Origins of the SARB

In the following article, I briefly outline and explain the origins of the South African Reserve Bank (SARB, the Bank). Reasons given on the SARB website are quoted in italics, after which I analyse the statements.  The reader will see that it becomes quite clear that the main reason the SARB was established in 1921 was to protect banking and business interests, in particular those who had a strong political lobby.  Furthermore, the government subsequently benefited from the wealth of opportunity (and cheap financing) its own private banker could bring to the party.

The SARB was established in 1921 in terms of a special Act of Parliament. According to the SARB website, conditions that led to its creation was that after WW1, gold was trading at a higher price in London relative to the domestic market. SARB says this meant that an arbitrage profit could be made by converting SA commercial bank-notes into gold, and selling the gold in the London market.

SARB explains that

“[SA] commercial banks had to buy gold at a higher price in London for re-import into South Africa to back their banknotes in issue than the price at which they converted their banknotes for gold. This “obligation to trade at a loss” posed a serious threat to the ability of banks to continue meeting their obligations.”

What this passage tells us is that SA commercial banks were simply over-issuing banknotes, because under the gold standard, every banknote issued is backed 100% by gold specie, in a fixed ratio. The ability of banks to meet their obligations could only have been impaired if it had over-issued banknotes in excess of the amount of gold on deposit. This is why today the US investment banking model has failed, as they borrow (very) short, and lend long and illiquid. The free market check under the gold standard was the good ol’ bank run that prevented banks from over-issuing and essentially counterfeiting money. (really like this section)

Another inconsistency with the SARB’s explanation is that if the banks concerned really needed gold, why didn’t they purchase it in the domestic market at the lower price? They did not have to suffer a loss to re-import gold from London. It is highly unlikely that most citizens would have exported most of their gold to profit from this trade. If they had done so, to the extent that there was no gold left in the local market, the money supply would have declined to break-neck low levels. Remember, gold was money. The likely result of banks borrowing gold from the local market would have been a rise in the gross market rate of interest. Gold was a monetary asset under the gold standard and as such, demanded a rate of interest, as fiat money does today. A rise in the market rate of interest on gold would have had other detrimental side effects to general economic activity.

SARB states:

“To protect their financial viability, the commercial banks requested the Government to release them from the obligation to convert their banknotes into gold on demand. This led to the Gold Conference of October 1919.”

Ring any bells with modern day banking and finance? To be sure, the banking sector has historically been a powerful lobby group, and this time of history evidently was no exception. Releasing the banks from the obligation to convert their bank-notes into gold would have provided the banks with the ability to extend credit and increase money supply without the risk of having a run on their deposits, leading to bankruptcy. (Nice)

“Parliament accepted the recommendation of the Select Committee on the creation of a central bank and promulgated in December 1920 the Currency and Bank Act, which provided for the establishment of the Bank. Effect was given to its various provisions in the course of the next six months, and the Reserve Bank opened its doors for business for the first time on 30 June 1921.”

The SARB was brought to life as a protectionist policy, as the commercial banking interest group saw to it that the government of the day passed the Currency and Bank Act, in order to spare them the effects of a run on their gold deposits. Through the creation of SARB, commercial banks ensured that they would have a “lender of last resort” in times of crisis, removing free market checks such as the process described above from leading to insolvency when a bank had acted imprudently; while the government saw the prospects of soon thereafter officially having its own “banker.”