21 June 2019

Liberia: President Weah Can End Inflation By Instituting a Currency Board

According to the International Monetary Fund, during 2018, Liberia saw a 26% depreciation in its exchange rate and a 28% spike in inflation. Inflation is Liberia's most pressing concern, but it is not a problem without a solution. President George Manneh Weah and the Government of Liberia can, in fact, minimize and even eliminate inflation within weeks by instituting a currency board (CB).

Inflation in Liberia owes to the Government's practice of borrowing from the Central Bank of Liberia (CBL). Rather than raising taxes or borrowing from the domestic market to offset its spending, the Government instead relies on newly minted Liberian dollars (L$) received from the CBL. According to the CBL's annual report, the circulating supply of L$ grew by 50% in just two years, going from L$12,755.1 million at the end of December 2016 to L$ 18,888.6 million at the end of November in 2018. This trajectory is not sustainable. Printing new money to pay expenses causes more L$ to chase the same amount of goods and service and leads to surging prices as this money arrives without any commensurate increase in production. Even more, flooding the economy with new money increases the amount of available L$ relative to the US$, causing a devaluation of the L$ and bidding up the price of the US$.

Depriving the CBL of the ability to print money to fund the deficit would require that the Government institute a CB. As an example of such a bold but essential move from recent history, consider the observations of the late Lee Kuan Yew, former Prime Minister of Singapore, who instituted a rule preventing the country's central bank from printing money to fund the government. "Keng Swee and I decided in 1965," Yew noted, "that Singapore should not have a central bank that could issue currency and create money," because "we were determined not to allow our currency to lose its value." And so, he concluded, "we retained our currency board which issued Singapore dollars only when backed by its equivalent in foreign exchange." At independence, one Singaporean dollar equaled one Malaysian ringgit; one of those same dollars now equals 3.06 Malaysian ringgits.

A CB has the authority to issue notes and coins convertible upon demand into a foreign currency at a fixed exchange rate. Reserves in foreign exchange or commodities back the domestic currency, a requirement which is set by law. The coverage could be 100-110% to ensure full convertibility. The local currency effectively becomes a replica of the anchor currency and gold. Moreover, a CB is passive, its role confined to investing the reserves underpinning the currency while exchanging the domestic currency with the foreign currency at a fixed rate. A CB does not set monetary policy (i.e., interest rates), a practice typically undertaken by a ministry of finance or similar government department.

For a CB, profits derive from the difference between the Board's earnings on the investment of the reserves and its own operating expenses. Unlike a central bank, a CB can neither print money to pay its operating expenses nor bail out banks or failing government enterprises (the root cause of inflation and devaluation). A CB issues currency only after obtaining reserves in foreign currency or gold; hence, the quantity of money in circulation is determined by demand for the local currency. Best of all, a CB is easy to implement, capable of being up and running in as little as three months.

Boards of this sort have been established in 70 countries, beginning with Mauritius, in 1849, and where they have been implemented, they have compelled governments to live within their means. The fiscal discipline at the heart of a CB yields lower deficits, reduced inflation, fewer banking crises, diminished currency risk, and more direct investments due to the full convertibility of the currency.

While some may argue that a CB's inherent fiscal discipline could discourage governmental support for unprofitable ventures, the overall and long-term benefits for society from lower inflation, reduced interest rates, greater investment, and increased predictability far outweigh any short-term drawbacks. What is more, when a CB is implemented for the first time, risks can be managed through financial settlements and other manners of stewardship.

If Liberia were to establish a CB, it could expect technical assistance in implementing such change. Commenting on the efficacy of a CB in halting the ongoing devaluation of the Turkish lira, the editorial page of The Wall Street Journal recently concluded that, "The best solution is to implement a currency board that fixes the lira to the dollar or the Euro. After freezing the monetary base, the lira would float for a period before a fixed rate is set. A currency board would also force Ankara to address its fiscal problems, since it couldn't pursue monetary schemes to finance wasteful spending."

The Liberian people deserve a sound currency, and President Weah's agenda to advance the wellbeing of the nation's poor can only be served by instituting a CB. Half-hearted measures will merely prolong the agony and sufferings of our people.

Liberia

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