One country, two monetary systems

I often write about odd monetary phenomena on this blog. Here's a new contender, Yemen's dual banknote system.

Yemen uses the Yemeni rial as a unit of account. As one of the poorest countries in the world, Yemen still relies mostly on banknotes to make transactions, which are issued by the Central Bank of Yemen, or CBY.

One of the convenient features of banknotes is their fungibility. This means that one banknote is perfectly interchangeable with another. For a few months now, something strange has happened to Yemen's banknotes. Old rials and new rials have ceased to be fungible. Any rial note that was printed prior to 2016 is now worth around 10% more than newer rial notes.

More generally, the entire Yemeni monetary system has split on the basis of banknote age. From a Western perspective, it would be as if every single U.S. banknote issued with a Steve Mnuchin signature on it, the current Treasury Secretary, were worth 10% less than bills signed five years ago by his predecessor Jack Lew.

Conflicts are always complicated. What follows is a short but drastically simplified explanation of how Yemen's banknote problem began.


In 2014, the northwestern part of Yemen was taken over by rebel Houthis. They also managed to capture the capital, Sana'a. Meanwhile, an internationally-recognized government occupies the south, the port city of Aden being its capital. Very few people live in eastern Yemen.

Source: Aljazeera

The Central Bank of Yemen has always been located in the capital, Sana'a. It tried to be a neutral party between the two warring sides. This sounds like it must have been a very awkward role to play.

For instance, before the war started the central bank was responsible for paying government salaries, including the army. When the war kicked off some soldiers supported the rebels in the north while others joined the internationally-recognized government in the south. According to Mansour Rageh & coauthors, this meant that the central bank was simultaneously paying the salaries of both sides of the conflict. That's touchy.

This balancing act eventually broke down in 2016 when the internationally-recognized government forced the central bank to move to Aden. Rageh et al explain how this happened. In short, the government convinced the international community to block the Sana'a branch's access to foreign reserves. It also prevented the branch from getting new banknotes printed.
So by late 2016 we've got two different branches of the central bank, one controlled by the rebels and the other by the internationally-recognized government. The latter controls most monetary functions.

With the stage set, we can now start to get into the meat of why old rial notes are worth more than new ones. After the Aden branch of the CBY had established itself in 2016, one of the first things it did was order a bunch of new banknotes to be printed up by Russian note printer Goznak. These arrived in Aden in early 2017. They looked like this:

Source: Banknote News

You can see that there are some differences between the new 1000 rial note and the old one, pictured below:

Source: Banknote News

The rebels were not happy with the new notes. It's easy to guess why. Fresh money could be used to pay government fighters, not rebel fighters. This "blood money" would then cheekily flow north via trade. Since anyone who holds a banknote is by definition funding the government that issues it with a no-interest loan, the rebel north was financing its own enemies. (The technical term for this sort of financing is seigniorage).

In 2017, the rebels began to limit the ability of northern civilians to use the newly issued banknotes. This mostly affected banks and other large businesses in the northern Yemen, which were now required to avoid dealing in the new notes. Anthony Biswell of the Sana'a Center for Strategic Studies has a much weightier explanation of this transition. Do read his article if you want to learn more about this topic.

Anyways, on December 18, 2019 the rial spat crescendoed into a full out ban. The rebel government announced that everyone in the north had thirty days to turn over new notes at any of 300 agents located across the region. In return they would get an equivalent amount of old banknotes, if available, up to 100,000 rials per person. That's around US$170.

Anything above this 100,000 rial limit would have to be converted into a digital rials. These would be supplied by one of three privately provided electronic wallets. Unfortunately, Yemen has almost no digital payments infrastructure, so these balances wouldn't be of much use.

Thanks to the December 2019 ban, the price of old and new rial banknotes has completely diverged. Below is a chart from the World Bank.

Source: World Bank

We can surmise why a big gap has developed between the two types of notes. The stock of old pre-2016 banknotes is fixed. It can't grow. But the supply of new banknotes is not fixed. The Aden branch of the CBY can get Goznik to print as many notes as it wants. So the rare rials, the old ones, are worth more.

I'd expect Gresham's law to kick in, too. Gresham's law says that if a government stipulates that two payment instruments are to circulate at the same rate, but one is worth fundamentally more than the other, then the "bad" one drives out the "good". More specifically, the undervalued money will be hoarded (or exported), leaving only the overvalued one in circulation.

In Aden's case this is likely to translate into "bad" rials (the post-2016 ones) driving "good" rials (the pre-2016 notes) out of circulation. Since the Aden government treats both old and new banknotes as interchangeable, but old ones are worth more, the old ones will all be exported to the north.


Where might all this lead? With the Sana'a branch having declared war on new notes, the Aden branch may do the opposite and try to hurt the old ones. This would involve orphaning all of its pre-2016 banknotes. That is to say, the Aden branch will demonetize them; cease accepting old notes as its liability or obligation.

But even if they were to be demonetized, orphaned rials would still circulate.

The topic of "orphaned" currency has popped up before on this blog. The Somalian central bank ceased to exist in 1991. Yet even though the Somali shilling now lacked a central bank sponsor, they continued to be used in Somalia as a medium of exchange, as recounted by Will Luther here.

A new Somali central bank has stated that it will re-adopt these old shillings and replace them with new currency. To date, this hasn't happened.

Along these same lines, even though Saddam Hussein disowned Iraqi dinars that had been printed in Switzerland, these so-called "Swiss Dinars" continued to circulate in northern Iraq. After Saddam was deposed by the Americans in 2003, the new central bank re-adopted all of the orphaned Swiss dinars.

If the Aden government is going to disown old Yemeni rials, I wouldn't expect them to remain orphaned for long. The Sana'a branch of the Central Bank of Yemen would quickly adopt them as their own obligation. At which point Yemen's unofficial two-currency system would become official. The Sana'a branch might even try to get its own version of the rial printed up. If so, it would have to rely on printers other than Goznak.


Yemenis already face so many difficulties. The sudden emergence of a dual-currency regime only compounds their plight. Prices are a language. We become fluent in this language as we engage in our commercial habits of buying, selling, and appraising. The sudden rial split forces Yemenis to start "speaking" in two different price arrays (three if the U.S. dollar is included). It's terribly inconvenient.

There are also costs to renegotiating rial-denominated debts. If one Yemeni owes the other, are they to pay in old rials or new ones? Debtors will always prefer the debased currency, new rials, but creditors will ask for the stronger one, old rials. Somehow a decision will have to be made.

Finally, a dual currency regime means that Yemenis will be forced to convert from one type of currency to another to make payments. That means incurring fees, hassles, and waiting time.

In the west, we take fungibility for granted. To achieve monetary standardization, a big investment in technology and coordination is required. The fact that a dollar is worth the same in Los Angeles as it is in New York, or Vancouver as it is in Halifax, is worth celebrating.

P.S. Yemen's old rials are really old. See image below. Dilapidated banknotes are a major problem. They make trade harder and allow for easier counterfeiting.

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