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Thursday, 22 September 2011

Foreign exchange

Foreign exchange

A foreign currency is not the monetary unit in a non–dollarized economy since it is not the generally accepted national monetary unit of account. The Rand is the monetary measuring unit of account in SA. The SA economy is not a Dollarized economy. The Rand is the monetary unit.

Money has three functions:

                                               1. Unstable medium of exchange
                                               2. Unstable store of value
                                               3. Unstable unit of account

A foreign currency like the US Dollar or the Euro is, however, a medium of exchange in SA. Most businesses and individuals would accept the USD or the Euro as a means of payment; that is, as a medium of exchange because they can easily sell the foreign currency amounts they would receive in transactions at their local banks for Rands.

A hard currency is also a store of value in SA. The USD and the Euro are hard currencies with daily changing market values. They are generally accepted world–wide as a relatively stable store of value. People know there are normal daily small changes in their foreign exchange values.

The USD and the Euro are, however, not national units of account in SA. You cannot normally do your SA accounts in US Dollars or Euros for tax purposes during low inflation and deflation. You have to do your accounting in Rand values in the SA economy during low inflation and deflation. The USD and the Euro are not functional currencies in SA since they do not fulfil all three functions of a monetary unit within the SA economy. A foreign currency like the USD or the Euro only fulfils two functions of money, namely, unstable medium of exchange and unstable store of value. They therefore are not money or the monetary unit in SA from a strictly technical point of view. They are not monetary items in SA.

Foreign currencies are variable real value non–monetary items in a non–dollarized economy. They have variable real values which are determined in the foreign exchange markets daily.

The US Dollar is only a functional currency unit outside the United States of America in countries like Ecuador, Panama and Zimbabwe which have Dollarized their economies. They use the US Dollar as their functional currency unit. They do not have their own national currencies. That is not the case in non–dollarized economies.

It just appears very strange to say that the US Dollar or the Euro is not money in SA. Technically speaking that is correct because an economic item can only be money in a non–dollarized economy if it fulfils all three functions of money. The Euro is only money in the European Monetary Union (EMU) and the USD is only money in the US and in countries which have Dollarized their economies using the US Dollar as their functional currency.

The man and woman in the street, however, regard anything that is a medium of exchange as “money” in very limited applications. Cigarettes are often used as a medium of exchange in prisons. Shells have been used way back in history as a medium of exchange.

The man and woman in the street in SA certainly regard the USD and the Euro as money in SA. SA entities, however, classify foreign exchange as a variable real value non–monetary item stated at its current market value and not the same as the SA Rand, that is, not as a monetary item when they choose to implement financial capital maintenance in units of constant purchasing power in terms of IFRS as authorized in the original Framework (1989), Par 104 (a) during low inflation and deflation, i.e. when they implement Constant Item Purchasing Power Accounting.

Dollarization can be in currencies other than the US Dollar too.

Nicolaas Smith 

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