Should Liberia Resist Dollarization?
April 21 2014 - By Jeffrey Cavanaugh - AFKI Original
As a frontier market, the countries of Africa represent both tremendous opportunities and tremendous risks. On the risk side of the ledger are all the usual complications of international trade and investment compounded by the problems inherent in a developing, emergent continental market consisting of 54 countries and 1.1 billion people – it's a lot to keep track of.
Luckily, the ups and downs of the African currency markets aren't one of them if you know where to look. To help with that, AFKInsider has compiled all the news you need to know now in order to slim down your currency risk. AFKInsider presents FOREX Africa – Should Liberia Resist Dollarization?
What's monetary sovereignty worth?
Early this month a bill was submitted to the Liberian Senate that would delink the country's dependency on the U.S. dollar by making it illegal to conduct commerce in anything other than Liberian dollars within Liberia. If the bill passes, this will end more than a century of dual-currency use in the country. The Liberian dollar will become the country's sole legal tender going forward.
The question is whether this is a good thing for the country and its people.
It is estimated that a huge proportion of Liberia's day-to-day financial transactions takes place in U.S. dollars and that the greenback makes up approximately 90-percent of the country's money supply. It's like this for a number of historical reasons that relate to both the country's relationship with the U.S. – unique in Africa — and more recent circumstances related to Liberia's experience with tyrannical rule and devastating civil wars starting in the 1980s.
First, Liberia, unlike other countries in Africa, was a 19th-century project of American colonialism aimed at repatriating freed black slaves back to Africa.
The U.S.-Liberian project was created in 1822 by the American Colonial Society and became "independent" of the U.S. in 1847. The country became dominated by the Liberian descendants of African-American slaves. These descendants swiftly imposed on the native Africans a similar system of colonial rule and exploitation that America and other Western powers imposed on other native people elsewhere around the world.
Given their links with the U.S., Liberia's American-Liberian elite bequeathed to their country an abiding cultural tie to the U.S. that included the use of the U.S. dollar. As the 20th century rolled on, the country's lucrative rubber plantations became dominated by American corporations. This was more-or-less the status quo until 1980 when Liberia entered a downward political and economic spiral after the overthrow of the Liberian government by a senior enlisted man in the Liberian military.
Brutal authoritarian rule and civil war went on nonstop for a quarter of a century. That the country experienced diminished growth and monetary instability is something of an understatement. Liberia, which had always been reliant on its relationship with the U.S. dollar, became even more dependent on. Liberians increasingly abandoned Liberia's dollar for America's.
As a result, by the time stability returned to Liberia in 2005 with the election of its current president — Ellen Johnson Sirleaf — the dollar was the de facto currency of the country, having widely displaced the Liberian dollar in most economic transactions. The Liberian dollar was relegated to small-scale consumer transactions in Liberian market stalls.
Given this history, is it a good idea to give up the greenback and make the Liberian dollar the sole legal currency of the land?
Research indicates that dollarization of the economy does two things. First, it keeps a lid on inflation by providing economic actors a strong, alternative currency to a collapsing one. This is especially true in unstable, conflict-ridden societies where insecurity and uncertainty – the bane of price stability – reign. In such situations economic actors will abandon the unstable, depreciating currency for the stronger one as has happened with the Liberian dollar.
On the other hand, research also shows that dollarization inhibits economic growth mostly by tying an underdeveloped, export-dependent economy such as Liberia's to a much stronger hard currency that the government of the underdeveloped economy has no control over. This makes the country's exports more expensive and imports less expensive and rearranges the economy away from a development path premised on production for export towards an economy based on domestic consumption.
This is not such a bad situation for strong, developed economies that produce a variety of manufactured goods desired by global markets. Nor is it a problem for oil-rich countries that export a single, highly-desired commodity that has no substitutes.
For countries like Liberia, however, competition is stiff globally. Liberia produces goods for which the terms of trade are low — meaning there are lots of competitor nations. Global demand for those products isn't very high relative to what the country imports. The gains from lower inflation that come with having the economy tied a more stable currency like the U.S. dollar are not enough to make up for the loss of export income that is the natural outcome of having or using a strong currency.
Inflation may be limited in such instances but this does not mean much when an uncompetitive currency chokes off economic growth by making export prices higher than what they might otherwise be. Thus, de-dollarization will mostly likely help certain Liberian industries but hurt others.
Exports of Liberian goods will certainly be helped by de-dollarization, as will the tourism industry. Tourists will find Liberia a much cheaper place to visit. On the other hand, anyone who exports capital to the country is potentially threatened as their in-country assets will now be denominated in Liberian dollars, thus potentially adding significant currency risk to an already risky investment.
This is a big burden for a post-conflict society like Liberia, where institutions are still in their infancy, the leadership untested, and the population not yet attuned to either democracy or modern, globalized capitalism. Unless external creditors can be convinced of the country's political stability and its leaders' commitment to sound fiscal stewardship, de-dollarization will add to the country's risk burden and so require additional compensation in the form of higher interest rates to make up for that risk.
For a country so recently emerged from civil war, it is perhaps too soon to throw it into the judgmental frying pan of international creditors by knocking away widespread legal use of the U.S. dollar — a key pillar of macroeconomic stability. Liberia needs to build up other pillars to support and even improve its current creditworthiness.
Doing so prematurely will only make Liberia's growth problem worse, not better, and will serve to undermine all that Sirleaf and her people have strived toward since the end of Liberia's quarter century of civil war.