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Sunday, February 5, 2023

In absence of resources to back up the Currency

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In absence of resources to back up the Currency

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These folks at the Central Bank of Sierra Leone need to go back to school and study real financial economics and monetary theory, not the voodoo economics they are practicing. For God’s sake….Why would any central banker arbitrarily appreciate currency without any appreciable assets to back up the currency, or No exploitable resources/assets to export to improve our balance of payment and purchasing power?

The current value of the Leone is the true value of Sierra Leone’s GDP and GNP that underlines the purchasing power of Sierra Leone’s economy. So knocking off zeros from the currency is arbitrary, and it depreciates all asset values for all Sierra Leoneans. A house that is worth 100 million today will be worth 10 thousand without any compensation to the house builder that bought building materials at the current prices with the zeros.

If you have 1 billion Leones in the bank today, it will be worth 100 million after they remove the zeros, even though you have earned the 1 billion at current asset pricing.  Essentially Bank of Sierra Leone is depreciating the real value of all assets, wages, goods and services by revaluing the currency, without any parity pegging of the Leones, to an international currency like the US Dollar, Euro or British pounds.

And since such pegging cannot be done because we do not have the productivity of exportable resources to back the Leones, our Bank of Sierra Leone folks are doing this tactical appreciation of the Leone currency to mask (put bandage on) the hyperinflation in the country in order to qualify for the West African monetary zone’s current participation requirement.

Economics is a science not an art and folks at the Bank of Sierra Leone need to understand the costs and benefits of their policy decision on the citizens and businesses in the country. Such a drastic arbitrary move requires a six months consultative public debate and transition to allow business to deplete current inventories and supplies already paid for or purchased at the current high prices, Allow employers to make adjustment for Labour wage rate and employee benefits differentials.

Sierra Leoneans will become poorer over night when this currency appreciation takes effect. In hyper inflationary counties like ours, residents and businesses do not hold cash in the bank because inflation eats all returns on your cash money; they instead buy tangible assets like land and/or build houses with their money, because tangible assets hold their value, and appreciate faster in value as compared to inflation. But if the government appreciates the inflated currency over night without a buyout adjustment and/or compensation for lost value, it will impoverish residents and businesses.

Sierra Leone to Redenominate Leone: What Is Redenomination?

A Commentary By Ranger

Modern history has many examples of redenomination, most of which occurred in the post-war period or in developing and underdeveloped countries.

Redenomination is an auxiliary tool that accompanies a decrease in the money supply and eliminates the effects of hyperinflation. Redenomination is proportional substitution of national currency bills for bills with a lower denomination. Simply put, extra zeros are removed.

For example, effective 1 July 2007, Ghana redenominated the national currency, the Cedi (¢). Ten thousand Cedis became equivalent to one Ghana Cedi. The re-denomination did not affect the intrinsic value of the currency – the value remained the same.

Two of the reasons given by the Central Bank for the re-denomination are the increasing difficulty in maintaining accounting and statistical records and problems with accounting and data processing software.

By itself, redenomination can cause panic – leading the population to buy up hard assets or foreign currencies, thus further exacerbating the situation.

For example, in August 2018, Venezuela held a major redenomination and took 5 zeros from the national currency. 500 bolivars became the largest bill, but this did not change the situation. Within a year, this bill could buy one egg, and the minimum wages of 40,000 bolivars – as much as two kilograms of meat.

As a result of the deep economic crisis in the country with the largest explored oil reserves in the world, in 2018, according to the IMF, hyperinflation exceeded 1 million percent. Venezuela is a good example of how one of the most effective economic instruments for overcoming the crisis turned out to be useless.

=Factors preceding redenomination:=

Imbalance in the national economy: Significant prevalence of imports over exports, unjustified growth of money supply not provided by production, budget deficit, growth of public debt and its maintenance costs, growth in unemployment, etc.

Hyperinflation: The imbalance of the national economy leads to uncontrolled price increases. To support the population, the state resorts to issuing. The increase in the money supply creates a new round of demand, followed by a new increase in prices.

=Denomination goals:=

Moving capital out of the shadow – The population that stores money in national currency will be forced to exchange it in any way possible. History knows examples where, in order to detain the economy, stringent conditions for the exchange of money involving personal identification were introduced.

For example, in Russia in 1993, two weeks were given for money exchange, the restriction was 100 thousand rubles per person, and the passport was stamped upon exchange. These measures were ineffective, because, instead of exchanging for a new currency, the population will invest shadow money in foreign currency, gold, and real estate. And such cash flows cannot be controlled.

Simplification of calculations – Operating in amounts with no extra zeros is simpler and more convenient.

Reduced issuing costs – Large bills require the issue of change bills/coins, the cost of which sometimes turns out to be higher than face value.

Redenomination is often accompanied by a decrease in the money supply (withdrawal of money from circulation) in order to contain and prevent inflation. Therefore, we can say that redenomination is also an auxiliary step towards strengthening the national currency.

Redenomination can cause huge amounts of money to be withdrawn from the banking system, effectively dehydrating the national economy. Thus, the best time for redenomination is the beginning of economic growth or a radical restructuring of the economy after hyperinflation is stopped. A crucial factor determining the success of this event is awareness-raising among the population.

Neglecting this need, redenomination could further aggravate the economic situation as it would fuel panic and demand for other safe-haven assets: foreign currency, essential goods, etc. Prices for these assets would rise while real estate and expensive property would fall.

Redenomination will not be effective if it is not accompanied by economic growth, which means inflation control, GDP growth, a decrease in unemployment, balancing the country’s balance of payments, etc. The example of Venezuela from the beginning of the review is what will happen if this principle is ignored.

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