Nuro Lemin Tewedede? Part 2

• The U.S following Zimbabwe's model
• History of banking in Ethiopia
• The rise of the free market, downside of the Derg regime, and the cause of Inflation In Ethiopia

 The Zimbabwe model

Its has been about ten days since we posted the first part of why we think life is getting expensive in Ethiopia. Its too much going on around us, life in the west as a student can be crazy. Professors barely teach you, but then assign you tons of homework, papers, etc. We aren't complaining but we are hoping this can pass us as a good excuse for taking to long to publish the second part. Mean while there has been a lot going on in the western hemispheres finance world. The Federal Reserve which is the central bank of the United States have decided to keep interest rates between 0 and 0.25%. It wants commercial banks to borrow money from the central bank basically for free, in the hopes that commercial banks can lend to consumers at cheaper rates. Instead the banks get the money and buy government bonds that earns them what is considered risk free 2% return. Americans have borrowed for so long and consumed so much in the past, there credit cards have maxed out. Its time to repay their debts not borrow more, Its time to save not spend, therefore the banks are scared to death to lend more money. Politicians and main stream economist still think they can meddle and fix the issue, we doubt they will achieve anything. Whats even more shocking is that, at the last meeting the federal reserve decided that they will be printing $50 billion per month for unknown period of time. That's insanity, we suspect they must have hired someone for consultation from Zimbabwe's central bank. This new money is most likely going to end up in speculators hand driving up prices to a new level. Therefore if you are sophisticated put your money in the stock market, if you aren't buy as much properties as you can. Lets explain residential properties have become so cheap and affordable, its a no brainier thanks to record low mortgage interest rates. In the states what matters when someone is buying real estate is the mortgage payments not the price tag of the property. Since the reality is record low mortgage rates housing in the states hasn't been this cheap in a long time. We aren't financial advisers but we have noticed a window of opportunity. The financial crisis has destroyed many peoples credit history, turning them to renters instead of owners. Demand for rental units has been going up ever since, alongside with increasing rent price. If you are someone with a credit score of 620 and have 3% down payment saved up, U.S department of housing and Urban development is ready to help you buy your dream property. If mortgage payments are cheaper, but rent is getting expensive we are certain you can make a buck. If mortgage rates keep going down you can refinance, or if the federal Reserves dream comes true and inflation goes out of hand, and they finally decide to raise interest rates , you will be safe because you have locked your mortgage at record lows for 30 years.

History Of Banking In Ethiopia

Modern banking in Ethiopia was introduced in 1905 when emperor Menelik, and representative of the British owned national bank of Egypt reached an agreement. At first the emperor didn't accept the idea at least not until the British begged the Patriarch of the Egyptian Orthodox church to sell the idea to Menelik. By February 16, 1906, Bank of Abyssinia was inaugurated as the first financial firm in Ethiopia. How did Britain used Egypt to expand fractional reserve banking? We knew you would ask. Egypt tired of the rivalry between the two oldest civilization over the Nile decided to end Ethiopians threat of diverting the river. Hence it invaded Ethiopia expecting an easy win, instead Egyptian Army was crushed in 1876. Thereafter Egypt declared bankruptcy and soon after fell in the hands of its creditors, the British.

Haile Selassie Regime 

During Haile Selassie's regime private banks flourished and most were foreign owned. Access to capital led to the formation of factories, commercial farms, and other industries.There was even a stock market then, a prime example that used the stock market to raise capital is Anbessa City bus. Sometimes we wonder where Ethiopia would be today if the free market was never interrupted by central planners.

The Derg Junta

The downside of the Derg began almost as soon as it over threw the Haile Selassie regime. After assuming power, it nationalized every sector of the economy. From the many few banks that existed, to only three state owned banks. Instead of letting the invisible hand allocate scarce resources, the Derg commanded the economy. Problem was more and more money was being spent on the military, leaving no money or fewer resources to the average citizen. In addition almost all industries that were run by the Junta were never profitable, destroying the cash in circulation. There was no productivity in the economy, we weren't alive then dear reader but we can imagine cash was hard to come by. Forget inflation or life being expensive, you would be lucky to get basic items the government was rationing.  

EPRDF Regime

By 1989 communism was for the history books, so was the Derg Junta. The Ethiopian People Revolutionary Democratic front, led by the late prime minister Meles Zenawi assumed power in 1991. Leaving the politics  for the world improvers, we will analyze the economic policy that is contributing to the double digit inflation. Despite been known for its communistic ideology at its roots, the party found itself in a world without the Soviet Union. Thus the closest model they can mimic was China. The government spends money on public goods, while a combination of state owned and private industries produce the goods. But first there is damage control which is steering the command economy to a free market. Once the country was stabilized from the transition of power and capitalism was allowed, private banks started opening their doors for business after a long vacation. And for every choice you make there is a consequence or opportunity cost. We suspect the following to be the cause root of inflation or the unintended consequences of choosing some form of capitalism.

Banking

Toady in Ethiopia there are a total of 15 private banks and 3 state owned banks. Assuming we all have agreed how banks operate all over the world, can you imagine how much money it has been created since Dashen, the first private bank became operational in 1995? To refresh your memory of how banks make their money across the planet, we will repeat ourselves. Its called Fractional Reserve System, which is a form of banking, in which a bank holds a tiny percentage of total deposits. For example say Abebe walks in Dashen bank and deposits ETB 1000, he then goes to continues his daily life. Mean while Dashen Bank hopes Abebe doesn't come back anytime soon to withdraw his deposit. As it is the case in Ethiopia, the national bank acts as a regulator (central bank) and demands Dashen bank to keep 10% of Abebes deposit calling it the reserve ratio. Which leaves Dashen bank with ETB 900 for its banking activity mostly for lending. Since Dashen is the only bank in town various people would need its services for different purposes. If the bank can manage to find nine other souls to lend ETB 100 each too, that would increase the money supply by 900%. As long as those nine souls spend the money inside the country in whatever form, demand for whatever goods or service the money they borrowed is chasing will sky rocket. So far a total of 18 banks are playing the game in hundreds of millions of ETB using the fractional reserve banking model, and almost all have been profitable to date. If that's the case, unlike the Derg that squandered money to the military, the free market is now allocating capital for productive use. Other wise how are the banks making money, unless most of their borrowers are repaying their loans? If there wasn't any profit to be made, we highly doubt the number of banks would reach 18.

Infrastructure

In order for free markets to function well, its is required that a country is up to date with its infrastructure. Ever since early 2000's the government has been building roads at unprecedented rate across the country. To build you need tools and human labor, which for the most part weren't utilized in the country for long time. What was once idle labor, is now working and earning an income. We doubt the average worker earns millions but we can assume he has now some money in his pocket that he/she didn't have before. When poor people first earn money they don't spend it on luxuries items instead they prefer to eat better. Previously either food aid or kolo was feeding the majority, would it be a sin to assume now they can afford one full meal per day? And also don't forget the construction sector. The real estate boom in residential, office buildings, Industrial parks, hotels, universities, health centers, dry ports, railway, dams etc are being built now. Directly and indirectly millions are earning some money from this activities.

Remittance 

The Dollars, Euros, and Pounds, the diaspora has been sending to help family members has been increasing year over year. This is a double edge sword, it can be good and bad. Good because many depend on this as their sole income, which then enables them to feed themselves. Bad because this isn't money earned by producing a good or service. There was no cost at the receivers end, he/she isn't simply replacing the cost of production of a good or service. Its new money that's entering the economy, which forces the national bank of Ethiopia to print 17 ETB for every $1 received.

The collective income of the millions that are employed alongside the remittance have a huge impact on a small economy like Ethiopia. If we aren't mistaken the economy just doubled within the past five years and now stands close to $50 Billion. But also, Microsoft founder Bill Gates is worth $50 billion, but imagine this, if he spent $5 billion per year, five years from now he will be worth $25 Billion, We don't think Bill Gates would be happy with that. That means on average the Ethiopian economy was generating $5 billion additional worth of production per year for the past five years. If we are lucky enough like S.Korea, China, Taiwan, Brazil, by 2018 Ethiopia's Economy could be producing $75 billion or a Trillion Birr worth of goods and services. Unless we produce more and flood the market, we wont be able to afford much of anything. A classic example is cement, when we left Addis Ababa in 2002, a bag of cement was no more than 50 ETB. As soon as the country began building the necessary infrastructure to accommodate a modern economy the price of cement hit the roof to 500 ETB. We also recall there were only 3 state owned cement factories that couldn't satisfy demand. Today there are 15 more cement factories flooding the market, when the newest factory was inaugurated in February 2012, the price of cement collapsed to 160 ETB. To us, it seems like the Ethiopians are demanding a lot of stuff but aren't yet producing enough to satisfy the demand that exists. Too much money for a small economy chasing few goods. Classic definition of inflation we would say.

Regards,
Eskinder Haile
 

Nuro Lemin Tewedede? Part 1

•  The basics first and the jargon's later...
• In order to understand why inflation is in double digits in Ethiopia, it is important to understand the monetary system of the World and its history

Dear reader we want to start by apologizing first. When we left Addis Ababa, Coca cola was only ETB 1.50, the Chinese Just began building the ring road, we were spending precious time playing soccer with our comrades, going to school, or anything imaginable you would think a 12 year old would be doing. Give us a chance dear reader as we have a lot to say on the Ethiopian Economy, what we have to say might be a little different as many of you are use to reading content from endangered species. As we promised we will start with the basics and answer few questions.

1. What Is Economics?

 Economics is the study of making choices, in simple terms that is. As humans we have unlimited wants, but mother nature have limited resources. What do we mean by that? Well dear reader, don't we all want to go to the best schools, drive the best car, buy the luxuriest house on the bloc etc..? We do but for the majority of us our resources are so limited many of our wants are just dreams, therefore forcing us to make choices.


    2.  What is Inflation?

Inflation is a rise in the level of prices of goods and services in an economy over a period of time.Which leads to a decline in your purchasing power, in which case you will need to ditch your wallet and switch to alternative methods to carry more paper money.


  3. What Causes Inflation?

Inflation has many different causes for too many different reasons. In our case we are just concerned as to why Ethiopia is experiencing double digit inflation, that has not been experienced in the history of the nation, or at least since the country's statistic agency learned how to count. To understand inflation its a must to know how money is created and ends in our pocket. I am sure you wonder where money comes from, dear reader hope we haven't lost you yet. You have probably said my job provides me with the income "Duhhh", how about this, have you wondered where your job got the money to pay you? Again you might say "Duhhh" and respond from its client. You might be a nerd and you are really wondering how the company in the first place got the money to provide its goods or services. You might say hmm probably it raised capital from shareholders or borrowed money from the bank. So where did the shareholders or the bank get the money? OK dear reader we aren't here to make you think too much, that's our job and we hope one day we will use it to change our country.

During the renaissance era, the Medici in Italy were a dominant merchants of their time. They were so profitable, they began to lend their savings or extend credit to customers. Since they used their hard earned money, they demanded interest on the funds they lent out. Banking as we know it was born, and the Medici family became so wealthy, Soon the Italian city states were borrowing cash in the form of bonds from the family.

By the 19th century most of Europe's finance was dictated by the Rothschild family. Mr. Mayer Amschel Rothschild, a German Jew began banking in Frankfurt in the early 1700's. Later he would send his five sons across European cities to establish branches and expand business. It is widely believed that the Rothschild family spread fractional reserve system which 99% of banks across the world use today.


  4. What is Fractional Reserve System?

 It is a form of banking, in which a bank holds a tiny percentage of total deposits. For example say Abebe walks in Dashen bank and deposits ETB 1000, he then goes to continues his daily life. Mean while Dashen Bank hopes Abebe doesn't come back anytime soon to withdraw his deposit. As it is the case in Ethiopia, the national bank acts as a regulator (central bank) and demands Dashen bank to keep 10% of Abebes deposit calling it the reserve ratio. Which leaves Dashen bank with ETB 900 for its banking activity mostly for lending. Since Dashen is the only bank in town various people would need its services for different purposes. If the bank can manage to find nine other souls to lend ETB 100 each too, that would increase the money supply by 900%. As long as those nine souls spend the money inside the country in whatever form, demand for whatever goods or service the money they borrowed is chasing will sky rocket.


It is widely believed after being so successful in Europe, the Rothschild smelled yet again another opportunity. This time they wanted to expand across the Atlantic in the newly born nation of the united states of America. If you have read the federalist papers which were a collection of essays promoting the soon to be constitution of the new nation, you would have noticed Alexander Hamilton's strong position on establishing a central bank. Despite strong resistance from the other founding fathers like James Madison and Thomas Jefferson fearing corporate influence and the destruction fractional reserve system brings. In order to establish "financial order and credit to the new nation and individuals" argued Alexander Hamilton a central bank was a necessity. To open its doors for business the new bank required $10 million in capital, of which the U.S government would purchase $2 million worth of shares. Raising a rhetorical question, the opposition camp asked where would the U.S government come up with $2 million? Hamilton was quick to respond and proposed the U.S government to borrow the $2 million from the soon to be bank. If the bank was looking for capital to establish itself, how would it lend to the U.S gov? We suspect the clever Rothschild family to supply the seed money. This isn't science fiction by the way dear reader nor a conspiracy theory. Alexander Hamilton was chosen the first U.S secretary of treasury and the rest was history as they say.

Oh emama Ethiopia we haven't forgot you, nor so far blamed anyone for your double digit inflation. We were just trying to understand the concept of money, so we can try to understand why doro (chicken) carries a Coach purse in the streets of Addis Ababa. That's how a dear friend of ours explained what inflation meant to him. In part two we will focus entirely on the Ethiopian economy and will try to answer why there is inflation, where is it coming from, is inflation telling us something and many more.

Regards,

Eskinder Haile