“Someone stop Tito, please,” implores a headline on a News24 column by struggle journalism old-timer Max du Preez.
His angry column brims with common myths about the economy, interest rates and inflation. Let’s look at them one by one.
Myth No 1: Higher interest rates cause higher inflation, including higher food and fuel prices.
“I’ve never understood the logic of making people pay more for the same things in order to combat inflation,” writes Max.
He also talks of the “sky-high fuel price and soaring food prices” as if the Reserve Bank were responsible for these.
Much of the hysteria around interest rates seems to neglect the difference between inflation and interest rates. An interest rate is the cost of money. Inflation measures the cost of goods and services. The cost of money is measured in the cost of housing and other goods bought on credit.
When interest rates go up they make the cost of borrowing more expensive. They don’t make the cost of all things more expensive unless you borrow to buy those things. That is the point. Higher interest rates are supposed to discourage you from borrowing to buy.
Higher interest rates do make the cost of mortgage bonds more expensive, but mortgage bond costs are only one of the costs consumers bear.
Inflation is a general rise in prices. If only food and fuel (and mortgage bond costs) were rising, it would not be inflation. Many other things are rising as well, and some rapidly. The last Statistics SA release on the widest measure of inflation, the Consumer Price Index, lists the main culprits for April.
They include not only food, housing, transport and fuel, and power but things like household operation, medical care and health expenses, and education.
Myth No 2: Interest rates are “high”.
I am careful to write about “higher” rather than “high” interest rates.
Max is in good company in believing that interest rates are high. An economist writing for Business Day made the same mistake recently.
This is the mistake of looking at the nominal rather than the real, or inflation-adjusted, interest rate. Adjust for inflation and the interest rate is not high. It is rather low, discouraging people from saving money. The inflation rate for April, as measured by the Consumer Price Index, was just over 11%. The prime rate, the key lending rate offered by banks, is 15%.
If ordinary people could get the 15% prime rate level when they put money into banks, the real interest rate they would enjoy now would be 4%. But the rates banks offer investors is far lower than 15%.
One bank’s Mzansi account, for instance, offers a maximum annual interest of 3.5%. Therefore the real interest rate is minus 7.5%. If you try to save money in this account you will be giving money to the bank.
A Mzansi account is not really designed for saving. But it’s not much better for those with more money to put aside for longer. You have to put your money into fixed deposits or buy Treasury’s retail bonds to get anything like a reasonable return on your money.
To encourage savings, interest rates should actually be higher. Why should older people, who no longer have any other income and are living off fixed interest, subsidise home-owners or people buying cars?
Myth No 3: Higher interest rates favour the banks.
Higher interest rates ultimately cause people to borrow less. This is not good for the banks. Banks want people to borrow more. Max mentions this.
He writes: “Talking about credit — can you believe that right in the middle of this economic crisis, in fact only two weeks ago, Nedbank sent me (and, I suppose, tens of thousands of others) an SMS encouraging me to take out a loan of R100 000?”
Banks also don’t like the effect of higher interest rates on bad debts. When interests rates rise, bad debts increase and banks lose money.
Myth No 4: The Reserve Bank governor is raising interest rates on a whim.
Max repeats the word “obsession” thrice in describing the Reserve Bank governor’s raising of interest rates to combat inflation. He also writes of Tito’s “raising of interest rates whenever he is in the mood.”
I don’t know how common this perception is. Such nonsense should not have to be refuted.
The decision to raise interest rates is not the Reserve Bank governor’s alone, and it does not depend on mood. The Monetary Policy Committee makes the decision by consensus after discussing a voluminous amount of information, including not only the present inflation rate but also inflationary expectations. The governor goes live on TV to defend the decision.
The governor also defends his policy to parliament, and the Reserve Bank conducts forums around the country to explain what it is doing.
Myth No 5: The poor suffer from higher interest rates.
The very poor don’t have bonds, hire purchase or any form of formal debt. What they do face is high food and fuel costs, among other things. Higher interest rates don’t affect the poor directly.
Ah, you might say, it does affect them by curbing economic growth. There is little evidence that this is happening in a big way. The growth rate fell to around 2% in the first three months of this year, mainly because of load-shedding rather than interest rates. That is lower than we’d like but it’s still not zero or a minus figure. Measured year-on-year the growth rate was 4%.
Myth No 6: Inflation-targeting hasn’t worked and should be abandoned.
That inflation targeting should be ditched has become a common theme, put forward recently by no less a person than former World Bank chief economist Joseph Stieglitz. Even he can be wrong.
Firstly, what would replace explicit inflation-targeting but implicit inflation targeting?
The US Federal Reserve has what is called a “dual mandate,” and is tasked with keeping economic growth healthy as well as keeping inflation under control. What level of inflation would the Fed be happy with? We don’t know. But surely the Fed would not tolerate anything approaching hyper-inflation? Surely it must have some unacceptable level in mind?
Secondly, inflation’s fall to levels unheard of for decades was accompanied by gradual raising of interest rates when inflation was high and gradual easing as inflation fell. Is this coincidence? What would have happened had interest rates been lowered when inflation rose, and raised when inflation fell instead?
In South Africa, the evidence of more than a decade since 1994 is that monetary policy enabled steady if low economic growth year after year, as opposed to the volatile boom-bust growth of the 1980s.
Myth No 7: Government can cut interest rates and control credit.
Unlike other critics, Max does offer an alternative to raising interest rates. His alternative is “controlling the credit the banks can give”. He also advocates freezing the interest rate (I assume he means the Reserve Bank’s influential repo rate) or cutting it by three percentage points (I assume he means three percentage points when he says 3%).
Government cannot do anything about the level of interest rates. Only the Reserve Bank can.
Further regulation of financial institutions is not out of the question. We already have the National Credit Act, which does offer protection for consumers. Maybe some way can be found to insulate homeowners against the effect of interest rate rises. Which homeowners, though? Surely not those of us in the formerly white suburbs? Surely in South Africa we qualify as the rich?
In any case, if controlling credit simply means simply cutting down the flow, that would affect economic growth. So are we seriously asking government to have the wisdom to decide how much credit to offer and to whom?
If I were making policy I would want to see evidence of this kind of intervention working elsewhere in the world, now rather than in the past, before contemplating such a move.
Changing the banking system is not something any government does lightly. So it is not an option for the moment.
Myth No 8: Higher interest rates don’t dampen inflation.
The reverse of this idea is that lower interest rates do dampen inflation. That makes no sense.
Cutting interest rates aggressively now would set off a spiral of inflation that would shove us into Zimbabwean-style hyper-inflation.
We have experience of hugely negative real interest rates in South Africa. Everybody who could borrow money did: nobody who had any choice kept any money in the bank. The only logical way of saving was by investing in the JSE, property or hard assets, directly, or indirectly through the products offered by the life assurers. Old habits die hard, so is it any wonder we have a low savings rate in South Africa?
The higher inflation rises and interest rates stay static, the lower the real interest rate becomes, advancing dangerously to the point when we have such marked negative real rates again.
Myth No 9: Higher interest rates have brought disaster on the middle classes.
Max writes in a gloomy fashion about people losing their homes and businesses. This must have happened, and it’s unfortunate, but there is no evidence of mass evictions or mass auctions in the suburbs. What has mostly happened is that people feel less wealthy. Therefore they should start to spend less.
House prices have not plummeted. The rate of increase in house prices has slowed. According to the latest Absa House Price Index, house price growth slowed to around 7% in April compared to April last year in what Absa calls “the middle segment of the market”.
So house prices have only fallen if you adjust for the inflation. And would-be car buyers might postpone their purchases, or buy smaller cars — a better idea with fuel prices where they are now.
If the Reserve Bank delays acting and inflation is allowed to accelerate to a point where the Bank has to increase interest rates sharply, instead of the gradual increases we have seen, then the middle classes will really start to feel pain.
Myth No 10: Falling property prices are an outright disaster and must be stopped at all cost.
I have sympathy for people who bought houses when interest rates were lower than they are now. I am one of them. But that is separate from the fall in house prices. Why should house prices rise forever?
Why is a general decline in house prices such a bad thing? How will young people, middle class or not, even get together the deposit for a house if prices continue to rise in the way they have been doing, unless they inherit money? How is this fair?
Finally, to forestall any personalisation of this issue, I am passing no comment on Max du Preez as a person or a political or social commentator, merely on what he has written in his column. And all of my myth-busting does not mean that we should not question monetary policy or cease debating economic issues.
In debating inflation and the pain it causes we should be more aware of the things in our economy that make inflation difficult to control. Collusion, price-fixing and economic dominance of some companies in certain sectors militate against controlling inflation. So do surging administered prices, such as the cost of public education and municipal rates, and these are things that government can and should control.
Whatever we write about, however, we must get our facts sorted out before we launch into opinion.
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