In part one of this paper, it was argued that the inability of the Naira to store value is among the most important factors responsible for the failing Nigerian economy and discussed why this is so. It was also discussed that her price levels are heavily dependent on external markets and factors. This is due to the volatility of the Naira and its exchange rate. As Nigeria has almost no production base and has to import nearly everything it consumes, this exchange rate has led to disastrous “terms of trade” for Nigerians, responsible for wiping out the middle class of the 70s. Now options of exchange rates do we have to adopt as a developing country. We have always been told by the IMF that we should allow our currency to float and allow our exchange rate to be determined by the demand and supply mechanism. This system is flawed and should not be practised in developing countries. This is a system that supposes that imbalances between exports and imports are adjusted automatically by changes in the exchange rate, rather than through government intervention. It was argued, that such a marketplace, an arrangement, without social balance is a place for developing countries to put their nations’ fate and expect a fair deal. This system is imperfect, only rewarding the strong economies and punishing the currencies of small economies. This arrangement determines the exchange rates of currencies by the following factors only:
a) Nigerian imports/export
b) Short and long-term capital flow abroad by Nigerian businesses as against short and long-term capital in-flows from foreign businesses and investors.
c) Other public and private payments from Nigeria to other countries as against other public and private payments from abroad to Nigeria.
We know that all economies are not equally developed, with the same education and technology level, with equally developed capital and financial markets, productivity level, real income levels, etc.; and hence all economies cannot fairly compete by the same rule. This would be like something, to put it simply, it is just like a situation with the following two partners: Partner A trades with partner B. Partner A sells different items to partner B different items that all require different Know-how and raw materials and labour hours. At the end of every day, week or month, we are compelled to sit down to tabulate who has sold more to the other. Now we say if A has sold more to B in that period, the price of B must go down by the percentage of the value A sells more to B relative to the last tabulation date. Each time you sell more to me, my price continues to go down. Now because B earns less, B can also buy less or has to start incurring debt with A to consume to buy the same volume of products he was buying without debts before. The logic of the theory is that if the prices of partner A go up, B would start buying less from A. And partner A would buy more from B. Meaning the depreciation in prices balances out the imbalance in trade, with Company B’s products becoming cheaper and consequently leading to higher demands for its produced products and growth of its companies. This theory in this case would be neglecting the specific production factors, such as the social costs, the structure of production inputs, the structure of imported materials, cost disparities, other specific geographic and environmental factors, etc., that are essential for determining cost and consequently prices. By now, we all know that this system is not working, because if B needs the items he buys from A, which he cannot otherwise substitute, he has to continue to buy the required quantities from A. And each time his prices are compelled to tumble. No sensible or sane businessman would accept such an arrangement. Because each time his prices deteriorate, he has to work harder to produce more products to exchange for the same quantity he was initially getting from A, whilst A needs less for what he was getting. This is an arrangement that only favours the stronger of the two partners and with time, B is likely to be pushed to the brink of bankruptcy. Now if the products Company B sells to company A are inelastic (in the case of Nigeria; OPEC fixes the volume of crude oil export that may be exported at any observable period. This is said to be responsible for over 85% of her revenues, so a lower exchange rate cannot lead to more demand), moreover, the product is quoted in a foreign currency which leads to higher demand for that foreign currency. We know that Nigeria does not convert her crude oil revenues into Naira but maintains dollars and other foreign accounts abroad from most of the monies that are directly spent for the payment of importation of different items. If no business partners would accept such an arrangement, so why are developing countries accepting it? This system is certainly not suitable for developing countries as it is unfair and they must refuse to adopt it. There is no known developing country where devaluation has led to sustainable growth and the creation of wealth for the masses. Instead, they have often led to a series of problems that have sooner or later led to the next devaluation, starting a spiral of economic decline. This is not an option for developing countries.
The world is changing and our knowledge is growing and the present economic model has got to change too. An ideal system would take the resulting terms of trade in any exchange rate between nations into consideration. I am working on a model that should include some other economic factors in determining exchange rates. In the meantime, all economists in the developing countries are challenged to come up with better models or proposals.
As already argued in part I, developing countries should be cautious when it comes to the devaluation of their currencies, as each devaluation indirectly destroys part of the wealth of their citizens. They should fully analyse the macro-economic impacts, first looking at other options, they must ask themselves, what they consider more damaging, as the merit of having an equilibrium exchange rate in the current world economic dispensation may be relatively small compared with the social cost to society and the loss of all the goods and services of all the people becoming unemployed in a Nation.
Is Pegging an Option?
Indeed, pegging is a reasonable option, but why the dollar? The strongest reason is that since the major product Nigeria exports is crude oil and this is quoted in Dollars, the Dollar automatically becomes the most important foreign currency to Nigeria, and therefore the first choice when considering which currency to peg the Naira. In addition to the foregoing, the US dollar is still the largest currency, given the fact that it is the currency of the largest economy in the world. In part I of this article, I argued that the Naira should be pegged at around Naira 1,25 to the dollar. The reason for this is that given the weak Nigerian economy, economic recovery and the re-creation of the middle class are only possible if the Naira is pegged to an economy stable enough to carry it along like the dollar. The advantage of this is that the volatility of the Naira would disappear making the Naira attractive to hold because it shall better fulfil its function as a value storage. Its tendency as the currency of a weak economy to swing almost only in one direction – depreciation and thus bad for long-term planning would be eliminated. Whilst pegging the Naira to the dollar is certainly better than what Nigeria has been practising since, after the introduction of the disastrous structural adjustment program of the eighties, this approach also has some drawbacks. Since the dollar has become very weak in the last couple of years, particularly against the Euro and the British Pound Sterling, as the dollar depreciates against such currencies the Naira shall depreciate against these currencies as well. Since Britain, given Nigeria’s history is a traditional trading partner and in recent years some other European countries, like Germany, France, Italy etcetera and now the far East are all gaining significance as trading partners of Nigeria, it is debatable if pegging the Naira to the dollar is the best option. We may wish to consider my “mixed basket” approach.
Is the currency Mixed Basket an option?
The advantage of the mixed basket approach shall be that it shall take all the currencies of all the major trading partners into the basket for the determining of the Nigerian currency exchange rate:
Exchange rate
n
Σe ti a ti
i=1
E = ---------------
n
Σe 0i a ti
i=1
Whereby E = Exchange rate
N = infinite
T = Observation Time
A = Aggregate
consideration accordingly
Valuation of currency to the dollar
3. Measures that must be in place to take care of the risk of inflation.
of the Naira has been doing to the economy and responsible for wiping out the middle class. It was recommended that the Naira should be restructured starting with a conversion of 100 Naira to one for a new Naira or currency with any name we may choose. The current state is doing enormous damage to the Nigerian economy and unfortunately bringing poverty to the masses.
DO DEVELOPING COUNTRIES HAVE AN OPTION OTHER THAN ALLOWING THEIR CURRENCIES TO FLOAT?
In my previous paper should think that since the purpose of government is to bring prosperity and not poverty to her people, the following questions must be addressed with all other options taken into consideration before deciding whether or not to allow the currency of a developing economy to float:
1. Are we a net importer/exporter (what is the structure of our foreign trade, do we import food and other consumer items in large quantities that can hardly be substituted by local productions?)
2. How is the structure of our industry (are we solely a raw material, half-finished products supplier or are we a supplier of high-end products as against how many millions of Nigerians, who in certain sectors still depend on imported materials and machinery, spare parts, vehicles, chemicals that will become more expensive from abroad
3. Can we increase our export by at least the same margin/percentage as the devaluation?
4. Do we expect a net gain of capital inflow?
5. What are the expected positive impacts on the economy and living standard of the masses?
I strongly argue that if the answers to the above are not convincingly positive, developing countries should consider other options, other than allowing their currencies to float freely as this only leads to uncontrollable depreciation and devaluation of their currencies with all their consequences. Devaluations under such circumstances only lead to better terms of trade for their trading partners with no benefit for the developing economy. The Nigerian experience has demonstrated too well that when a country is a net importer with her most important export commodity (crude oil) quoted in the dollar, whose allowed export volume and even price are fixed by some cartel outside her boundaries, devaluation would make little sense as the demand for crude oil which amounts to over 80% of her total export volume would not increase thereby leading to any economic growth. Isn’t it inevitable that given this circumstance the Nigerian economy was bound to fare badly as it has been ever since the devaluation experiment started? Wouldn’t Nigeria doubt be faring better by either pegging her currency to the dollar being her largest trading partner’s currency responsible for over 85% of her foreign trade earnings or to a basket of the currencies of her most important trading partners, like the dollar, Pound Sterling and the Euro, I admit though, that the idea of the mixed currency basket is still in development that I hope to discuss fully in another paper. Now, depending on the movement of the currencies in the basket, the exchange rate of the Naira shall be determined by an index and reviewed say once every month. This can be called “controlled or managed floating”.
Most policymakers in developing countries seem misled to assume that after deregulations and opening up the capital market followed by a floating currency and some devaluation, the market just takes care of itself producing those desirable results with the invisible hands doing all the magic. Yet we know that some of these medicines can be fatal to the health of a developing country, as uncontrolled import and capital outflow in times of economic crisis often lead to a worsening of the initial crisis that leads to the measure. The measures often punish those that are supposedly designed to help and reward their trading partners with better terms of trade.
Such developed economies like Austria and Switzerland which are amongst the richest countries (income per capita) in the world, had their currencies pegged to the German Deutsche Mark until the introduction of the Euro 2 years ago. The Swiss Franc which can still be considered to be amongst the stronger and stable currencies of the world is not floating freely; it is more or less pegged, with a bandwidth within to move, to the Euro. The stability pact signed by all European Union members before the Euro was introduced that sets a limit of a maximum 3% fiscal deficit for all countries of the Eurozone was designed to keep the Euro strong and stable. Thus, if the conventional theory was always right, that devaluation leads automatically to higher demand for local products and growth, then generally speaking periodic devaluation should be desirable, but why should the European Union actually be relentless in their efforts to protect the value of the Euro and avoid just that. Why the Europeans aren’t happy to have a weak Euro as this should be good for European export is because they know that the merits are often outweighed by the demerits of higher costs for imports and other services from abroad that could eventually lead to imported inflation and economic decline. Developing countries that have little to export or whose exports are not elastic shouldn’t carelessly allow their currencies to float, instead, they should peg them to the currencies of their most important trading partners, and this irrespective of what outsiders and half-baked economists may tell them.