Weak Rand a result of sick Economy

 

“South Africa’s currency has been the subject of much vexed discussion, from the corridors of power to dinner parties and braais. When the rand weakens, we all intuitively sense that it’s not a good thing. This collective intuition is correct. It is a fact of history that when countries and economies are mismanaged and under-perform relative to their peers for prolonged periods of time, their currencies weaken. Let’s briefly explore why.

 

The exchange rate of a currency is the net result of two things. The first is how desperately people want to buy or sell the currency. The second is how much of the currency is in circulation. The first is demand, the second is supply – simple economics.

 

If people, both locals and foreigners, on average at any given point in time want to buy the rand more desperately than others are willing to sell it, the rand will tend to appreciate, or get stronger. This would tend to be the case when interest rates offer attractive real (inflation-adjusted) returns on holding rands in a bank account, when the economy is growing and therefore generating more demand for transactions and holding rand bank balances, when people want to buy South African companies, bonds or property, and when people want to buy South African goods and services. Conversely, people will be more willing to sell the rand than others are willing to buy it when it’s unattractive to hold the currency in savings, transaction demand is stagnant because of poor economic growth, South African companies, bonds or property are unattractive to own, and fewer people want to buy South African products.

 

In terms of currency supply, more supply of rands will tend to weaken the currency, and less supply will tend to strengthen it. But currency supply and demand are also intimately related. Currency supply expands when interest rates are lowered and central banks are encouraged to print money out of thin air and lend it out. But this injection of new money and lower interest rates cause inflation to rise and interest income on savings to fall, making people less willing to hold rand bank balances. With more money supply in the economy and less demand to hold it in savings, the currency can weaken even more than the initial weakening on account of rising supply.

 

If demand falls fast enough because of a lack of confidence in the currency as a credible store of value, the currency can weaken faster than its supply is rising, making it harder to meet the country’s ability to pay for imports. This can become a vicious cycle, as it did during Zimbabwe’s hyperinflation where repeated and enormous money printing caused demand for the currency to collapse in a heap of withered confidence.

 

In South Africa, years of stifling corporate regulation and taxation, excessively low interest rates and persistent inflation, public sector inefficiency and over-indebtedness, over-reliance on exporting low-value commodities amid a global commodity price slump and chronic infrastructure constraints on economic growth have contributed to a weakening rand. South Africa’s money supply has continued to expand, creating price inflation, while bank savings offer paltry returns. Hostile government policies repel talent and deter foreign tourists and investors. The net effect of all this has been to cheapen the rand as people, on average, are more willing to sell it than buy or hold it.

 

Although the rand may experience brief periods of stronger demand and appreciation, its long-term structural depreciation can be arrested only by dramatic economic reform that makes it more attractive to save money in South African banks, discourages excessive borrowing, improves economic growth and productivity, incentivises foreign investment and restores government fiscal health. The same is true of countries such as Turkey and Brazil.

 

It should be obvious that such reform requires interest rates to be at a level that encourages more saving, as well as deregulation, tax cuts, slashing red tape, scrapping capital controls and balancing the state’s budget through downsizing the public sector.

 

It is vexing that so many economists persist in their fallacious belief that a weaker rand is good for the economy. Exasperatingly, they cannot see that rand weakness is actually a symptom of economic sickness. They further fail to perceive that a weaker currency undermines the very bedrock of what drives the virtuous cycle of wealth creation and prosperity, namely savings and discerning capital investment that beget greater productivity and economic progress.

 

* Russell Lamberti is the chief strategist at investment advisory firm ETM Analytics. He is co-author of When Money Destroys Nations, a book about Zimbabwe’s hyperinflation crisis with lessons for a debt-saturated, money-printing world.”

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