The US Dollar or the South African Rand - Let’s examine the facts

Dollarization, it has come as a popular term for currency substitution. This is a term mostly used when a foreign currency is used instead of the domestic currency as legal tender. In this instance, the foreign currency takes over all functions of domestic money: unit of account, medium of exchange, and as a store of value. Zimbabwe dollarized its economy on the premise of halting inflation, uncertainty, and at the same time encouraging stability and growth. The idea is a noble one, however, for successful dollarization there are two major conditions that ought to be met. The first is the formulation of right policies to prepare for a successful reintroduction of the domestic currency. Then, the second is the choice of which foreign currency to take - which is going to be a focus for this article. We raise points in support of the use of South African Rand over the currently widely circulated US Dollar.

Allowing the foreign currency to freely circulate in the domestic economy is a strong commitment to pegging the domestic currency to the foreign currency at one-to-one exchange rate. To successfully peg domestic currency to a foreign currency, requires that the two countries have a high degree of economic integration, that is to say, the two economies should be closely linked by trade in goods and services and by factor mobility. Factor mobility entails the free flow of labor and capital between the two economies. Second, the two countries should exhibit economically similar exogenous shocks, including “symmetric” growth and recession. At the very least favorable end, they should face more symmetric shocks and fewer asymmetric shocks. Since the idea of dollarization entails that two countries are subject to a uniform monetary policy, then a common monetary policy is appropriate when the booms and bursts are similar. If a country chooses to peg its currency to that of a country that doesn’t share similar economic shocks with her, that means that the two countries would not share similar business cycles and hence a common monetary policy would be destabilizing.

To allow the easiness of the flow of goods, services and factor mobility, the two countries ought to be geographically close. In addition, to reduce transaction costs, increase cooperation and reduction in uncertainty, the bulk of a country’s trade should be undertaken with the trading partner(s) to whose currency it plans to peg. Otherwise, there will be an increase in uncertainty, calculation and transaction costs that arise when exchange rates float are a more serious issue for the country’s balance of payment and hence economic growth.

Tying a country’s currency to a foreign currency is similar to a firm acceptance of a fixed exchange rate system. Having a fixed exchange rate means that a country is susceptible to the importation of foreign macro-economic shocks into the domestic economy. This may lead to financial crises that have an adverse impact on the balance of payment, price stability, output and employment. Zimbabwe is using the US dollar as its main currency, which implies that the domestic interest rates are always tied to the foreign interest rates. Thus, an increase in interest rates in the US will have an adverse effect on the competitiveness of the domestic exports and employment. In particular, a fiscal expansion in the US coupled with the trade protectionism implies that there is a significant compromisation of the independence of the monetary economy. Assuming the host country is adopting a transparency, accountable and sound monetary policy system, the only major advantage of a fixed exchange rate is that it acts as nominal anchor that helps to keep domestic inflation low.

Given the points raised above, mainly focusing on the need for cooperation on currency adoption between the two nations, high factor mobility i.e. Labor and capital mobility in response to a shock in one of the two countries. There is compelling support to ditch the American dollar in favor of the South African rand.