Downward-trending inflation ensures rand will not become worthless

"The rand is worth nothing," was a regular refrain 30 years ago. It was not true then, just as it is not true now. But by 1991 South Africans had experienced almost two decades of double-digit inflation. Compared to the rand of 1961 — the year the rand was introduced — the rand of 1991 was worth only 6c.

The 1961 rand was worth 40% more than the dollar. But 30 years later the rand was worth 60% less than the dollar — and the dollar had been suffering its own chronic, though less severe, inflation. Neither currency had made it through the previous 30 years without shirking its duty to serve as a reliable unit of account. We were living in a world where the primary standard for measuring economic value was itself changing, often erratically, causing uneven ripples of price changes across the economy.

One of the dirty secrets of inflation is that it never treats people equally. There can be no magic helicopter drop of currency such that everyone enjoys the same proportionate increase in their currency holdings, or even an equal share of the fleeting increase in purchasing power. And that brings us to another dirty secret, which is that inflation never increases total purchasing power: at best, it merely redistributes it.

The inflation we experience now, as then, is caused by central banks. But all the real purchasing power we enjoy is created by people who work to produce and trade goods and services. Inflation makes the work of those people more difficult. Even when the average inflation rate is predictable, there are still wide variations in price changes across the economy. Business errors are more likely, just as households will be more prone to miscalculate the relative values of their wages and their purchases. The higher and the more erratic the inflation, the worse it gets.

As has been true elsewhere, SA's best economic progress occurs during periods of relatively low inflation or when inflation is falling, or at least stabilising. Not all good performance is attributable to currency stability: there are always other types of government policy in play and life is full of "supply shocks" and innovations. The statistics are messy because life is messy, which is why we always have work to do and something to work for.

A relatively stable currency facilitates that work by transmitting price information more reliably to reflect the realities of the marketplace. When monetary policy becomes inflationary, it can have a stimulative effect on economic activity. This effect has led to the belief that a little inflation stimulates economic growth, and a naïve statistical analysis would seem to confirm this. Similar statistical analyses would suggest that amphetamines improve human performance, until they don't.

It could be argued for inflation also that the dose makes the poison: a little inflation is better than a lot of inflation. But in both cases the stimulus distorts the information flows and encourages too much of one action rather than another. Apparent gains will periodically be lost to "corrections".

The latest consumer inflation rate in SA is 5.2%, which is within the Reserve Bank's target range of 3%-6%. Americans were shocked earlier in 2020 when their own inflation rate rose above 3%, and then reached 5%, after 15 years of rarely rising above 2%. Inflation in both countries is expected to rise further. The US Federal Reserve predicts that the current burst of inflation will be transitory and will soon subside to "normal" levels.

Such a forecast is warranted for SA as well. The long-term trend for inflation has been downward and, despite the recent inflationary pulse, monetary conditions now suggest a resumption of the downward trend within a year. If inflation continues to rise it will not be due to monetary factors unless the Reserve Bank feels compelled to respond to the effects of other governmental policies. The draconian and counterproductive lockdowns imposed in various jurisdictions over the past year have certainly provoked inflationary monetary responses, the full results of which we have yet to see.

The good news is that with inflation trending downward the rand will never be worth nothing. By the way, if you had kept that 1961 rand in your pocket, it would now be worth 1c.

This article was first published on BusinessDay on 3 August 2021.

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