To what extent can a central bank print money?

The Bank of England (BoE) has issued banknotes since it was established in 1694. In this context the term issuing means the same as printing. The bank notes have traditionally been printed on paper substrate.

Daniel Ngwira,Chartered Accountant

From mid-September 2016, the Bank of England started issuing some notes on polymer substrate. This material makes notes cleaner, safer and more durable than paper-based notes. It is estimated that polymer notes last at least 2,5 times longer than paper notes. This has a bearing in reducing the cost of maintaining the quality of notes in circulation. When bank notes are issued, they need to be replaced over time as they would have worn out due to constant use. This is particularly so in economies which place excessive reliance on the banknotes instead of other forms of money such as electronic and plastic.

From history we learn that money has to be worked for or earned. Yet if the bank notes are easy to counterfeit, people can decide not to work and concentrate on counterfeiting. Over time, this could result in the loss of value. That is why at every stage there are deliberate processes and procedures to ensure it is as difficult as possible to counterfeit.

Money is used as a medium of exchange. It is not in itself a desired end; people love money for what it buys. Money makes life easier for as long as it is difficult to counterfeit and it is stable in value. When the value of money cannot easily be determined or is not stable, money becomes a burden to mankind. This has been the case in Zimbabwe in the run-up to 2008 when people had to use trillions to board a bus, this despite having removed zeros several times.

Gross Domestic Product (GDP) is a term used to refer to the value of finished goods and services expressed in money. These goods and services are produced in a country within a defined period, usually a year.

The size of GDP has, in recent times, been used to judge the size of an economy and, therefore, the importance of such on the global stage.

The US economy is celebrated as the largest economy in the world followed by China and Japan. GDP is merely a measure of size not well-being, though it is an important input in determining the well-being of a people. For instance, while the Japanese economy is now third following a decadelong slowdown on her economy, it is more advanced than China.

When we use population as a divisor, then we realise that China is still a developing economy whereas Japan is an advanced economy. Be that as it may, using GDP numbers we note that China is a very important player on the global stage. Since 2000 the Chinese economy has expanded seven fold, in the process elevating her people from poverty.

There is a key relationship between money and GDP. As alluded to above, the value of GDP is expressed in monetary terms. This can either be nominal currency or in real terms. Whichever way, money is key in expressing the value of GDP. But what does money mean in today’s parlance? Money has many definitions.

From a household point of view, money means money in the bank, cash in hand, cheques, electronic transfers, mobile transfers and the famous plastic money. It is possible that one can be rich yet they rarely see the colour of the physical money or banknotes. In fact, in modern times cash has become associated with small transactions whereas big transactions are done in electronic transfers; the Real-Time Gross Settlement (RTGS) system introduced in Zimbabwe on November 16 2002 is a key feature of our modern monetary and banking system in Zimbabwe. The modern world discourages the use of cash as it can be used to promote money laundering.

Money laundering refers to the practice of transforming the proceeds of criminal activity into apparently bona fide funds. Non-cash forms of payment leave an audit trail thus making it harder for launderers. In addition, cash has been at the centre-stage of helping fund terrorist activities.

In a conservative economy, with two forms of money; bank notes and coins, the value of GDP should equal the value of bank notes and coins in circulation. This will facilitate easy trade or buy/sell transactions. But modern economies are more complex than that.

When there is a shortage of money to buy the goods and services in the economy there will be price deflation. On the other hand, when there is too much money chasing too few goods, then there will be price inflation.

Here is how it works. When there are too few dollars or any other currency in circulation compared to the goods, producers of goods and services will be competing for the few dollars in circulation. Thus to attract that, they have to lower the prices of their goods. Those with the money, knowing well that there are too few dollars chasing goods, will seek to bargain by paying as little as possible.

The opposite is a situation whereby there is too much money chasing too few goods. In that instance, the demand for the available goods will be too strong and what is then experienced is demand driven inflation.

When demand is stronger than supply, then what happens is that those prices go up. When I was an economics student in 1993, we needed to read textbooks to appreciate what inflation and deflation meant.

These days it is no longer necessary as Zimbabwe has lived through both in recent times.

The market adjustments happen because equilibrium has to be achieved. Going into modern economies, central banks must have a healthy balance of all the forms of money to give confidence to the banking sector and ensure facilitation of trade. A central bank must always try to balance the stock of money supply at any given point in time. What we know from economic theory is that the moment people lose confidence in the banking system; they rush to the bank to withdraw cash. This raises the demand for cash and there will be a risk that banks can run out of the cash. We have seen this happening in Zimbabwe.

As of 2017, the pound value of cash in circulation is around 73,2 billion or just under 4% of the 2016 country’s GDP. On the other hand, the value of US dollars in circulation is 1,54 billion or 9% of the country’s GDP. This figure accounts for nearly 2% of the total notes, coins and savings and demand accounts of the global economy as at 2015, still far less than the amount of 1,2 quadrillion sitting in derivatives during the same period. The value of US dollars in circulation of US$1,54 billion includes the US$1,490 billion in notes which account for about 8% of the country’s GDP.

In its January monetary policy statement, the Reserve Bank of Zimbabwe (RBZ) reported that it had issued $94 million of bond notes into the market or 1% of the (2015) country’s GDP. How low this figure is explains why there have not been any economic shocks caused by the prevalence of bond notes in our midst. The figure is too low to cause any inflationary pressures in the economy.

The South African Reserve Bank (Sarb) statement of assets and liabilities as at April 30 2017 shows total notes and coins in circulation amounting to R136,760 billion or 44% of the country’s GDP. This shows an increase of 3% on the March figures which amounted to R132,296 billion notes and coins in circulation or 42% of the country’s GDP as at March 31 2017.

In addition, the country’s gold holdings in rand terms as at April 30 2017 were R67,457 billion.

This compares with R66,337 billion as at end of March. The April numbers show a 2% growth on March numbers. Thus the value of gold is 49% cover of the April notes and coins in circulation. This entails that using the gold standard South Africa would only be able to issue notes and coins to the extent of R67,457 billion in April and R66,337 billion in March. The current scenario subsists because firstly the rand is legal tender and secondly economic players have confidence in the rand.

Using the above data, it can be noted that generally the more advanced an economy is, the less it needs to issue notes and coins in circulation relative to its GDP. There are outliers in the above data. Firstly, the reason why the United States has such a high level of notes and coins in circulation relative to its GDP when compared to the United Kingdom is that its currency is the primary global reserve currency.

In addition, the US dollar is used by many countries some of whom have adopted it as a primary currency in their respective currencies; including Zimbabwe, these countries are nine. It should also be noted that South Africa caters for countries in the Rand Monetary Union, suffice to say that none of the countries in that area are economically larger than South Africa. In addition, one of the countries opted to have its own currency.

On the other hand, Zimbabwe’s notes and coins in circulation are too low due to legacy issues which include that the country discontinued the use of its currency to adopt multi-currencies, primarily the greenback.

What does it mean for Zimbabwe? The country is in a very unique case where it uses the US dollar as its own currency yet it does not control its monetary policy. The governor of the BoE estimated that if Scotland were to use the pound sterling as an independent state, it would require reserves of 25% of its GDP. This level would enable the country to convince the world that it can be able to act as a lender-of-last-resort should a crisis arise. We have seen this test being failed by the RBZ in the hour of need.

For a considerable period of time, the central bank has been undercapitalised, rendering it ineffective to perform the lender-of-last-resort function. The essence of the lender-of-last-resort function is that it helps smoothen the financial markets, thus maintaining confidence in the sensitive sector. As a developing economy, Zimbabwe would require higher reserves than Scotland.

Using South Africa as a model African economy, the RBZ could increase the stock of bond notes to 44% of its GDP or US$6,3 billion without causing any massive shock in the economy. However, there is a proviso here. The country could raise the stock of its bond notes gradually to 4% or US$576,8 million or increase it to 8% or US$1,153 billion. The implication of this move will be to shake the parity level of the bond note to the US dollar.

I have said in my previous articles that it is not sustainable to maintain this parity level.

Essentially, what it entails is that the bond note could be pressured into depreciation but the exchange rate will be maintained once the printing of the bond notes is stabilised and only increased in line with the growth of the GDP, ceteris paribus. This move will have far-reaching implications on the facilitation of trade within the country and also it will have an impact on the pricing of imports and exports.

This analysis has been prompted by the fear of bond notes which the market had prior to introduction. When one takes stock of what has happened since the introduction of the fiercely resisted notes, it is easy to appreciate that the central bank has demonstrated discipline since November 2016.

Of course, we do not know how long this discipline will last. In history, the printing of money has never been a matter of concern, but rather the excessive printing of money is what causes economies to falter. Sarb increased its stock of notes and coins in circulation by 3% between March and April 2017. What market players worry about is the loss of value caused by excessive printing.

The fact that bond notes are kept low, as they have been, does not guarantee that money is not being printed on the RTGS platform. If it is being printed or in other words not supported by the physical US dollars, there might as well be merit in increasing the stock of bond notes to the extent of supporting domestic transactions. This will enable people to get back to work and focus on the much-needed production unlike what has happened in the past year. A central bank should print money guided, primarily, by the country’s GDP and GDP growth rates. In addition, it should consider the entire forms of money in use in the country and seek a balance guided by usage.

This does not mean that a country using another country’s currency cannot be successful or that it is impossible to run a country on foreign currency alone without any form of medium of exchange like bond notes.

For instance, the British Virgin Islands have been using the US dollar since 1959. These are very prosperous islands in the Caribbean with GDP per capita over US$40 000. What we can never run away from is that something fundamental happened in our economy which led to the disappearance of the US dollar, which the country used smoothly until 2015.

Ngwira is a chartered accountant, former bank treasurer and former university lecturer. He holds finance and business qualifications. — cell: +267 73 113 161.