The sudden collapse of the rand in the fourth quarter 2001 was due to a flood of money printed by the South African Reserve Bank (SARB) according to monetary economist Richard Grant, a former chief economist at the Chamber of Mines.
Writing in the Free Market Foundation’s weekly e-mail report, Grant said the SARB drastically increased the quantity of money during the last half of 2001.
M0, which is the sum of notes and coins in circulation plus the reserves held by banks at the SARB and is known as the narrow money supply measure, increased at an annualised rate of 30% from July through November that year.
“Such an increase went way beyond that which might have been justified by an increased demand for cash or reserves. It is quite understandable that the rand’s fundamentals would be weakened by this flash flood of money. And so they were,” Grant wrote.
The rand went from a best level of R9,7950 per dollar on November 29, 2001 after Moody’s Investors Service had upgraded South Africa’s foreign currency rating by one notch to Baa2, to a worst level of 13,86 on November 20 2001. During 2002, the rand strengthened throughout the year to end 2002 at R8,59 per dollar and touched a best level of 7,8357 on March 6 2003.
“In the panic to escape a risky situation the damage is often compounded. As people traded their rand for more predictable assets, it became clear that the rand-dollar exchange rate had ‘overshot’ the level warranted by the new fundamentals,” Grant wrote.
“This is not, however, to suggest that the traders were irrational: had the Bank continued its steep inflation of the money supply, the rand would have continued its plunge. By February 2002 the level of M0 had peaked and then appeared to level off for the next few months as if to atone for the previous burst. From March through July the Bank seemed to have acquired a new steadiness, which, if continued for the rest of the year, would have brought the rate of price inflation back into single digits by early 2003. Instead, the M0 growth rate remained flat just long enough to resume its long-term inflationary trend.
“This recent reversion to trend is, and should be, disturbing. Unless the SARB can regain control of its operations and hold the growth rate of M0 to low levels, it will never be able to achieve its inflation target. The task at hand is neither difficult nor complicated; and it remains reasonable to expect the Bank to succeed in regaining monetary control so as to build and maintain public confidence. The deviation from plan during the past two years was unnecessary: it was a policy error. It caused a delay in meeting the inflation targets by at least two years, maybe three.
“If the Bank persists in its recent de facto policy of excessive monetary inflation, one reason may be that it has become overconfident due to the apparent strength of the rand. If you want to know the fate of the rand, then watch what comes out of the Reserve Bank. If the quantity of M0 continues to grow at a high rate then the result will be a continuing high rate of price inflation. That is the monetary story of 2003,” Grant concluded. – I-Net-Bridge