This article was first published by the Business Day on 25 January 2023
The other side of the inflation coin
The worst evil a government can impose on its people is inflation. It takes money straight out of the pockets of savers who believe they are diligently planning for their future. It distorts markets, creates inequality and ruins lives. But almost as bad as inflation is the misunderstanding of how it comes about.
In 2022 a number of theories were advanced in the media to explain the causes of global inflation. It was the conflict in Russia; cost-push from the oil price; a tight labour market; or supply issues from China. Notably absent was plain old monetary theory, which says if you print more money prices will be affected.
The theory says money is everything, and like everything it has a value based on supply and demand. However, since money is the standard by which we measure everything else, things can appear to be upside-down. Prices decrease when there is increased demand for money. In contrast, when there is less demand for money (and greater demand for goods), prices rise.
What is perennially under-appreciated and generally ignored is the frequent and constant inflation of the money supply by governments and their central banks. Since 2008 these institutions have printed a fresh 5-trillion in new currency worldwide. They acquired every imaginable debt issue on the market in an effort to manipulate interest rates to ever-lower (and ultimately negative) levels.
While the US Federal Reserve extended this to private debt, for the most part central banks bought sovereign debt, which governments were more than happy to issue. The Austrian government was even able to issue a 100-year bond at 0.88%. The US national debt now stands at a staggering $31.5-trillion.
According to monetary theory, central banks are directly responsible for inflation. The term "accommodative" refers to interest rates kept below the rate at which the market would settle. This wiggly term means a government’s central bank is printing money and buying bonds faster than the economy needs it.
Our Reserve Bank acknowledged artificially low interest rates were a contributing factor to inflation when, in last year’s September statement, it spoke of "sustained policy accommodation”. In November it further acknowledged that what had come before was undoubtedly abnormal because now, "policy normalisation has accelerated”.
The reality is we now live in a world of rising prices as a result of governments pulling tomorrow’s consumption into today’s electoral cycle. This places an ever-increasing burden on the children of the world’s taxpayers.
Waning purchasing power
One problem with the way inflation is presented to the public is as a rising index. It implies prices are increasing, instead of conveying what’s really happening — purchasing power is declining. How different it would be if the media were to reverse the published inflation figure, converting it from an increasing index to one subtracted from a starting base. Where the current consumer price index is measured incrementally by the level of inflation each month, what if we were to go in the opposite direction?
Every month we would see how much less the rand will buy by subtracting the inflation rate from the index’s shrinking value. For SA, if we were to begin our index at 100 in January 2000, by December 2022 it would read 26.75. Put another way, today each rand can buy only 27% of what it was able to buy in 2000 because the currency’s purchasing power has deflated by 73%. Now that’s a headline that would grab the public’s attention!
Section 224(1) of our constitution says the “primary object of the SA Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth”. Given the drop in purchasing power over the past 20 years and the limited economic growth, I would say it has (criminally?) failed in its duty. Imagine if we had had 0% inflation and 5% growth, instead of the other way around!
Reserve Bank governor Lesetja Kganyago has stated the bank’s explicit devaluing aim is to move from a targeted inflation rate of 2% to something approaching 4%. Supposing the Bank can even get to this low rate given today’s “accommodative” policy, our decreasing index would still reach 12.8 by 2040, implying you could buy less than 13% of what you would have in 2000 with the same rand.
Slowing, not falling
Talking about inflation “peaking” or “flattening out” is another misleading habit of the media and central bankers. Inflation is a number representing a percentage change. To say the change is slowing is to talk about the second differential. When a journalist says inflation is “down” this month because it has moved from 7.5% to 7.4% it conceals the fact that the inflation increase has slowed down, not that prices have fallen.
Other theories of inflation fall short of explaining why prices don’t go down when the variables they cite as causes return to normal. When a war is over, supply chains are rebuilt or the labour market becomes more balanced, why don’t prices return to where they were before the crisis? This one fact should prompt people to check their priors. Only monetary theory explains why, if the supply of money has been increased, all else being equal, purchasing power will be at a new and lower level.
In a market economy every decision — whether to buy, save or invest — relies on knowing how much something costs. However, this foundation is undermined when governments corrupt the unit of account. The past 14 years have been witness to an unprecedented experiment in clipping the national coin, better known as “accommodative monetary policy”.
At low interest rates there is no incentive to save. With no saving there is no capital formation and without capital we do not get growth. When central banks manipulate the money supply to the degree they have, people have to constantly recalculate their assessment of value.
History shows this calculation is difficult and that mistakes get made. What follows is recession, unemployment and ruin.