Citizens of any nation should not be surprised to see the number of currencies in the world getting smaller. There are obvious benefits to be found in this reduction: when one currency disappears without replacement, its users switch to another existing currency. The currency to which they switch then has a larger user base, and becomes a more useful currency. This is the reason that the US dollar is so widely used for international trade: it is recognised and trusted by most people, and serves as a common unit to compare prices of goods in different countries. This is also the reason for the recent creation of the euro, which is now the common currency of most member nations of the European Union, and will soon completely replace members national currencies.
As worldwide recognition of the euro increases, it will be more easily accepted and used in other countries. It might even come to be used in place of the national currencies, whether officially or not, in some smaller countries. This has already happened with the US dollar, which has long been used in Liberia and Panama, and was last year officially adopted by Ecuador. Other countries, such as Singapore and Argentina, kept their own currencies, but based them completely on the US dollar through a formal currency board structure, which permanently fixed the exchange rate. To the extent that the managers of the currency boards are trusted to obey the rules, their currencies will be part of the US dollar market, and will exhibit inflation and interest rates that are close to, and move with, those in the United States.
The downside of adopting another currency, or fixing its exchange rate, is that we become dependent on the managers of that currency to continue to manage it well. But central bankers commonly feel compelled to adjust the money supply and influence interest rates in a manner that they deem best-suited to conditions in their own economy. Of course, this is a problem only when you believe that your own central bank will follow a more appropriate path. In many cases, this is not so, and even if it were, the benefits of integrating the two currencies would more than compensate for it.
When investors face the uncertainty that comes with the management of particular investments, they commonly deal with these risks through diversification. If a central banker were concerned about the risks of fixing his currency to another, he could also get a more predictable result through diversification. Rather than fix the exchange rate to only one other currency, it could be fixed to the total value of a portfolio of other currencies. Many countries, including South Africa, could profitably adopt this approach.
In my monograph, Gold, the euro, the dollar and the rand, which has just been published by the Free Market Foundation, I propose fixing the value of the rand to a simple, but high quality, portfolio consisting of a set amount of dollars, euros, and gold. Each one of these three currencies could be safely adopted individually as a standard of value for the rand. Further, the dollar is the most widely used currency in the world; linking to it would help keep the value of the rand stable and invitingly predictable to traders and investors, both inside and outside South Africa. Linking to the euro would offer similar benefits; huge amounts of trade and investment will be conducted through the medium of the euro. Gold has the longest monetary history, and is still an international reserve currency. Of the three recommended components, gold would have given the best internal performance. Had the Reserve Bank fixed the rand to gold during the past few years, the average rate of price inflation in South Africa would have been virtually zero.
Nothing proposed here comes with a promise of perfection; it promises only to do better than we have done. Fixing the rand to any one of gold, the euro, or the dollar would have delivered a far better performance than South Africa has actually experienced. Inflation would be lower; interest rates would be lower; the rand would be stronger; and the monetary conditions for economic growth would be much more favourable. Combining the three into one portfolio would create a standard of value that is more consistently stable than any one component alone. The rand would be more stable than the dollar with respect to gold and the euro; it would also be more stable than the euro with respect to gold and the dollar. By including gold in its standard of value, the rand would also bear a better relation to the South African economy than would either the dollar or euro alone.
Details of how to structure the portfolio may be found in Gold, the euro, the dollar and the rand. What is needed beyond this is the political will to fix the rand to the chosen standard of value, and the discipline to keep it fixed. Such a demonstration will, in a short time, bring predictability, and then the trust and confidence to focus our worries on the other important aspects of the economy.
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Source: Richard J Grant is the author of Gold, the euro, the dollar and the rand, and the book, Real Money, both published by the Free Market Foundation. This article may be republished without prior consent but with acknowledgement. The patrons, council and members of the Free Market Foundation do not necessarily agree with the views expressed by the author. (The monograph described in the article is available from the Foundation at (011) 884-0270 for R30 and Real Money for R85, including postage and packing.)
(See also Policy Bulletins – Jack Kemp on Gold as anchor and economic reference point and Dr Richard Grant – Index the rand to stabilise its international purchasing power)
FMF\5 July 2001
