In the next few months, economists shall pay close attention to how the Central Bank of Kenya will navigate the sensitive process of demonetisation. So why have some countries successfully executed demonetisation while others have miserably failed?
The simple answer is that money has three distinct functions. It serves as a medium of exchange, as a store of value and as a unit of account. Countries that have successfully conducted demonetisation have effectively managed to change the medium of exchange without significantly disrupting the stored value.
This is typically achieved through an efficient process of remonetisation, which is the process of introducing new currency to ensure that total money supply in the economy remains steady. Australia is a good example.
In 1996, the Australian government chose to withdraw its paper-based notes and became the first country to adopt polymer-based notes while ensuring that only the medium of exchange was changing.
Similarly, 12 European Union countries did away with their national currencies and adopted the Euro on January 1, 2000. The European Central Bank prepared for almost three years while participating countries distributed eight billion notes and 38 billion coins making it arguably one of the most aggressive remonetisation exercises in monetary history.
India provides a powerful lesson of a bungled demonetisation. In November 2016, Prime Minister Narendra Modi, in a surprise announcement, declared that the 500 and 1000-rupee notes would be banned in four hours’ time. But new notes could not be printed fast enough, and the policy sparked a months-long currency crunch, costing India over 1.5 million jobs and wiping off at least 1 per cent from the country’s GDP.
The United States also bore the brunt of poor demonetisation. The Coinage Act of 1873 demonetised silver in favour of adopting the gold standard as the legal tender. The withdrawal of silver from the economy, was not counterbalanced by any form of remonetisation resulting in a contraction of the money supply, which subsequently led to a five-year economic depression in the country.
Reflecting on the economic hardships that arose after the demonetisation of silver, Senator John Reagan would later on write: “I am persuaded history will write it down as the greatest legislative crime and the most stupendous conspiracy against the welfare of the people of the United States, which this or any other age has witnessed.”
The writer is CEO at Mentoria Economics