CURRENCY WEAKENING- Why it’s so easy to blame the banks

A colleague of mine recently told me, “I hate banks”. And it seems she is not alone.

If I post a comment that is critical of a bank, my timeline is soon filled with people adding their “bad bank” stories. If I post something positive, then usually I am accused of being in the pockets of banks.

There are various reasons people love to hate banks. Banks are our largest touch point when it comes to our finances. We engage with them every day, whether it is transacting, borrowing or saving, so there are many opportunities for the banks to disappoint us.

The fees they charge are exorbitant (in most people’s opinion), but we begrudgingly have to pay these fees to keep our money safe and be part of the payments system.

Banks are where we go when we need money, but borrowing is costly, and that hurts. It can put us in financial difficulty, so we see the banks as being responsible for our financial woes.

There is certainly a perception that banks only benefit the wealthy, and in South Africa that can often be synonymous with “white people”. Households with stronger balance sheets and good credit scores are more likely to get preferential loans at lower interest rates, while those who earn less and have less, pay more. That feels very unfair.

Banks have a major influence on our lives, and we may often feel that we are the David trying to fight Goliath.

Therefore, when news broke that banks have been manipulating the currency, it was very easy for people to believe that this is the reason we have such a weak rand.

Banks are not to blame for the weak rand

My X (formerly Twitter) timeline has been full of angry people spitting toxic comments. The narrative is that because of these evil banks, the rand is far weaker than it should be and that is causing the financial woes we are all experiencing. It is a great soundbite, but this narrative is seriously flawed.

I am not about to tell anyone that currency manipulation does not happen, but what I can say with some certainty is that it cannot affect the long-term valuation of a currency.

There are several ways a currency or share price can be “manipulated”. Traders can take advantage of a negative event, and the value of a currency or a share could fluctuate wildly in the short term.

Traders can work together to increase te value of a currency or a share – a good recent example is GameStop, where a co-ordinated group of traders worked together to raise the prices of the GameStop share to squeeze out hedge funds that had taken a short position against the stock.

The important note here, is that these movements are all short lived. This is the nature of markets. There are short-term traders who impact short-term prices, but over the long term, prices revert to their value based on economic factors. This is why long-term investing is less risky than short-term trading.

The currency manipulation case between 2007 and 2013 – which involved multiple currencies and not just the rand – was a type of front-running. (Note: It has not been proven that the large South African banks were involved; the banks deny the charges and the Competition Commission is holding further hearings.)

Through collusion, traders at certain international banks were able to profit by selling to the client at a higher rate and buying the currency later at a lower rate from the market.

If you want to understand more about the nitty gritty of how this all worked, here are links to good explanations from Investopedia and earnforex.com.

The collusion resulted in currency movements of just 20-30 pips (a fraction of a cent), but this can turn into huge profits on large volumes. But these short-term profit trades are not why we have a systemically weak rand.

So why, then, is the rand so weak?

There are several factors currently affecting the rand. Some are structural, and others relate to the relative strength of the US dollar globally.

Kim Silberman, economist at Matrix Fund Managers, explains that currently the dollar is historically strong on a trade-weighted basis.

The DXY Index measures the value of the dollar versus the basket of global currencies. Historically the DXY traded around 85 index points but has strengthened to 102 index points.

This is due to the aggressive interest rate hikes by the US Federal Reserve which made dollar-based interest-bearing investments more attractive. Silberman estimates that about R1.50 of the rand weakness is due to the relative dollar strength.

South Africa has usually had a higher inflation rate than the US and our currency has therefore naturally depreciated against the US dollar.

As inflation undermines the purchasing power of the rand, so it affects the value of the rand. Prior to the global financial crisis (GFC), the difference in the inflation rate between SA and the US was around 5ppts which means our currency would have devalued by 5% a year to maintain purchasing power parity between the two countries.

The rand exchange rate is driven by demand and supply, just like any good, and will depreciate if people are buying fewer rands.

Silberman explains that with South Africa losing investment grade status and our government bonds no longer part of the global bond index, foreign demand for our government bonds has decreased. That means investors are not buying as many rands to purchase SA bonds.

In 2017, before the sovereign downgrade in 2020, purchases by foreigners accounted for around 70% of bonds issued in that year. This year that figure is only 13%.

Last year National Treasury increased the allocation that fund managers of pension funds could place offshore from 30% to 45%. Silberman says the average offshore allocation has increased from 28% to nearly 40%. This required that domestic fund managers sell rands to buy foreign assets.

Finally, there is the reduction in demand for rands to purchase South African goods. South Africa’s export volumes have decreased, partly due to economic issues like loadshedding and Transnet’s incapacity to rail goods to ports, and partly because commodity prices have decreased.

Silberman says given these factors, a fair value for the rand would be between R18.50 and R19.50 to the dollar. At time of writing the currency was around R18.82 to the dollar.

While we would like to believe that having a stronger rand would be as simple as stopping traders from dodgy practices, the truth is much harder. We must convince the world we are worth investing in.