SANE Views

Vol.5 No.15, 22 June 2005

What Price a Return to the Financial Rand?

Margaret Legum

There is a way the government can mitigate, if not remove, the malign effects of currency volatility on employment The price of the rand has two functions, and it is time we separated them. It determines the price at which capital can enter and leave the country. And it also determines the price at which our goods are traded – sold overseas and bought from overseas.

Until some thirty years ago, when capital was unleashed to roam the world, the distinction between the two functions was not vital. About 80% of exchange transactions financed trade, so the currency price reflected a country’s success in trading. Today over 90% of foreign exchange transactions worldwide are for speculative capital flows. So our traders must use a currency whose value is polluted by speculation.

But we could introduce a dual currency price – one for capital flows, the other for goods and services. (It was used successfully in the later apartheid years: ingenious solutions sometimes come from unsavoury sources.)

It would work like this. The rand price of the foreign currency used for trading in goods and services would be set by the amount of foreign currency we earn from our exports in relation to the amount of foreign currency people need to buy imports.. So the value of that (commercial) rand would rise when we are exporting more than we are importing. Similarly it would fall when imports rise relative to exports. It would reflect our trading position.

The price of the (financial) capital rand would rise and fall by reference only to how much capital comes and goes, no doubt much more volatile, due to speculation. Very logical, very market-based.

The point would be that the two kinds of rand value would be separate, and the commercial and financial accounts would not disadvantage each other. Currently, if we gain capital for whatever reason – sensible and understandable or crazy and speculative – the value of the rand rises. That wouldn’t matter if it applied only to the terms on which we import and export capital.

But today a capital inflow means trouble for exporters, who have to pay more for what they buy and compete with cheaper imports, and that loses jobs. The reverse happens when we lose capital – resulting in a loss of employment in importing enterprise. And by the way capital intensive investment always ensures that fewer are employed when a sector recovers from a downward blip.

The losers from such a dual system would be those who make their millions by currency speculation, which is always helped by volatility. An editorial in Business Day (31/03/05) notes that “the ‘unrecorded transactions’ category of the balance of payments was a huge positive R32 billion last year….The Bank does not know where these came from. So we just do not know if they might suddenly and inexplicably reverse.”

South Africa’s attractiveness for that speculative capital is due to our sophisticated stock exchanges and the ease with which our currency can be used as a speculative tool – ‘as a shock absorber to hedge losses elsewhere’, in the words of one investment guru. Well, thanks, glad we could help.

Is that what we seek? If the answer is no, but it may be the price of global market approval, then at least we could limit its effects on the part of the economy where it actually causes real human pain – unemployment.

Radical solutions rarely receive a warm welcome. But the price of carrying on regardless, in the face of danger, may be very high.

Danger? From three quarters. First, the global rise in debt-based money supplies is very dangerous. US Federal Reserve Chair, Alan Greenspan, puts it this way (perhaps so as not to frighten the masses): ‘The Federal Reserve remains concerned that the stress tests that some participants are using to evaluate potential losses in the event of a large participant’s default do not fully capture the potential interaction of counter-party credit risk, especially in concentrated markets’ Eh?

He means there is a danger that a huge bubble is forming through borrowing that is backed by nothing but thin air. American bank loans rose 10% in one year, while the economy grew by less than 3%. Once the bubble bursts, the financial system has little substance. A dual rand would provide some cushion against that effect.

Second, nobody doubts there is an unsustainable and deeply painful level of unemployment, hence poverty and destitution, regardless of statistics. Therefore, every act of policy must be interrogated first for its effect on those evils. The dangers of doing otherwise are obvious.

Third, temporary remission from the obvious fact that oil is currently passing its peak production, should not blind us to the inexorable steady upward trend in oil prices. While we peg money supply to low inflation, which is affected by oil prices, we are in for a regime of globally competitive interest rate hikes, making currency volatility worse.

There are two alternatives to a dual rand market. The first is a fixed rand, at a price that would make us competitive. That seems unlikely. To beat the Chinese we would need an exchange rate of about $1 to R35, because that is the competitive gap in terms of Chinese labour conditions and its fixed over-valued currency. Second, we could set tariffs on all imports which have an advantage which our local products lack.

Anything short of those leaves us impotently hand-wringing over employment. Or, we could try a return to the financial rand.