The big Sh67 billion riddle that defies zero sum theory

In theory, there is a game called zero-sum, which is a mathematical illustration where one person’s gain is equivalent to another person’s loss, so that the net change is zero.

Consider the stock market. You can only realise price gain(s) by making another person lose.

The same game can also be played in a demonetisation exercise, such as the one that was concluded this week by the Central Bank of Kenya (CBK).

Demonetisation, in itself, is the act of withdrawing a medium-of-exchange function of a currency, such that it is no longer acceptable. In central banking parlance, the currency is said to lose its legal tender status.

So how does it work? For illustration purposes, if there are 100 units of a currency in circulation and you want to replace them with new generation notes, you simply ask holders to return them in exchange for new ones.

You haven’t created anything new in the process, which is why it is a zero-sum game.

When the CBK announced the demonetisation exercise on June 1, 2019, it gave a September 30, 2019 deadline for the exchange of the old Sh1,000 currency notes ostensibly, in CBK’s own words, to deal with illicit financial flows and counterfeits.

According to the apex bank, there were 217.047 million Sh1,000 denomination notes in circulation as at June 1.

By the end of the exercise, it received 209.661 million notes, which implies some 7.386 million notes did not return.

One can assume that either they were destroyed, burnt or maybe people holding them opted not to return them. But that in itself is a subject of intense debate.

That notwithstanding, the financial sector regulator adds that by close of the deadline, it had pumped in some 149.692 million of the new Sh1,000 notes into circulation.

Commercial banks and other licensed intermediaries were the agents in this demonetisation exercise.

Let’s have some logical argument here. If a commercial bank, or any other licensed intermediary with access to CBK’s currency centres, evacuated a certain amount of cash from its premises to the CBK’s currency warehouse, that bank expects to receive in full, either immediately or at a later date, the same amount in the new currency notes (since the old series notes were being sterilised).

That is to say, if it delivered 100 units of a currency, it expects exactly the same 100.

Consequently, the 149.692 million of new notes that the apex bank had pumped into circulation by September 30 was in exchange for a similar amount of old notes that had been returned.

And the logic here is very simple: it’s a note for a note (one-for-one). The big question, then, is, where are the extra 67.335 million of the old Sh1,000 notes (of which only 59.969 million came back to the CBK)?

Do we want to say that there were some 59.969 million of the old notes that were delivered without a corresponding entry?

One can argue this to be implausible, for the simple reason that every person who delivered an old series Sh1,000 note ideally received a replacement (with the new series note).

The only explanation to this puzzle could be that maybe the apex bank re-issued the balance in other lower denominations, in which case they need to come clear.

Something else to note is that currency sitting inside the central bank’s warehouses is not in circulation.

Meanwhile, we also learnt, from the exercise, that the much hyped cash hoarding, where people held large sums of cash in their bedrooms, was anecdotal and has, consequently, been disproved.

In my own words, the so called corrupt are way too smart with their asset allocation. But that aside, there exists an unexplained Sh67 billion hole.