Africa has a long legacy of being the leading supplier of the world’s basic resources especially gold. So, a gold-backed currency is a rather obvious no-brainer.
The continent has fed the rest of the world with the material resources that they have needed to grow their respective economies. The mineral resources hosted by the continent are vast ranging from precious metals like gold and platinum, to precious stones like diamonds, industrial metals like iron, copper, manganese, mineral sands, tin, chrome, lithium and fossil fuels like oil, gas, and coal.
- The gold standard is the original monetary system that many of the countries of the world subscribed to.
- Under this monetary system, the gold standard that is, all money was based on the value of the gold reserves that a country held with its central bank.
Notes and coins under the gold standard were easily changeable into actual gold.
- Discussions around the reintroduction of the gold standard or some form precious metal standard have become more frequent with calls becoming louder for countries on the continent to base their currencies on the vast mineral resources that they are endowed with.
These mineral resources have been exploited relatively successfully in varying degrees. However, many of these minerals on the continent remain largely untapped. This goes to show economic promise the continent has in terms of the extraction and beneficiation. Globally, the world economy has been frothy, characterized by rising inflation, stemming from the geopolitics from the conflict in Ukraine and its contagion effect on the cost of living. Inflation has also been a legacy of the Covid pandemic which has caused supply chain disruptions.
This adverse economic developments on the global stage tend to amplify their impact on Africa. The continent is not short of its own issues. Currently, the continent is in the throes of a sovereign debt crisis which is the result of African nations taking on more public debt than they can service in response to the Covid pandemic.
Some countries are said to be on the brink of defaulting on their foreign debt obligations. Some countries have even defaulted on these obligations like Zambia. The outlook for countries in as far as foreign debt is concerned is not encouraging. The IMF has stated that most African countries have foreign debt stock that is beyond what can be classified as appropriate. The foreign debt stock is adding inflationary pressure to the respective economies of the continent given the context of a resurgent and strengthening US dollar.
Countries in Africa have a disproportionate amount of their debt stock denominated in United States dollars save for outliers like Eritrea.
Weakness in their currencies makes debt service payments expensive and unsustainable. In South Africa for example, there was an outcry when it was discovered that debt service payments were taking up a considerable chunk of government revenues leaving little room for financing of social development initiatives. As debt service payments take up more of government revenues, those governments experiencing fiscal deficits will want to explore ways of reducing those deficits. The most obvious way of increasing revenue for government will be to increase taxes.
Tax increases can lead to inflationary pressures. Businesses will often try to pass on the cost of increased taxes to the final consumer through higher prices.
With this background in mind, one cannot help but wonder if there is merit in the continent using its vast mineral resources to anchor the value of its respective currencies. Is there scope and a case for a return to the gold standard or a hybrid variation of the gold standard where the value of African currencies is underscored by the various minerals that each country produces? This monetary system is not novel. In fact, the gold standard was the first attempt in human history to underscore the value of money with actual gold.
- Calls for adoption of the gold standard by Africa and its countries come against a background of rising inflation, looming recession, and a potentially catastrophic sovereign debt crisis. Historically, currencies whose monetary value was based on some precious metal standard, were known to hold their ground whenever inflation reared its head.
- The mitigatory effect of a gold standard monetary system or a currency based on some precious metal standard is the reason a return to this system looks appealing especially currently.
- Re-adoption of the gold standard has merit where inflation is concerned but has some fatal shortcomings which would make its reintroduction a failure. The United States of America was on the gold standard until President Richard Nixon took the decision to take the US dollar of the monetary system in 1971.
According to the World Gold Council, “The Gold Standard was a system under which nearly all countries fixed the value of their currencies in terms of a specified amount of gold or linked their currency to that of a country which did so. Domestic currencies were freely convertible into gold at the fixed price and there was no restriction on the import or export of gold. Gold coins circulated as domestic currency alongside coins of other metals and notes, with the composition varying by country. As each currency was fixed in terms of gold, exchange rates between participating currencies were also fixed.”
Under this monetary system, a country’s monetary supply is linked to gold or some other precious metal or mineral in the context of Africa. This feature is arguably the most attractive to African countries battling with inflation.
Money supply cannot be increased at will as doing so would need to be followed by a commensurate increase in gold reserves. Inflation that is linked to increases in money supply is not likely under a gold standard monetary system. However, as has been seen from inflation in recent times, inflation has arisen from factors other than merely the increase of money supply. Inflation has come from cost push factors which are somewhat independent of the money supply in an economy.
Central to the functionality of the gold standard as a monetary system is the necessity of being able to convert fiat money into gold on demand strictly limited the amount of fiat money in circulation to a multiple of the central banks’ gold reserves.
Under this monetary system international balance of payment differences are settled in gold and not United States dollars as it were. Countries with a balance of payments surplus would receive gold inflows, while countries in deficit would experience an outflow of gold. Theoretically, this settlement of international transactions in gold means that an international gold standard system is meant to be self-correcting.
This means that a country running a balance of payments deficit would experience an outflow of gold, a reduction in money supply, a decline in the domestic price level, a rise in competitiveness and, therefore, a correction in the balance of payments deficit. The reverse would be true for countries with a balance of payments surplus. Although this system appears on the face of it a simple system or a no brainer, however, it is more complicated and must be used in conjunction with central bank operations in terms of monetary policy.
How practical would it be for African countries to return to the gold standard or a hybrid version of it?
Inflation is problematic.
The gold standard does offer a veritable solution to inflation that is driven by an increase in money supply or reckless government spending. The latter tends to be an endemic problem in Africa. A return to this monetary system would do a lot of good for African countries in the sense that it will force fiscal consolidation. According to personal finance and investment website, The Balance, the United States of America had reasonable success with the gold standard as a monetary system because the country had legislation that obligated the government to redeem paper money with actual gold that it was linked to. This was achieved through the Gold Standard Act of 1900.
- Most countries in the world like the US are not on the gold standard. They adopted what is known as the fiat currency system. This is where all currency issued by the central bank of a country is backed by the full faith and credit of a country and not by gold or some other precious metal.
- The biggest disadvantage of the gold standard is that it makes it difficult if not nearly impossible to conduct monetary policy especially in instances where a government would either want to stimulate a slowing economy or to cool an overheating one.
- A precious metal standard or gold standard requires for a country to have actual gold bullion in its reserves in its central bank and then to issue a currency based on this. A country cannot provide a monetary base for the value of its currency premised on minerals that are still in the ground… Much less those that are not refined.
“The act guaranteed that the government would redeem any amount of paper money for its value in gold, and it meant that transactions no longer had to be done with heavy gold bullion or coins because paper currency had a guaranteed value tied to something real.”
African countries looking to anchor their currencies on either gold, or a combination of gold, precious metals, and other minerals would need to start with legislation which would make it legal for the governments of those countries to redeem paper currency with either those minerals or a derivative of those minerals.
Zimbabwe in late August began an initiative where it sold actual gold coins to its citizens which had been minted by that country’s central bank. This move was initiated to halt the slide of the currency on the parallel and official markets. This county’s policy so far has been successful in slowing down the trend of inflation which had begun to run amok.
It would be remiss to attribute the slowdown inflation to the gold coins. The country dramatically tightened its monetary policy by increasing interest rates to over 200 per cent in May 2022 and temporarily banned commercial bank lending. One of the disadvantages of the gold standard is that governments struggled for decades to make the system work globally. The gold standard reached its watershed when Richard Nixon in 1971 took the United States dollar off the gold standard.
For monetary system where the value of a currency is anchored on the minerals a country produces to work an essential and unavoidable prerequisite would be for the said country to have substantial reserves of the said minerals either on hand physically or a derivative of the said minerals either through certificates or futures or any documentation proving the physical existence of the said minerals. According to Britannica, this disadvantage was the nemesis of the gold standard as monetary system.
“The availability and value of gold fluctuates and does not provide the price stability necessary for a healthy economy.”
Gold though considered an investment haven, is not immune to fluctuations in price. A currency tied to gold or any other mineral for that matter would be subject and susceptible to the vagaries of price fluctuations beyond what can be controlled through monetary and fiscal policy. The other elephant in the room which African countries need to be alive to is that: a currency cannot be anchored by minerals that are still underground. A currency would need to be anchored by minerals that have already been extracted and most importantly beneficiated.
Gold would need to be dug out of the ground and refined into bullion and deposited with the central bank or an African equivalent of Fort Knox. The same can be said about diamonds, platinum, copper, and related. They would need to be extracted and refined and then stored safely away. Only then can a currency be issued against these. The success of such a monetary system needs for the issuing country and government to have significant quantities of the minerals in reserves. This is obviously complicated and not anything that is easily achievable in the short run at least. The same can be achieved through export led economic growth and building up foreign exchange reserves.
Finally, and perhaps most importantly is that a return to a gold standard or a hybrid monetary system where African currencies are anchored by mineral resources would inhibit the ability of central banks to help economies in Africa out of depression and recession periods as well as to address unemployment. Central banks can manipulate the value of a country’s currency through interest rates to either stimulate growth in an economy or to slowdown one that is heating up. This is under a fiat monetary system where the value of the currency is underscored the full faith and credit of the issued country’s government.
Under a gold standard system, it is decidedly much more complex as the value of the currency would need to match the gold or metal reserves in that country’s central bank. The country would need to buy or sell gold to achieve its monetary policy objectives in stimulating or cooling the economy. The idea for a hybrid monetary system where the value of a currency is inextricably linked to the mineral resources is a good one. It is not novel. It is however, complex and one that most countries cannot afford presently.