Thursday, May 12, 2011

Call For South African Currency Board

Back on February 17th of 2009, Eustace Davie called for the South African government to show leadership in the post-crisis world by tying the rand to gold. He didn't advocate a gold standard, as he believes conversion to gold money would be too difficult to implement. Instead, he advocated a gold-linked currency board: each rand issued would have to be backed by reserve gold held by the South Afrcian central bank. The currency itself would not be convertible to the metal, and the link would only apply to coins and bills in circulation.
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 unnecessarily increase the quantity of rands in circulation.”
Since South Africa is moving into economic alliance with the BRIC countries, Mr. Davie has reintroduced the proposal as a means of fostering regional trade in a low-inflation environment. He seems to have the idea of cutting those countries' dependance on the U.S. dollar.

It's not a bad idea, but failing to include bank reserves leaves a gap that would lead to inflation in a fractional-reserve banking system. Demand deposits are not covered, probably because doing so would require way too much gold. The trouble with his currency-board system is, a flight to currency would oblige the central bank to buy a whole lot more gold or else refuse to issue the bills and coins. The end result is that demand deposits would not be convertible into physical currency over and above the gold-backed float. That lack of convertibility could lead to a two-tier money system, as coins and bills could not be inflated without additional reserves but bank deposits could.

Still the currency-board idea is a step towards a real gold standard.

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