The CFA Franc and Africa's Monetary Dependency

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.

Cedric Muhammad

Thursday, May 4, 2000