How countries combine their currencies

Xavier Owino disagrees with the statement I made two weeks ago that money has no value unless you spend it; that the value is in what you spend it on. He writes that “money is a store of value… a seller is willing to part with the goods for the money because he values the money more than the goods, otherwise he won’t sell.”

Xavier elaborates further: “You can become rich from currency speculation, if you are holding the right currency at a particular time and you are lucky the markets move in your favour, you get richer.”

The question that still needs an answer is this: when you make all that money, what will you do with it? In other words, what will you buy?

With that idea in mind, we can tackle a related question that came from Isaiah Masinya. He is wondering about the “system [that] countries use to merge their currencies like what the Europeans did thus coming up with the Euro. If, for example, the East Africans came up with one currency, who would lose and who would gain since the Kenya Shilling is very strong and Uganda’s the weakest?”

First of all, it is not right to conclude that the Ugandan currency is weaker than the Kenyan one simply because they exchange at the rate of 35 to one, respectively.

DOLLAR STANDARD

When we ask what the two currencies can buy, a different picture arises. A kilo of maize flour costs about USh2,000 in Uganda and KSh60 in Kenya. But USh2,000 = KSh57 in the financial markets. So, in terms of maize flour, the Uganda Shilling is approximately equal to the Kenya Shilling.

When combining currencies, countries arbitrarily fix the exchange rate of the new currency to another one that they all trade with. A common reference is the US dollar. In the East African Community, one dollar is equivalent to KSh104; TSh2,235; USh3,591; RFr823; and BFr1,686.

East Africans may create a new common currency, the EA Currency (EAC), and fix its exchange rate at, say, 1US$ = 10EAC on the day of conversion. On that date, 1EAC = KSh10.4 = TSh223.50 = USh359.10 = RFr82.30 = BFr168.60.

On that conversion day, the bank balances in each country would be changed by the respective exchange rate of the EAC. Of course, some people would end up with smaller balances than others but that wouldn’t necessarily make them poorer.

This is because prices of goods and services would henceforth be quoted in the new currency. Hence, the citizens would still be able to buy the same quantity of things with the new money.

A Ugandan, for example would get EAC5.57 for the USh2,000 that buys a kilo of maize flour while a Kenyan would get EAC5.77 for the KSh60 that buys that same product. The small difference should not worry us, for, even inside Kenya, the price of unga varies from region to region.