Abandon apartheid’s counter-productive forex controls

Modern foreign exchange (forex) controls were introduced in Nazi Germany just before the Second World War in a vain attempt to stop fleeing Jews from taking their assets with them. Hitler’s gold and foreign currency reserves then dwindled faster than ever and his decision to go to war was in part to plunder the assets of his country’s neighbours as a means of bolstering the finances of his tyrannical regime.

South Africa’s apartheid regime followed suit and introduced forex controls in 1961 after the Sharpeville massacre in its own misconceived attempt to prevent the ‘flight of capital’ from the country. Not only did the action fail to prevent local people from moving their wealth offshore, it did exactly the opposite and greatly exacerbated capital ‘flight’. Former Reserve Bank Governor, Gerhard de Kock, lamented that it works when you don’t need it and doesn’t when you do. He said he was sorry that he did not remove the controls during his term of office because they probably kept more money ‘out’ than ‘in’. Throughout its ignominious history, this tool of tyranny has failed to achieve its intended objectives wherever it has been tried.

Global empirical research has shown that forex controls don’t stop people from acquiring foreign assets. After more than four decades of draconian forex laws and penalties, the recent amnesty revealed that some citizens had more assets offshore than in South Africa! Similarly, many foreign investors are averse to making long-term investments in a country with forex controls and the controls certainly do not enhance local or international trade.

Since the 1970’s open, democratic, and self-respecting states have ditched these failed and thoroughly discredited practices. A list of countries retaining forex controls contains the names of every one of the world’s pariah states and having South Africa among them has become increasingly embarrassing. Retention of controls, whatever reason may be given for doing so, displays apartheid-style disrespect for the freedom and democratic rights of citizens and a complete lack of understanding of how wealth is created and transferred. Moreover, we surely don’t want to continue playing in the pariah league.

Rands do not ‘leave’ South Africa through the foreign exchange mechanism. In order to ‘get money off-shore’, South African residents exchange their own hard-earned after-tax rands for dollars or some other foreign currency. Rands in South Africa and dollars elsewhere merely change owners. Banks settle forex debts with foreign currencies in foreign banks. At the moment of exchange, no wealth leaves the country and none enters it. When an American and a South African exchange currencies, the American, who could have spent his dollars offshore gets rands instead which he can spend only in South Africa. The South African can now buy a Big Mac in New York and the American can buy one in Johannesburg. Neither country is richer or poorer. A country’s wealth is a function of its production of goods and services, not the ratio of forex to local currency owned by its citizens, its government or foreigners.

Creating endless hassles for South African firms and individuals wishing to enter into transactions with foreigners is not conducive to achieving the high economic growth we need in South Africa. High growth countries deliberately set out to create the kind of environment that will attract risk-taking entrepreneurs and investors. They do this by cutting down on taxes and red tape, and most importantly, they refrain from attempting to prescribe to law-abiding local and foreign firms what they may and may not do with their own money.

One of the ostensible reasons for maintaining forex controls is to maintain the exchange rate of the currency at some stable level. Events have shown that such attempts always fail unless the issuer of the currency maintains exemplary monetary discipline, in which case the forex controls are superfluous and an unnecessary hindrance to trade. South African exporters are the main earners of foreign currencies, which they sell for rands to registered South African forex dealers. South African importers, who are the largest forex purchasers, buy forex with rands from the dealers in order to pay for their imports. The price at which the exchange takes place is determined by supply and demand for the various currencies.

The real purpose of forex controls may be to create an artificial forex shortage, the intention being to drive up rand values. Higher rand values transfer wealth from exporters to importers and those with foreign debts. Government is a net importer and debtor to foreign lenders.

Will the scrapping of forex controls lead to a rush by owners of rands to buy foreign currencies and assets at any price? Not likely, but even if there is a short-term increase in rand selling, it will soon dissipate should the rand weaken. And if local rand sellers drive the price of the currency down after abolition of exchange controls, there will be foreign buyers happy to pick up bargains in the newly-liberated market. Their demand would counter and reverse the trend. Parts of South Africa’s economy will benefit from either a stronger or a weaker rand while the currency finds its true value in the international markets, unfettered by forex interventions.

As foreign investment flows relatively easily in and out of the country some people believe that the remaining South African forex controls do not have any negative consequences. However, international investors expect to be able to transfer funds into or out of respected currencies at the click of a computer button. They therefore do not take kindly to the presence of bureaucrats sanctioning their transactions and are highly suspicious of governments wanting to play by their own rules in the setting of entry and exit terms. Investors realise that it is just as easy for bureaucrats to prevent money from ‘leaving’ as it is for them to agree to it ‘entering’. Why would anyone want to invest under such circumstances when there are so many easier, less risky, foreign investment options available?

When past president Nelson Mandela opened Parliament in Cape Town in 1996, he said that it was not a matter of if forex controls would go, but when. That was 10 years ago. Why does government then continue to weigh down the economy with this costly burden? Is it because 1,000+ Reserve Bank employees would become redundant if forex controls are scrapped? If so, it would be better and cheaper to scrap forex controls and pay forex staff to do nothing. No government agency or ‘empire’ relishes downsizing, no matter how beneficial for the country. Maybe the reason why governments retain forex controls is that they find it hard to give up power over their citizens.

Author: Leon Louw is the Executive Director the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.


FMF Feature Article/ 23 May 2006 - Policy Bulletin / 10 November 2009