While Alan Fine’s article, “Let’s rethink R6,40 dollar” covers a highly topical subject, he has nothing to say about the cause of the wide fluctuations in South Africa’s exchange rate.
Fine is not alone in doing so, as none of our politicians addressed the problem at any stage during the recent election campaign. The consensus seems to be that we have no alternative but to accept the strong rand as inevitable, along with its devastating effects on employment.
Here is an analysis of what is happening to the rand, and what might be done about it.
Current policy allows the market to set the exchange rate, and with international rand speculation amounting to about R1-billion a day, it is clear that speculation is the dominant factor.
In combination with the Reserve Bank’s single-minded focus on inflation as a guide in setting interest rates, an opportunity is created for South Africans — and even more for foreigners — to make easy fortunes through bond trading.
When inflation threatens, central banks increase interest rates as a practical means of limiting the money supply — hence the increase in the repo rate up to 13,5% in 2002. The banks followed suit, and the home-loan interest rate soared to 17%.
In a closed economy, this would have simply meant a transfer of money from South African debtors to South African creditors, a zero-sum game. However, the fact that money can flow in and out of the country meant that interest-rate differentials between countries created special opportunities, which many had previously overlooked.
This was especially so as a result of the sharp reduction in the United States bank rate in the wake of the September 11 terror attacks. US investors looked around for better opportunities for making money out of savings.
Interest rates were already higher here than in the US, but the sharp increase in our interest rates in 2002 created a special opportunity.
So billions of dollars flowed into South African securities — such as our R150 government bonds — with the inevitable result that the rand value of our bonds increased.
This speculative money flow also strengthened the rand to such an extent that our financial analysts were taken by surprise.
By the second half of 2003 Reserve Bank Governor Tito Mboweni proudly announced the first in a series of interest-rate cuts, noting that his “medicine” had worked and the inflation rate had come down.
The accompanying table summarises the important changes in the financial indicators that resulted from March 2002 to December 2003. What the table indicates is that, for every R1 000 you might have invested in R150 bonds in October 2002, you would have earned R143 in interest by December 2003.
More importantly, the change in bond yield from 12,3% to 7,4% meant that, while you still earned the same amount of interest, the market value of your bond would have increased. Your capital of R1 000 would, in fact, have risen to R1 662.
Profit in interest plus capital gain for the period would consequently be R805, and far better than you might have done through stock investments during that period.
A US investor would have done even better over the same period. He or she would have acquired R10 090 worth in R150 bonds for each $1 000 invested. This would have produced R1 448 in interest, while the capital would have risen in rand value to R16 771, or a total of capital and interest of R18 219.
But, as the exchange rate altered during the period from R10,09 a dollar to R6,33, these rands would realise $2 878 if this US investor chose to convert back to dollars. His/her total profit per $1 000 invested would be $1 878.
As our interest rates — even after the recent series of reductions — remain high in relation to what may be earned elsewhere, these investors may be in no hurry to cash in their rands. However, as they will be sitting on huge unrealised capital gains, they will most certainly become nervous if the exchange value of the rand should fall.
And if the difference in interest rates were to narrow much more, it could cause something like a fire sale in rand investments.
As these are converted back into one of the major currencies, the rand could well slide back to something like its December 2002 level. The slide of the last few days may be a bellwether of what is coming.
Reserve Bank policy of inflation targeting, in combination with the policy of floating exchange rates, is wonderful for speculators.
It is too bad that the high interest rates of 2002 destroyed many small businesses, and now the strong rand is destroying even more jobs in those industries largely dependent on exports, as well as in those that cannot match cheap imports.
It is also unfortunate that the highly profitable opportunity created for foreigners results in a huge net outflow of money from the country.
We might wonder why those in power have opted for such a destructive, unstable economic situation instead of emulating the far more successful and appropriate monetary approach of China and India.
China, in particular, has achieved spectacular economic growth through linking the yuan to the dollar at a suitably low level, while it also avoided the Argentinian debacle by exercising a measure of currency control.
So why do we so slavishly cling to the prescriptions of the International Monetary Fund? Is it because we are too proud to admit that a First-World economic policy is inappropriate in a country with 40% unemployment? And why do we fight inflation with high interest rates?
Surely it would be far less destructive to the economy if we brought back the idea of a savings levy as a surcharge on income tax.
In that way, you would merely delay access to some of your profits, rather than saying a permanent goodbye to your funds through high interest charges.
Paul Malherbe is an economist and author of A Pragmatic Approach to the Creation of Value, Enrichment and Prosperity