I must admit that nine out of ten economic policies from Nigeria comes as a surprise. You could be thinking of the unimaginable, and boom, the Nigerian government is set to implement it. Yet again, in a country that is battling galloping inflation, shrinking manufacturing activities, and an exchange rate crisis; the government is proposing fighting inflation with gold. In this proposition, Nigeria’s lawmakers want the Central Bank of Nigeria to hold ~30% of its reserves in gold.
How does a country fight inflation with gold? Combatting rising prices through gold usage is a sophisticated and detailed approach that includes using gold as a component of a wider economic strategy. This wider economic strategy is essentially a reversion to the gold standard, which used to be practice by central banks before the adoption of the Dollar. With the gold standard, countries peg their currency to gold, such that the face value of each note and coin in circulation is backed by an equivalent value of gold. During inflation, the central bank can sell some of its gold reserves to stabilize the currency and control inflation. The sale of goldwill absorb liquidity from the market and reduce inflationary pressure. Furthermore, since gold is an internationally recognized commodity like oil, holding gold reserves can enhance investors confidence. Investors like to invest in countries with a stable currency value so that when they pull out their investment, there is no ‘erosion’ in their initial investment. Historically, gold is one of the stable commodities. Using data from 1976, the value of gold shown in the chart below has been relatively less volatile than the Dollar and has experienced more episodes of stable appreciation. Therefore, using gold to denominate a country’s reserve can potentially lead to greater currency stability, which can mitigate inflation, especially in a country like Nigeria, which is super dependent on imports.
The description above is generally textbook knowledge. How effective gold is as a hedge against inflation is a practical debate which depends on the macro and microeconomic context of different countries. In Nigeria, the average household currently does not have sufficient income to support their demands. There is a middle class that is being wiped out due to emigration and weak purchasing power, and there is the low-income class plunging deeper into the ‘poverty hole’. Therefore, I do not think Nigeria’s galloping inflation is demand-pull because effective demand in Nigeria is currently low. In fact, latest statistics showed that household expenditure slumped to N37.3 trillion in Q4-2023 from N41.4 in Q3-2023. Nigeria’s inflation is a mixture of structural and cost-push inflation. Structural in the sense that the structure of the Nigerian economy has shifted from a domestic resource-fed manufacturing sector to an import-reliant manufacturing sector; the state of infrastructures is debilitating; and there is a high dependency on import for domestic consumption. Cost-push in the sense that manufacturers find it expensive to import raw materials and when they attempt to transfer these costs to consumer in the form of higher price, they are met with low demand. In this unique inflationary environment, I would ‘vote’ against using gold to curb inflation. Interestingly, I think the Nigerian government is fighting a self-induced reinflation because it sounds counterintuitive to attempt to mop up money supply when the same government is pumping more money into circulation though social intervention programmes. Additionally, savings rate in Nigeria is likely extremely low now given that households are barely surviving. So, my question is, what exactly do you want to mop up with the gold?
There are other reasons why this proposed ‘gold solution’ to inflation could be a wild goose chase. Gold is not fully transactable in Nigeria. Unlike financial instruments like bonds, there is relatively lower population of Nigerians who would be able to buy gold from the government if the latter sells gold to mop up the supply of money. In addition, although gold, like land, is believed to appreciate often, its value is still influenced by supply and demand. Therefore, in the event of a gold shock like during 1981-1983 and 2013-2016, it could become extremely difficult to implement monetary policy. There has not really been a case like this with the Dollar, which the U.S. can easily print to boost supply if need be. Besides, with the use of gold as reserves, there is the opportunity cost of losing returns that could have been generated if the reserves are denominated in other assets that yield higher return.
There is no issue with using gold as a reserve – it was an old practice – but it could be a futile effort attempting to use that gold to fight inflation. If gold were that effective in fighting inflation, there would be some country benchmarks out there. There are not many countries exploring the use of gold as an arsenal against inflation. Even if there were, inflation in Nigeria does not paint a demand-pull picture; so, it’s like beating the air. I do not think the policy would be overly effective and probably would not have my vote if a referendum was called and I participated in it. The solution to Nigeria’s inflation is clearly written on the wall – it’s a structural issue, which I think it will take some time to resolve given that the problem itself took some time to compound.
Written by Michael Ogunremi
Data source – investing.com, National Bureau of Statistics (Nigeria)
Featured image credit – Pexels