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Opinions of Thursday, 16 August 2007

Columnist: Amegashie, J. Atsu

The new Ghana cedi versus the US dollar

.... one more time

In an article titled “Does the new Ghana Cedi have a higher value than the US dollar?” (ghanaweb, August 9, 2007), I argued that the redenomination of the cedi had no effect on its purchasing power. My inability to acknowledge a very trivial fact may have led some commentators to miss the substantive point of my article. Based on public and private reaction to my article and the interest generated thereof, I have decided to write this follow-up article.

In this article, I shall argue that there are trivial facts and there are important issues and that we should focus on the latter. Indeed, the focus of my previous article was on an important issue (i.e., what is the effect of redenomination on the purchasing power of the cedi?).

Let me begin with an analogy. A mile is longer than a kilometer. Before Ghana switched from the imperial system to the metric system, the distance from Accra to Nsawam was 22 miles; actually it still is, if you are an American. After the switch, the distance was changed to approximately 35 kilometers. Did that change the cost of traveling from Accra to Nsawam? Did it increase or decrease the physical distance from Accra to Nsawam? No, it did not. So while it is a fact that a mile is longer than a kilometer, it is a very trivial and unimportant fact because it has no effect on the much more important issue of whether the distance from Accra to Nsawam is longer or shorter. Similarly, while it is true that we have relabeled our currency to make it worth more than the dollar in Ghana, it is, nevertheless, a very trivial fact because it has no effect on the more important issue of whether the stock of goods and services has changed. As explained in my previous article, it has no effect on real income. Just as measuring distance in miles or kilometers will not change the cost of travel, so will measuring all incomes and prices in old cedi or new cedi have no effect on real variables (e.g., the real income of the Ghanaians) unless, as explained in my previous article, people suffer from the psychological framing effect known as money illusion.

Indeed, if redenomination could have suddenly increased the true value of our currency, then the governor of the Bank of Ghana, Dr. Paul Acquah, must be fired immediately for gross incompetence. He could have done much better by adding, at least, one more zero to the new cedi-old cedi conversion rate. For example, the current exchange rate of the new Ghana cedi to the dollar is approximately 0.95 Ghana cedi = $1 or 1 Ghana cedi = $1.05. So if Paul Acquah had set the new cedi-old cedi conversion rate at 1 Ghana cedi = 100,000 cedis instead of 1 Ghana cedi = 10,000 cedis, the exchange rate today would have been approximately 1 Ghana cedi = $10.50 instead of 1 Ghana cedi = $1.05. Should he be fired for not adding an extra $10.5 – $1.05 = $9.45 to the value of our currency? No!! But why not? Because any such increase in the value of the cedi is spurious. It is artificial. The redenomination of the cedi does not affect what we really care about (i.e., real income).

The reader will notice that in international financial news, the focus is not on one whether the pound has a higher value than the yuan or the dollar has a higher value than the yen and vice versa. What one typically hears is ‘the dollar weakened against the yen’, ‘the cedi fell in value against the US dollar’, ‘the pound opened weaker today, losing ground against all the major currencies’, ‘the dollar has been depreciating against the euro for weeks’, etc. If the pound has increased in value relative to the dollar, that is not the same as saying that the pound has a higher value than the dollar. It only means that the value of the pound today is higher than what it was yesterday.

Given that any domestic currency (e.g., the cedi) can be relabeled (i.e., redenominated) such that one unit of the new currency can buy more than one unit of a foreign currency (e.g., the dollar), it is meaningless to use this as the basis for comparing the value of one currency to another. Therefore, if one Ghana cedi can buy more than one dollar in Ghana, it is nothing to be excited about in any meaningful sense nor should this be used as the basis for judging the inherent strength of the cedi. A meaningful comparison is the value of the Ghana cedi today relative to its value tomorrow. Suppose that today, the exchange rate is 0.95 Ghana cedi = $1 or 1 Ghana cedi = $1.05. If the exchange rate tomorrow is 0.9 Ghana cedi = $1, we can say that the Ghana cedi has increased in value relative to the dollar.

When we talk about the relative levels of inter-country macroeconomic variables, we focus on things like the per capita GDP, unemployment rate, rate of inflation, etc. So, for example, it is meaningful to say that the USA’s per capita GDP is higher than Ghana’s per capita GDP. Similarly, a comparison between the unemployment rates in Ghana and the USA is meaningful. In contrast, we do not focus on the relative values of the currencies because that is actually meaningless (i.e., a trivial fact). What is meaningful is the movement over time in the relative values of these currencies. For example, what matters is how the new Ghana cedi appreciates or depreciates (in value) over time which is ultimately a reflection of the changes in the real value of the goods and services (i.e., GDP) that Ghana produces. Therefore, we are back to square one: GDP.

As a trivial and vacuous statement of fact stemming from relabeling the cedi, we could amuse ourselves by saying that the Ghana cedi has a higher value than the US dollar in Ghana. But in matters as serious as nation-building, we should not focus on simplistic and trivial statements that tell us nothing about economic fundamentals. A meaningful aspect of the redenomination exercise is the fact that it reduces transactions costs and eliminates the inconvenience of carrying money in plastic bags. If at all, this is what we should focus on and indeed, the Bank of Ghana has made this point clearly and admirably. But ultimately, we have to focus on increasing the productive capacity of our dear nation. With sound macro-economic management and good leadership, the redenomination of the cedi will be a step in the right direction.

*The author, J. Atsu Amegashie, teaches economics at the University of Guelph, Canada.

Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage.