• Adil

Your Time, Your Life... Their Money

Updated: Jun 15, 2020

Pandemic fears are gradually receding, in a bleak trail of an economic aftermath. We are now deep in it, and people all over the World, at all levels of prosperity, are pinning their faith for economic recovery on policies being deployed by their central banks. Financial markets bear witness. Even though the toolkit is varied, one theme is obvious – increase the money supply.

Since early March, the Bank of Mauritius (BOM) has introduced a number of measures to assist businesses and households with liquidity – cutting the repo rate, providing relief funds, reducing the cash reserve ratio, offering moratoriums on loan repayments, easing banking guidelines on lending, setting up foreign currency credit lines for exporters, swap arrangement for importers… During the latter half of May, the Bank of Mauritius Act was amended, clearing the way for Rs. 60 billion to be granted/contributed to the government plus $2 billion to be made available to the Mauritius Investment Corporation (MIC) for private equity investments.

The prevalent school of thought in monetary economics hinges on the idea that money supply majorly influences national output – this is known as Monetarism. Easy credit, and at times, easy money, will entice businesses to expand. This proposition in its initial form is associated to Milton Friedman, an American economist who in 1976 received the Nobel Memorial Prize in Economic Sciences.

Today, debates around the present policies rage on. Observers, and the opposition, are not comfortable with a central bank printing money beyond its capacity, especially when it’s granted to a majority government which is by its very nature biased by its electorate and within. Too much money for not enough economic growth will make our currency worth less. The counter argument, by example, is that expansionary policies implemented after the 2008 financial crisis seem to have worked, if gauged by the financial markets and metrics of employment and GDP growth (somewhat), without spiraling inflation. Proponents also suggest that the BOM has enough reserves for the planned $2 billion and that there’s enough liquidity and willingness from the markets to finance the Rs. 60 billion.

Now, my honest hope is that the policies formulated work for the benefit of the people, not just for temporary relief but for the preservation of value of the time spent by our citizens to earn an honest living and make savings – past, present, future. And my wish is not to engage in monetary policy debates. My wish is to find answers to some questions, which are primarily directed to myself.


Questioning Money

Money is needed to drive incentives and the economic machine. We base entire life decisions around money – our careers, our projects, our education, our children’s welfare, our estates… Yet… we cannot agree on how present-day money works. It’s quite unreal.

What exactly is that money which authorities can just increase the supply of? Why does it have obscure, uncertain, unpredictable properties? Does it not bother you that even the best economists cannot give you a satisfactory definition of what present-day money is and what policies work? Are you content with ‘it’s a complex thing’ for an answer?

Why would the stuffs you buy cost more or earn you less, depending on how well policymakers did their job, not on the value attributed to these stuffs? Would you be okay that the 9 or so hours you work every day mean less today than what they did previously even if the products or services you supplied then are now equally in demand and consumed? Would you be okay that the 9 or so hours you worked every day for 20 years suddenly not be enough to purchase the education you promised yourself for your child because policymakers’ decisions turned out to be unfavourable?

Unless you are completely recluse and off grid, you need money to live. But then, the central bank and the banks have control over your money. Do these institutions then control your life? They can create money, you can’t, you have to earn it, or apply for it (contingent on offering a guarantee). Does it make any sense to you? You, who contribute to the economy?

I wish here to discuss the nature of present-day money and how the system became what it is in the context of an independent developing nation. Most of us alive today were born in it – we perhaps don’t know any better than what has been passed onto us, other than from books and the rhetoric of policymakers. But I wish to question it. After 49 years of fiat currency, and centuries of central banking and fractional reserve banking… in the face of a worldwide economic upheaval… the time is ripe.


Ceding Power over Your Money

Globalisation, with the relics of colonialism, planted dominant systems of governance, laws, schools of thoughts, and languages across the World. Heck, even this article is in English. The BOM model, devised in 1967, is a replica of the Bank of England (BoE), itself established in 1694, itself a 17th century phenomenon to prevent bank failures and financial crises as a result of fractional-reserve banking.

Fractional-reserve banking is the practice of accepting deposits, keeping a fraction of them, and lending the rest. It resulted from the reasoning that deposits kept at the bank can be put to use and benefit the community, instead of sitting idly in the vaults.

We pause here for an open-ended question: You are in any year prior to the 1600s. You just earned some money, in gold coins. Not willing to walk around with this gold, you turn to a reputable bank to store this money. The bank promises you to keep it safe, and in return gives you a receipt. Knowing that the bank is in the business of lending, you are faced with a choice. You can let the bank lend at its discretion or you may ask for a say into how the bank gets to lend your money including whether it lends it at all? What do you choose?

The reality is that banks have always had discretion over your money. So, banks made loans as they deemed fit, and it so happened that at times, depositors would actually request their money back all at once, causing bank runs. Since the money due not being available in the vaults and the loans not being able to be repaid immediately, banks went bust. As a solution, the idea of central banking came into being to prevent such situations to occur. We are in 1668 Sweden, when the World’s first central bank was established.

Policymakers in those days decided to write laws empowering central authorities to protect banks from going under – so fractional-reserve banking could continue. Central banks were authorised to become the central storage for precious metals, regulate banks, and act as lender-of-last-resort if any bank faced a bank run. I guess no one paused to ask whether depositors’ consent may be an option.

With time, more authority was granted to central banks, allowing them to influence the economy and manage interest rates and the money supply. Today, also through legislation, they can grant the government money, at their discretion.

In effect, legislation was considered more effective to protect the financial system. It is through this process that people handed the power over their money to the commercial banks initially, and eventually, the central bank.

Do you think it would be a good idea that your bank asks for your permission before lending your money? I’d like to get your view on this.


Nixon Shock

On 15th August 1971, something quite extra-ordinary happened. Richard Nixon, the 37th president of the United States announced a series of economic measures known as the Nixon Shock. In anticipation of presidential elections scheduled for November 1972, the emphasis was greatly on the state of the economy; the unemployment rate was 6.1% and inflation was 5.84%. Nixon then imposed a freeze on wages and prices to control inflation and an import surcharge of 10% to protect the local industry. In this populist bundle, he also suspended the convertibility of the dollar into gold.

This suspension meant a transition into a fiat currency system, and the reason why the money you own today is called legal tender for itself, and not legal tender for gold, nor for anything else. It’s a circular reference. It only gives you purchasing power because the government decrees it to be so. Same for the dollar, same for the euro, same for the rupee, and all currencies around the world. The central banks can print as much or as little money as they wish. You place your trust in them and the respective governments to manage this.

If you earn rupees, whatever you dedicate your time and life to in view of your sustenance and progress, is in exchange for that legal tender issued by the BOM, under the authority of the Bank of Mauritius Act. As long as everyone respects the legal tender in exchange for products and services, you hold purchasing power.

Milton Friedman was an adviser to Nixon at the time, and the president saw the monetarist proposition on money supply as a way to reduce unemployment. Under the previous system of convertibility, paper money had to be kept in check with gold reserves, but under the new fiat currency system, this was no longer an issue.

Although he had been warned by Friedman himself about the dangers of inflation, Nixon pressured the then-Fed chairman Arthur Burns to ease monetary policy, that is, increase the money supply. This was actually revealed in the Nixon tapes.

Friedman would break with the president following the August announcement. In a much later interview, he would be quoted saying: “The problem with Nixon was not intelligence and not prejudices. The problem with him was that he was willing to sacrifice principles too easily for political advantage.” Basically, Nixon traded off longer-term economic costs for his own political gain.

The only relic of the Nixon Shock today is the fiat currency system, in which we all operate.


Deciding for Ourselves

Being aware of the history of money, for which we sacrifice our most precious commodity, that is time, perhaps makes it easier to close the disconnect between our aspirations and the medium we use to achieve them. Understanding how present systems of money came about, we may decide for ourselves whether what worked for the originators of these systems may work for us.

Having been a French and then a British colony, we inherited a fractional reserve banking system, along with its issues of bank runs, and the eventual creation of a centralised monetary authority – replicating 17th century Europe. Well, so have other nations under European colonised powers – most of the world at some point, right?

We may also question whether behavioural assumptions inherent in Friedman’s models necessarily mirror those of another nation. And even though Friedman’s theories were formulated for the welfare of the economy and the people, we may not be assured of the same intentions from policymakers who are politically tainted. We very well know that central banks are not independent institutions. Every time we make such an assumption, we plug flaws into predictive models. Plus, politics across different countries, have their own cultural hues and agendas.

At the same time, even as an independent nation we have little room to maneuver when we are subjected to the beliefs and convictions of international powers to which we subscribe, such as the International Monetary Fund (IMF) – perhaps the subject of another debate.

All this said, it would be foolish to bet on an immediate major overhaul. We are in a system where commercial banks have power over your money, the central bank decides on the money supply, the government has legislated to be the direct beneficiary of monetary policy, and local politics are way too disarrayed and self-absorbed to brave an entirely new system. We have to live with it, but the least we can do is understand the potential effects of policies enacted. What could it all mean then when the money supply is expanded?


The Bowl of Peanuts

Around a table, a group of friends is sharing a bowl of peanuts. At some point, the group leader decides that it would be great to have more peanuts. She gets up and fetches a larger bowl into which she transfers the existing peanuts – this can be likened to printing money. While the bigger bowl has the capacity to hold more peanuts, they still have to figure out ways to get actual peanuts, the real economy.

In the same line of thought, if she had, say, brought the bag of peanuts closer to the table where anyone could refill the bowl when needed, this would be akin to lowering interest rates – making the source of peanuts more attainable.

Lowering the interest rates will make credit more accessible and create more money in the process, but it will be a function of demand for that money – no one takes out a loan just for fun. But printing money arbitrarily and ignoring the demand for money, can just leave you with a bigger bowl.

At some point following the 2008 financial crisis, there was no longer room for the Federal Reserve to lower interest rates. They began to print money, through a process called quantitative easing. In fact, the US have more than doubled their money in circulation since 2008. Yet… inflation didn’t spiral nor did the dollar depreciate, actually quite the contrary.

One logical explanation could very well be that the dollar is constantly demanded worldwide. Our international suppliers want to be paid in dollars, not rupees. The Rs. 120 billion we imported more than we exported in 2019, required dollars. The World trusts the monetary authorities and the government of the US, more than any other authority, to preserve the purchasing power of its work and labour. Is it true? Or is it because we all have nuclear guns and the threat of sanctions pointed at us?

In the bowl-of-peanuts allegory, the US dollar is simply a bowl no one can (or dares to) do away with.


Reversing the Equation

You may want to ask then, if the BOM provides more rupees to support our affected sectors, say tourism and manufacturing, would that boost the economy? Tourists must demand and consume. Retailers in Europe need to have demand of their own to in turn demand our manufactured products. Even if you make the extreme assumption that Mauritians could make up for all the lost foreign demand, we still have to earn foreign revenue to finance our imports, right?

There’s a limit to the land we can sell to foreigners. There’s a limit to the lip service paid to the European Union to convince them that our jurisdiction does not wash money when reports on drug trafficking go unheeded and people are murdered in our prisons by government officials. There’s a limit to the credibility of a government when private enterprises are dismantled, and administrators earn hefty commissions. Etc. Etc. If we were self-sufficient and our currency had any international value, more rupees could very well mean more peanuts for everyone. But that’s not the case.

It makes sense to invest money in sectors whose products and services have potential foreign demand, right? Then we could very well just do that. Let’s see where there’s likely to be foreign demand and head in that direction. How long can anyone support dying sectors to keep the illusion of employment for fear of disrupting comfort zones. A political conundrum?

The promotion of the life sciences sector is not a bad idea at all. Of the 2,040 km2 which make up our island, 36% of this area is used for sugarcane cultivation, yet the value contributed by sugarcane and sugar is less than 1% of what we produced in 2019 – and decreasing. Can we find crops with higher mark-ups? We own 2.3 million km2 of Exclusive Economic Zone – there’s plenty that the World could demand from that, sustainably and at fair prices. The World also consumes software, right? Let’s get in there. Let’s support the young programmers. We could extract our own suspected gas reserves eventually – instead of soliciting foreign support and protection.

But yes, people cannot eat ideas, as much as they cannot eat the pointless bickering of policymakers. We need to revisit our economic model, don’t you think? Start the thinking process from demand instead of money supply?

But to implement any change of that magnitude, we require strong and genuine leadership. We need capable policymakers who inspire and encourage us all to unite as a nation to work for one identical goal – national progress. We all wake up to earn that currency issued by that one common government. We all better be defending that currency if we want to protect its purchasing power. That leadership I am talking about needs to unite, instead of divide.

In the meantime… just be mindful that should the music stop, you are not the last one standing.

P.S. Money doesn’t grow on trees, but there’s surely no fortune without them. :) 

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