Everyone is talking about the plummeting rand and there are as many theories about the cause as there are commentators. As some contend, Robert Mugabe's autocratic behaviour has probably induced some foreign investors to sell their South African investments. And our high crime rates certainly don't encourage foreigners to invest here. Africa's sorry history of poor and corrupt government also undoubtedly affects South Africa's ability to keep and attract foreign investment. And perhaps the debt crisis in Argentina has made others nervous about investing in developing countries. But these and other less credible suggestions are not the fundamental cause of the rand's slide.
Expropriation and outright confiscation of property has been one of the hallmarks of rapacious African governments. What Mugabe is doing in Zimbabwe is therefore not new to Africa. The desire for unlimited power, the failure to maintain and defend property rights, and disrespect for freedom of contract, have featured in all the government failures on the continent. Potential foreign investors are particularly sensitive to threats to property rights and the proposed nationalisation of South African minerals, especially without full compensation, would be close enough to "Mugabe-like" behaviour to frighten off many a foreign investor. As Professor Richard Epstein, the well-known American legal scholar said in commenting on the nationalisation proposals, "I can tell you one thing for sure, American investors will be on the first airplane out of here". Foreign investors who make the property-rights link will be nervous, wondering what will be nationalised next. So this proposal, along with any other policy that is bound to have counter-productive consequences for the economy, will undoubtedly reduce foreign investment and consequently the demand for rands. Although unwise, the proposed mineral-grab and its obvious association with Mugabe's land-grab is nevertheless also not the main reason for the rand's woes.
The "contagion" notion, which suggests that events in Argentina can have an automatic and unjustified effect on the value of the rand is also ill founded. Subsequent appraisals of the so-called Asian currency crises of 1997 found deep-seated flaws in the financial markets of the affected countries. These consisted of uncovered exchange rate exposures, under-capitalised and poorly supervised banks, and various unwise government policy decisions that allowed or fostered unsound banking and financial market practices. Profligate government spending and a concomitant debt burden have caused Argentina's problems. The fundamental policy errors can be identified in every case. So whatever happens elsewhere cannot have long-term catastrophic consequences for the rand so long as South Africa's economic policies and currency management remain sound. However, what we can expect is that crises elsewhere will encourage investors and currency speculators to look for flaws in the economic and currency management of all developing countries. And if they find any, they will pounce. When they discover such flaws they sell the currencies and force errant governments and central banks to mend their ways. They are, not surprisingly, much hated for the service they provide to more staid investors. And they have discovered a serious flaw in South Africa's management of the rand - a flaw of long standing.
The problem with our currency is that there are too many rands chasing too few goods and services, as is always the case when the purchasing power of a currency declines. The accompanying graph shows that M0 (the base money supply, which consists of notes, coins, and deposits of financial institutions with the Reserve Bank) has increased from R4,7 billion to R43 billion during the period January 1985 to October 2001. During the same period the rand/dollar exchange rate fell from about R2 to the dollar to R9.45, and has since then declined even further. The general rule is that M0 should increase by no more than the rate at which goods and services are being produced, that is, at the rate of growth of GDP if price inflation is to be avoided. South Africa's base money supply has grown by about 815% in just less than 18 years. During the same period GDP increased by a total of 31 %. An indication of the extent of the problem is that if M0 had increased at a more acceptable fixed rate of 3% per annum since 1985, M0 would have been R7.8 billion at the end of this year.
(Graph supplied by Garth Zietsman who is a statistician at a major South African bank)
Would you exchange your dollars for rands while the Reserve Bank is printing money at this rate? Obviously foreign investors have access to these figures and will act on them. A mechanism is needed to control money supply increases. South Africa has no discipline such as a Currency Board, convertibility to gold, or other means of preventing an untoward increase in M0. Excessive increases in the quantity of rands, such as those to which we have become accustomed, are therefore totally in the discretion of the Reserve Bank. Printing too much money inevitably causes price inflation and a decline in the exchange rate of the currency. However, whilst the rate of increase in the Consumer Price Index (CPI) closely followed the rate of increase in M0 for many years, the graphs for these two rates diverged early in 1994. The CPI started to lag M0 by an increasing margin. However, as can be seen from the graph, the rand/dollar exchange rate has continued to move in tandem with M0. No one has yet suggested a satisfactory explanation for the divergence of the CPI from its previous pattern. If the divergence consists merely of a delay in the timing of price increases, consumers could be in for a torrid time during the next few years as prices once again catch up with money supply increases.
South Africa's economy will not grow rapidly, and problems such as unemployment and poverty will not be reduced, if the erosion of the internal and external purchasing power of the rand is not halted. In the recently published FMF monograph, Gold, the euro, the dollar and the rand, Dr Richard Grant described various monetary control methods and finally suggested fixing the rand to a unique index standard consisting of two parts euro, two parts dollar, and one part gold. Adoption of the proposal would not only stabilise the rand against all other currencies, it would also give us an inflation rate and interest rates comparable to those in the E.U. and the U.S.A. The benefits would be considerable. Dr Grant says elsewhere in the monograph "Excessive monetary inflation leaves in its wake confusion, uncertainty, error and, ultimately, real economic destruction" and that is what South Africa faces right now.
Source: Eustace Davie is a director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement. The patrons, council and members of the Foundation do not necessarily agree with the views expressed in the article. The FMF publications Real Money and Gold, the euro, the dollar and the rand, both by Dr Richard Grant, which deal with this issue in detail, are available from the Foundation at R80 and R40 respectively. Phone Christine at (011) 884 0270.
FMF Article of the Week\19 December 2001