The South African repo rate now sits at 3.75%, lower than it has been in the past 20 years at least. The interest on the 91-day treasury bills, which are issued by the South African Reserve Bank (SARB) on behalf of the Treasury, currently sits at 4.12% (the average rate at which the bills are allotted during the weekly auction): the lowest it has been in the past 40 years at least.
The repo rate is the rate at which banks are lent bank reserves by SARB; it is the ‘risk-free rate’, i.e the safest possible return on your money. Every other asset whose price is denominated in rands has to generate a return exceeding the repo rate in order to be attractive to investors (who could always get together and start their own bank, theoretically). This explains, for instance, why the rates on the 91-day treasury bill are also at a historic low. Because inasmuch as higher repo rates make it harder to attract investors for assets that generate low returns for their risk, a lower repo rate makes it easier for the same companies to attract investor capital.
This has the effect of making what would have been considered a riskier asset, to be perceived as less risky, and that assessment would be true if the base rate (repo) was set by the market. Unfortunately, the repo rate is not set by the market. It is set by a committee, the Monetary Policy Committee (MPC) to be exact. These seven individuals (the Governor, three Deputy Governors and three ‘senior officials of the bank’) are tasked with determining what the price of money should be, thereby influencing the monetary supply, incentives/disincentives for saving, the price of goods and assets, investor perception of risk, etc.
Low borrowing rates
Granted, they have access to the best economic modelling expertise the country has to offer, but a sophisticated model means very little if the underlying assumptions are wrong. We have entered an unprecedented era of monetary policy easing. Just to give one example, the South African repo rate is now at 3.75%, and this is lower than the US Federal Funds rate in January, 2008 (3.94%). Since the relative rates are based on the relative economic strengths of both countries (factors influencing international demand for both countries’ currency as well as government debt), could anyone seriously claim that investing in South Africa in 2020 is less risky than investing in the USA in 2007?
The low rates have dropped the costs of borrowing for the entire economy. When it costs less money to take on debt, two things inevitably happen: 1) The cost of servicing the debt for those who can refinance or have an adjustable interest rate, goes down. 2) Borrowers who might have been rejected previously are seen as less risky and can access credit. These two factors act to incentivise taking on more debt, by the public and private sectors.
The supply of money for those taking on all this new debt is provided by the banks, who can create and loan out as much money as they want, provided they have the necessary banking reserves to back the newly created, to be lent-out, currency. (Banks pay the repo rate on the reserves they borrow from SARB). The ratio of reserves to currency that can be created and that makes its way into the money supply, is also set by SARB.
Reliance on the SARB
In essence, everything in the economy denominated in rands is ultimately dependent on the SARB not lowering the repo rate so much that the banks can get banking reserves for free, which would lead to the erosion of the value of goods and services held in the economy. (The nominal repo rate doesn’t have to be at 0%, it suffices that it is below the rate of inflation). (It is not as simple as that, other factors such as the Çantillion effect have to be considered). Inflation is what happens when you have more money bidding for the same number of goods. This is true for consumer price inflation at least.
Typically, Central Banks will act against inflation only when consumer prices start to increase at a faster rate than they want it to (In South Africa, the inflation target is 3-6%). Yet, the very fact of increasing the money supply causes inflation by definition, i.e inflation of the monetary supply. It is deemed acceptable to have some consumer price inflation, as long as real rates are positive. (This is no longer true in many Western countries and Japan). This means that for all savers, a committee decides how much of a return they are entitled to, even if the market would offer them a higher return on the capital for the same risk or lower, if left to its own devices.
The whole edifice of Central Banking serves to mask a grand theft, from risk-averse savers to those who are willing to take on more risk investing in the stock market, buying property, etc. Except they are not using their own money to take these risks, but stealing the purchasing power of hard-working retirees. The debate is not whether central banks should exist or not. The debate should be whether this system, where the price of money is set by a government-appointed committee, is appropriate and what its effects are on those who save money.
The system relies on the infallibility of seven people. This is reckless in the extreme. The value of money is set by individuals in the market, and the price (interest rates) should also be set in the same way, by the millions of individuals trading in rands.
Finally, the risk always exists that the MPC could make decisions that are so bad that the rand loses all value in international currency markets, as the Zimbabwean dollar did. The only sure way to avoid this scenario is if SARB increases its foreign reserves. In doing this, the SARB needs to avoid making untested assumptions about the safety offered by the US Dollar (the current monetary policy environment is unprecedented) and should perhaps move a greater proportion of its foreign reserves from the dollar to gold. This would mitigate the risk of the US devaluing its currency, since it also has a central bank.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
If you like what you have just read, subscribe to the Daily Friend