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How to protect the rand

Aug 31 2015 07:19
Edward Ingram

WHAT matters is not the value of the rand, but its stability. The correct value of the rand has the ability to manage the balance of trade and bring our export industries the strength they need to support the rand - and the employment which that can create.

Last week I explained why that is not happening. I explained why we need to prevent international capital from disturbing the value of the rand as well as the interest rates we have. I did not have space to explain how our own capital markets can be accessed by foreigners so that they can bring their expertise and their factories to South Africa for our mutual benefit.

READ: Whither the rand?

I did say that we are perfectly capable of creating as much credit and printed money as we need. I did not say how that is best done, but I have dealt with all of those issues in previous essays for Fin24. However, there were some small gaps in my own prescriptions which I think I can now fill.

The market in currency swops

I have mentioned currency swops before but have not stated what options exist to create a market in currency swops. A currency swop is an exchange of ownership of a certain agreed amount of capital or debt between two parties, one from one nation - let us say, from the UK - and one from another, say South Africa.

The UK entity wants to invest £100 000 into South African equities and government bonds. The currency exchange rate is 20:1, so he/she is wanting to swop ownership of £100 000 for R2m. This cannot be done on the currency market, but the value of the rand currency can be used as a marker for how many rands' ownership might be exchangeable in the swops market.

The swops market may however give it a different value. It depends on how many South Africans want £100 000 to swop to invest in the British capital markets. Each investor involved in the swop will take a risk on what the swops market will offer on any return trip back to their own currency.

This will be offset by what they each think they can get in terms of an investment return and what risk they think they are taking on the swops market value of the respective currencies, or on a further swop into another currency instead of returning to rands or pounds.

No currency will be created by either of the central banks to facilitate this trade. Each nation creates an amount of credit and printed money in accordance with its own needs.

Foreign capital is not needed and would not be of any use in the shops anyway. It could only be exchanged on the currency market, where it would cause an upset by dumping too much of the stuff and unbalancing the balance of trade.

That is what happens around the world today. With a currency swop (of ownership of capital) there will be no effect on the interest rates of either country except insofar as each party becomes a trader in the other party's capital markets and so influences interest rates in the other capital market in that way, the same way that locals might do when they borrow or invest. The foreign entity becomes a part of the South African economy on equal terms.

That is OK. Every country has to get the best use out of its savings and credit markets, and the rate of interest will rise if more foreign investors can make better use of the South Africa capital and credit which is available than locals can. They will bring in new ideas and technology that way. Less capital will be used for unproductive purposes. The economy will do well out of that.

That idea brings us to the foreign entity that wants to build a factory in South Africa. This entity wants to bring capital in as well as machinery. Two markets are involved - trade for importing machinery and capital for spending in South Africa to get the factory built and the initial working capital in place.

For importing machinery, that can be done by using the South African currency swop to get the capital to buy it with and then buying/importing it through the currency exchange market like any other South African. Or if it is pre-owned machinery, or bought elsewhere, it can be brought to South Africa directly.

If the foreign entity wants to borrow from the banks on the South African money market, the capital obtained will be offset by the prospective earnings in South Africa and the South African lender will take that risk in the usual way. Any deposit will be pre-owned and shipped out machinery as collateral or brought in as swopped currency.

The one thing that I have not explained here is why this foreigner might affect our interest rates. I have assumed here that there would be a limited stock of credit and printed money on the money market, and that interest rates would determine who could afford to borrow it.

That is not how things work today, but it is how they ought to work. Interest rates are a price which is supposed to perform the balancing function. Central banks can create the credit and the printed money needed by the economy. Interest rates can distribute it to those best able to make use of it.

Next week I will explain this further.

* Edward Ingram is a leading thinker on the world stage of  macro-economic design and has written a series of essays for Fin24.

edward ingram

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