science, with clear guidelines on how to relate the money supply to productivity and growth in the economy. In the late 1970’s and through much of the 80’s, inflation in the US was very high, pushing interest rates up significantly, spurring inflation and eroding the purchasing power of ordinary people.
During the last economic crisis in the United States that began in 2008, the US Federal Reserve used a method called “quantitative easing” to inject liquidity into the country’s financial system in order to stave off the disastrous effects of the downturn in the housing market, which had global reverberations. The verdict is still out on the efficacy of the method, but the Obama Administration believes “quantitative easing” helped nurture the economy back to health and revitalized critical sectors, such as the housing and automobile industries, which are responsible for a substantial amount of economic output and jobs. But at great costs! Mind you, the net effect of “quantitative easing” was an increase in the US national debt, which stands at 19.2 trillion dollars as at April 30, 2016. The debt climbs by the seconds.
Responsible governments do not print currency willy nilly due to the negative consequence of price level changes, making the value of paper money reduced substantially, or worse yet to make it worthless. Thus, If not sequenced and accomplished with much study of the negative effects or done properly, it could be disastrous. Countries with weak economies that have issued currency as an alternative to taxation to defray expenses without the corresponding economic growth have seen hyperinflation as was with Germany during the Weimar Republic, from 1921-1924 and recently in the case of Zimbabwe, from 2000 to 2009 with inflation of more than 1,500 percent annually.
The Weimar Republic issued currency to defray the expenses of World War I, while Zimbabwe issued currency to pay regular expenses due to a drastic downturn in GDP growth, as a result of the economic, political and social policies of the Mugabe government. To Liberia’s credit, inflation has been kept at bay to single digits for most of this administration, of which core inflation was 9.9 percent (CBL Annual Report 2015), while other West African countries have seen price levels rise higher. We can thank the dual currency regime, workers’ remittances that in some years reach 400 million dollars from Liberians in the Diaspora and minor improvements in economic output during the pre-Ebola Virus Disease (EVD) outbreak period.
Liberia is in a difficult position when it comes to issuing additional currency for several reasons. The country was the 14th most dollarized country in world with the US dollar estimated to be 90 percent of broad money (M2) in 2007 (IMF REPORT) The value of M2, which is currency in circulation plus quasi or near money, such as checking and savings accounts and other liquid assets was more than 70 percent, according to the Central Bank of Liberia Annual Report of 2015. The rate of dollarization can be technically defined as the ratio of Foreign Currency Deposits to Broad money or FCD/M2. The US dollar share of broad money was 41.5 billion Liberian dollars at end of 2015.
A country is considered dollarized when more than 20 percent of broad money is denominated in a foreign currency. Our country also uses the US dollar as legal tender along with the Liberian dollar, making it a hybrid dollarized economy. Thus the use of seigniorage is severely limited as we cannot print both currencies. We can only print the Liberian dollar portion in circulation of broad money.
Considering the ratio of Liberian dollars to US dollars (30:70) in M2, using the CBL own figures, any significant alteration in the Liberia dollar ratio to US dollars, unaccompanied by significant economic output could be highly inflationary and cause social tension due to the reduction in purchasing power by Liberians. Adding to our challenges are the dire circumstances of slow economic growth. Growth projected for 2015 to be 0.7 percent is now reduced to only 0.3 percent, with nominal GDP at 2 billion dollars from World Bank estimates and real GDP at 899 million dollars as of December 2015 from the CBL Annual Report.
Liberia’s economic problems are mostly due to reduction in the value of its primary exports, with rubber and iron ore prices declining drastically on commodities markets and lack of economic probity including corruption, cronyism and overreliance on rent seeking activities. With the decrease in economic output, obviously, government revenues are suffering, with a projected deficit of more than 70 million dollars in the national budget for fiscal 2015/2016, equivalent to 7 percent of real GDP.
Clearly, the cynics including this writer would want to believe that the government’s efforts to print additional money is to make up in seigniorage revenues with what it cannot from the contraction in the tax base. The temptation will be too great, especially for a government nearing its end and that could be very costly for Liberians, if the optimum revenue gains from seigniorage that can only be 2 percent of real GDP (in our case only 18 million US dollars) according to most economists is exceeded, making it counterproductive to print additional currency for several reasons. Some economists believe that dependence on seigniorage revenues is correlated to political instability or lack of social cohesions in countries (Aisen and Veiga, 2005).
Another reason why Liberia is in dire straits is due to fact that the country is import dependency. Most consumer goods are produced abroad, including rudimentary agriculture products such as spices and grains from the neighboring countries. The trade deficit in 2015 widened to 2 billion dollars in 2015, from 1.5 billion in 2014!
In order to import, Liberia needs foreign currency, principally the United States dollar and it would have to exchange newly printed Liberian dollars to import making it more expensive to do so with additional local currency in the money supply. This is all happening while the foreign exchange reserves are below the minimum West African Monetary Zone (WAMZ) requirement of 3 months of import, down to 2.7 months, albeit a modest improvement from 2014 when it was 2.4 months.
It would be bad monetary policy to infuse a large amount of printed currency into the economy at one time, and therefore, even if 2 percent of GDP as seigniorage income is to be earned, that must be phased over a period of time with inflation cures and in addition to expansion of economic output, especially in sectors that earn hard currencies. Therefore, seigniorage income cannot be the basis for printing additional and substantial amount of currency to be infused into the financial system, as that income is not worth the risks, and I am convinced that Liberia’s monetary authorities are smarter and wiser than to base expansion of monetary aggregates solely on gains in seigniorage.
Furthermore, the CBL reported in its annual report of 2015, that since 2013 it has been mopping up excess liquidity by selling treasury notes and sterilizing the Liberian dollars. That was five months ago. What has been the dramatic developments in the economy to change policy, and now instead of mopping up excess liquidity of Liberian dollars and sterilizing, the CBL wants to print more Liberian dollars? It does not make sense or pass the smell test.
The government of Liberia needs to be frank with the public. It must tell us how much is being printed. How much of that is due to replacement of mutilated notes and how much is due to their aim to gain seigniorage revenues? I trust that we can all deliberate before plunging Liberia into the unfathomable depths of dramatic defacto currency devaluation that will spell disaster for an already poor and desperate populace. And so it goes.
About the Author:
Samuel P. Jackson is a trained banker, with undergraduate and graduate education in Banking, Economics, Management, Quantitative Methods and International Business. He worked at Chase Manhattan Bank, Bank of America, and Credit Suisse in New York City and consulted with several international and domestic firms. He was also Minister of State for Economic and Financial Affairs of the Republic of Liberia. He can be reached at [email protected]