This article is the first of a two-part series. The second part, which focuses on the hypothetical formation of a crypto-backed ecosystem in Somalia, will be published shortly.
In 1991, Somalia’s government collapsed under the Barre regime and left the country stateless. As monetary arrangements were at the helm of the open market, opportunistic businessmen started to create forged reprints of the Somali shilling in order to inject capital into the burgeoning economy. The economic anarchy which ensued provides us with a rare opportunity to study the nature of competing currencies in an African context.
Hayek versus Freidman
Hayek is often credited with initiating the resurgence of research in alternative monetary systems. He argued that an individual should be free to transact in any currency of their own choosing, even if it meant rejecting the favoured sovereign offering. Hayek claimed that private money issuers in a system would be dissuaded from manipulating the money supply in undesirable ways due to the competitive forces of the market. As a result, any deviations from the straight path of providing honest money would lead to the rapid displacement of an offending currency.
Friedman, a key opponent of the Hayekian perspective, cited network effects and the psychological cost of switching as a counter motion to the view that the private market should be allowed to introduce competing currencies. To marginalise the above-mentioned deterrents, a new currency must be operationally linked to an established currency in order to achieve a positive value.
Network Effects
Network effects are necessary when the desirability of an item depends on the number of people using it. A classic example is the telephone — a positive externality is created when a telephone is purchased without its owner intending to create value for other users, but does so regardless.
As with currency, the more of a person’s network using a particular money, the easier it is to transact with that money: the easier it is to transact with a particular money, the more desirable it becomes to a person’s network. Once a currency has gained widespread acceptance, a network tends to always prefer it over any mooted alternatives.
Individuals are concerned with the size and location of a currency’s network and, as a result, a proposed currency might ultimately fail to displace an incumbent currency already enjoying widespread circulation.
This is not because the proposed currency was poorly conceived or seriously flawed. It is because of the nature of currencies in general. Since the usefulness of a medium of exchange depends crucially on the number of users in its network, agents are inclined to continue accepting the incumbent money. In other words, there is a systemic bias against monetary transition.
Private Money Supply in Stateless Somalia
After the collapse of the state-run banking system, the value of the Somali shilling was disrupted. Subsequently four new currencies came into circulation: the Somaliland shilling, the Na’ shilling, the Balweyn I, and the Balweyn II. Each currency, with the exception of the Somaliland shilling, claimed to be part of the pre-1991 Somali shilling.
- The Somaliland shilling was introduced in 1994 as the official currency of Somaliland, a self declared republic that is internationally recognised as an autonomous region of Somalia.
- The Na’ shilling banknote was introduced in 1992 by a North Mogadishu faction leader. It did not resemble the pre-1991 Somali shilling banknotes in appearance or in denominations and subsequently failed to gain significant traction. It did not successfully merge with the pre-1991 Somali shilling and as a result only circulated around the clan base of the issuer.
- The Balweyn I Somali shilling banknotes were introduced in 1997 by a South Mogadishu faction leader. Despite it being a forgery of the pre-1991 Somali shilling, it managed to successfully merge with it.
- The Balweyn II Somali shilling banknotes were introduced in 1999 by the Puntland Administration. It was also a forgery of the pre-1991 Somali shilling, and has since successfully merged with it.
As individuals were accustomed to transacting with Somali shillings and knew that their trading partners were similarly accustomed, they readily accepted the Balweyn notes, even as their purchasing power decreased over time. This suggests that these two new currencies bypassed the problem of network effects and switching costs due to their similarity to the original Somali shilling.
At initial glance, the case of Somalia appears to provide empirical support for Friedman’s doubt, as it provides valuable insight concerning network effects and switching costs of money. This cost might be interpreted as:
- Changing prices to reflect the new medium of account;
- Learning to think in terms of a new medium of account or;
- Changing record-keeping processes.
It could also be argued that this historical episode is an anomaly. Given that Somalia is a poor country with an underdeveloped financial system, it might be inappropriate to extrapolate this case to a wealthier country with a more complex economic system. However, despite these caveats, the evidence at hand highlights the inconsistencies with the Hayekian position, especially given the observed reluctance of Somalians to switch tender in the absence of legal restrictions.
Conclusion
In part two, we will explore a hypothetical situation where a crypto-backed ecosystem is formed in Somalia, to determine whether or not it strengthens the Hayekian position.
The advent of blockchain technology introduces a decentralised framework for finance, in which network effects for crypto-assets could be formed internationally. In an increasingly globalised context, are individuals more likely to look beyond matters of statehood to capture any salient economic opportunities?
Rebuilding a viable financial system after a period of sustained conflict is a challenging task. Can the use of crypto-assets, which can facilitate the transfer of value without the need for a trusted third-party intermediary such a central bank, fast track the development of financial services within Somalia?
References
Mubarak, J. (2002). A Case of Private Supply of Money in Stateless Somalia. Journal of African Economics, 11(3), pp.309–325.
Munzele Maimbo, Samuel [editor]. 2006. Remittances and economic development in Somalia : an overview (English). Social development papers conflict prevention and reconstruction ; no. 38. Washington, DC: World Bank. http://documents.worldbank.org/curated/en/129711468167064074/Remittances-and-economic-development-in-Somalia-an-overview
Luther, W. (2013). Friedman Versus Hayek on Private Outside Monies: New Evidence for the Debate. Economic Affairs, 33(1), pp.127–135.
Shapiro, C. and Varian, H. (1999). Information rules. Boston, Mass.: Harvard Business Press.
