Would dropping the value of its currency be good for an economy?

The Financial Rand was an awkward kludge.  Dreamed up by the dreary dictators of Apartheid, it was designed to prevent South Africans from taking their money out of the country.  If you wanted to exchange your rand for dollars you first had to buy financial rand.  Which were worth nothing.

When the financial rand went, in 1995, the new ANC government was fearful of currency instability.  High interest rates of over 20% and severe limitations on exchange control held capital flight in check.  Wags worried, with the rand drifting to R5 to the greenback, that South Africa would soon be the 7/11 economy; R7 to the dollar, R11 to the pound.

If only.  For one breathtaking moment the rand collapsed to almost R12 to the dollar and R21 to the pound.  That was in 2001.  Now the rand is back in a firm 7/11 range.  The question is: is this too expensive relative to other currencies?

This isn’t of mere academic interest.  Around the world numerous governments are struggling with the same question. The fear that weak coinage would make politicians look weak is offset by the way debasing the currency would improve wage competitiveness and deflate away debt.

What exactly does this mean?

A strong currency allows consumers to import goods cheaply from the rest of the world.  A weak currency allows producers to export goods cheaply to the rest of the world.  People are both consumers and producers.  Clearly, there have to be trade-offs.

A government can control the value of its currency in only two ways:  by controlling its supply - either printing or destroying money in circulation - and by setting interest rates either higher or lower to attract investors; or, by controlling the salaries it pays to its workers.

The response to the credit crisis has provided good case studies for the different ways that countries can attempt to shift the value of their currencies.

The UK introduced “quantative easing” as a disguised way of “printing money”.  The pound fell rapidly against its trading partners and unemployment remains low at 7.8%.  The economy has even started growing again now that manufacturers find it easier to sell their goods abroad.

European countries can’t devalue the euro or change interest rates since that would involve collective action by all the member countries all of whom want different things.

The only other choice is to lower salaries.  Government expenditure often makes up close to 50% of national expenditure.  A decision to reduce government wages has a dramatic impact on business and production costs.

For inaction, look to Greece where jobs are scarce as the economy collapses.

Retailers, who may rely on cheap imports to stock their shelves, often complain when the currency weakens.  Producers, who rely on exporting cheaply, have the opposite problem.  However, from an individual perspective, any drop in wages or increase in retail prices has the same affect.  It reduces what they can afford to buy.

Ordinarily governments wouldn’t touch such fiscal weakening with a ten-foot-disinfected-barge-pole.  However, when unemployment rises dramatically then the mathematics changes.  For the unemployed have no income.  Increasing prices become unimportant next to the desperation to get a job, any job.

A weak exchange rate can neutralise even the worst political and economic systems and problems.  China ignores continuing demands from the US to strengthen its currency precisely because this low rate makes them the world’s manufacturing hub.

South Africa’s unemployment levels are the worst of any industrial economy.  The expanded rate is at 35.9 percent and 870,000 have lost their jobs in the last 12 months.

Some of the people worried about a cheaper rand are concerned about the expense of future overseas holidays.

For the millions out of work a cheaper rand may be the only thing that would make South Africa an attractive manufacturing investment destination.