Currency Fixing and Economic Development: Are They One and the Same Thing?

By Saliem Fakir · 8 Jun 2010

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Picture: Fazila Farouk
Picture: Fazila Farouk

While they may fight on the shop floor and often agree on little, in a rather strange twist of relations between business and the labour unions, they seem to agree on one key macro-economic policy issue, i.e., on the question of the rand’s value.

Both want a lower rand in order to boost the order books for our locally manufactured goods.

A joint statement by South Africa’s three top unions and manufacturers was issued on the 10 of May 2010. The statement called for interventions, which ensure the rand, is “appropriately valued, competitive and stable.”

The statement comes in the context of the job crisis and the rollout of the second Industrial Policy Action Plan (IPAP), touted as a key policy document to broaden and deepen South Africa’s industrial base.

Not all of business stands side by side with the idea that the rand should be pegged at a weaker level. SASOL and one of the big mining corporations distanced themselves from the joint statement.

They didn’t give any reasons. But one can only speculate that a stronger rand helps SASOL and other South African multinationals to buy foreign acquisitions cheaply. If this is the case, a strong rand is in their favour.

For the unions at least, if yesterday was about inflation targeting, today is certainly about the unruly rand. On the basis of a superficial outlook, the plaintiff’s arguments seem logical, but things are never as simple in a complex economy.

And, neither can our country’s development be pegged to the vagaries of a single economic variable. To think that only a misbehaving rand is the cause of our woes would solidify a misrepresentation of the causes of the rise and demise of our economic prosperity.

Even though currency depreciation is the game that everybody plays to improve their competitiveness, there is something rather fictional about it.

The US consistently did it, devaluing its currency whenever it found that its manufacturing sector was underperforming compared to Japan, for instance. By devaluing its currency, it temporarily boosted its economic growth. It could do so because the dollar was the dominant and world’s reserve currency. But as the US is discovering it can’t keep on doing this without addressing the under-lying problems of its economy.

Similarly, pegging the rand at a weaker level is also a very different thing from intervening in the currency markets to reduce its volatility. Besides, what the right level of devaluation for the rand should be is as open to dispute as the debate about the merits of depreciating the currency itself.

The main problem may not be the overall value of the rand (as some argue it is weak already) but the fact that this value keeps changing, very quickly, from R7 on one day to R8 or R9 the next.

The real culprits behind this volatility are speculators who bet on the rand for no other reason than to make profits on unearned income.

The Reserve Bank, which doesn’t have the luxury of a high reserve of dollars, can’t out-compete the currency speculators whose appetite for the rand seems insatiable. Amongst themselves, speculators hold greater volumes of dollars than the Reserve Bank could ever match. So, they are almost always able to buy more rands than the Reserve Bank is able to buy back.

Currency punters favour the rand because it is a freely available commodity as well as a widely traded currency. Only a financial tax on speculative short-term trade can temper some of this trade.

Speculators are not South Africa’s only concern.

Commodity booms, which are starting to take shape again, tend to drive up the amount of dollars that enter the South African market, either through the purchase of shares on the stock market or the direct purchase of commodities like gold and platinum.

Commodity booms do not necessarily lend themselves to sustained growth. They can be as shifty and unreliable as the commodities markets themselves, as the last recession has proven.

Since South Africa is largely a commodities-driven economy, it is also predisposed to the classic Dutch Disease Syndrome – first discovered in north European oil producing countries like the Netherlands.

One catches the Dutch Disease, so to speak, when a commodities driven economy tends to drive up the local currency and increase the cost of exports.

Which simply means that while the commodity (oil, in the case of the Dutch) does well, other segments of the economy begin to suffer because the currency is too high to make exports competitive.

It is one of the reasons Australia is currently looking at introducing a Super Profits Tax (SPT). This is to ensure that profit takers don’t gain more than the sovereign state. However, the SPT’s other explicit aim is to ensure the resilience of non-commodities sectors against the withering effects of a stronger currency due to the commodities boom.

While currency devaluations may improve exports, the sustained consumption of imported goods only increases the rate of inflation because import costs go up. In our case, we are still dependent on oil imports (60% of our fuel comes from imported oil), certain foods, clothing and machinery.

The costs of these things will go up as the currency depreciates -- contributing to inflation.

Inflation’s curse is that it lowers the wealth of the populace by lowering their purchasing power. This in turn curtails consumption, which negatively affects growth in production and the economy as a whole. Thus, the benefits of exports accrue to the wealthy rather than the poor.

A commodities-driven economy also tends to improve the fortunes of the middle class whose appetite for luxury goods pushes up the import bill, which in turn also increases the demand for dollars and encourages a stronger rand.

The middle classes’ general habits for foreign goods and luxury items drive up imports and only certain segments of the economy tend to grow -- especially security, financial services (the speculative segments), entertainment and other service sectors.

This was certainly the case in Argentina, which in the early 1900s was one of the world’s highest income countries. But, the displacement of export earnings for growth in imports due to the ravenous appetite of its bourgeois only facilitated Argentina’s downward descent into economic obscurity.

The mismanagement of Argentina’s economy in the 1990s led to catastrophic outcomes for its economy even today. Compared to other countries it depicts relatively slow growth and high rates of boom and bust cycles never quite reaching the steady and sustained growth it needs.

Government inefficiencies also take their toll on a currency especially if procurement policies tend to be inclined towards imported goods rather than using local manufacturers.

Wastage and corruption can also divert government spend from the right things as these diversions tend to increase the income of a few and their profligacy for imports. On the other hand, the improved incomes of a broader base of the populace tends to localise consumption.

High exports with lower imports - as conventional theory argues - is better because we earn more dollars in the current account rather than dispose of them as fast as we get them because of continued dependency on imports.

But, one must be careful what one asks for. Industrialisation is best when exported goods rely predominantly on the use of locally manufactured machinery and other inputs.

This happens when the lower tiers of the economy like agriculture and mining feed the higher value ends of the economy - the manufacturing and service sectors.

The moral problem with currency devaluations is that it is false fixing of the economy. It can happily create the illusion of progress without having to deal with underlying causes that hamper economic progress.

The lesson here is that depreciation of currency without looking at the whole system is a false cure and often under-girded by the wrong diagnoses of what the causes are of our economic woes.

And, many times, these issues are not purely economic but also originate in our politics. A less cohesive and unequal society tends to produce a weaker capacity for managing external shocks while export led growth can only strengthen the dominance of the wealthiest few.

And, as always, we will be back to the root question: What is happening to the quality of opportunity and the lives of our people -- and how will the depreciation of the rand improve this? The answer does not lie in fictional shifts but real shifts in the structure of the South African economy.

Fakir is an independent writer based in Cape Town.

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Miles Teg
14 Jun

Keep It Simple

The price of a currency depends on whether it is free floating or not. If, like SA, we choose a free floating currency then we are open to all sorts of vagaries in the market. We could be like Botswana or China that peg their currencies to the dollar or a basket of currencies, which is feasible and assists us in economic planning. The point about all this is that what the Rand Commission obscured is that the efficient markets hypothesis (EMH) and rational markets theory (RMT) that underpin most SA analysis of the market simply is not borne out by reality. As long as the pundits play the EMH and RMT game, nothing will happen.
While we sit on Special Drawing Rights and the Economist ranks us as one of the most at risk emerging markets we continue to deregulate (including derivatives at the WTO - the cause of the crash) and liberalise, increasing our exposure foreign induced volatility instead of preserving our policy space. And this is what we call conservative monetary and economic policy while COSATU is labled as interventionist. Please would SA come out of the laager - even the Swiss are intervening... and it is in the open. Saying that intervention is wrong is just bunkum... the issue is can one outsmart speculators... and Mahatir of Malaysia did it defying the IMF. We are following the IMF though... not so cleva Treva...

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