Beyond the Bike - The Value of Money

“Mzungu, show me the muni!” is the constant request from kids that have greeted me on the side on the road in Malawi. Three questions spring to mind from these experiences: 1) Have all the kids been watching too much Jerry Maguire 2) What is money and what is its primary function in this part of the world? 3) Would giving the kids or anyone here money help them?

OK, so I suspect that the answer to the first question is “NO” but the kids (and some adults) do a great impersonation of Tom Cruise in that famous scene when the sports agents Mr Macguire pleads with one of his clients to ‘show him the money’.

“Mzungu, Show me the Muni”

The pertinent economics questions are of course the latter two, the answers to which are important for any budding monetary or development economist. I will spend the rest of this blog addressing the question of money, returning to the ‘giving’ question another time.

“Money is a matter of functions four, a medium, a measure, a standard, a store.” So said the textbooks of old. Today it is generally seen to have three functions: a medium of exchange, a unit of account and a store of value, with the standard (for deferred payments) being subsumed into the others. All three have varying degrees of importance depending on the state of the economy one is considering. Given the tumultuous state of Malawi’s economy today, manifested in an FX and fuel crisis, which one is most important here?

I would argue that the medium of exchange is the primary function in this part of the world, closely followed by the unit of account with store of value sadly limited by frequent bouts of inflation.

Money systems in nearly all the world today are based on what economists call Fiat money, which is without intrinsic use value as a physical commodity, and derives its value by being declared legal tender by the government. Africa is no different and whilst there is still some exchange through barter, countries here generally adopted Western monetary systems, transitioning from the gold standard to the current system post the Bretton Woods conference in 1971.

As a medium of exchange, notes and coins play a more important role here than in the West where physical money has been replaced by the use of credit cards. Back in the summer of 2007, when the UK experienced its first run on a bank in 150 years, there would not have been enough notes and coins in circulation to pay all the depositors of Northern Rock, despite it being a relative minnow compared to the likes of Barclays or HSBC.

No credit cards accepted here…

Money allows economic agents (households & firms) to trade efficiently as well as aiding transparency in the value of the goods and services that they exchange. What happens if there is inflation, as has occurred most spectacularly in neighbouring Zimbabwe?

Double digit inflation is not uncommon in this part of the world. The loss of value of money (each unit of money is worth less and less each year, or minute in the case of Zimbabwe!) means that the wealth of savers using money as a store of value is eroded. Zimbabwe’s hyperinflation, touching an annual rate of over 200,000,000% at its peak in 2008 was somewhat different. Savers using money as a store of value essentially lost all of their wealth.

Even you could be a Zimbabwean Trillionaire…

Interestingly, Zimbabwe has subsequently introduced US dollars as its formal currency, with the finance ministry sensibly shelving the Zimbabwe dollar in 2009. However, the transition has created some practical dilemmas for the authorities regarding the function of money. The US treasury assisted in sending over enough dollar bills (notes) to get the economy functioning. The lowest denomination in notes is $1. With many of Zimbabwe’s basic goods selling in units of less than $1, it was estimated that the country would need $10m of coins for change. The minister of finance visited the US treasury to discuss sourcing this. As it turns out, his officials calculated that cost of transporting enough change (it would fill 3 jumbos) would be higher than the opportunity cost, namely that of the economy ‘muddling through’. So when you want to buy something that isn’t divisible by one dollar in Zimbabwe today, don’t be surprised to get your change in sweets or Rand (South Africa’s currency!)

When economic agents lose confidence in a government’s ability to control inflation or, more seriously, to honour its debt, they will seek other assets to ‘store value’. With fears remaining over financial meltdown in Europe and contagion to the world’s capital markets, we’ve seen a continued ‘flight to safety’, pushing the gold price, for example, to new records. Any gold will do - a jewellery designer in Lusaka told me that a Chinese man had come in and purchased two identical gold rings worth USD 7.5k each. Clearly this was his way of storing his money, or perhaps hiding it from the authorities!?

So money isn’t real but it helps the ‘real’ economy (the flow of goods and services) to function, acting as a medium of exchange and unit of account. To work as a store of value, agents need confidence in the authorities’ ability to control inflation. This explains central banks’ obsession, in normal economic climates, of trying to keep a low and stable inflation rate.

The black-market rate for Malawian Kwacha was some 25% better than the official rate. Just don’t get robbed!

Having just left Malawi for Tanzania, you may be asking the question - did I give the children any money. As poor as they are, giving them money is unlikely to help them, especially in the long run. Rather, it risks exacerbating the dependency culture that has arguably contributed to the slow development in this part of the world. I parted with my final kwacha at the border, only to be robbed by a couple of dishonest but clever black-market FX dealer. With hindsight, I wondered why his rate was too good to be true. As Milton Friedman said, ‘there is no such thing as free lunch’.