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Efficient remonitisation key to economic stability

Ken Gichinga

This year’s Madaraka Day celebration delivered unusual excitement to Kenyans following the announcement by the Central Bank of Kenya Governor Patrick Njoroge, that a new generation currency had been introduced to replace the old one.

Of equal importance, was the pronouncement that Sh1,000 note will be withdrawn from circulation in October. This is in keeping with the heightened war on corruption.  And for this, we commend President Uhuru for the bold move.

In the next few months, economists shall pay close attention to how the Central Bank of Kenya navigates the sensitive process of demonetisation, which has experienced both success and failures in different countries. So why have some countries successfully executed demonetisation while others have failed?

The answer is that money has three distinct functions. It serves as a medium of exchange, as a store of value and as a unit of account. Countries that have successfully conducted demonetisation, have managed to change the medium of exchange without disrupting the stored value.  This is achieved through an efficient process of remonetisation, which is the process of introducing new currency to ensure that money supply in the economy remains steady.

Australia is a shining example of how a country can demonitise and remonetise in an efficient way that minimises disruptions. In 1996, faced with a similar set of challenges around fraud and counterfeits, the Australian government withdrew its paper-based notes and adopted polymer-based notes.

With a singular purpose of replacing paper with plastic, the government was clear that only the medium of exchange was changing, and it made every effort to ensure that stored economic value was conserved through an aggressive remonitisation process.

Similarly, the European Union (EU) demonstrated how successful demonetisation is achieved when 12 EU countries did away with their national currencies and adopted the Euro on January 1, 2000.

The European Central Bank prepared for almost three years while participating countries distributed eight billion notes and 38 billion coins through banks, post offices and sales outlets making it arguably one of the most aggressive remonetisation exercises in monetary history.

However, countries that have poorly managed demonetisation have ended up causing untold suffering to citizens. In this respect, India provides powerful lessons on the difficulties that can arise when demonetisation is bungled.

In November 2016, Prime Minister Narendra Modi, in a surprise announcement, declared that the 500 and 1000-rupee notes would be banned in four hours’ time. People were given several weeks to exchange their demonetised currency for new notes at banks.   But new notes could not be printed fast enough, and the policy sparked a currency crunch, cost India more than 1.5 million jobs and wiped off at least one per cent from the country’s GDP.

The US also bore the brunt of poor demonetisation. The Coinage Act of 1873 demonetised silver in favour of the gold standard as the legal tender.

The withdrawal of silver from the economy, was not counterbalanced by any form of remonetisation resulting in a contraction of the money supply, which led to a five-year economic depression. In response to the situation and pressure from silver miners and farmers, the Bland-Allison Act remonetised silver as legal tender in 1878. 

Reflecting on the hardships that arose after the demonetisation of silver, Senator John Reagan would later on write “I am persuaded history will write it down as the greatest legislative crime and the most stupendous conspiracy against the welfare of the people of the United States, which this or any other age has witnessed.” Senator William Stewart would add, “The demonetisation of silver was the crime of the 19th Century.”

The key formulators of Kenya’s monetary policy are invited to consider both the positive and negative outcomes that different countries have experienced when conducting demonetisation.

The balance of evidence suggests that the Sh230 billion that will be withdrawn from the economy, will need to be conserved and reintroduced back into the economy through an efficient process of remonitisation. Anything less, could lead to a contraction of money supply, which could unleash powerful deflationary forces. — The writer is the chief executive at Mentoria Economics [email protected] —CNN

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