The “Mystery” of the Rocketing Rand

In an FMF article titled The “Mystery” of the Plummeting Rand, published on 19 December 2001, I suggested that the precipitous decline in the exchange rate of the rand was no mystery at all. The rand averaged R11.55 to US$1 in December 2001 and briefly depreciated to R13.84 during the month. At the time various explanations were put forward for the decline.

I said in the article: “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.”

A much more credible explanation was contained in a speech given by Reserve Bank Governor Tito Mboweni on 30 November 2001, in which he said: “When the Reserve Bank opened its doors for business 80 years ago, the total value of notes and coin in South Africa was less than R30 million. It is now R31 billion. For wider monetary aggregates, roughly the same order of magnitude for growth as for notes and coin applies over the period. This thousandfold increase in the money supply could not be absorbed by the twentyfold increase in the quantity of goods and services produced over the same period, but largely fed inflation.” Mr Mboweni should rather have said that the increase in the base money supply was totally responsible for the general price increases (inflation). The consequence (general price increases) has assumed the name of the cause (money supply inflation) and it is no wonder that few people now understand why prices keep increasing.

This week the rand has been hovering around R7.40 to the dollar, having strengthened from about R10.40 at the same time last year, an increase of almost 29%. Exporters are complaining bitterly and importers are quietly cheering. When the exchange rate tide was flowing in the other direction the importers were losing badly and the exporters smiling all the way to the bank. Exchange rate volatility is not good for economies; they function a great deal better when there are no exchange rate fluctuations to interfere with the economic calculations of firms. They also function better when prices of goods and services remain relatively stable over long periods and price rises and declines perform their proper function of signaling supply shortages and surpluses.

Totally stable exchange rates can be achieved only when all money has the same underlying value (a single global currency) as was the case when money consisted of bullion (gold or silver) or when paper money was fully convertible to bullion. Even attempting to make gold and silver coins convertible at a fixed rate caused problems in the past when the demand for, and supply of, these metals fluctuated at different rates.

The base money supply (quantity of notes and coins in circulation) in SA does not provide a total answer to the question of exchange rate fluctuations and the depreciation or appreciation of the currency but it is an important fundamental factor. Exchange rates are the result of many complex long-run and short-run factors, including the rate at which central banks print money. Current dollar weakness and rand strength is, without doubt, largely attributable to the fact that the US Federal Reserve is printing excessive quantities of dollars while the SA Reserve Bank is not doing the same with the rand.

Current SA money supply figures make interesting reading. The year-on-year rate of increase of the various monetary aggregates at 31 January 2009 was M3 0.57%, M2 0.17%, with M0 (notes and coins in circulation plus bankers’ deposits with the Reserve Bank) at 6.28%. The rate of increase of M0 (y-on-y) has been in single figures since February 2009, with a low of 3.89% in October 2009. The value of notes and coins in circulation at the end of February 2009 was R68.3bn and at end February 2010 R72.3bn, an increase of R4.0bn (5.86%), which was slightly less than the increase in M0. This is a highly creditable performance and a great improvement on June 2007 when M0 increased y-on-y at 22.65%, a rate of increase responsible for the rapid increase in prices we subsequently experienced. The strengthening of the rand is no mystery; it is largely due to sound monetary management just as, in 2001, the plummeting rand was due to unwise management.

Some commentators maintain that SA escaped the worst of the global financial meltdown because of stricter laws on credit extension. My view is that we escaped the worst of the world recession because of sound monetary policy, which was almost let slip in mid-2007 but then corrected, and judicious fiscal policy that over a period of years reduced SA government indebtedness to more manageable levels.

If sound monetary policy continues, government cuts down on waste to reduce taxes, and starts moving SA up the Ease of Doing Business index, the economy should rapidly recover. A steady-as-she-goes policy should bring about lower interest rates, a more stable rand and good economic growth sooner than generally expected.

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 / 09 March 2010 - Policy Bulletin / 04 August 2010