Currency devaluations and consolidating democracy

The example of the South African rand

Bibliographic Data

ID7440532
AuthorsEdward Lipuma (University of Miami), Thomas A Koelble (0000-0002-6918-873X, University of Cape Town)
Year2009
Volume38
Issue2
Pages203-229
Publication date2009-05-01
Peer ReviewedYes
Open AccessNo
TypeARTICLE
VenueEconomy and Society (JOURNAL)
Journal identifiersISSN: 0308-5147 • E-ISSN: 1469-5766
PublisherTaylor & Francis (PUBLISHER • GB)
DOI10.1080/03085140902786553
OpenAlexW2024023607
LanguageEN
Citations received6
References cited28

In 2001 the South African rand depreciated suddenly and steeply against the dollar and euro. This triggered inflation as the prices of imported products gapped upward. To offset the imminent inflationary effects and attract foreign exchange, the Reserve Bank raised interest rates, resulting in slower domestic growth. The critical question was the cause of the currency depreciation. We argue here that the rand's decline was the result of a concatenation of internal and external factors, specifically the way the operations of the global financial markets magnified and exacerbated the effects of internal financial policy decisions. The article illustrates the heightening connectivity between domestic policy decisions aimed at regulating the national economy and the globalizing financial markets that operate on an altogether different logic. The Reserve Bank's attempt to regulate the local foreign exchange regime in concert with the corporate use of financial instruments to circumvent these exchange controls led to a relatively illiquid currency market that was easily susceptible to attack by speculative capital. The end result was a crippling devaluation that especially hurt the impoverished black South African majority in the process of getting on its feet economically, thereby adding a further constraint on the consolidation of post-apartheid democracy. Keywords: asset swapsCommission of Inquirycommodity currencyderegulation of exchange controlsDeutsche Bankexchange controlsfinancial instrumentsforeign exchange marketsglobalizationspeculative capital Notes 1. Technically, volatility is the amplitude of price movement of a security over a bracketed time period. Given a starting price relation (say 7 rand to the dollar), volatility is the measure of how much above and below this price relation a security gyrates over a given time period (e.g. between 6 and 8 rand to the dollar). Those in the financial markets think of and use volatility as a proxy for the expectation of risk embodied in the financial instruments that capture this relation (e.g. the dollars–rand relation). 2. For more on derivatives, see Pryke and Allen (2000 Pryke, M. and Allen, J. 2000. Monetized time-space: Derivatives – money's new imaginary'. Economy and Society, 29(2): 264–84. [Taylor & Francis Online], [Web of Science ®] , [Google Scholar]), MacKenzie (2003 MacKenzie, D. 2003. Long-term capital management and the sociology of arbitrage. Economy and Society, 32(3): 349–80. [Taylor & Francis Online], [Web of Science ®] , [Google Scholar]), and LiPuma and Lee (2004 LiPuma, E. and Lee, B. 2004. Financial derivatives and the globalization of risk, Durham, NC: Duke University Press. [Crossref] , [Google Scholar]). 3. It is worth noting that in the United States and Britain, the world centres for the growing derivative markets, the financial sector now accounts for 31 per cent of total corporate earnings, up from 20 per cent in 1990 (Morgenson, 2007 Morgenson , G. 2007 . There's no superhero waiting in the wings . New York Times , Business Section , 11 . [Google Scholar]), and, as importantly, the sector, fuelled by the creation and amplification of financial instruments, is projected to grow as fast in the upcoming decades. 4. In his Language and symbolic power Pierre Bourdieu Bourdieu, P. 1991. Language and symbolic power, Cambridge, MA: Harvard University Press. [Google Scholar] writes that 'the specialized languages that schools of specialists produce and reproduce through the systematic alteration of the common language are ... a compromise between the expressive interest and a censorship constituted by the very structure of the field in which the discourse is produced and circulates' (1991, p. 137, italics in original). Bourdieu is saying that fields, such as finance, create a special argot that allows insiders to communicate with one another even as it prevents those who are not familiar with the specialized language understanding what is happening. He goes on to point out that fields create these 'strategies of euphemization' because, among other things, the new terminologies help shield the fields from scrutiny by the wider society (ibid., pp. 137–44, italics in original). 5. The primary source of data on the rand's decline in 2001 can be found in the evidence presented to the Commission of Inquiry into the Rapid Decline of the Rand. During its hearings, detailed submissions were made to the commission by various participants in the foreign exchange markets, including the Reserve Bank, foreign exchange trading community, banks, economists, lawyers, accountants and members of the general public. The two final reports were issued in 2002 and full transcripts can be obtained from the Department of Justice under whose jurisdiction the Commission operated. 6. Liquidity is the ability of holders of an instrument to convert the instrument easily and rapidly into cash with only a minimal price concession. 7. A transaction which involves the actual exchange of two assets (e.g. land and money) on some specified date at a rate agreed on at the conclusion of the contract, followed by a reverse exchange of the same two assets at a date in the future at a rate agreed on at the inception of the contract. 8. The studies cited attributed the 15.1 per cent variance in the relative value of the two currencies to multi-factorial productivity growth differences, which translates as: if the factors of production differ slightly, so probably will the cross-currency rates. 9. Normal condition correlation models, while informative, have serious explanatory limitations. Most importantly, they cannot account for: why, over any specific time period, commodity prices should be disproportionately telling with respect to other factors, such as productivity and inflation; why during a significant period of rising commodity prices some commodity-based currencies rose while others suffered declines (as opposed to predicted advances); why the exchange value of the currencies has been more volatile than the underlying commodity prices; and, most significantly, why absent violent shocks to the South African economy, the rand should diverge so dramatically from the Australian dollar in 2001. 10. Not surprisingly, a characteristic description of panic is 'herd behavior' (Kim & Kim, 2000 Kim , S. & Kim , S. 2000 . Financial panic and exchange rate overshooting during a financial crisis . Retrieved from http://www.tufts.edu/~skim20/paper/ero.pdf [Google Scholar]). The metaphor of herding suggests the expression of a deeply-held instinct, such as that which compels cows, sheep and other animals to act collectively and without forethought, as when they are led to slaughter. Herding exemplifies an instinctually-driven behaviour, such as fear, as opposed to a rationally-defined one. 11. The difference between the various accounts turns on where along this casual chain they place the predominant emphasis. So, Noble and Ravenhill (2000 Noble, G. and Ravenhill, J. 2000. "Causes and consequences of the Asian financial crisis". In The Asian financial crisis, Edited by: Noble, G. and Ravenhill, J. 1–35. Cambridge: Cambridge University Press. [Google Scholar]) have produced a theoretical piece arguing that 'panic stricken behavior' is the motivating variable and Feldman (2003, pp. 201–3) submits that investor over-reaction is the key dynamic, while Goldstein, Kaminsky and Reinhart (2000 Goldstein, M., Kaminsky, G. and Reinhart, C. 2000. Assessing financial vulnerability: An early warning system for emerging markets, Washington, DC: Institute for International Economics. [Google Scholar], p. 68) suggest that the underlying state of a nation's financial system is both the source of and solution to the problem. 12. To the best of our knowledge, our distinction and analysis of the relationship between takers and bidders is the first account of currency trading which foregrounds the two types of agents that have emerged in the context of monetary liberalization. 13. The technical underpinning of 'fair value' is the conceptual work done on the venerable notion of purchasing power parity (PPP). In theory, the rand price of a commodity in South Africa should be identical to the rand price of that same good in any other country. What this means is that, for two countries, the ratio of the two national price levels will determine the prevailing exchange rate of their respective currencies. A historical review of the empirical evidence would suggest (1) that there can be significant divergences from the hypostasized PPP relationship and (2) that these divergences tend to evaporate over time. Note, however, that the PPP model is premised on production-centred, nation-state-based economies that are in equilibrium. It cannot therefore account for the timing or duration of divergences, or why the worldwide frequency and magnitude of these divergences have increased so exponentially since the advent of floating exchange rates. Nonetheless, the concept is still widely in use because, as Landsman (2006 Landsman , W. 2006 . Fair value accounting for financial instruments . Working Paper no. 209. Bank for International Settlements . [Google Scholar]) suggests, central banks require metrics to organize monetary policy and the concept of fair value is the most available tool. 14. A short sale is the sale of an asset in expectation that its price will fall, allowing the seller to buy it back at a lower price and thus secure a profit. So speculators may borrow rand to buy dollars on the wager that once the rand has fallen they can sell back their dollars at more rand to the dollar, thereby booking a profit. 15. This point about bountiful credit, based on what some commentators have referred to as the over-accumulation of capital, was made by Benjamin Bernanke in a speech given a few days after assuming the leadership of the US Federal Reserve (New York Times, 22 March 2006). 16. The provision was as follows. (1) Corporations were allowed to transfer up to R250 million from South Africa per new investment into member countries of the Southern African Development Community. It was, however, specifically mandated that firms wishing to invest abroad had to apply for permission to make use of corporate asset/share swaps to finance these investments. 2) South African institutional investors had, since the inception of the asset swap mechanism in 1995, invested over R100 billion abroad. The asset swap mechanism had, therefore, according to the Reserve Bank been successful in achieving the aim of portfolio diversification. So the statement read: 'As a consequence, with effect from today, no further asset swaps will be permitted irrespective of availability under existing asset swap limits' (Statement on exchange control issued 21 February 2001). 17. What this means is that the demand for the dollar was much greater than that for the rand. So the quantity of rand for dollars for sale could not be matched with buyers who were willing to accept rand for dollars. 18. The IMF offers an alternative interpretation, which, coincidentally no doubt, conforms to its recommendation that the rand be allowed to float freely in order to help correct imperfections in the domestic market. So, IMF economists hundia and Gottschalk maintain that 'domestically generated nominal disturbances [that is, market 'imperfections' such as currency mismatches (too many sellers and not enough buyers of rand) or the absence of liquidity] explain by far most of the rand depreciation in the final quarter of 2001' (2003, p. 2). The intractable problem with this explanation is that it reverses cause and effect: namely, market disturbances, such as currency mismatches and the disappearance of liquidity, are precisely what happen when global speculative capital overruns a domestic market (see Soros, 1998 Soros, G. 1998. The crisis of global capitalism, New York: Public Affairs. [Google Scholar]). Note that Bhundia and Gottschalk have no genuine explanation for what motivated the mismatches or the disappearance of liquidity at that point in time because, in our view, they bracket the introduction of massive amounts of speculative capital into the SA financial system. Their account simply imputes explanatory power to what is no more than a description of the reality effects of what happens when markets are disrupted. Long-term observer Barry Eichengreen, for one, is not surprised by this attempt to lay the responsibility on the domestic market. As the lead author of a 1998 IMF report meant to address the concerns of emerging market officials about 'the elephant in the pond problem' (2003, p. 193) – i.e. when elephantine amounts of speculative capital venture into emerging market financial ponds – he recognizes that a critical focus on the power of Euro-American capital flows 'would have cut against the grain of IMF policy and the preferences of its principal shareholders, advanced industrial countries all, for capital-account liberalization' (ibid., p. 198). 19. The official explanation for this large foreign investment in US government debt is that emerging market nations have a surplus of savings that they cannot profitably invest in their own countries, motivating them to park the money in the US. Given the reality that most postcolonial nations have enormous and well-documented infrastructural deficits, this notion of an unusable surplus is highly implausible. The fact is that the decision of emerging market reserve banks is that the most profitable use of their dollar revenues is to ward off attacks on their currency

Capital account · Convertibility · Depreciation (economics · Foreign-exchange reserves · Liberian dollar · Economic Theory and Policy · Fiscal Policies and Political Economy · Global Financial Crisis and Policies

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