How government defence expenditure affects exchange rates


One of the key aspects of fiscal policy is how it manages to influence the activity of government expenditure, in some cases unexpectedly, like in the relationship between the US defence budget and the value of the dollar. This is because the US model of awarding defence contracts is big business, while the South African defence budget for 2019 remains static.

In the US, billions of dollars of military defence contracts are being finalised every weekday at 5pm, so it isn’t surprising that they have an effect on the bigger financial picture. After the signature of these huge contracts, there is a small reaction in the value of USD which is consistent with the World Economic Forum’s concept of macroeconomic theory: “In an economy with a flexible exchange rate, government spending ‘shocks’ should lead to appreciation of the domestic currency.”

And it does. At the time of the ‘shock’ (which is just the reaction to big budget expenditure), the dollar actually appreciates by 0.0001 (that is, 0.01%) at a corresponding daily timescale approximately 25 days later. This is an astonishing economic fact.

The same cannot be said for military expenditure in South Africa which reached an all-time high in 1988 of USD 5 billion. The amount the South African government spent on its defence capabilities since then has actually decreased. Between 2016 and 2017 the defence budget was USD 3.11 billion, a reduction of over USD 60 million, reflecting a year-on-year decrease in military spend since 2015. This happened after six consecutive years of defence budget increase.

However, during that time the relative value of the rand (ZAR) to the dollar decreased significantly. In December 2010 the ZAR was worth 0,1518 USD, but had fallen to 0,07 USD by February 2019. This has impacted on the growth of currency trading and forex brokers in the country. As regulatory pressure in Europe and the US mounts, more brokers are focusing on South Africa’s huge potential market. CM Trading, which is regulated by the FSB in South Africa, is just an example of a broker which looks to service a growing demand for financial services.

The devaluation of the rand to less than half its 2010 USD value makes the relative spend on the SA defence budget appear to have shrunk substantially. Obviously there are a lot of other factors that haven’t been considered, but it goes to show how significant defence and military budgets are on national finances. The size of the SA defence budget is shrinking relative to that of the US. It means that the army’s job has become a lot more difficult, with border security remaining a priority across nearly 4,471 km of land bordering Botswana, Zimbabwe, Swaziland, Lesotho, Mozambique and Namibia.