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Monday, 1 December 2008

The Lungu solution...

Prof John Lungu thinks he has stumbled on a potential solution to our current predicament:

“Let’s not just be bearish in our approach. We can also be bullish and start thinking about politicking now, because when the stocks are low this is the time to think about investments...In any case, if you look at the prices why can’t the Zambian Government start buying copper, if it has any foreign currency? They can buy the copper, stockpile it and sell it at the right time...”

Okay, let me think through this one. Zambia which has only $1.6bn worth of import cover in foreign reserves, and gets a pitful amount from copper revenues, should now buy copper from the mining companies, who many believe are conning the Zambian people anyway, and sell it again at a higher "unspecified price", sometime after 2010 when many believe the copper prices may rebound? I sometime wonder.....

12 comments:

  1. I agree that the government should have much more money at the ready than it does today - because it didn't receive revenues from the mines.

    In any case, if you look at the prices why can’t the Zambian Government start buying copper, if it has any foreign currency? They can buy the copper, stockpile it and sell it at the right time...”

    Another way would be to wait for some of these mining companies to go bust, and buy them up.

    But actually locking in prices (either high or low) is not that difficult. I'm just wondering whether this government is up to it. The IMF isn't going to hold their hand, even though the UN may be more receptive now about infrastructure spending.

    I also think that Zambia should have it's own commodities exchange. And that the government should be involved in reducing shocks in the price of copper.

    But that's all pie in the sky when you have a government that is still stuck on neoliberalism, and whose response to the current crisis is to chase after more FDI.

    After a disaster that has shown the error of their approach, doing more of the same is the hallmark of people who don't know what they're doing or why.

    The MMD ran out of ideas as soon as it was elected in 1991, and it has been following the IMF's disastrous prescriptions ever since.

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  2. MrK,

    I laughed when I read your comment about the mining companies going broke and then buying them up!

    The commodities exchange idea is intriguing.

    What would be the aim of such an approach?

    Is to force them to trade in Kwachas? Or is it simply to regulate how much they sell and when.

    Knowing the objectives would help untangle how optimal such an approach can be.

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  3. The objective would be to smooth out impact of changes in the price of copper on the government's revenues - for starters.

    I have been thinking about prof. Lungu's idea, but what if the Zambian government developed some new mines, ran them on a cost only basis and started creating large copper reserves?

    The Kwacha could be backed by copper. It would be Zambia's own gold standard.

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  4. Basing the currency on an industrial metal would create much more 'sound money' than the IMF's insistence on low inflation through reduced government spending.

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  5. MrK,

    I must admit that while the objective certainly seems laudable, I cannot say that I fully comprehend how the methodology works on this. I have similar difficulty understanding the logic behind gold standard advocacy in the US.

    My limited historical knowledge leads me to believe that the primary reason for the end of the gold standard was the advent of electronics, transforming the element from a precious metal suitable for use as a freely convertible marker representative of any and all goods and services, into an industrial metal with a supply and demand curve much like any other. I may be missing something important here due to the informal nature of my education.

    How is a currency based on a reserve of copper different from or superior to, say the PRC "basket" of foreign currency reserves concept? By suggesting that the new mines be run on a "cost only basis," do you mean only selling as much of copper ore that is produced as is needed to cover costs, and stockpiling the rest? Would a reserve of copper ore be more or less useful as a currency backer than refined copper? And if the growth of reserves increases and decreases with the international demand and price fluctuations (sell more copper to meet expenses when price is low, less when high), how does that serve to cushion the government budget from copper based fluctuations?

    Thanks for any light you can shed into this relatively dark corner of my economic understanding.

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  6. Yakima,

    My limited historical knowledge leads me to believe that the primary reason for the end of the gold standard was the advent of electronics, transforming the element from a precious metal suitable for use as a freely convertible marker representative of any and all goods and services, into an industrial metal with a supply and demand curve much like any other.

    Why couldn't there simply be flexibility in the percentage of coverage relative to the money that is in circulation? It would still give the GRZ some flexibility in adjusting the amount of money and credit in the economy.

    The problem with fiat money is that in times of extreme inflation, the 'full credit and confidence' of the government may not exist.

    And clasically, in times of inflation, real commodities are the place to be.

    It would also prevent what happened in the US, where the Fed kept interest rates artificially low for years (basically to inflate it's way out of the recession that followed the Crash of 1987. At the same time, they formalized NAFTA and allowed much of it's manufacturing base to disappear to low wage countries. The result was an economy based on credit - and the bill has come due.

    We are seeing the result of what happens when you have a perfect neoliberal economy. It is as Utopian and based on the quicksand of credit as the theory itself, with it's magical selfcorrecting market mechanism and direction by selfinterest or greed.

    How is a currency based on a reserve of copper different from or superior to, say the PRC "basket" of foreign currency reserves concept?

    Because in times of high inflation, those currencies are not going to be worth much. Copper is going to be worth more in currency terms as inflation rises.

    At the same time, the government could lock in the price of copper by using futures and options, using it's stocks as collateral, and making it's revenues from copper more predictable than the present dependence on a windfall tax only.

    And lastly, using futures and options, the government could serve as a buyer of last resort.

    If it costs (for instance) $850 per tonne to produce copper, and the price market price is $3000 per tonne, the government could sell enough on international markets to cover the $850 and keep the rest in reserve. It could buy put options lock in the price at (say) $2800 for a long time.

    There are lots of possibilities of the government would return to mining, and avoided corruption and nepotism in parastatals.

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  7. The gold standard was used many years ago because there is a limited supply of gold, and thus linking money to gold would control the amount of money in circulation and thus inflation. The problem with the gold standard occurs when there are monetary or real shocks.

    Monetary shock example would be the gold discovery in California in 1850 substantially increasing gold supply and therefore money supply creating inflation. Real shock example would be San Francisco earthquake of 1906 where British insurance companies paid claims creating gold outflows from Britain, forcing their bank to raise interest rates and discriminate against American finance bills pushing the U.S. into recession.

    During the Great Depression, where there was fear of lending and spending leading to a deflationary spiral, the gold standard was an obstacle to the government increasing money supply to stimulate the economy.

    Because the U.S. government was not able to influence the economy due to the above reasons, the gold standard was abandoned. My opinion is that it was correct to abandon it, as it gives the government power to handle deflationary spirals (like the current situation) as well as inflationary ones, and as long as the government's economic policies do not create too much inflation or deflation.

    http://www.econlib.org/library/Enc/GoldStandard.html

    http://ideas.repec.org/p/nbr/nberwo/9176.html

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  8. MrK and Kafue,

    Thank you both for your explanations, I think I am beginning to understand somewhat but please bear with me as I try to understand why linking each kwacha in circulation to a physical reserve of copper (in some standard form presumably) would produce a stronger currency than other means of support, not to mention why a stronger currency is necessarily desirable. I tried to track down some numbers on exchange rates and copper prices over time, here's some of what I found relevant:

    The approximate range of exchange rate fluctuation of the Kwacha against ten regional and important international currencies over the last five years:

    ZMK:USD = from 3100:1 to 4800:1, currently 4600:1
    ZMK:GBP = from 5600:1 to 9000:1, currently 6758:1
    ZMK:EUR = from 3800:1 to 6300:1, currently 5851:1
    ZMK:CAD = from 2800:1 to 4000:1, currently 3611:1
    ZMK:AUD = from 2350:1 to 3750:1, currently 2980:1
    ZMK:ZAR = from 400:1 to 820:1, currently 446:1
    ZMK:NAD = from 390:1 to 800:1, currently 441:1
    ZMK:CNY = from 380:1 to 669:1, currently 669:1
    ZMK:JPY = from 27:1 to 49.5:1, currently 49.5:1
    ZMK:INR = from 68:1 to 110:1, currently 93:1

    In general, the Kwacha appears to be trading toward the middle or upper portion of the range against the currencies of the US, Britain, Canada, Australia, India and the EU. The Kwacha is trading at the lower end of the range against the regional currencies of South Africa and Namibia (medium or long term data on other regional currencies welcome!), and is only hitting new highs against the Japanese and Chinese currencies. Over the same period of time, copper has traded between about $2000/tonne and $9000/tonne, currently around $3000/tonne.

    While I understand that ownership of well functioning parastatal mining corporations, if such can be achieved, would do wonders for the government balance sheet compared to the present circumstance, I fail to understand the whole currency tie-in with the concept. How exactly do the copper reserves act as a hedge against currency supply or price inflation superior to other forms of support such as the Chinese "basket" approach?

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  9. Yakima,

    How exactly do the copper reserves act as a hedge against currency supply or price inflation superior to other forms of support

    As a last resort, the government could always sell part of their copper reserves for other world currencies. Yuan, dollars, pounds, whatever it needed, without getting loans or asking permission from the World Bank. That in itself would smooth out the exchange rate - if other world currencies don't collapse for whatever reason.

    such as the Chinese "basket" approach?

    I think the PRC is in deep trouble because of it's holding of too much dollar assets. They are holding half a trillion dollars ($585,000,000,000) in US treasury bonds. I remember back in the 1980s when a billion dollars was an incredible amount of money.

    All fine in normal times, but these are not normal times by anyone's stretch of imagination. We have seen the largest bear move in stockmarket history, and there is going to come a recession/depression after it to match. When that happens, commodities will be much more valuable than cash - food included.

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  10. Here is a very good book about the role of money in economics and a very good description of economic history. I read it many years ago and I became very knowledgeable.

    Money: Whence It Came, Where It Went by John Kenneth Galbraith

    http://hubpages.com/hub/Money_Whence_It_Came__Where_It_Went

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  11. Dear all -

    The logic of using foreign currency reserves to speculate on the future of the commodity that the economy is already over-exposed to makes no economic sense and confounds any logic.

    Two points of note:

    1. Whatever reserves the government has should be invested appropriately to grow and appropriately reduce risk through diversification, in whatever basket of global asset classes makes the most sense.

    2. Any viewpoints on how much money the government should have vis-a-vis what the copper companies have been able to extract, should be balanced with what little the government has actually done since the unbelievable opportunity created by the simultaneous forgiveness of foreign debt and the recent global demand spike for base metals (in particular from China).

    As an observer to this, the main metrics I can see from this incredible opportunity are the following:

    1. increased government spending and the associated trickle through to civil servants that has resulted in a large speculative property bubble particularly in Lusaka (owing to the inability for many to invest in more liquid assets locally and abroad).

    2. a short bull run on the LUSE driven in part by (1) above but also by the reduction in government T-bill rates. This has placed institutional money at risk as the portfolio of companies on the LUSE are not sufficiently diversified. As the last few months have shown, the currency and LUSE are very susceptible to the inflow and outflow choices of foreign institutional investors and susceptible to movements of very small amounts as well.

    3. Hardly any noticeable investment in public infrastructure where it matters - health, education, transport, etc.

    4. Higher taxes and the fluctuations of the currency markets is stifling any meaningful diversification of the economy away from its mineral roots.

    The currency is as a result subject to the vagaries of the commodities market, the global credit situation, and the ability of the government to judiciously preserve and grow what wealth it can.

    Through the recent elections this has not been a topic of real debate and unfortunately without some real steps towards building the nation through careful planning, appropriate public spending, and a measured pace, it looks likely that the plight of the average Zambian is likely to be no better off in the medium term.

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  12. Anonymous,

    Thank you, that description makes abundant sense. It is my understanding that balance of payments is likely to impress currency markets more than size of reserves under normal circumstances, do you feel that this is still (if ever) the case under the present fiscal "cloud"? Should we be worried about a weaker kwacha or is it likely to improve export position and overcome balance of trade difficulties for unavoidable imports such as petroleum?

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