Currency Confidence Tricks

The beleaguered Rand has found some support in recent days, partially due to a resolution of several strikes in the mining sector, as well as a further announcement of the BRICS (Brazil/Russia/India/China/South Africa) “Contingency Reserve Arrangement” (CRA) which is meant to provide support to Emerging Market (EM) countries suffering from severe currency depreciation.

http://www.bdlive.co.za/economy/2013/09/05/south-africa-to-contribute-5bn-towards-brics-contingent-reserve-arrangement

Talk of a CRA was brought up earlier in the year at the BRICS summit held in Durban, and the strategy seems to be that the idea will be revived any time EM countries come under pressure. The recent depreciation of EM currencies in the wake of Fed tightening fears was the perfect time to bring up the matter again.

It appears that the BRICS are mimicking the confidence tricks of central banks in the developed world, where forward guidance and the warnings of the power of central bank’s balance sheets are often used to push the markets in a desired direction. The oft repeated Wall Street saying “Dont fight the Fed” reflects the market’s view that one should never bet against the US Federal Reserve’s ability to stimulate the economy and market, and this power has been assumed of Developed Market (DM) Central Banks in general. The European Central Bank (ECB) under Mario Draghi has been particularly successful in convincing the market of its power, with Draghi’s “believe me it will be enough” statement to support the Euro in July 2012 helping to reverse the contagion that was underway in the peripheral European economies. Despite Draghi’s limited ability to make good on his threats given the constraints of the ECB’s mandate, the market’s fear of central bank power was enough and the threat of action precluded the need for actual action.

This EM Currency Reserve talk shows that the BRICS have some way to go before they can flummox the market in the same way as their DM peers. A confidence trick in the central banking world requires assertiveness and the threat of aggressive action, but the vague announcement and extended time frames announced by the BRICS takes away much of the sting.

The BRICS announcement also suffers from a lack of credibility due to that fact that the BRICS circumstances vary substantially by country and they do not share a single currency. There is no ideal way to determine the quantum and timing of any intervention, which means that the support for individual countries is likely to be limited to their contribution. South Africa’s $5bn contribution may as well remain with the South African Reserve Bank, who can choose to intervene in the currency markets should they feel it necessary.

The nature of the CRA announcements to date makes it seem unlikely that the fund will materialize as a central pool of assets, but would rather just be some form of non-binding pledge by the individual central banks. Any form of currency intervention is risky, and South Africa knows this as well as anyone given the experience of 1998 where then Reserve Bank governor Christ Stals squandered billions of dollars an attempt to stave of Rand depreciation. The lesson of 1998, 2001, 2006 and 2008 is that it is best to leave the Rand to find its own market level, given the difficulty of influencing a global currency market which trades over $4 Trillion a day. This attempted confidence trick lacks the necessary confidence, and is will therefore be quickly brushed aside by the markets.

Rashaad Tayob

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