Understanding Money, Banking, and Inflation in Nigeria (Part 1)

In April 2021 the governor of Edo state, Godwin Obaseki, said that the Federal government printed an additional NGN 60 billion to be shared at the Federation Account Allocation Committee (FAAC), between all the states. This was denied by the Minister of finance, Hajia Zenab Ahmed. The former Central Bank of Nigeria (CBN) governor, Godwin Emefiele, was a bit more forthright. He said “That is our job. To print is about lending money. So, there is no need of putting all the controversy about printing of money as if we go into the factory, print the naira and start distributing on the streets … It’s very inappropriate for people to give colouration to printing of money as if it’s some foreign words coming from the sky.”

It’s not surprising that the Central Bank of Nigeria (CBN) governor was upset when a state governor revealed confidential information about the CBN, as Nigeria’s inflation rate was reported to be 31% at the end of 2020, according to economist Steve Hanke. When a government increases the money supply in a crude manner, such as printing new money, it can lead to higher inflation expectations among citizens, causing them to demand less of the currency and quickly exchange it for assets that retain their value, such as real estate, cars, jewelry, or Bitcoin.

This can result in rapid inflation and ultimately the collapse of the country’s monetary system. Central banks, including the CBN and others around the world, use more refined and covert methods to increase the money supply.

If the government gives in to the urge to print a large amount of new money, it could result in a phenomenon called hyperinflation, where the currency loses its purchasing power and becomes practically worthless as a means of exchange for goods and services. This has happened in the past, such as in Germany during the 1920s, Zimbabwe in the late 2000s, and Venezuela in the mid-2010s. Hyperinflation occurs when there is an extreme and rapid increase in the supply of money, which reduces the value of money and causes prices to rise dramatically. This can lead to a collapse of the monetary system and a breakdown of the economy.

Source: Reserve Bank of Zimbabwe

To avoid hyperinflation the process of adding new money in the economy is done through more sophisticated means. Generally, the government increases the money through its Central Bank’s control over private commercial banks.

So, while Obaseki was right about the fact that the NGN 60 billion was created out of thin air to share at the FAAC, he may have been wrong about how the money was created. We say ‘may’ because Nigeria is still very much a “cash” economy, that is, most Nigerians still make payments for goods and services with physical paper currency, so the possibility of increasing the money supply by actually printing more paper money, is high. But printing more money than necessary is not recommended for reasons stated above.

What is money and why is it necessary?

Before going deep into the complexities of central banking and the issues of inflation in Nigeria, it is essential to understand the fundamental concept of money and its purpose. As economist Lionel Robbins defines economics as “the study of the use of scarce resources with alternative uses”, it is clear that there is a limited supply of goods and commodities available to meet our needs. This scarcity of resources necessitates the use of a medium of exchange, known as money, to effectively manage and utilize these resources. As Thomas Sowell aptly puts it, “without scarcity, there would be no need for economizing, and therefore, no economics”.

In essence, to make do with what we have, many of us engage in exchanging our possessions for the things we need. This is especially true in a barter economy, where individuals trade goods and services without using money. For instance, if Mr. A has an orange and Mr. B has a mango, they can exchange their goods to meet their needs. Mr. A can offer his orange in exchange for Mr. B’s mango, or vice versa. This way, both parties have what they require to make ends meet. Therefore, at its core, economics is about exchange.

But the barter system has serious challenges and cannot provide the modern and advanced economy needed to increase standards of living and prosperity beyond mere subsistence. These challenges include:

1. There is no of coincidence in wants: if a music teacher wants to sell her piano classes for eggs and donuts, how can she find someone with eggs and donuts willing to buy his piano lectures? What are the odds of that happening? Pretty remote!
2. Indivisibility of some goods or lack of coincidence in scales: If John has a tractor but wants sugar, eggs and bread, how can he can’t break his tractor into smaller bits in exchange for those groceries because very few people, if any, want to buy a one third of a tractor.
3.  There is no coincidence in time frames: If you have perishable goods like fish, you need to exchange it as quickly as possible before it goes bad and becomes useless for exchange. What are the odds of you finding someone who wants fish, and also possesses the thing you need to exchange with.
4. Difficulty in economic calculation: many of us look at prices as money and think they are synonymous. They are not. A price is the exchange ratio between two commodities. So, as per our previous example, if Mr A exchanged two oranges for 4 of Mr. B’s mangoes, that means the price of an orange is two mangoes. Now imagine what chaos would arise if the prices of all commodities were presented in relation to all other commodities? One goes to the market to buy oranges, and sees the mango prices for oranges, the tractor price for oranges, the donut price of oranges, and so on. In a barter economy, simple economic calculations would be a cumbersome task and highly impractical.

Indirect Exchange — Enter money

Overtime people realized that there exist some commodities that were more marketable, more durable, could easily be divided without losing much of its value, and in high demand. Hence if Mr. A wanted a mango, he went to purchase 2 ounces of salt with his orange, and then used the 1 ounce of the salt to buy 2 mangoes from Mr. B. Mr. B could then use the one ounce of salt to buy something else. This way the prices of most commodities can now be represented in salt. Hence there is a salt price for oranges, mangoes, donuts, etc. This is called indirect exchange, and where the money enters the economy. Salt has become the medium of exchange. Hence salt has become the money.

Throughout history, various items have been used as currency, such as tobacco in German POW camps during World War II, cattle in Ancient Greece and East Africa, cowrie shells in West Africa, and salt in Abyssinia. However, gold, silver, and copper have consistently been the most widely accepted commodities as money. Until 1971, when President Richard Nixon removed the United States from the gold standard, most countries have relied on some form of metal-based monetary system. Today, the majority of currencies are government-backed fiat money, which holds value only because the government declares it so through legal tender laws.

The history of how commodity money basically doesn’t exist as an official medium of exchange anywhere in the world anymore and fiat (government-backed) money has become the order of the day is long, complex and beyond the scope of this article. (See Rothbard “What has the Government Done to Our Money”). Hence for the remainder of this article we will stick to calling fiat money — the Naira notes we all use — money.

Now we have money as a medium of exchange. Dammy can now buy an orange at a price represented in money; BOLUWATIFE can sell his tractor for money in Lagos and buy shoes in Abuja with that money; Adebisi can quickly sell her fish before it rots for money and save it for a long period of time without it losing most of its value.

Check out  part 2: The Central bank and the supply of money

If you enjoy this work, anticipate the second part and you can also drop your comment.