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FEW people will have failed to notice the plunging value of the rand. The cost to the country of an unstable currency is huge.
READ: Rand sinks most since 2011 as commodities tumble
The world of economics as taught today is blind to many of the fundamentals it needs to understand if financial stability is to be achieved.
I have just been in a discussion with a highly placed economist in Canada, who simply does not understand the meaning of some very basic words. That being so, what hope do we have of solving the problems the world is facing?
The words in question came into the discussion when I was pointing out that fixed interest bonds cannot adjust to the forces of rising demand in an economy.
The prices, costs and values of everything in an economy have to be free to adjust to the ever-changing level of spending (demand) that occurs in the economy. Demand, supply, price: this is a fundamental equation for any balanced economy.
The response he gave was that prices and values are free to respond - despite his contradictory acknowledgement that bond values are fixed, and that the cost of servicing them is fixed. He did not see the contradiction. The reason is because economists are taught a different meaning, a wrong meaning of the words 'free to adjust'.
Prices adjust to demand - that is, if they are free. That is not taught. What is taught is that prices are free to adjust. The meaning of those words is not correctly taught. They left out what they are free to adjust to - clearly, not to the level of overall spending per person in the economy.
In the imaginary world of a financially stable economy, ALL prices - which include bond values, bond servicing costs, and all loan servicing costs as well as interest rates (the price of credit) and the pricing of currencies - must adjust to the changing level of demand (overall spending per person) in the economy.
A 10% rise in spending, which ultimately comes from earnings per person, must be allowed to increase ALL PRICES accordingly, so that all prices become 10% more THAN THEY OTHERWISE WOULD HAVE BEEN. That includes house prices, mortgage repayment costs, and currency values.
The entire economy needs to be able to float on the rising tide of spending and earnings, without prices or costs or international trade getting out of balance.
What has this to do with the pricing of a currency? A currency has a price. Does it float in this way? No. Why not?
Last time I was informed of the data, 40% of South Africa's sovereign debt (fixed interest rate and very unstable valued bonds) was owned by foreign entities.
Of itself, that is not wrong. What is wrong is the way in which they gained ownership of those bonds.
They have no right to hold any of South Africa's sovereign debt unless they first offer to exchange ownership of some of their own currency for some of our currency. If they do that, the value of the rand will not be affected at all. This means that we need three marketplaces for capital: the currency market for traders, the capital swop markets for capital ownership swops, and the domestic money markets to create a balance between the credit available and the demand for credit.
In the foreign exchange market, exporters will place onto the foreign exchange market any foreign currency they have no particular use for, after buying such imports with their foreign earnings as they need. People wanting to import goods and services will then offer rands in exchange for that foreign currency.
If there is too much foreign exchange being earned, there will be too few bidders. Fewer rands will be offered. The value of that foreign currency will fall. Less will be exported and more will be imported. A new balance of trade will be created at a lower currency price.
However, because we allow foreign investment capital to take part in that same market, there is far more money looking for a bidder than is needed for trade. This is why we will get huge currency price instability.
The price of the rand is affected not only by trade but by foreign capital and foreign rates of interest on capital. Since about half of all world economic output is priced in foreign currency, it means no one can make a sensible budget and business plan. The cost of not being able to plan half the world's business costs is huge. It is not an acceptable framework for any economy.
If foreigners have to compete for capital in our domestic capital markets as equals with ourselves, the South African national economy can have the right amount of credit and printed money, and its own interest rates to suit its own economy.
What the USA is doing with its interest rates will not affect the rand or the interest rates in South Africa. We need to have control over our own economy and to be able to balance trade.
We need a different, domestic market for foreign investors, where we share our capital and credit markets with them in competition on equal terms. If they can bring more to South Africa using our financial resources than we can, then let them use our capital markets to bring their knowledge and expertise and make both them and us better off.
* Edward Ingram is a leading thinker on the world stage of macro-economic design and has written a series of essays for Fin24.
