The catch phrase in mainstream macroeconomic circles for the past few months has been ‘currency wars’, that is individual countries depreciating their currencies to encourage exports to improve their Current Accounts as well as promote employment and growth. This is seen as a problem that will afflict only the developed countries, but the real antagonists will be the emerging economies, South Africa being one.
There are two sources of this war, first the US Federal Reserve and their quantitative easing (QE), the second the inflexibility of the Chinese monetary policy, with both colliding, it is creating a steamy environment for emerging economies.
The US Federal Reserve has recently sanctioned a second round of QE, that is printing new money, US$600 billion to purchase government bonds, which in theory should help the US economy grow faster than it currently is, through lower interest rates that QE will produce. A less valuable US dollar via QE means that US exports are now cheaper on the world market, thus taking away competitiveness from emerging economies. Investors in the US will also have the possibility to borrow capital at low cost (presently 0.25%), forcing them to search for higher returns in emerging markets with higher interest rates.
The Chinese monetary policy is one of pegging itself to the US dollar, or only permitting a 2.5% increase over the dollar. This then makes Chinese exports cheap and more competitive relatively to the USA, and that then makes Chinese exports cheaper across the globe.
South Africa has played its part too in the lead up to this impending doom. Domestic Monetary Policy has borne jobless growth with the regime of Inflation Targets. The Reserve Bank of South Africa has maintained their consumer price inflation target at 3% – 6%, meaning that to keep this level of ‘heating’, they need to ‘cool’ the economy with high interest rates to dissuade consumption and increase savings.
Combine these three factors, and you get the beginnings of a currency appreciation that South Africa is experiencing.
The G20 Conference is underway, and despite the pleas of South African Preside Jacob Zuma and his Finance Minister Pravin Gordhan for all countries to work in the interest of the global economy and not their own, South Africa is nearly 24 months into a currency war. The Rand has appreciated by 36% since January 2009 to November 2010 against the US$, exports have steadily becoming uncompetitive globally. This is based on high interest rates in South Africa, at present 6%, which offers a higher return than most other countries at present. A higher interest rate keeps inflation relatively low, but makes the domestic currency more dear abroad and attracts ‘hot money’. Allied with inflation of over 11% in the two years, South African trade competitiveness in the last 22 months has fallen by 46%.
The ramifications of a highly valued currency are great indeed for a country like South Africa and it’s current development plan. First, uncompetitive exports will drive firms to make labour redundant, and with the slow down in manufactures, will add to the already high 25.3% unemployment rate.
Second, it raises the possible scenario of asset bubbles, reminiscent of East Asia in the 1990’s.
Third, the emergence of unbalanced growth, a higher currency favours extractive sectors such as mines that are enjoying record high commodity prices, encouraging more investment in this sector to the neglect of others like manufacturing, which in the long term becomes a bane on the economy.
Fourth, the widening of the current account, South Africa has a deficit of 4% of GDP, with more imports, the country will need to find more inventive ways of servicing that deficit in the absence of export earnings.
Fifth, the possibility of protectionist measures that may lead to South Africa experiencing higher inflation from domestically sourced products.
The appreciation of the Rand is an issue that the government has recognised is cancerous to the economy, introducing a relaxation of currency flows, allowing money to leave easier, but also widening the remit of the Reserve Bank of South Africa to purchase foreign currencies to steady the rate of appreciation of the Rand. Such measures may only prove to be temporary if the rest of the global economy follows through on the messages the winds of change are blowing.