The Introduction of The Euro And French Monetary Mismanagement Leaves CFA Franc Nations In Liquidity Crunch

The arrangement between the Francophone nations of West Africa and Europe continues to be problematic in the realm of monetary policy. The bizarre relationship has taken another unnecessary turn due to France’s refusal to supply the CFA franc nations with the liquidity - in small denomination African notes - necessary to lubricate their struggling economies. Because the CFA nations rely upon the French to manage the printing of their currency notes, they are in a position today where not enough African notes and coins are in circulation to pay for basic and necessary expenses.

This scenario, has already created an instant and excruciatingly painful monetary deflation in some African nations. Less currency in circulation now means that less money is chasing the same amount of goods. As a result, prices are bound to fall as the same amount of retailers, goods and services compete for a lesser quantity of money. In some cases, Africans have been forced to return to a barter economy. In other cases, economic activity has hit a standstill due to the lack of money or suitable barter arrangements.

For over a year now, we have been recommending that the CFA Franc nations move toward a gold-price rule currency board. Under such a regime, the CFA nations would have been able to print their own currency at a fixed exchange rate with the euro or temporarily with a fixed exchange rate with the French franc. Under the the pegged arrangement they have with France, they are ultimately supplied their own currency by France.

And because France and the nations of Europe are taking care of their own euro liquidity needs, they are not as concerned with supplying the CFA Franc nations with their own notes and coins. If the CFA franc nations were operating under a currency board arrangement they would currently be included in Europe’s rushed efforts to satisfy euro note liquidity.

And although they would have suffered along with Europe, as the European Central Bank introduces the euro and withdraws the old currencies of its member nations, they would have been far better off than they are now, under the current peg arrangement with France.

A currency board, if firmly tied to a gold-price rule, would work far more effectively than the loose peg that the CFA Franc countries have had to the French franc. Under the CFA franc regime, central banks have only had to maintain a 20% foreign exchange cover and have had to deposit 65% of their foreign exchange holdings with the French treasury. The system is not as transparent as a currency board and also has provisions that make it prone to the accumulation of huge external debts and the involvement of the IMF and World Bank.

With a currency board firmly tied to a euro-gold price rule, a central bank in Africa would tie its currency to the euro at a fixed exchange rate, which it would maintain every day, but it would only do so if the euro-price of gold stayed within a certain range. This would enable the African nation to determine whether European monetary policy itself was unstable - inflating or deflating excessively - and be in a position to react appropriately.

Here is the BBC article explaining the problem in Africa, followed by our an editorial we wrote about the CFA franc last spring. As one can see, the European Union has been having serious problems managing the supply and withdrawal (from circulation) of its 11 currencies, as it moves to introduce euro notes. The problem is much more serious than economists have imagined:

Euro printing hits Africa
Sept. 6

Lots of euros but not enough CFA Francs

Preparations for Europe's new currency, the Euro, are making life difficult for people across West Africa.

Residents of both Dakar and Bamako are having trouble getting hold of small denomination banknotes because local banks say they do not have any in stock.

The Bank of France is giving priority to printing the Euro at the expense of our requests (for small denomination notes)

Seyni Ndiaye
BCEAO Countries from Senegal to Cameroon already have their own single currency - the CFA franc - which is supported by the French treasury.

But an official from the West African Central Bank, BCEAO, says the French Bank is too busy printing new euros to supply the scarce African notes.

Senegalese newspaper Sud Quotidien quotes a Mr Ndao as saying it is impossible to get change to buy a bus ticket.

Crisp new notes

"I asked the cashier to give me CFA F25,000 in small denominations but she said she didn't have any. Isn't that incredible coming from a bank?" he asked.

The BBC's Said Penda in Mali's capital Bamako says that commercial banks there have also run out of new F500 (67 US cents) and 1,000 notes.

France is concentrating on euros not African Francs

In a strange twist, he says that people who wish to impress by distributing crisp new notes to praise-singers at weddings and naming ceremonies pay a premium.

"To change F5,000 into small denominations, people pay an extra F1,000 on the black market," he said.


The BCEAO Senegal director told Sud Quotidien that the shortages were being caused by Europe's new currency, due to be introduced on 1 January 2002.

"The Bank of France is giving priority to printing the Euro at the expense of our requests (for small denomination notes)," said Seyni Ndiaye.

BCEAO supplies commercial banks with their currency.

The link with the French treasury has remained in force despite the creation of the Euro. The exchange rate is fixed at FFr1=CFA F100.

Mr Ndiaye also pointed out that the shortage of low value notes was being especially felt in Senegal because of the importance of small-scale trade in the poverty-stricken economy.

Street corners across the country are characterised by women selling small piles of tomatoes or men selling individual cigarettes or sweets.

The CFA Franc and Africa's Monetary Dependency
May 4, 2000

A picture of just how dependent Africa still is upon Europe can be seen in the recent movement of the CFA franc. The CFA franc is the currency used in 14 African countries that have formed a monetary union. The CFA first tied its currency to the French franc and now ties to the euro since the establishment of the European Union (EU). Recently economic reports in the media have expressed alarm that the CFA franc has "depreciated" to a record low against the U.S. dollar, having gone from 691 to 1 dollar two weeks ago to 722 to 1 dollar yesterday.

But the economic reports are misleading and mask an even more dramatic aspect to the story unfolding regarding the CFA franc's value.

To most observers the fall of the CFA is depicted in terms of the CFA franc's lack of strength relative to the U.S. dollar. But that emphasis placed upon the CFA-dollar exchange rate ignores a more important correlation between the world's currencies and gold that tells the real story of Africa's monetary dependence upon the West.

In order to really understand what the CFA franc's recent moves mean, one has to look at the CFA franc's value in terms of gold. Why gold? Because of all of the commodities in the world, gold is the best indicator of a currency's value. It is the best indicator of whether a currency is inflating in value or deflating in value. It is not enough to think of a currency's value in terms of other currencies. Only when currencies can be compared in terms of a common denominator can their values relative to one another be known.

A currency's value must be defined in terms of something. Gold, over thousands of years has proven to be the best something to define money in terms of. Gold has historically provided the best definition of a currency's value. This primarily has to do with the unique characteristics of the precious metal.

If one looks at the value of the CFA franc over the last 6 years, such a review will show that in the beginning of 1994 one ounce of gold cost 230,000 CFA francs and by the fall of 1999 one ounce of gold cost 160,000 CFA francs. That means that by a gold price measurement, from 1994 to 1999 the value of the CFA franc had deflated by 30%. It deflated most dramatically from 1997 to 1998 - the very same time that the U.S. Dollar was deflating in terms of gold. In fact, it was the Federal Reserve's monetary policy that was responsible for driving the rest of the world into a deflation. This occurred as leading currencies across the world attempted to keep their currencies and monetary policies in lock step with the dollar and Federal Reserve.

The 30% deflation in the CFA franc, in terms of gold, from 1994 to 1999 means that it took 30% less CFA francs to buy an ounce of gold in 1999 than it did in 1994. But if you had been a person who had borrowed CFA francs in 1994 and had to pay them back in 1999 you would have lost out because the CFA francs you paid back in 1999 were more valuable than the francs you borrowed. In such a scenario the creditor or bank that loaned you the CFA francs would profit at your expense.

Looking at the gold price today, we see that an ounce of gold is worth 200,000 CFA francs. This is critical to note because it is only when you look at the value of the CFA franc in terms of gold that you are able to see that what the financial media is referring to as the CFA franc's "depreciation" in recent weeks is really only the CFA returning back to the value it held prior to the most dramatic part of the world wide deflation of 1997-1998 - which was generated by U.S. monetary policy that caused the dollar to become too strong in terms of gold. The steepest part of the U.S. led- deflation saw the price of gold go from $385 per ounce to $315 per ounce.

The current price level of 200,000 CFA francs per ounce of gold is not a "depreciation" when compared to where the CFA franc was, in terms of its value in gold, three years ago. And in comparison to where the CFA franc was in 1994, it has not "depreciated" enough. Rather, it is inflating back to its previous value. It only appears to be depreciating when compared to its value one year ago. But one year of review is not enough to get a real context of the real movement of the currency. In terms of its 1999 value, 180,000 CFA francs per ounce of gold, the CFA franc today, does appear to be depreciating. In terms of its 1994 value, 230,000 CFA francs per ounce, the CFA franc today, is only beginning to return to that level.

Now, why is the CFA franc inflating in recent weeks, in terms of its gold price value? And why is the CFA franc becoming less valuable relative to the U.S. dollar? The answer to both of these questions is that the CFA franc is linked to the euro. And the euro price of gold is rising (in the same manner as the CFA franc) and the euro is becoming less valuable relative to the U.S. dollar. The euro is moving in the manner that it is because as the euro becomes the only currency in Europe, replacing 11 other currencies, the European Central Bank has failed to remove enough currency out of circulation in order to keep inflation from occurring. This has resulted in the euro losing its value relative to gold and in its weakening against the U.S. dollar. The European Central Bank has made a mistake in that it has attempted to raise interest rates as a means of addressing the problem as opposed to taking money out of circulation by selling bonds into the marketplace in exchange for currency and bank reserves.

Because the CFA nations link their currencies to the euro, how the euro goes, the CFA franc goes. That is why the direction of the movement of the price of gold in terms of the CFA franc and the euro are exactly the same.

The problem is that the European Central Bank determines its monetary policy in the interest of the European Union and not in terms of the best interests of the CFA. And they make mistakes in the setting of that policy. Which of course means the CFA nations will always import the mistakes of European monetary policy - there is no way to avoid it- under current circumstances. As long as the CFA nations blindly link to the euro, they will be vulnerable to inflations and deflations caused by fluctuations in the value of the euro both in terms of the gold and in terms of the U.S. dollar.

The best solution to this problem would be for the nations of Africa to form their own monetary union and currency not linked to the euro but defined in value in terms of gold. Then the CFA and Africa as a continent would be almost entirely free of their current dependence upon Europe and the U.S. for monetary policy. The Organization of African Unity (OAU) recently reiterated its call that Africa form a monetary union last year. The optimistic projection is that such a monetary union could be formed by the end of this decade. More conservative estimates place the formation of the union by 2025.

Short of a monetary union with a new African currency backed by gold, the African nations can alleviate the ill-effects of their dependency upon the euro by announcing that they will tie their currency to the dollar and euro but only as long as the dollar or euro price of gold stays within a certain range. By linking to the dollar or euro but only as long as they stay within a certain price range, in terms of gold, the CFA and Africa can make themselves almost immune to importing or deporting man-made inflations and deflations from Europe and U.S. monetary policy makers.

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Cedric Muhammad

Thursday, September 6, 2001