Sanlam recently published an article about currency performance and it might be of value to have a look at the results. Very few countries on earth, if any, exist in an economic bubble. For as long as we can remember, there has been trade between different regions and this will go on forever. Trade usually happens because you don’t have some specific product in your own region, or you can get something cheaper from another region than by producing it yourself. If we take South Africa as an example, we don’t have sufficient oil and depend on other oil-rich countries to supply us with what we need. We, on the other hand, have a lot of gold, platinum, iron ore and the like, which some other countries have a shortage of.
So why is the currency of one country worth more than another, and why is there a constant change in the exchange rate between different currencies? There are a few things that will determine the value of your currency and one of them is the strength and predictability of your economy. A currency is just a piece of paper issued by a country with a promise to honour a certain value attached to it at any given time. If you don’t trust a government to honour such a promise, you don’t accept their currency, or you demand some other form of insurance. South Africa has a very small economy with a volatile political history, so almost no other country will accept the rand as method of payment. The US$ on the other hand is the complete opposite.
A currency will strengthen or weaken against another due to a change in the level of trust between the countries, as well as the purchasing power of a currency. Inflation plays a big role in the purchasing power of a currency and we can use the following example: If you sell an SA apple worth R1 to the US for $1in year one for $1, you have established a 1/1 exchange rate between the rand and the dollar. If in year two workers demand a 6% increase in wages, the apple will cost you R1.06. If the buyer can get the same apple somewhere else for $1, you will get only $1 for something that cost you R1.06. The buyer is not prepared to pay for your inefficiencies.
If we look at the following spreadsheet, we can see the movement in currencies of different countries against the US$.
Over a five- and ten-year period, only the Swiss franc managed to strengthen against the US$ annually. The rand has weakened by 4.6% annually against the dollar over the last ten years. If we translate that into an investment, you will see that if you bought R100 000 worth of dollars ten years ago, you would now be able to sell the investment for R156 790. It is interesting to note that the average annual inflation rate in South Africa over the last ten years was 4.9%, which is basically the same as the rate of depreciation of the rand.
