In reality, a US dollar is equal to eight Kenyan shillings!

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

15 April 2007

Anthony Mathiu is wondering about what he calls the ‘real value’ of money He says: “Apart from forex rates, what factor is used to determine the 'real' value of foreign currency...is there some economic factor that is applied to foreign currency in order to take into account things like cost of living? For example, $4,000 can be considered to be casual money in the US but KSh280,000 is quite a lot here in Kenya (assuming exchange rate is taken at 70).”

Foreign Exchange rates depend on the amount of imports and exports that a country has. If the volume exports increases faster than that of imports, then the currency becomes “stronger” and vice-versa. But the "strength of money can be confusing. For example, one Japanese Yen currently exchanges for less than KSh0.60 (60 Cents!). Does this mean that our shilling is “stronger” than the Japanese currency?

Ultimately, there are two ways of finding the ‘true’ value of money, first, by asking what it can buy and, secondly, by asking how it can be earned. The comparison that Anthony is making between a US dollar and a shilling is based on the first value - purchasing power: Sh280,000 can buy a lot of stuff in Kenya but $4,000 in America is almost “pocket change”.

For example, a loaf of bread costs about Sh25 in Kenya and two dollars (Sh140 using bank rates!) in the US. Therefore Sh280,000 will buy 11,200 loaves here and only 2,000 loaves in America. In terms of purchasing power, the US dollar is equal to about Sh12.

To get the second value we consider the cost of work, say unskilled manual labour. A Kenyan labourer can earn Sh5,000 to Sh10,000 per month, that is Sh7,500 on average. To accumulate Sh280,000, the Kenyan would have to work for about 38 months (over three years).

In the US, a labourer earns about $10 per hour. That is $80 per day working 8 hours daily. Thus to accumulate $4,000, the American worker needs to put in only 50 days (about one and a half months).

In 38 months, the US labourer will have earned a total of over $90,000. Thus one can argue that Sh280,000 is equivalent to $90,000. This gives a “Real Exchange Rate” of about three shillings per US dollar! (280,000 divided by 90,000).

Therefore, the ‘true value’ of one dollar is somewhere between the earning rate (three shillings) and the purchasing power (Sh12.50). This gives an average of about Sh8 to the dollar.

But still, who is richer – the American labourer or the Kenyan? To get the answer, we have to find out what each can buy in his own country – say, how much bread. At Sh25 each, the Kenyan can buy about 300 loaves per month. At two dollars each, the American can buy 40 loaves daily or 1,200 in a month. Clearly, the American wins the challenge.