To deliberately weaken the rand is a recipe for disaster

Those who favour the deliberate weakening of the rand are, in effect, proposing in principle that the SA Reserve Bank should set a similar monetary management course to the one followed by the Reserve Bank of Zimbabwe.

Of course, it is not their intention to create the same magnitude of economic chaos. Rather, merely to cause minor chaos that will bring great benefits for the few. But, as Gideon Gono, the Governor of the Zimbabwe central bank discovered, no matter what the intentions might be, the consequences of such monetary meddling for the majority of a country’s citizens can be dire.

It is not possible to weaken the external value of a currency without simultaneously weakening its internal purchasing power. The supporters of the weak-rand notion are not telling the public that the purpose of the exercise is not to benefit “the country” but to transfer resources in a manner that benefits some at the expense of others, especially the poor.

They do not reveal to the people at large the knock-on effect from policies implemented to substantially weaken the exchange rate of the rand against foreign currencies. They do not tell SA consumers and savers that aggressively printing more rands will be devastating, that the savings and pensions of the elderly will be eroded, that all low-income people will struggle even more than they do now to feed, clothe and house their families. They hide the fact that if the rand is deliberately weakened by 50%, the price of all imported goods will quickly increase by a similar percentage, as will the price of locally produced goods and services.

As economist Ludwig von Mises explained, “By committing itself to an inflationary or deflationary policy a government does not promote the general welfare, the commonweal, or the interests of the whole nation. It merely favours one or several groups of the population at the expense of other groups.” There can be no mistake that those who propose that the rand be substantially weakened do so for their own perceived short-term benefit at the cost of SA’s long-term economic stability. To recklessly suggest that the government should commit itself to high inflation is extraordinary when we have an example in Zimbabwe of how inflation can devastate a nation.

Have the proponents of a weak rand forgotten that by 23 June 2008, the value of the Zimbabwe dollar had fallen to 21,888,000,000 (or 21,888,000,000,000 pre-2007 Zimbabwe dollars) per 1 US dollar? That the largest denominated note was then 50-billion Zimbabwe dollars and prices increased at an estimated 400,000% per annum? That the interest rate was 6,500%, CPI 974,925,192.9 and the year-on-year inflation rate at the time estimated at 100,580.2%? The Zimbabwe inflation started with mild mismanagement and then got wildly out of hand. Zimbabwe’s CPI at the end of April each year showed a startling progression: 2001 – 84.5; 2002 – 180.8; 2003 –- 667.5; 2004 – 4038.8; 2005 – 9251.2; 2006 – 105,734.3 and 2007 – 4,032,633.7. These figures are a record of an imploding economy and the culmination of a process that started with mild monetary transgressions. The end result was that the value of the Zimbabwe dollar declined to zero.

How has the Zimbabwe experience, which provided a spectacular demonstration of inflation-creation, failed to persuade some people that printing too much money causes rapid and general price increases (inflation)? How has it failed to convince them that inflation can destroy an economy? What seems to escape their understanding is that in order to weaken the rand, SA would be required to deliberately induce an inflation rate higher than any prevalent in those countries with which it trades. Something that will take some doing if SA is to outstrip the monetary madness that prevails in some of SA’s trading partners.

SA is only now recovering from an inflationary glitch caused by excessive money creation. The inflation followed a period of monetary laxity during which, in June 2007, the year-on-year increase in M0 (the monetary base) hit a peak of 22.65%. Fortunately, the Reserve Bank reverted to honouring its primary constitutional function to “protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic”. Improved management reduced the rate of increase in the money supply, reduced the rate of inflation, stabilised the rand exchange rate, and made a decrease in interest rates possible.

To cause and then reduce inflation incurs costs that our country’s citizens should not have to contend with. The proponents of a weak rand say they want a stable currency, which immediately contradicts their proposal to artificially weaken the rand. A stable currency cannot be achieved by monetary manipulation, only by wise and responsible monetary management.

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 / 11 May 2010