Posted by: michaeldavidpower | December 4, 2009

Duck Shooting Season in the South African Economy

There follows the Op-Ed piece I recently wrote for South Africa’s Business Day.

As the Rand debate moves centre-stage, the flak of misinformation that accompanies this migration is increasing in intensity. Indeed a veritable flock of canards have taken flight, all needing to be shot down and roasted if a proper, well-reasoned debate is to be had.

One canard in particular is regularly seen aloft: were the Rand to be fixed at a lower level, South Africa does not have enough foreign exchange reserves to defend it. This canard keeps company with another: if we do fix the Rand, the market will take us on.

Both reflect the unpleasant experience South Africa endured during the 1990s, when the SARB tried to defend the Rand’s value and, for its folly, ended up losing us over R30bn on our forward book. Lesson learned: never intervene in the FX markets. Once bitten, forever shy. Case closed.

Not so fast. The reason why we were caught in the market’s crossfire was that we tried defending the Rand – and here’s the rub – at an exchange rate that still meant running twin deficits on both trade and current accounts. And let me state unequivocally, were a future policy of our Treasury to envisage fixing the Rand at a rate which did not turn our twin deficits into twin surpluses, I would unhappily sympathise with the “Rather do nothing at all” cop-out crowd.

When recommending that South Africa engineers a more competitive exchange rate for our currency, I am always talking about a rate that would, over the full course of our economic cycle, generate a trade and current account surplus.

Most of the new converts to the cause of “the Rand is too strong so perhaps a more competitive rate would bring recession-ridden South Africa some relief” would most likely envisage a minor tweaking of the Rand’s cross rates downwards. Indeed even existing advocates of the devaluation idea probably do not imagine us adopting an exchange rate that would generate twin surpluses.

By moving into this twin surplus camp, most South Africans will have to undergo a profound rethink as to what they accept as the right exchange rate policy for a resource-exporting, recession-ridden, grossly unemployed emerging market in today’s fast-shifting-East world.

A good friend – steeped in the received wisdom of standard neo-classical economics textbooks – recently upbraided me “But South Africa should run a current account deficit”. And according to those textbooks, he is right: we should be that capital importing, developing country yin to the yang of a developed world core; in turn that core should be running a current account surplus, a savings surplus they should be investing in us, the developing world.

If only. We live in an upside-down world: this year, the US, with only 4% of the world’s population, will consume over 60% of the world’s mobile savings through that giant sucking straw that is its current account deficit. Add in the deficits of the UK and the Eurozone and this ratio exceeds 80%. Do traditional textbooks have it back-to-front? Some leading economists like Joseph Stiglitz now believe so.

So if the West is abusing the purportedly natural order of neo-classical economics and consuming the world’s savings when they should be producing them, why then should South Africa stick to those now outdated economic ‘rules’ by running a current account deficit? Surely not for the honour of vying with the West for those savings? Or some sort of mistaken sense of quasi-Anglo-Saxon solidarity?

Why not instead learn from Asia which, in 1997, discovered how fickle foreign savings flows can be? The New Asia now saves for itself by purposely and purposefully running twin surpluses; this has increased its monetary independence and, in case you have not noticed, allowed it to prosper even as the West chokes.

The New World we live in favours a New Normal for emerging markets: if you want to be sustainably successful, run a current account surplus. Furthermore, successful resource-rich countries – even the developed likes of Canada and Australia – run, at the very least, trade account surpluses. This suggests that doubly qualified South should run a current account surplus, not – as many in South Africa deem to be our divine duty and destiny – a current account deficit.

All this brings me back to those canards. If South Africa does intervene to engineer the Rand down to a more competitive rate, we must be prepared to go beyond the swampy no-man’s-land of still not running a current account surplus to the dry land on the other side where we will. Why? Because if we live exposed in the open of those middle ground marshes, we will be easy game for trigger-happy speculators. Far better to be on the far side of those firing ranges grazing on those greener pastures on which South Africa should be thriving. That landscape will also suit us far better than sheltering in the dreary economic shallows where we take cover today, at the mercy of the Scylla of fickle foreign capital and the Charybdis of our own credit cycle. Our present-day hide-out remains an economic backwater from where it is next-to-impossible to emerge into the bright sunshine of high GDP growth and material generation of new jobs.

We desperately need to target that rich dry earth of structural current account surpluses, a territory wholly unfamiliar to South Africans: it will allow our country to become export-oriented and foreign demand-led, not import-intensive and domestic demand-dependent as now. Rest assured, this terrain is one where those ‘amorphous markets’ would be pursuing a very risky course of action if they tried attacking a currency rooted in the terra firma of a current account surplus. (The only time such madness occurred – when speculators attacked the Hong Kong Dollar in 1998 – the Hong Kong Monetary Authority ‘won’. The speculators – Bank-of-England-slaying Soros included – ended up with very bloody noses.)

Why is this? Because it is far harder to drown a man if he is initially sitting on dry land. A current account surplus implies that, far from having a daily quota of foreign capital one needs to attract, one has a positive balance at the end of every average day, a balance that would be added to the sandbags of one’s foreign exchange reserves.

Why would speculators attack the Rand if it was already deliberately competitively priced? As the SARB is the Rand’s monopoly issuer of the last resort, our Reserve Bank cannot really lose. If speculators shoot US Dollars at us, we catch them and add them to our reserves. And if – bizarrely – they were to shoot Rand, in extremis, our best response is to let them. The ‘worst’ that can happen is that the Rand becomes more competitive, our current account surplus widens and our foreign exchange reserves increase.

My central point is this: most of the Rand debate thus far presupposes any new lower exchange rate would still not be low enough to generate a current account surplus. And were that to be the case, the canards I identified above would indeed be sitting ducks guaranteed to attract the crosshairs of any half-awake speculator. If this swampy no-man’s-land rate is all that is being envisaged then we might as well give up even before we have started.

Instead what I am recommending is a whole new way of thinking for a Brave New South Africa struggling to make its way in a world where the Old Order – from who is the ruling hegemon to which economics textbooks apply – is giving way to a brand new one.

Alternatively, we can continue skulking amongst the bulrushes in today’s economic backwaters, missing out on the opportunities of that exciting New World, naively reading and believing in the economic textbooks of yesteryear. You choose.

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