Category Archives: Finance

Whose money is it anyway?

By Tunde Obadina

In its endeavour to shore up the naira currency the Central Bank of Nigeria (CBN) has in recent months taken steps to curb domestic use of foreign currencies in Nigeria. It  barred authorised money dealers from importing foreign currency banknotes without prior approval and stipulated that beneficiaries of international money transfers must be paid in naira only. The regulator has also tightened restrictions on the operation of bureaux de change to limit demand for hard currencies.

According to monetary officials Nigeria has become one of the world’s largest importers of US dollar notes. Restricting domestic use of foreign currencies, they believe, is necessary to combat money-laundering, especially by corrupt politicians and Islamist insurgents. The CBN also wants to counter what it says is the dollarisation of Africa’s largest economy. Its aim of checking money laundering is undoubtedly commendable; but corruption is not the only driver in the growth in local usage of foreign currencies.

There are many legitimate reasons why people may choose to hold dollars or other currencies in preference to the local currency. Lack of confidence in the national monetary system is an obvious reason. Individuals and businesses may believe their interests are better served storing their wealth in assets that are more stable and less prone to losing value in the foreseeable future.

Money is in some ways similar to debt. Unlike barter, where people exchange commodities that both parties can immediately ascertain their respective value, a monetary transaction involves the seller receiving an item that has no inherent worth. The real value of money is determined at the time of its application as a means of exchange. For example, when customer A gives one dollar to shopkeeper B for a bar of chocolate, A receives a product which has instantly realisable utility. For B the actual worth of the dollar note will only be known to him when he deploys it in a future transaction. At that later time its purchasing power may provide more or less chocolate as at the time he accepted the note, depending on whether the currency has meanwhile appreciated or depreciated. When the seller exchanged his chocolate for money he acquired a note that contained a promise of future entitlement. He took a risk in doing so. He entered the transaction because he believed that the asset he receives will retain a value that is at least close to its present worth. His faith could prove to be misplaced, if when he comes to spend the money it buys much less in value than the chocolate customer A had long digested.

Given the volatility of money, the choice of people living in economies with high inflation and weakening local currencies to hold some of their wealth in sturdier foreign currencies is rational. It is a way to protect against risks of devaluation. Needless to say, governments and central banks throughout the world intensely dislike their citizens using foreign currencies. This is because the practice undermines their control over the financial system and the economy. The effectiveness of monetary policy is limited if members of the public can choose to ditch government-issued money in favour of other mediums of exchange and wealth storage.

Control over money supply is arguably the most wide-reaching and effective means the state has to affect the lives of individuals within its domain. People can ignore or circumvent most government regulations, such import bans and licensing laws, but holders of the national currency cannot easily escape the effects of state monetary actions. For example, when governments print large amounts of money, thereby fuel inflation, their action invariably devalues the money in the pockets and bank accounts of all who possess the currency. Citizens can evade paying direct taxes, but they cannot easily avoid the taxation effect of money printing. The state does not need to know of your existence or location to take your money.

Currency shifting by individuals and businesses to protect their wealth against the effects of poor state financial management is not peculiar to developing countries.It is world-wide. It is one of the reasons that the export of dollar notes is a big U.S. export. The relative stability and strength of America’s financial system is also a reason why individuals, businesses and governments across the world deposit most of their external reserves in the U.S.

In a free society individuals may hold their wealth in any form that does not violate the property rights of others. Individuals alone assume the risks involved in their investment decisions, including any limitations on the number of people willing to accept the currencies they possess. Some readers may think that this libertarian perspective only benefits rich people with money. This is not so. Poverty does not mean being penniless, it is having very little amounts of money. This is why the opportunity to choose currencies that are least susceptible to depreciation is important for the poor. A subsistence farmer who saves 5,000 naira in an economy with 10% annual inflation rate will find that after a year his nest egg is worth only 4,500 naira in real terms. Had he changed his money into a more stable currency, the value of his meagre savings would have been better preserved.

Currency shifting is not necessarily an act of national betrayal. It is the case that rich people in developing nations keep much of their wealth in foreign assets, including overseas bank deposits.

Finance – The magic app Africa needs to develop

By Tunde Obadina

In his book, Civilisation: The West and the Rest, economic historian Niall Ferguson contended that Western Europe was able to out-develop other regions of the world because it developed what he described as six killer applications that others lacked. These were competition, consumerism, democracy, medicine, science and work ethic.

There is no doubt that in the period leading to the industrial revolution European countries exceeded in these areas, at least five of them. It is debatable whether Europeans were harder workers or believed in the goodness of labour more than peoples elsewhere in the world did. Nonetheless, Ferguson’s thesis has merit over the works of many other analysts who have explained Europe’s material advancement in terms of geography, climate, culture or politics, though it is unlikely to be the last prognosis on the fundamental drivers of Europe’s economic advance. It is debateable whether the six apps identified by Ferguson were root causes or the consequences of Europe’s wealth creation. It may be that European countries had more competition and consumerism and better education and medicine because they were wealthier than other nations.

People in other regions knew science and medicine in the pre-industrial age, but Europe was able to push ahead in these fields because it had the material resources to invest in their development. Competition, consumerism and the work ethic are also the consequences of increased economic activity and wealth. As for democracy, it is debatable how much of it existed in mid-eighteenth century Britain. In any case modern day China and some other non-democratic Asian countries have achieved rapid economic growth without this app.

There is one crucial element missing in Ferguson’s growth enhancing apps list. It is financial innovation. This is the creative use of money/capital to enable production and trade and thereby create wealth. Although all regions of the world used money in one form or the other in pre-industrialisation eras, it was in Europe that financial innovation developed and became integral to economic development.

We cannot comprehend the occurrence of the industrial revolution without understanding the role of financial institutions in its emergence and evolution. The rise of manufacturing could not have happened without the operation of financial institutions such as banking, insurance, joint stock and debt. It was the fuller understanding that money and capital can be used to create wealth that gave Europeans a considerable advantage over others. Financial innovation enabled people and companies to share risks, share ownership, mobilise resources for production, generate future wealth, and dare I say, spend beyond their immediate earnings.

In a modern economy, virtually every aspect of production, distribution and consumption is underpinned by finance. A subsistence farmer may, without need for money, use his hands to plough his land and gather his crops. But if he is to increase output, he is likely to require money to obtain inputs such as fertilizer, seeds, ploughs etc. Beyond a certain level of pure labour productivity it is capital and the knowledge of how to use it that creates additional wealth. A commercial farm owner uses money to buy labour, equipment and services needed to produce at a profitable level. Of course, he could exchange some produce for the work of labourers, but it is not feasible to use barter to acquire a tractor or the fuel to run it. Financial debt allows the farm to pay labourers for work and to pay suppliers for other inputs needed to create wealth. Financial instruments allow individuals and companies to pay for the production of goods and services before the items reach the market and generate revenue.

This is not to say that all economic production issues can be simply solved with money. A subsistence farmer cultivating a tiny plot of land with potential to generate a maximum of $1,000 in annual revenue is unlikely to be given a commercial bank loan of $10,000 at 10% interest rate to buy a tractor or other input. This is not because bankers do not appreciate the importance of food, but the fact that the farmer is unlikely to be unable to service the loan. Even here, money used as a measure of value helps us to assess the present and future commercial viability of any given business endeavour.

Finance is one of the most vital elements in the allocation of scarce resources in a market economy where decisions on production and consumption are based on assessments of value. We should be careful in the current social climate of distrust of bankers and other financial services practitioners that we in Africa do not undervalue the importance of finance in economic growth and development. African countries need to develop systems for financial risk sharing, savings and debt management to enable economic collaboration between individuals across ethnic, national and regional boundaries.  A modern financial system enables people with excess funds in one part of the world to invest and share risks with strangers in another of the planet. This could involve all sorts of activities – the building of factories, construction of railways, planting of new species of crops or setting up of novel services.

Fighting terrorism cost money

By Tunde Obadina

The failure of the Nigerian security forces to recover the more than 200 schoolgirls abducted in April by the Islamist insurgency group, Boko Haram, has generated much public anger at home and abroad. President Goodluck Jonathan has been derided by all sorts of groups amazed by the inability of his administration to find and rescue the girls. As understandable as this outrage is from a moral perspective, much of the criticisms have side stepped the real dilemma facing Nigeria in dealing with the Boko Haram insurgency.

It is obvious that Nigeria’s military and police forces lack the competence to adequately protect citizens against the onslaught of Boko Haram, a ruthless group that has over the past five years grown in military and operational capabilities. But the common suggestion that the inadequacy of the security forces is mainly due to corruption and indifference is plainly over-simplistic. Also dubious is the idea that poverty is the underlying cause of the unrest in parts of the north, leading to the conclusion that the solution to the crisis is more development spending in the affected areas. Without meaning to diminish the importance of reducing poverty in any part of Nigeria, the linking of organised violence with poverty stems from false assumptions. Boko Haram militants do not bomb or kidnap civilians because they are by poor – the movement is comprised mainly of religious fanatics who want to topple secular government to impose their version of Islamic dictatorship.

To defeat Boko Haram and other terrorist groups the Nigerian state must devote much more resources to developing its capacity to protect the lives and property of citizens. The view that government already spends large sums of money on security is simply baseless. The fact is that government expenditure on security as a ratio of GDP in Nigeria is one of the lowest in the world. Federal budget allocation to the security sector, which includes the military, police and the state security service, rose from US$3.3 billion in 2009 to US$6 in 2013. Despite the doubling in allocation, the current level amounts to only 1.17% of the country’s GDP, which is very low. Much is said about the incompetence of the Nigerian military, presumably compared with armed forces in more developed parts of the world, but few critics consider that annual budgetary allocation for defence in Nigeria is about US$2.3 billion, equivalent to just 0.5% of GDP. This compares with the United States which spends about US$680 billion (2.5% of GDP), Britain US$61 billion (2.5% of GDP) and South Africa US$4.6 billion (1.3% of GDP). It is hardly surprising that U.S. counter-terrorism capabilities are far superior to Nigeria’s considering that spending on homeland security in America rose from about US$17 billion in 2001, before the 9/11 attack, to nearly US$70 billion in 2013. Similarly, it is not amazing that the British police force is a more capable fighter of crimes than the Nigerian police, considering that UK taxpayers pay about US$20 billion a year for police services compared with US$2 billion spent in Nigeria.

Some readers will retort that is misleading to compare government expenditures in poor and rich nations and make the valid point that Nigeria can only spends what it can afford. But the cost of an effective security service does not depend on the wealth of the nation or client but on the cost of the factors needed to achieve the desired level of safety. The fact that the security forces in Nigeria lack basic equipments required to operate effectively is not made less consequential because the country is poor. The minimum amounts of human and physical capital needed to establish an effective intelligence and surveillance networks is not lessen by consideration of financial constraints.

The bottom line is that the Nigerian security forces lack the capabilities to adequately deal with Boko Haram largely because they are poorly trained and poorly equipped for the job. They are lacking in all kinds of essential instruments, including facilities for transportation, surveillance, communications, data gathering and analysis, combat and combatant safety. The reality is that modern day soldiering and policing are more capital intensive activities than they were in previous eras. Strength depends on expensive hardware as well as costly human capital, including stocks of knowledge and cognitive skills.

No matter what opinions critics have about the competence of the Nigerian government, the fact is that the current level of financing of the security forces is grossly inadequate for dealing with the many different conflicts raging in the country. The issue that should be debated is how to radically reprioritise state spending. Indeed, the situation calls for redefining the nature of the state. Government, already facing mounting domestic and foreign debts, may have to drastically cut or totally eliminate its involvement in some non-security spheres of activity to free up resources to improve its ability to protect the lives and property of the citizenry, which is the prime purpose of the state. How to achieve this restructuring is the real dilemma in the fight against Boko Haram.

Needless to say, increasing financial provisions for the security services will not invariably improve their ability to better protect civilians. Not much would be gained if any extra funding is mismanaged or diverted into the pockets of officials. However, the potential for corruption cannot be a reason to leave the state weak in its ability to maintain law and order.

The Money Illusion

By Tunde Obadina

African politicians and policymakers have probably been watching with a sense of schadenfreude the unfolding drama of the public debt dilemma facing governments in the West. Not too long ago western commentators were poking fun at African nations crippled by high debt burdens, while multilateral agencies were advising African leaders on the wisdom of financial prudence.

Yet today government debt levels of most western nations are higher than those of many African countries when they were derided for their indebtedness. America’s public debt to GDP ratio is now around 106%, compared with Nigeria’s 60% before Abuja negotiated a debt buyback/cancellation deal with western creditors. As some economists have pointed out, US government debt is actually several times more than the official figure when the state’s commitments to future spending on welfare schemes are factored in. Today, Nigerian government debt to GDP is less 20%, below the level of debt of all developed nations, except Estonia. Perhaps a better way to view the debt burden of governments is to use the ratio of debt-to-government revenue. The IMF considered impoverished African countries with debt-to-government revenue ratio exceeding 280% as Heavily Indebted Poor Countries (HIPC) in need of debt relief. Today, the US federal debt is more than US$15 trillion and federal government revenue for this year is projected at US$2.6 trillion. I leave you to do the maths.

Before we get too carried away with the comparison between African and western debt levels, it is worth bearing in mind a major difference in debt management in the two areas. Unlike Nigeria before its debt restructuring, the US regularly services its debts. As long as it continues to meet its obligations, its debt burden is not an immediate threat to its economy. Debt becomes a problem when the borrower is unable or unwilling to service its loans, or when creditors fear it is going to default and as a result stop providing more credit.

Debt is not intrinsically a bad thing. It has been crucial source of financing for the establishment and operation of industries and infrastructure that have generated material prosperity in modern economies. Without debt it would have been difficult if not impossible to build railway systems, electricity power stations and manufacturing factories that require large amounts of capital. When loans are invested in projects that generate sufficient revenue to service the debt, indebtedness is not an unmanageable or unsavoury burden. All parties to the transaction – the borrower, the lender and the consumer – benefit.

Where debt is a problem and arguably immoral is when money is borrowed to pay for consumption, without prospect of revenue to service and repay the loan. Debt is particularly bad when the borrower acts in the expectation that somebody else will be lumbered with the repayment obligation. Here, not everyone benefits from the transaction. A striking feature of government debts today – both in the west and elsewhere – is that they largely comprise of this unwholesome type of debt. Basically, governments have and are incurring debts which are claims on future generations. Debt is being used as a means of enabling some of today’s generation to live off the earnings of future generations. This is what happens when government borrows to provide welfare benefits to people today or to finance military campaigns or to fund other non-revenue generating projects.

Although Nigeria’s debt to GDP ratio fell to 11.8% in 2006 as a result of the Paris Club deal, it has since risen to 18.3%, according to IMF data. The debt, mostly domestic borrowing, is liable to continue climbing as governments continue the habit of spending more than they earn. Most of the existing debt related to consumption expenditures, including payment of fuel subsidies and funding of unproductive state agencies. Even where government has spent on potentially revenue generating projects, such as power generation and distribution, the expenditure has been used for consumption. The billions of dollars spent by successive Nigerian government on the power sector over the past decade produced little extra electricity, only lumbered the present and future generations with debt.

The inequality resulting from government debt does not only affect the relationship between different generations but also that between different classes of people in the here and now. Besides borrowing from creditors, government also simply create money to fund their activities and even to repay their debts. One of the consequences of printing money is inflation – too much money chasing too few goods and services – which affects different groups in different ways.

Inflation may not be a problem for people who can offset the rise in prices by increasing their earnings. But individuals unable to do boost their incomes, inflation means a decline in living standards. One section of society so affected is the poor with limited or no earning capacity. So in printing money that fuels inflation government in effect robs the poor to enrich the better off. This has been the story in Nigeria and other parts of Africa where inflation rates have been high for decades.

The challenge facing people in both developed and developing nations is how to stop governments from running budget deficits, accumulating debt and printing money.It is essentially a political problem with economic consequences. Governments make claims on future generations and print money whenever they feel like it because they have power to do so. Today’s children and the unborn are powerless to prevent plundering adults from incurring debts whose repayment obligations await them in the future. While the poor, whose meagre earnings are eroded by inflation, may not be even aware that they are being robbed by elites who spend phantom money in the cities.