Fiscal responsibility or neo-imperialism – Crises, debt, and currency boards in Africa

The days of easy money and low interest are now officially behind us. Punishing monetary policies will have domestic consequences in America and Europe, but its most lethal consequences will be felt in Africa. Wyatt Constantine argues that we have seen the results of fiscal austerity, deflationary pressures, and monetarism before – those with investments and assets profit, while wages fall, and benefits are slashed. We need to engage with the far more complicated and nuanced questions of building a new economic order.

By Wyatt Constantine

Inflation will likely be remembered as the buzzword of the year for 2022. It has consumed both popular media attention and is the principal issue vexing central banks the world over. The causes have been more or less well established. Lingering supply chain disruptions from the pandemic, a massive increase in the cost of energy inputs resulting from the Ukraine war, and, according to conservatives and deficit hawks, expansionary monetary policy and fiscal stimulus as a response to the pandemic.

The days of easy money and low interest are now, however, officially behind us. The American Federal reserve rate has recently increased the federal funds rates to over 3.25% with more rises likely to come, and the European Central Bank, after nearly a decade of 0% and even negative rates, has set rates rising. This punishing monetary policy will have domestic consequences in America and Europe to be sure, but its most lethal consequences will likely be felt in Africa.

What connection might interest rate hikes by the American federal reserve have for Africa? With the exception of the CFA zone most African countries now have independent central banks with at least some degree of flexibility in the implantation of monetary policy, and utilize currencies not indexed or pegged to either the USD or the euro.

We need not look back too far into recent history to understand the incredible destruction that the Federal Reserve rates hikes can deliver globally. No student of Africa needs reminding of the austerity and deprivation imposed upon Africa by the debt crises of the 1980s. Spiraling cost of servicing debt hit many nations with dollar denominated loans as commodity prices crashed. Country after country were forced into IMF structural adjustment programs that saw massive cuts to social services and the public sector workforces.

The debt crisis was instigated in large part by the “Volcker shock”, when the Federal reserve hiked the federal funds rate to a historically unprecedented 20%. This had the effect of bringing down the double-digit inflation that had plagued America for most of the 1970s, but the effect on developing nations with dollar denominated debt was disastrous. At the same time that the cost of paying down debt exploded, the monetary squeeze instigated by the Fed helped to send commodity prices crashing. Nations that had enjoyed fiscal expansion in the 1970´s due to high commodity prices saw the prices of those commodities rapidly decline. It effectively ended the power of the Third World and the spirit of the New International Economic Order that had been borne out of the 1970s.

Figure 1:  Federal funds effective rate (Federal Reserve Bank of St. Louis).

Today we seem to be experiencing a similar scenario. The European Central Bank has raised all three of its key interest rates, and the Federal Reserve has followed cue as well. For countries that have dollar denominated debt and are primarily dependent on volatile commodities, such as oil or cacao, to acquire the hard currency they need to service their debt, the recipe is one tailor made for disaster, austerity, and misery. The conditions for this vulnerability and indebtedness of African states has sadly not diminished since the introduction of HIPC initiative, as the debt and inflationary issues Africa experiences have a deeper structural issue. Namely, that of inequity in terms of trade.

No country illustrates this better than Ghana. Ghana´s exports are made up almost entirely of commodities with little to no value added. Gold, which makes up nearly half of Ghana´s export revenue, has tanked in 2022, trading at over $2,000 per ounce at the beginning of 2022 and falling to little over $1,600 as of this writing. The imports bill, however, is composed largely of refined oil and petroleum, despite Ghana being an oil producer, the prices of which have exploded. The Ghana Statistical Service bulletin for July 2022 reported a 31.7% increase in the combined Consumer Price Index, and the cedi has more or less collapsed. The debt burden that Ghana faces is enormous, and the total cost of its debt servicing is staggering. Over the past several years the state has spent anywhere between 70-80% of its total revenue on servicing debt alone. Its recent move to seek relief from the IMF has meant that its sovereign credit rating has been downgraded to near junk status. At the same time that it can barely service its debt, the country has been effectively shut out of international capital markets.

At this precarious juncture, wherein inflation and currency depreciation are wreaking havoc on the Ghanaian economy, a peculiar form of monetary order is being proffered as a solution. Namely, the introduction of a currency board. The principal voice advocating for this is Steve Hanke of Johns Hopkins University. A former official in the Reagan administration and a fellow at the right-wing CATO institute, Hanke’s advocacy for the currency board system spans decades. He has written extensively on the currency board system and dollarization and has advised numerous nations on the implementation of economic reform, including numerous post-Soviet states in the 1990s who all experienced rapid currency depreciation, as well as Argentina. His support of the system has been unrelenting, and it seems there is no country he can identify that will not be served by a currency board regime, whether it is Turkey, Bulgaria, Argentina, or Indonesia. His advocacy even spurred Paul Krugman to refer to him as a “snake oil salesman”. His most recent target has been Ghana. In a series of tweets illustrating the outrageous inflation the country has experienced over the past year, (his own metrics show a rate more than double that of the Ghanaian statistical service – roughly 81% as opposed to 31%), he has reiterated his claim multiple times that the only option left for Ghana is to eliminate its Central Bank and install a currency board. While Hanke claims that no currency board has ever failed, and the state of the Cedi is indeed most deplorable, the implementation of a currency board should be critically questioned.

The currency board system operates on a relatively simple principle. Instead of a central bank which can work to expand or contract the money supply, a currency board is essentially an automatic exchange mechanism with no discretionary or fiduciary power. Namely, it issues a domestic currency which is tied in value to an anchor currency. It must hold reserves of the anchor currency in such amounts that each unit of currency it issues is backed by an equal unit of reserves. Today the currency board system is something of a curiosity, but it experienced a renaissance in the 1990s in the former Soviet republics and in the former Yugoslavia. Another was more famously instituted in Argentina in the 1990´s as well.

The principal argument for the implementation of currency boards is to both eliminate high inflation and to reign in the power of unaccountable central banks. On these counts, the currency board system, which Hankes has claimed “has never failed”, seems to have a historical basis for success. With their currencies tied to the dollar or the Deutsche Mark, inflation was drastically reduced and no longer could central banks run the printing press and drive inflation upwards. The drop in inflation upon adoption can be seen in the cases of Argentina and Bulgaria, for example, so the argument of Hanke that the currency boards can provide a measure of stability is true, to a certain extent.

The currency board system was a common characteristic of British imperialism in the early 20th century until independence. While it existed in the 19th century to a limited extent, the major push came with the creation of the West African Currency Board in 1912 and the East African Currency Board in 1919. The prelude to the implantation of these currency board systems had been a series of currency crises and also a massive outpouring of silver coinage into the colonies. The currency boards issued a token currency in exchange for sterling, and held reserves equal to 100-110% of the coins in circulation in the form of sterling or of British national securities.

As work by Tal Boger, Kurt Schuler, and Steve Hankes has pointed out, this system of stringent reserve requirements and holding of short-term securities largely benefitted the imperial treasury in Britain far more than it did the colonies and deprived them of revenues they might have otherwise earned.

After the post 1960 waves of independence across Africa, the currency boards largely vanished as central banks were established in the former colonies. The currency board saw a resurgence during the debt crises of the 1980s as well as in Eastern Europe after the collapse of the Soviet Union. Today, they are mainly used by some small Caribbean countries such as Bermuda and the Caymans, as well as in Hong Kong.

If we are to imagine then the introduction of the board in the case of Ghana, having scrapped the central bank, perhaps inflation is reduced, but what then? Ghana would be beholden to stringent reserve requirements, and therefore required to build a substantial foreign currency reserve of US dollars or other hard currencies or assets. Currently the nation has seen its reserves decline from USD11 billion in September 2021 to under USD8 million in July, 2022. The currency board might remove one element of instability for the nation, the central bank, but in this case is it treating the source or the symptom of its larger problem?

Ghana would still be dependent on the export of volatile commodities, cacao, gold, and petroleum, in order to earn its foreign currency to maintain its reserves. Will the currency board encourage further foreign direct investment or greenfield investment in such a way as to remove Ghana from the precarious position of being a commodity exporter? If we look to recent examples of currency boards, that becomes a somewhat hard case to prove.

If we look at Bulgaria, with a GDP roughly similar to Ghana´s (though a much smaller population), the country has maintained a currency board since 1997, first with the Deutsche Mark and now at a roughly 2:1 exchange with the Euro, shows if anything a high degree of volatility. Despite an enormous increase in FDI through the early 21st century, it has collapsed since the beginning of the Euro-zone crisis, and its decline has not abated since. While it is unwise to draw definitive cases from a single comparison, it should nonetheless make us question whether the supposed stability of the currency board regime can likely encourage investment or growth.

Figure 2: Serkan Sahin and Ilhan Ege ‘Financial Development and FDI in Greece and Neighbouring Countries: A Panel Data Analysis’  (Procedia Economics and Finance2015).

Clearly an unstable exchange regime is a major turn-off for investment, but have the currencies boards been able to provide stability? While they may serve to lower inflation, any claim beyond that seems far more opaque. Ghana also has a population of over 30 million people, roughly 25% of whom, by the most generous measures, continue to live in extreme poverty. A currency board would leave the level of currency in circulation entirely in the hands of market forces, with deflationary threats a large risk. Granted, central banks can do serious damage by creating inflationary pressure or through unwise monetary expansion, but restrictive monetary policy and deflation can be just as devastating, increasing unemployment and depressing wages. A highly deflationary move could prove disastrous.

The case that large economies cannot use currency boards is countered often by Hanke;s  reference to the case of Hong Kong, whose LERS (Linked Exchange Rate System) maintains full reserves of USD and is committed to a fixed exchange rate system. Hong Kong, however, is not only a global logistics hub and one of the largest ports on earth, but the composition of its exports is also highly varied.

Ghana’s export basket, however, is almost entirely gold and agricultural commodities. Of the USD$13.1 billion that Ghana exported in 2020, USD$5.93 billion alone was gold, a further USD$2.71 billion was crude oil, and further USD$1.7 billion was cacao and cacao paste. Almost the entirety of the export basket is commodities, commodities that are likely to see abrupt swings in demand and price due to shocks in global energy prices and shipping. While a currency board may signal “stability” to investors, it certainly does not offer any assurance in regard to terms of trade, foreign direct investment, predictability in export markets, or wages. Of the two mandates often given to central banks, inflation and unemployment, the currency board seems to offer assurance for only the supply side interests.

While a currency board regime might have success in the fight against inflation, the claim that it can be a panacea for all economic woes remains unproven, and its supporters may have more ideological motivations then they let on. In the case of a highly indebted country like Ghana, dependent on volatile commodities for export, the currency board cannot serve to change the fundamentally inequitable position of the nation´s trade position.

However ill-advised the Central Banks actions may have been, will stripping Ghana of its monetary sovereignty remove Ghana or other large African exporters from their precarious and costly positions in the global economy, which repeatedly brings them to these crisis situations? Will the “stability” engendered by a currency board support the preconditions for such a move? It seems unlikely.

It is no real mystery what the appeal of the currency board to conservative and reactionary thinkers is. If we take lessons from the Republicans in the US, or the budget slashing politics of the Tories in the UK, high inflation is the perfect excuse for slashing social spending and shrinking the welfare state, all under the guise of “fiscal responsibility”. High inflation has also been the reason trotted out for the introduction of the currency boards. Whether by accident or design, the IFIs, the Federal Reserve, and the global bond market have given countries like Ghana precious little room to maneuver. The yield on Ghana´s sovereign bond topped 34% in August, as global investors punish Ghana for seeking debt relief and rising interest rates from the US and Europe make borrowing prohibitively expensive. As prices for Ghana´s commodities seesaw up and down in 2022 and the cost of capital goods explodes, the currency board does nothing to alter the concrete inequities of the global economy.

As nations in the global north run up massive debts to fund unemployment benefits, the Global South is being asked to essentially cut off its own legs voluntarily and to submit to austerity. We have seen the results of punishing fiscal austerity, deflationary pressures, and monetarism before, and the result is always the same. Those with investments and assets profit, while wages fall, and benefits are slashed. It is long past time we throw the snake oil of fiscal conservatism and its accompanying institutions into the rubbish bin of history and begin to engage with the far more complicated and nuanced questions of building an economic order not dependent on the misery and austerity of the many to allow for the wealth and comfort of the few.

Wyatt Constantine is a PhD candidate at the University of Leipzig in the Department of African Studies working on the political economy of labour in the horn of Africa.

Featured Photograph: A shopkeeper serves a customer in the Somali capital Mogadishu (Stuart Price, 23 October 2013).


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