Last weekend’s Madaraka Day celebrations delivered unusual excitement to Kenyans following the announcement that the old one-thousand-shilling note will be withdrawn from circulation in early October. This is in keeping with a heightened war on corruption. For this, we commend President Kenyatta for a truly bold initiative.
In the next few months, economists shall pay close attention to how the Central Bank will navigate the sensitive process.
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 effectively managed to change the medium of exchange without significantly disrupting the stored value. This is typically achieved through an efficient process of remonetisation, which means introducing new currency to ensure that total money supply in the economy remains steady.
Australia is a shining example. In 1996, the Australian government chose to withdraw its paper-based notes and became the first country to adopt polymer-based notes. 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 aggressive remonetisation.
Similarly, 12 European Union 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 8 billion notes and 38 billion coins through banks, post offices and sales outlets.
However, countries that have poorly managed demonetisation have ended up causing untold pain and destruction to their citizenry. In this respect, India provides powerful lessons. 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 months-long currency crunch, costing India over 1.5 million jobs and wiping off at least 1 per cent from the country’s GDP.
The United States also bore the brunt of poor demonetisation. The Coinage Act of 1873 demonetised silver in favour of the gold standard as the legal tender of the US. The withdrawal of silver from the economy was not counterbalanced by any form of remonetisation, resulting in a contraction of the money supply, which subsequently led to a five-year economic depression in the country. In response to the dire situation and pressure from silver miners and farmers, the Bland-Allison Act remonetised silver as legal tender in 1878. Reflecting on the economic 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 that this or any other age has witnessed.”
Senator William Stewart would add that “the demonetisation of silver was the crime of the 19th century.”
Kenya must consider both the positive and negative outcomes that different countries have experienced. The 230 billion shillings that will be withdrawn from the economy will need to be efficiently reintroduced in the form of new currency to avoid a contraction of money supply, which could unleash powerful deflationary forces.
Mr Gichinga is CEO at Mentoria Economics; Email: [email protected]
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