Why the N5000 Note is Long Overdue

by Odilim Enwegbara

Rather than N5000 note and N20 coin causing inflation, they’ll promote efficient transactions.

Henry Thornton, famous for his quantity theory of money in 1802, argued that more money equals more inflation, and that doubling money in an economy also doubles prices and inflation too. This line of argument came from the 16th century inflationary experience accompanied the flooding of European coinage market with gold and silver from the Americas.

The quantity theory of money left the true variables determining inflation completely out. Failed to be captured are the three main variables mediating the effects of changes in the money supply and demand on the value of money and the price level. One, that an increase in the money supply (unless trapped in the financial system as excess reserves), can cause a sustained increase in GDP instead of inflation, especially in a deflationary economy. Two, that if the velocity of money increases, an increase in the money supply could have either no effect, an exaggerated effect, or an unpredictable effect on nominal GDP growth. Finally, the quantity theory of money failed to capture the fact that because the velocity money changes as consumers’ preferences and business spending impulses change, the velocity of money can never be constant in any dynamic economy.

Being the number of times a single banknote is used to purchase goods and services in a given period of time (one year precisely) the velocity of money is a key input in determining an economy’s inflation. The velocity of money is also important to investors, who use it to gauge how robust a country’s economy is. So, the more times a given note is spent, the faster the economy grows and the higher are the productivity and GDP. However, while high velocity of money is needed, excessive velocity of money carries inflation along.

But should central bank pump money into an economy without a corresponding increase in velocity of money, even if a growth in GDP is witnessed by the bank’s actions, rather than spurring economic activity, it is a liquidity trap that the economy should experience. While keeping government printing press constantly running has long been a staple of political economy, just printing more money has been discovered not to be the right medicine for curing deflated economy. With the 2008 liquidity squeeze, monetary authorities undertaking massive expansion of the money supply are now discovering the painful truth that instead of lifting nominal GDP, velocity continues to fall because nominal GDP is relatively unchanged.

Because size of economy, population, and productivity growth affects the velocity of money, money supply should increase equally to meet such growth, or else deflation appears. But what we are seeing in western economies is low velocity which rather than more increase it, in the absence of growth in productivity, pumping more money worsens the situation. The only way for a central bank to increase money supply by 5% for example, should be if the bank foresees 1% population growth, 2% productivity growth, and 2% increase in the velocity of money. High currency denomination has no meaningful role to play in making the monetary policy shifts.

Therefore, rather than high currency denomination determining the rate of inflation, it’s a combination of low productivity and excessively high velocity of money that cause inflation. Not only that high denomination notes cannot on their own cause inflation has been demonstrated by the low inflation rates experienced by most economies with high denomination notes. In some of these cases, it has been demonstrated also high denomination can lead to reducing cost of seigniorage (cost of printing, storing, transporting and distributing money).

Singapore is a good example, having introduced since January 29, 1973 Singaporean dollar (SGD) 10,000 note, valued approximately US$6800 in circulation. Besides giving businessman an alternative to hold real money instead of playing with only figures, the SGD 10,000 note has no inflation effects. That is demonstrated by the country’s 2.81 per cent inflation average since 1962 to date.

Circulating more than three times its population, notwithstanding the circulation of a 1000 franc Swiss note (valued is at about $1080) Switzerland remains one of the countries in the world with the lowest inflation rates in the world, averaging 2.68 per cent between 1956 and 2012. So, if having a high denominated note hasn’t caused inflation in Switzerland, then, where is this argument that high denominated currency is synonymous with high rate of inflation coming from?

Did its 500 lat note (valued at US$944) stop Latvia from being among the fastest growing economies in the European Union? With such developed service and industrial economy, Latvia has historically low inflation rate, averaging 4.75 per cent from 1998 to 2012. The same is true with Canada, which having $1000 Canadian (dollar) note (about US$940) is still maintaining 3.25 per cent inflation average since 1915 to 2012.

Japan too has a history of high denominated yen (¥) notes and coins, with ¥500 coin (equivalent $7) and ¥10,000 note (about $128). Even though ¥10,000 note is in circulation, being a highly cashless society, rarely is it used. Even with Japan’s high coin and note denominations, Japan maintains very low inflation rate, averaging 2.83 per cent between 1971 and 2012.

So, with these examples, we can now bring to an end this debate about the introduction of N5,000 note as pro-inflation. Nigerians ought to know that because ours is a dollarized economy, naira’s exchange rate is floating alongside the dollar in international exchange markets. So, CBN’s volume of naira circulation always matches the amount of dollars available to it, otherwise printing more naira will put inflationary pressure on the naira since more naira will be chasing fewer dollars kept in CBN’s vault. In other words, pumping a great deal of naira outside the dollars in its vaults would have made the CBN less protective of the naira value, especially since banks do not lend to the productive sector. This may be the N5,000 note’s anti-inflation missing link. Therefore, rather than N5,000 note causing inflation, it’s the velocity of the naira that is the key variable determining inflation.

The only way circulating N5,000 can cause inflation is if produced in excess to meet excesses, including uncalled-for government’s deficit spending as well as government’s bond obligations. This brings us to differentiating between monetary inflation and price inflation. Monetary inflation is the creation of money from an inappropriate source, such as lending money in circulation to government. This happens when banks purchase government bonds and other assets that do not bring additional goods and services into the market. Price inflation, on the other hand, remains the most visible to the public because it results in increase in the general price level.

Printing N5,000 note should be received by Nigerians as something its time has come. It is desirous to if we want to reduce large commercial transactions involving unnecessary quantity of naira. Not only will it drastically reduce pressure on N1,000 and other notes, the high cost associated with notes wear and tear will be brought down. Also it is important to note that in a modern, credit-money economy money supply is not wholly dependent on direct central bank intervention. Besides, most central bank’s actions are dependent on what private sector of the economy does and willing to do.

Rather than blaming N5,000, it’s Nigeria’s premature joining of WTO that has to be blamed. Having fully been dollarized our economy, it makes no sense shying away from making sure we have also in circulation a higher naira note to narrow the gap between the naira and the dollar, especially given that the dollar is becoming a highly inflated currency. That’s why Mr. Tunde Lemo is right for ar

guing that ”the distribution and structure of cash in Nigeria is inefficient and [that] with N5,000, it will begin to be corrected.”

With N5000 notes in circulation, our superrich who have since abandoned the naira in their daily domestic transactions because of the inconveniences and transaction inefficiencies associated with naira’s low denomination will no longer have reasons to prefer slim currencies like dollar, euro, and pounds. They will discover that all they require are three pieces of N5000 to equal $100 note. Definitely, N5,000 and high naira coinage, rather than hinder the ongoing cashless policy, will further speed it up. Besides, with N5,000, inconveniences of either carrying large quantity of coins or finding N5,000 counterfeited note in one’s hands will force Nigerians to join cashless society.

Because Nigerians have no culture of carrying coins, CBN’s idea of temporarily allowing N5, N10, and N20 notes and coins to circulate side-by-side should be made permanent. This is because in increasingly modern economy like ours, both the note and coin have specific roles in aiding financial transactions. I wish this could become another wise decision made by our visionary and bold Governor. Until then, I want to remind us that next week we will be returning to the second part of the US-China reserve currency cold war.

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