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Wednesday, April 1, 2009
Glittering opportunity?

The current turmoil in the world’s financial markets is a currency crisis caused by governments and central banks. This is the view of Eustace Davie of the Free Market Foundation. He recently presented a paper entitled, A Golden Opportunity for South Africa, to a public meeting at the offices of the Foundation in Johannesburg.

“The US government and its Federal Reserve Board are primarily responsible. The world needs an alternative reserve and the only feasible option is gold.
“The main reason for the absolute terror gripping the world is that its reserve currency, the once-mighty dollar, has been debased and manipulated to the point where it no longer serves its former purpose. Even more frightening is the fact that the US government and Federal Reserve Board are in the process of compounding past errors by debasing the currency even further,” Davie says.
“There are numerous problems related to a return to a fully convertible currency based on gold, not least of which is the large quantity of paper money in issue. Gold, nevertheless, could be used to engender confidence in the rand in the same way that a country like Estonia uses the euro to give people confidence in its currency, the kroon. By backing the rand with gold SA could insulate itself from a great deal of the world’s currency volatility and even profit from it by acting as a safe haven for foreign investment.”
According to the website of the Eesti Pank, or Bank of Estonia, a currency board is an automatic system based on stringent rules. In order to maintain the fixed rate of the Estonian kroon, the central bank's liabilities, including the monetary base in the economy, must be fully guaranteed by gold or foreign exchange reserves. Eesti Pank operates independently from other state authorities. Under the currency board arrangement, the central bank is prohibited by law to directly or indirectly credit the central government and local governments.
According to the Law on the Security of the Estonian Kroon, Eesti Pank has no right to devaluate the exchange rate of the kroon. The fixed exchange rate is 15.6466 kroons to one euro, previously 8 kroons to one deutsche mark. This exchange rate has remained the same since 20th June 1992, except for the switch to the euro.
Currency boards prevent governments and central banks from manipulating their currencies. They function even better if they are independent, separate from central banks, and have the sole purpose of providing the country’s citizens with a sound currency.
Davie proposes that, “SA should consider establishing an independent Currency Board that utilises only gold to back the rand.”
According to the 28th February 2009 statement of assets and liabilities published by the SA Reserve Bank, the liabilities reflected Notes and Coins in Circulation amounting to R68.3 billion, and the assets included R38.4 billion (4,011,603 ounces) of gold holdings valued at R9 569.11 per ounce. At the same price, to fully back the notes and coins in circulation with gold, a purchase of a further R29.9 billion of gold would have been necessary.
If an independent Currency Board had been established on 28th February 2009 to manage the rand, it would have taken over the Reserve Bank’s R68.3 billion liability in respect of notes and coins in circulation, its gold assets of R38.4 billion and, theoretically, forward cover provided by the Reserve Bank for another R29.9 billion of gold at R9 569.11 per ounce to settle the balance of its liability to the Currency Board.
On that date, 28th February 2009, one rand would have been declared to be equivalent to (say) 1/9 569.11th of an ounce of gold, fixed for all time. While the Currency Board would be compelled to maintain precisely correct gold holdings at the fixed weight of gold per rand to cover notes and coins in issue, it would not undertake to part with any of its gold in exchange for notes and coins. The reason is that the gold holdings of the Currency Board would represent a control mechanism to prevent excessive printing of money, not a return to gold as money, which would be something vastly different and more difficult to implement. For all new rand notes or coins issued, other than for replacing damaged notes, the Currency Board would have to purchase gold so it would have no incentive to increase unnecessarily the quantity of rands in circulation.
Davie says that having an independent Currency Board manage the rand would have several important benefits. He explains that, “The currency would be seen by potential foreign and local investors to be free of political interference and therefore free of the danger of excessive increases in the money supply and inflation. Total gold backing for the rand would act as a curb on money supply increases and ensure a low inflation rate, which would engender enormous confidence in SA’s currency in these turbulent times. There could be no better advertisement for the return of the monetary role of gold than a gold-backed rand. SA would stand out among developing countries because the rand would be unusually strong relative to its per capita GDP, and the SA nation a world leader on monetary reform.”

Copyright © Insurance Times and Investments® Vol:22.4 1st April, 2009
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