Printing money is dodgy economics

When a country prints money to pay salaries or print money to pay its debts that is not quantitative easing. FILE PHOTO | NMG

By TONY WATIMA
More by this Author

Summary

• Those thinking that a country can simply print itself out of its problem and enjoy economic growth are mistaken. The temptation to print money is always sweet for governments but there is also a political price to be paid, which the Omar al-Bashir regime in Sudan can testify to it.

Early this year, economist David Ndii on Twitter gave an excellent explainer about the effects of printing money to an economy, using illustrative names from Elgeyo Marakwet to put his message across.

It was my opinion that this false argument had finally rested but it has again reared his head. It seems Ndii’s explainer was lost in the ‘Sonko Malong’ satire he used. I would encourage advocates of printing money to re-read his explainer because the commentary of Kenya printing money is dodgy economics. They are punching above their weight, and it’s evident that monetary economics is not their turf.

First, let’s start with a clarification. Printing money and quantitative easing are not one and the same. They are distinct. When a country prints money to pay salaries or print money to pay its debts that is not quantitative easing.

Quantitative easing is when a central bank injects money into the economy by buying assets of the private sector to lower interest rates (which is always the main target) and boost economic activity from the new liquidity provided to the private sector.

For example, in the US 2008 financial crisis recovery, the Federal Reserve injected money through quantitative easing by buying treasury bonds and toxic assets (mortgage-backed securities from the subprime crisis linked to the financial crisis) from banks and financial institutions. It’s recorded that reserves of the US banks held with the Federal Reserve rose from only one percent of their total assets before the crisis to just over 20 percent by September 2015. Therefore, quantitative easing is a monetary transmission tool.

Second, it’s recklessly erroneous when advocates of Kenya printing money always draw comparison with US and Japan. They forget these two countries have a very different economic set-up to ours. They need to draw comparison to Sudan and Zimbabwe.

In fact, Zimbabwe provides the clearest case why developing countries can’t get away with printing local currency as a source of revenue. Printing money always looks a good short-term solution until when the river of inflation (more money chasing few goods and services) bursts its banks and there are floods all over.

Around 2007-2008, the Mugabe administration was short of government revenue and opted to print money for its expenditure.

A few months later, it was hit by the second worst hyperinflation in world history. Inflation started rising and citizens abandoned the local currency and started using foreign currencies — an instance former Chairman of the Bank of England Mervyn King calls good money driving out bad money.

Zimbabweans went as far as accepting the sale of mobile phone airtime as a substitute currency in an effort to avoid local currency. By the end of November 2008, prices of goods were doubling every day.

There was only one solution out of the hyperinflation floods — to dump the local currency, something that will come as a surprise to printing money advocates in Kenya. The use of other foreign currencies was encouraged and use of US dollar became the official policy in 2009 and the resulting effect was that inflation started dropping drastically and economic growth resumed.

So, those thinking that a country can simply print itself out of its problem and enjoy economic growth are mistaken. The temptation to print money is always sweet for governments but there is also a political price to be paid, which the Omar al-Bashir regime in Sudan can testify to it.

Lastly, there are those who have argued that Kenya should print money and use it to pay foreign debts and that it will avoid inflation since the new money will not be circulating in the local economy.

What this argument is oblivious to is that the Kenya government must buy the dollars after printing local currency. This means the Central Bank of Kenya (CBK) dollar reserve will be raided by the government, depleting its reserves leading to the depreciation of the shilling with the CBK having little reserves to intervene, and inflation kicking in.