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Why the rand is unstable

Apr 30 2014 07:20
*Edward Ingram
LAST week and a couple of weeks before I was writing about the idea of limiting the amount of the money supply in an economy to the amount that it may need to maintain its full rate of employment plus some to allow it to grow.

This would mean that instead of creating new money when it was not needed but just asked for as happens now, the money supply authority (MSA) - or central bank - would hold a stock of unlent deposits belonging to no one but available for lending.

There would be some mechanism that saw interest rates rising as the remaining stock of deposits got scarce. I confess to not having thought out how that interest rate response would work – yet. This is all basically a thought experiment.

The last time I wrote about currency instability I pointed out that one currency price cannot fulfil two functions. It cannot deal with both trade and foreign investment capital, both coming in through the same pipeline. The fact that we try to do this impossible thing seems to me to explain why the rand is so unstable.

So to create a separation between the two, I proposed what is basically a swap of deposit accounts when a foreign investor wanted to participate in our economy.

What it amounted to was that the foreigner would be given some free (unlent) deposits from our MSA, which would be accessed by the foreigner through one of our local banks.

In return, the same value of deposits would be transferred from the foreigner’s own bank account in the foreign country, to the ownership of our MSA.

Banks in both countries act as agents of their respective MSAs in finding loans and attracting deposits, both of which they administer on behalf of the MSA. The MSA is responsible for there being enough aggregate deposits, storing some idle ones that are not in use until they are lent but limiting the total supply.

This ensures that there is enough money to lend and spend in the economy, but not too much.

By using the above deposit swap system to facilitate the entry of a foreign investor to our bank of deposits, no capital would cross frontiers and the aggregate amount of deposits in both countries would not change. The deposits now belonging to our MSA in that other country would still be available for lending there, by that bank.

That answers the question I left open last time of who would own those swapped deposits.

Wreaking havoc with the rand

As I was saying, the price of a currency cannot cope with both trade and foreign currency inflows and outflows because that is exactly what is causing havoc with the rand, for example.

One price can only have one function. If the price is right for the balance of trade then people can get on with their international trade with relative confidence, knowing that the price of their respective currencies is about right.

It will rise and fall a bit but it will not leap around. (You could say the same about the price of gold for the same reason: two sets of traders – trade on the one hand, and use as a ‘store of value’ on the other hand. The price cannot then be trusted for trading and mining purposes. It is also useless as a potential currency or for backing a currency for this reason: the value is too unstable.)

International traders want to know approximately what they will get paid for their exports and what their imports will cost.

With our currency arrangements as they are now, if some foreign government, or other investor, comes along and wants to invest in our economy, and we allow that to add to the amount of deposits available for spending here… what if we do not have a great many additional goods and services to offer when those deposits get spent, or lent and spent?

That is a problem. Governments/treasuries or central banks can ‘sterilise’ that surplus by issuing (unstable fixed interest bonds, as they like to do) but they have to pay interest on those. That looks like a waste of resources and another distortion in the economy. Interventions always help here and distort there.

We do not want those extra deposits coming in from outside. If we use my new MSA model, we already have enough deposits and spendable resources to fuel the economy. See my recent essays.

And we do not want our currency to rise in price when they buy our currency just to invest and not to import our goods and services.

The above alternative can be there if we want to use it. Or can it?

Just a thought, but it now raises more questions about interest rates and how they will manage the allocation of those resources, both domestic and foreign.

Do we still have two conflicting roles for the interest rate? One when there are no foreigners involved, and another distorted one when there are?

These are thoughts that I am pondering. Does anyone have any better or helpful ideas? Work on progress.

 - Fin24

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.”

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edward ingram  |  money  |  investments

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