Rand Weakness Owed to Excessive Money Supply Growth, Not Strikes

The Rand is weakening dramatically at present. In the past two weeks the $/R exchange rate has climbed from 8.20 to 8.61 this morning. The media and talking heads are blaming this Rand weakness on ongoing strike activity.

This is typical of people who do not understand economics to clutch onto anything that is topical at the time to blame Rand moves on. Why is it that while Marikana was happening, the Rand was resilient and even while strikes continued thereafter, actually strengthened?

There are fundamental reasons for why the Rand is weak presently. On September 10 my colleague Russell Lamberti wrote to ETM Analytics clients regarding the Rand outlook (I am cutting a long story short):

On balance therefore we are cautious of long rand positions from a cyclical strategy perspective.  Longer term (2-5+ years) we see the continued destruction of major fiat currencies and prefer holding EM currencies and hard commodity currencies like gold.  However in the short to medium term South Africa’s currency management leaves much to be desired and places considerable pressure on the exchange rate on a structural basis.  A reversal of capital account inflows is likely to hit the currency very very hard indeed.

I have written on numerous occasions about the poor management of the Rand money supply by the Reserve Bank, see here, here, and here.

Earlier this week, I sent the following chart to ETM Analytics clients. It depicts the interplay between the USD-ZAR and demand and supply of the ZAR.

Regarding it, I wrote

Noting the chart below (ZAR vs Money demand/supply), the evidence is clear: During periods when Rand money supply growth far outstrips net portfolio inflows, (i.e. Rand supply exceeds Rand demand) the Rand weakens, and vice versa. The period from late 2004 to early 2009 was a time when Rand money supply growth was outstripping portfolio inflows. In other words, demand for Rand did not match supply growth. As a result, the USD-ZAR trended higher from lows of 6.00 in late 2004 to a peak of just over 10.00 in early 2009.

This contrasts with the period from early 2009 to mid-2011, when demand for Rand was more robust than Rand supply growth. Stated differently, portfolio inflows exceeded Rand supply growth, and a consequence of this was a strengthening Rand. The USD-ZAR moderated from 10.00 to lows of 6.50 in mid-2011.

However, since then, the fundamental outlook for the Rand has changed once again. Rand money supply growth has accelerated sharply in recent months, while portfolio flows have not kept up. Rand supply is growing faster than Rand demand, and it is not surprising to see that the Rand has already begun to weaken. The USD-ZAR has climbed from 6.50 in mid-2011 to levels of 8.50 in May 2012.

In conclusion, I wrote that

The dynamics of relative Rand supply and demand will establish direction for the USD-ZAR going forward. Should we see a period where Rand money growth remains robust (which is not unlikely following the recent interest rate cut), while portfolio inflows slow at the margin (as we have seen in recent months of August and September), the USD-ZAR is expected to continue to increase and could potentially breach levels of 9.00 toward year end.

The bottom line is that the current sell-off of the Rand is a result of accelerating Rand money supply growth at a rate faster than USD, GBP, EUR supply, while demand for Rand has not kept up with the increase in supply. The fact that the USD has weakened against the EUR, while the ZAR has weakened against the USD, shows just how weak the ZAR really is. The SARB’s mismanagement of the Rand is going to cost us much higher prices of goods and services going forward.