Covid-19 is no excuse for spendthrift policies

26 March 2020
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Global financial markets continue to be hit hard by the Covid-19 coronavirus outbreak.

On Monday US stock markets experienced their third-worst percentage decline on record since the crash of 1929 and Black Monday in 1987.

But, the virus is not the only cause.

Oil prices crashed amid a price war between the Organisation of Petroleum Exporting Countries and Russia, putting further pressure on the US stock market due to its relatively high-cost shale industry.

Adding fuel to the fire, interest rates were already near 5 000-year lows, a sign that the economy had not fully recovered from 2008’s global financial crisis.

Financial markets were already showing signs of stress as the repo market, the US dollar short-term funding market, experienced a rate spike in mid-September, prompting the US Federal Reserve to reactivate its own repo facility, last used in 2008.

These headwinds have found their way to South Africa, as exemplified by the fall in share prices on the JSE.

Central banks in developed countries lowered rates and pumped billions into their economies; the temptation might be very strong for the same to happen here.

Western nations have signalled the intention to follow the loosening of monetary policy.

South Africa cannot do this.

Unlike the 2008 crisis, South Africa enters this crisis with a budget deficit, record low-interest rates, high government debt to GDP and taxes that are so high that the government cannot squeeze any more out of the economy.

Household savings are also in long-term decline.

This combination explains why South Africa cannot pursue a policy of either monetary or fiscal stimulus in response to the Covid-19.

The SA Reserve Bank’s monetary policy committee cut the repo rate by 100 basis points, or one percentage point, from 6.25% to 5.25% on Thursday.

If the central bank lowers interest rates, the cost of government borrowing falls, meaning savers get lower returns.

This discourages saving.

If central banks create a set of incentives that punish savers and reward spending, especially government spending, then the budget deficit would tend to grow because the cost of having that deficit would be low and the principal would be reduced by inflation.

Society would become less able to respond to shocks and invest wisely in the future because of the decrease in savings.

Fiscal and monetary measures need to complement each other.

The traditional conception of a central bank is of an institution that dispassionately reads the economic tea leaves and formulates the best answer regardless of the political situation.

If that were true, politicians would not have created central banks and given them so much power: Control of an entire nation’s money supply.

You cannot engage in deficit spending if borrowing costs are too high; the voter has to bear the tax increases.

If governments think they can somehow inflate their way out of the tax increases, the result can only be a rapid devaluation of the currency in question.

To engage in deficit spending requires capping interest rates for a period of time.

This is not sustainable in the long term.

Eventually, the debt accumulates to the point where no sane investor is willing to accept the artificially low bond yield (interest rate) and the government and its central bank can once again choose between inflation or an honest default.

An honest default requires throwing yourself at the mercy of your creditors, seeking the least bad option for both parties.

Governments are not generally known for their humility.

It is of special importance, therefore, that South Africa does not follow its counterparts in the West by pursuing reckless monetary and fiscal policies.

The ultimate victim of such policies can only be the consumer, through higher prices or an increase in their debt burden.

There is no doubt that this proposal to do nothing except continue on the path of fiscal consolidation, as outlined by Finance Minister Tito Mboweni in the budget, will meet with some criticism.

In moments of panic, prudence looks like madness.

It is critical that we factor into our consideration the state of the economy after the Covid-19 pandemic and whichever form the global financial system assumes in future.

Clarity of thought is crucial in a crisis. South Africa requires leaders that understand that the economy’s long-term health supersedes all other concerns.

If the economy continues to deteriorate, the standard of living will continue to decline, well into the future, for future generations.

The interventions we need right now are to double up on reform, abandon all loss-making, capital-destroying state-owned enterprises and remove regulations that hamper small businesses, which are the most agile first responders to any crisis.

By submitting a special bill in Parliament, a greater cut in spending could be introduced – the objective being to attain a budget surplus as soon as possible in these uncertain times.

The central bank needs to either keep interest rates unchanged or adjust them upwards to encourage saving as well as to give those who are panicking somewhere safe to put their money.

Some central banks around the world have been buying an increasing quantity of gold in the past few years; in fact, central banks are now net buyers of gold after being net sellers for many years.

This reflects the uncertain world in which we live and is a prudent step to safeguard the monetary system.

Unfortunately, the SA Reserve Bank has not been doing the same, with gold reserves as a percentage of foreign reserves falling from 24.7% in the fourth quarter of 2002 to 11.1% in the fourth quarter last year, according to the World Gold Council.

In the same period, Russian gold reserves as a percentage of foreign reserves increased from 8.9% to 19.9%.

The last thing this economy needs is reckless action in response to Covid-19.

True leadership includes discernment, calm thought and action.

It includes, above all, an overriding concern for the future.

This article was first published on City Press on 19 March 2020

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