Central banks have more to offer a distressed economy than lower interest rates. They can supply far more money in the form of the deposits they supply to private banks. They can add as much money to the economy as they believe necessary, by lending more to their governments, private banks and businesses.
If the banks and their borrowers respond favourably to these monetary injections, the supply of private bank deposits and bank credit will increase by a multiple of any additional central bank money. The extra money and credit created will then be exchanged for goods and services, the labour to help produce them and other assets. Higher share prices, more valuable long-dated debt, and real estate, translate into more private wealth, leading to less income saved and more spent, helping to relieve distress.
Lockdowns have disrupted output and sacrificed the incomes of businesses, households and governments on a large scale. Getting back to an economic normal requires a mixture of increasing freedom and willingness to supply goods, services and labour. It also needs more spending to encourage firms to produce more and hire more workers and managers. Money creation on a large and urgent scale is helping stimulate demand almost everywhere. M2 (bank deposits) in the US have grown nearly 25% over the past 12 months. Quantitative easing (QE) is working rapidly this time around.
The SA Reserve Bank has adopted a different strategy and rhetoric. It has decided it has done all it can for the economy by cutting the repo rate three percentage points to 3.5%. It has rejected any QE that might have reduced pressure on interest rates at the long end of the yield curve. It argues that a structural inability to supply, over which it has limited influence, is the cause of our economic distress, not the weak state of demand. Go figure, as they would say in New York.
Yet perhaps all is not lost on the SA monetary front. The deposit liabilities of the banks (M3) had grown by about 11% by August and the supply of Reserve Bank money was up 12.5% per annum in September, compared with the year before. This represents a marked acceleration.
Much less helpfully, bank lending to the private sector was up by only 3.9% per annum in August. The difference between the growth in bank deposit liabilities — up 11% — and assets (up about 4%) is accounted for by a large increase in bank free cash reserves of a net R60bn in 2020.
The banks invested a significant R110bn in additional government debt between January and June 2020. This is helpful to a hard-pressed fiscus but also crowded out lending to the private sector. The now steep slope of the yield curve adds to the attraction of borrowing short to lend long to government. It also implies that short rates are expected to increase dramatically over the next five years.
Unless inflation or real growth picks up surprisingly fast, the much higher short rates implied by the yield curve seem unlikely. Borrowing short to lend long seems a good and profitable strategy for SA banks and others. Borrowing short and rolling over short-term debt, rather than borrowing long at much higher rates, seems a good idea.
This all leads to an undeniable conclusion. Any revival of the SA economy will depend on realising lower real long-term interest rates and flattening the yield curve. It will bring lower real required returns for any business that might invest more in the SA economy, essential if the economy is to pick up sustainable momentum. Only a credible commitment to restraining government spending over the longer run can lead SA away from the stultifying burden of expensive capital.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.