How the monetary system operates
By: Ben Patrick
All money we use today is called fiat money. Meaning it’s just paper and has no value. This also applies to the US dollar, the British pound, the euro and all other currencies you know.
What gives fiat money the value is the law. The law says pay the bearer on demand. If you don’t accept the legal tender you are liable to imprisonment or fines. Otherwise real money ended with the gold standard that was there between 1878 -1914. In fact the US dollar only became fiat money in 1971 when President Nixon closed the gold window therefore forbidding the exchange of the dollar for gold!
So how do governments print money?
In the gold standard, governments would only print money equal to the gold reserves they had. In this case there was no inflation. Each coin or note had an equivalent amount of gold to back it up. Today, there are various formulae that exist to determine how much a government should have in circulation. One economist argued that the amount of money a country needs should be equal to the price of all goods in a particular country.
Well, in so many countries, money is printed based on an amount such that the holy trinity is happy i.e. interest rates, exchange rates and inflation. Too much money because of very low interest rates leads to high inflation and depreciation of the local currency while high interest rates can lead to stable exchange rates as forex moves in from investors wishing to gain on the interest rate arbitrage. But high lending rates can reduce economic growth. So the headache of the monetary authority of each country is to find a balance using available monetary policy tools.
In 2010, the holy trinity was stable but in terms of infrastructure, South Sudan was 55 years behind the Sudan of today. So when the world bank and IMF begun emphasizing the need to enhance policy framework, infrastructure development, the government then started formula 1 which is now called Dumbo $ 30000. Other very ambitious projects were created and I am sure if you wake up the dead from 2010, they won’t recognize the South Sudan of today. So what has this got to do with the monetary system? Well, various infrastructure projects were funded using borrowed money.
So when government gets forex debt, they give the forex to the BSS which is their bank to exchange for South Sudanese pounds in order to pay contractors. That is why the period 2011-2015, there was a lot of liquidity in the economy because as we borrowed we increased money supply. Now the exchange rate and interest rates are unstable because the money that was introduced into the economy by the BSS was backed by forex given to the BSS by government.
The problem is that during infrastructure development, some materials were imported and contractors were foreign so when they were paid in South Sudanese pounds they started demanding forex to either externalize profits or to buy materials.
From 2016-date various stakeholders started crying for austerity measures to be implemented and cut on borrowing. In fact debt major debt growth shoot-up in 2017. It might appear that even at that period debt was growing fast because of the way you calculate debt. For contractor funded projects you add debt as the disbursements come in. So debt acquired in 2013 can only partially appear on our balance sheet because that project has been halted. Because a lot of people don’t understand this, they start speculating on real debt levels.
So why is there a liquidity problem now?
Remember we are now repaying debt through oil. In the beginning we were increasing money supply and everyone was happy and money trickled down from contractors to other sectors of the economy. So now government collects its revenue in South Sudanese pounds and takes it to the central bank to get forex and then that forex is used to payback forex debt. So as we repay forex debt, we are withdrawing money from circulation. So money supply reduces. Each time we repay forex debt, the SSP equivalent is withdrawn from circulation.
Ideally at this stage we are supposed to experience very low inflation because of reduced money supply.
So what is causing high inflation?
It’s the exchange rate. Because we are demanding forex to pay debt, buy fuel, fertilizer and other goods we consume, we have put pressure on the South Sudanese Pounds. So when the South Sudanese pounds lose value, prices of imported goods move up.
Even South Sudan producers hike their prices because psychologically their currency benchmark is the dollar.
So what is the treatment?
This is where I now differ with my colleagues. Austerity measures cannot take a country anywhere. Instead of austerity we need to just optimize expenditure. The word austerity creates an impression of a country in Greece’s position. What we need to do is to ensure that we encourage more forex inflow into the country. Our major privatization forex earner has not been sincere with us. That forex should be not banked locally. So for me, the lasting solution is to come up with interventions that will boost forex. A deliberate program should be implemented to do that ASAP.
Role of speculators
There are too many speculators in the market and also measures should be put in place to avoid speculation.
Well Greece got billions of dollars from the IMF. What is their situation today? We however need to work with the IMF because they control the international monetary system. They were created in 1944 to specifically ensure stable exchange rates for member countries. So unfortunately we have to obey their rules otherwise we shall end up like Ecuador or Zimbabwe who have no currencies of their own. But following their guidelines does not mean getting their loans.