Exchange rates not set on feelings

12 Jul, 2019 - 00:07 0 Views
Exchange rates not set on feelings

eBusiness Weekly

One of the weirder predictions floating around Zimbabwe at the moment is the statement that the Zimbabwe dollar has to sink to a 1-1 exchange rate with the South African rand, with those “independent economic commentators” having nothing to back that statement than a desire to forgo simple arithmetic.

Exchange rates are not normally set on 1-1 nominal value unless the two currencies have come from exactly the same starting point and the two economies they circulate in have had exactly the same economic history and are totally linked. Zimbabweans should know this from their own attempt to maintain a fictional exchange rate of 1-1 between the RTGS dollar and the US dollar. It did not work.

The South African rand was created in February 1961 using the fairly common exchange rate at that time when decimalising of R2 to one pound South African, that pound being exactly equal to the pound sterling, even though South Africa was preparing to leave the sterling area and so lose the link.

The nearest local equivalent currency was the Rhodesian dollar, introduced in 1970, also at the rate of R$2 equal to one Rhodesian pound which had been at 1-1 with the pound sterling before Rhodesia was kicked out of the sterling area after UDI and then made its currency a strictly non-convertible currency with all exchange rates set at figures that were convenient for internal propaganda. That had more in line with the German Democratic Republic which set the exchange rate at one ostmark equal to one deutschmark, something that only worked because ostmarks could not circulate outside East Germany. It did cause trouble to West German taxpayers when the two German states reunited.

But the original Zimbabwe dollar, the renamed Rhodesian dollar, and the South African rand had started from the same point, half a pound sterling, and if identical fiscal and monetary policies had been followed both sides of the Limpopo might well have stayed in 1-1 parity. Of course Zimbabwe followed different policies and in the end printed the old Zimbabwe dollar out of existence with the final exchange rate being quadrillions of Zimbabwe dollars equal to one rand.

At dollarisation there was a minority view that Zimbabwe should have randerised rather than dollarised. This may have helped, but probably not. Namibia, Lesotho and Eswatini use currencies on 1-1 parity with the rand and the rand circulates within those states at 1-1. But as members of the rand currency area they are compelled to align their fiscal and monetary policies with South Africa, meaning they cannot just do their own thing.

While the USA did not care if a comparatively tiny country like Zimbabwe kept its accounts in US dollars, South Africa would have demanded far more if we had switched to the rand. And the odds are that the then Zimbabwean Government would have been reluctant to do that and the RTGS rand would have delinked from the SA rand a lot earlier than the RTGS dollar was delinked from the US dollar and would now be trading on the street at around 15 SA cents.

Even now people align the RTGS dollar with the US dollar, not the rand. Nostro accounts are kept in US dollars and there are still far too many suppliers who price in US dollars and then convert, with a substantial safety margin, to RTGS dollars at the moment of sale. We are not aligned with South Africa.

But even if we decided to join the rand monetary area, and even if the calculations many are making that the Z$ should be trading at something between four and five to the US dollar, all that the Government would need to do would be to introduce a new local currency, under a new name, and set the rate at three of them to the new Zimbabwe dollar and with a fixed exchange rate of 1-1 with the rand.

We do not have to devalue the Zimbabwe dollar to the nominal value of one rand, we just set the conversion rates, either for rand to Zimbabwe dollar or for Zimbabwe dollar to the new currency that will be at par with the rand.

The world saw this when most of the European Union adopted the euro. No one upgraded their currency so that it traded at 1-1 with the euro. They all did their conversion rates and then converted bank balances, account currencies, bank notes and coins to euros at the set rates. No one went in at 1-1. Some indeed had a lot of zeroes in their conversion rates. It did not matter.

In fact Europe offers a long example of how currencies change. Most old European currencies obtained their names from the old silver standard of the time before the 19th century when the gold standard took over. So we have a pound of silver, also called a livre or a lira depending on language. The pounds were different, but the idea was the same. A mark was two-thirds of a pound; a crown was a quarter; and shilling was a twentieth; a florin was a tenth; and so on. But no one ever thought that a British pound and an Irish pound were the same value, let alone a British pound and an Italian lira, although all once started off the same. Even when Scotland and England united in 1707 the pound scots was converted at 12-1 to the pound sterling although in the 1100s they had been equal.

The only other significant addition to the European naming group came in 1520 when a significant rich ore body of silver was found in a valley in the north of what is now the Czech Republic. The Kingdom of Bohemia, shortly to become part of the Hapsburg inheritance, started minting a quality silver coin just under 30 modern grammes.

The valley was in the then German speaking part of Bohemia and so Joachim’s Valley was known as Joachimsthal and the coin was known as the Joachimsthaler, shorten to thaler.

But as others copied it they pronounced it differently, hardening the first consonant and rounding the first vowel, and so we had dollars (with one l). The Dutch circulated these a lot, including their American possessions centred on Manhattan Island In any case with the Dutch being part of the Spanish empire when Spanish freebooters were conquering vast swathes of South and Central America with rich silver mines, the Spanish minted identical coins and these were the standard coins through the Americas, in British and French territories as well as Spanish lands.

When 13 British colonies cut loose they were using Spanish dollars. They then decided to mint their own copies, regrettably with Alexander Hamilton weighing a pile of worn dollars when setting weights so the US dollar was on the light side and most people preferred Spanish dollars (and later full-weight Mexican dollars) with conversions done with scales.

But until some former sterling area countries decimalised on a standard of 2 local dollars to one pound, all dollars in the world were derived from the Bohemian Joachimsthaler, via the Dutch lion dollar and the Spanish dollar.

It is one of those odd facts that the new Zimbabwe dollar, being derived from the US dollar last year, is now in that Bohemian-Dutch-Spanish group, rather than the old Commonwealth group of half pound where the original Zimbabwe dollar originated. Incidentally the Japanese Yen is also one of those derived Spanish dollar currencies, and collapsed as a result of World War 2. But it is now a strong international reserve currency although there are extra noughts when converting from US dollars.

The point of all this digression is to show that there is nothing magical about an exchange rate with the rand, or the US dollar or any other currency. The exchange rate is set, in the end, by the fiscal and monetary policies of the territories in which the currencies circulate along with the production of goods and services in those countries. And in the 21st century exchange rates are set by supply and demand in official markets, or where these are not working, then unofficial markets. They are not set by vague feelings.

If you want something close to a real measure of the worth of any currency, then comparing money supply to GDP is a far more obvious starting point.

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