How South Africa can lead the world out of the global financial crisis

Professor Friedrich Hayek, 1974 Nobel Laureate, foresaw the calamitous situations that governments could create through their insistence on establishing national currencies under their total control. He wrote of “the source and root of all monetary evil, the government monopoly of the issue and control of money”. He also wrote that: “The cause of waves of unemployment is not ‘capitalism’ but governments denying enterprises the right to produce good money.”

In his 1976 paper, Denationalisation of Money: Analysis of the Theory and Practice of Concurrent Currencies, Professor Hayek warned that governments and their appointed central bankers would be tempted to misuse their money monopoly to print excessive quantities of money, cause instability, indulge in undisciplined state expenditure and impose economic nationalism.

If he were alive today, this great economist would be aghast, not at the accuracy of his predictions but by the extent to which the US government and its appointed Federal Reserve Board broke and continue to break the rules of prudent monetary and fiscal management. He probably would not be surprised by the misinformation being put out regarding the cause of the current crisis. When writing his paper more than three decades ago, Hayek obviously was responding to similar allegations when he said: “It was not ‘capitalism’ but government interventionism which has been responsible for the recurrent crises of the past.”

Another great economist, Professor Ludwig von Mises, in his preface to the 1934 edition of The Theory of Money and Credit wrote: “The remarkable thing in the present situation is not the fact that we have just passed through a period of credit expansion that has been followed by a period of depression, but the way in which governments have been and are reacting to these circumstances. The universal endeavour has been, in the midst of the general fall of prices, to ward off the fall of money wages, and to employ public resources on the one hand to bolster up undertakings that would otherwise have succumbed to the crisis, and on the other hand to give artificial stimulus to economic life by artificial public work schemes. This has had the consequence of eliminating just those forces which in previous times of depression have eventually effected the adjustments of prices and wages to the existing circumstances and so paved the way for recovery. The unwelcome truth has been ignored that stabilisation of wages must mean increasing unemployment and the perpetuation of the disproportion between prices and costs and outputs and sales which is the symptom of a crisis.” He could have been writing about today instead of the Great Depression of the 1930s.

In a previous article, Governments, Free Markets and the Financial Crisis, I described why governments and their central banks were responsible for the global crisis. In this one I attempt to identify a solution – a solution in which SA can play a leading role.

The main reason for the absolute terror gripping the world is that the world’s reserve currency, the once-mighty dollar, has been debased and manipulated to the point where it no longer serves its former purpose. Even more frightening is the fact that the US government and Federal Reserve Board are in the process of compounding past errors by debasing the currency even further.

The world needs an alternative reserve and the only feasible option is gold. There are numerous problems related to a return to a fully convertible currency based on gold, not least of which is the large quantity of paper money in issue. Gold, nevertheless, could be used to engender confidence in the rand in the same way that a country like Estonia uses the Euro to give people confidence in its currency, the kroon,

According to the website of the Eesti Pank, or Bank of Estonia, “A currency board is an automatic system based on stringent rules. In order to maintain the fixed rate of the Estonian kroon, the central bank's liabilities, including the monetary base in the economy, must be fully guaranteed by gold or foreign exchange reserves. Eesti Pank operates independently from other state authorities. Under the currency board arrangement, the central bank is prohibited by law to directly or indirectly credit the central government and local governments. According to the Law on the Security of the Estonian Kroon, Eesti Pank has no right to devaluate the exchange rate of the kroon.” The fixed exchange rate is 15.6466 kroons to one euro, previously 8 kroons to one deutsche mark. This exchange rate has remained the same since 20 June 1992, except for the switch to the euro.

Currency boards prevent governments and central banks from manipulating their currencies. They function even better if they are independent, separate from central banks, and have the sole purpose of providing the country’s citizens with a sound currency. SA should consider establishing an independent Currency Board that to back the rand utilises gold rather than a foreign currency.

According to the 31 January 2009 statement of assets and liabilities published by the SA Reserve Bank, the liabilities reflected Notes and Coins in Circulation amounting to R68.4bn, and the assets included R37.7bn (4,011,417 ounces) of gold holdings valued at R9398.79 per ounce. At the same price, to fully back the notes and coins in circulation with gold, a purchase of a further R30.7bn of gold would have been necessary.

If an independent Currency Board had been established on 31 January 2009 to manage the rand, it would have taken over the Reserve Bank’s R68.4bn liability in respect of notes and coins in circulation, its gold assets of R37.7bn and, theoretically, forward cover provided by the Reserve Bank for another R30.7bn of gold at R9398.79 per ounce to settle the balance of its liability to the Currency Board.

On that date, 31 January 2009, one rand would have been declared to be equivalent to 1/9398.79th of an ounce of gold, fixed for all time. While the Currency Board would be compelled to maintain precisely correct gold holdings at the fixed weight of gold per rand to cover notes and coins in issue, it would not undertake to part with any of its gold in exchange for notes and coins. The reason is that the gold holdings of the Currency Board would represent a control mechanism to prevent excessive printing of money, not a return to gold as money, which would be something vastly different and more difficult to implement. For all new rand notes or coins issued, other than for replacing damaged notes, the Currency Board would have to purchase gold so it would have no incentive to unnecessarily increase the quantity of rands in circulation.

Recent events have demonstrated the disastrous consequences of currency manipulation. Under current conditions, any nation with the will to produce and implement a practical means of providing a stable currency free of political manipulation would attract not only investment but also highly talented people capable of creating wealth and jobs. It would also attract emulation. SA has for long had a gold-based economy. It should now demonstrate to the world its confidence in its product and a better way out of the global financial crisis.

Author Eustace Davie is a director of 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 / 17 February 2009