Caught in between the devil and the deep blue sea

 

 At the risk of being labeled a sadist, I’d like to state it here that I certainly think that the Kenyan economy is going through very interesting times. To paint the picture quite starkly, consider the following context; In just about 6 months, the government will be required to cough up to $ 3.6 billion to pay up for the first round of our monthly fuel imports in addition to that, in about the same time, multi-billion shilling loans will be falling due for payment.

Now consider that, vis-à-vis the fact that the government is facing a revenue shortfall of about sh714.97 billion with only three months to the end of the current financial year.  This means that for the tax man to meet the full-year target of sh2.108 trillion, it would have to collect at least sh238.3 billion every month to June or about sh7.9 billion daily, a feat more impossible than trying to fit a camel through the eye of a needle considering that the highest monthly collection achieved in the present financial year is sh194.05 billion- collected in December when, unlike other months, households’ consumption expenditure is high due to festivities.

Sorry dear reader, but it does not end there. Both the fuel imports and debt payments (external) are made in dollars, and given that the shilling continues its downward spiral against the dollar, then, even more Kenyan currency will be required to pay for the maturing payments.

So bad is the situation that the president’s top economic adviser Dr David Ndii in a recent tweet said that treasury would have to make a choice between delaying civil servants’ pay yet again or defaulting on public debt. As is apparent, Kenya’s economy is caught in between the devil and the deep blue sea.

It is against the backdrop of the afore-described grim situation that a friend of mine asked, “Why not just print money and cool things down for a while?”

Before I could answer he added, “Don’t give me that inflation crap economists keep floating about as an answer to that question,”

This question has been asked a gazillion times before and while it may seem simple and straightforward, I reckon that the reason why it keeps popping up time and again is because most folks just don’t understand what “printing” money actually means and what its implications are.

            So what is “money printing”?                

What economists actually mean by “money printing” is that, the government (through the treasury) temporarily buys bonds through open market operations (OMOs) then later, when the interests and principal repayments are due, the government prints this money and pays it off.  The reason why it is called “money printing” (and here’s the catch) is because new money is created without a concomitant increase in nominal GDP.

However, I understand that this is not the type of printing most people have in mind whenever they ask that question. What they actually mean is actual printing of money like you would print documents at a cyber cafe and then finding a way to inject that money into the financial system. That too happens but any monetary authorities worth their salt just don’t print money on a whim. There are several considerations to make and this is closely tied to the first explanation on the economists meaning of “money printing”.

Before explaining further, what most proponents of this debate largely forget or fail to understand is that, money is not a stand-alone item. Money really is a facilitator of exchange between two (or more) people. It is in essence a middleman in trade. This will come out more clearly as you read on.

While trying to break down money printing, former Sri Lanka Deputy Central Bank Governor, W.A. Wijewardena used the following analogy in a newspaper article:

Suppose we have only one commodity, say coconuts, and people have to satisfy all their needs with coconuts. In this economy, what we know as the total output or the Gross Domestic Product or GDP is represented by the number of coconuts. If the coconut production has increased by 100% we can say that the real GDP too has increased by 100%. Suppose in this economy we have another commodity called money supplied by the Central Bank to facilitate the exchange of coconuts among people. For convenience, let’s call that money rupees or in short Rs.

At the beginning, let’s suppose that people produce 10 coconuts and the Central Bank has supplied Rs.100. Now, people have to exchange these 10 coconuts for Rs.100 and the price of a coconut is Rs.10, arrived by dividing the stock of money by the number of coconuts. Suppose that the production of coconuts increases by 100% to 20. If the Central Bank does not increase money supply, the price off a coconut falls to Rs.5, a situation known as deflation.

 What will happen if the Central Bank allows the money stock also to increase by 100% to Rs. 200? In this case, the price of a coconut remains unchanged at a stable level of Rs.10. Hence, in the economy, Rs. 100 has been newly created but it has not caused inflation to set in. Thus, a government can allow new money in an economy without causing inflation if it limits the new money creation equal to the increase in the real goods and services, commonly known as real economic growth rate.

But what would happen if the Central Bank allows money stocks to go up to Rs. 400? In that case, the price of a coconut also increases to Rs.20, bringing inflation to the economic system. Hence, printing of new money per se is not sinful. What is sinful is the printing of money over and above the expanding capacity of the economy, as reflected by the real economic growth rate.

I believe the above excerpt suffices to explain inflation as a possible negative outcome of printing money. The other negative outcome of printing money is the loss of faith among foreign investors.

           

 

Which way for Kenya?

The reason why I find Kenya’s present scenario quite fascinating is because, it would be interesting to see how the government wiggles its way out of this one given that the president has issued stern statements to the effect that his government is not looking to borrow more (they have little leg room for that anyway) and it is highly unlikely, nay, impossible, that they are going to cover the revenue shortfall. One of the possible solutions they could pursue is severe austerity measures as far as government spending is concerned. But by the look of things, they don’t seem too concerned in plugging the leak. Meanwhile, we cross our arms and wait in anticipation.