You won’t catch “Dutch Disease” at a braai — but South Africa is suffering from the malady, or a variant of it. It is most acute in tourist areas, and the antidote is mistakenly believed to reside in the Reserve Bank building in Pretoria.
The term refers to a windfall of new wealth that has negative longer-term consequences. In the 1960s The Netherlands experienced a vast increase in wealth after discovering natural gas in the North Sea. The Dutch guilder became stronger, making Dutch non-oil exports less competitive.
Economists have also used the paradox to examine such episodes as the flow of American treasures into 16th-century Spain and gold discoveries in Australia in the 1850s.
The initial wealth effect leads in the longer term to improving foreign currency reserves and a stronger currency. This benefits foreign investors, who get on board early and ride the double-crested wave of rising currency and bond prices.
But for most export and tourism- related industries, the experience is a painful one. Even for importers, the impact can be destructive if their competitive advantages do not include predicting currency exchange rates.
The recent wealth effect in South Africa is not as simple as a large commodity discovery. The rand had become excessively weak, while the currency in which so much international trade and commodities is denominated, the US dollar, had grown excessively strong. Today’s weighty US trade and fiscal deficits have sharply reversed the dollar’s long bull-run.
The rand’s recent strength was initially spurred by fundamentals, but has increasingly reflected speculative influences.
Economists use the “purchasing power parity” tool to calculate a fair value for exchange rates. At R12 to the dollar any South African can work out that taking the kids to Disneyworld is out of the question. But at R6 to the dollar, if grandma wants to sell her home in Dainfern and buy its twin on a golf course near Orlando — one of America’s fastest growing cities — it is an even-money trade. An economist would say the pricing is at parity.
If the home has to be financed, the other tool so popular with economists for calculating exchange rates, interest-rate differentials, comes into the picture. A comparison is complicated because not only are US interest rates much lower, but the buyer has the option of accepting a fixed-rate mortgage for up to 30 years. Importantly, it is not really fixed — if rates decline, the home owner has the option of refinancing at a lower rate.
The rand and interest rates have played a leading role in determining why South African homes are now more fully priced relative to their overseas counterparts. But they don’t tell the whole story. Much can be attributed to the Dutch Disease’s travelling companion — the “spending effect”.
This psychological phenomenon is spurred when companies, losing competitiveness due to a stronger currency, redirect their focus — and pricing — toward local consumers. In the Western Cape, for example, airlines and game farms are showing renewed sensitivity to the local market.
The Reserve Bank’s tools of managing the money supply, moving interest rates or buying foreign currency are ineffective in controlling the directions of international commodity and currency markets. The bank cannot determine the price of gold or platinum, nor would it want to impede upward price movements of key export commodities.
Yet rising commodity prices have boosted the rand and spurred on speculators. The dollar sell-off hurts commodity-dominated export revenues and earnings and makes other exports less competitive.
Commodity-based economies generally perform less well than diversified economies. South Africa has made great strides over the past 20 years in diversifying away from commodities to generate growth and foreign currency earnings.
The best long-term hope for doing this is the formation of hundreds of innovative, smaller, high-growth companies. South Africa’s track record in this regard is patchy, but not too discouraging.
What is discouraging is the impact of a strong and volatile rand plus rising commodity prices on tomorrow’s entrepreneurial superstars. The strong rand undermines their competitiveness; the volatile rand means they need more precious capital to ride out the storms.
Lastly, strong commodity prices have the effect of bolstering the rand and shifting resources and focus away from the country’s best long-term prospects.
The combination of rising commodity prices and a stronger currency has led to lower interest rates and the perception of a sharp wealth effect for affluent South Africans. But, for most citizens, and even the wealthy who do not emigrate, the longer-term effects are likely to be negative.
The international precedents point to South Africa’s long-term interests being best served by growing non- commodity sectors of the economy and the rand stabilising at a less lofty level.
Shawn Hagedom is an independent strategy adviser who writes on macroeconomic policy