I have often said that when America gets a cold the rest of the world sneezes in response. What has happened in the global economy in recent times is a result of America having pneumonia. It seems as if the sickness in the air of the world economy has given everyone a running nose and perhaps even a blue eye.

Well let us understand the cause of the collapse without getting too technical.  Too much credit was pumped into the whole economic system as a result sustained and very low interest rates. Thanks (or no thanks) to the interconnectedness of the modern investment world, this was not isolated but was inherently global.

When interest rates fall below the rate of inflation, the result is that risk becomes incorrectly priced. The average person overextended themselves because their debt repayment was in effect cheaper than the appreciation in (lets say) their house. So what happens when house prices come right down? You guessed it- people are overextended and cannot sell their house to pay off the debt that they have used their house to secure. And the sub-prime crisis ‘begins’…

Back home, the middle class was probably hit hardest through this slump. As they traveled the spiral downward they were getting their heads bumped from both sides- sitting with a tax burden but not enjoying fiscal expenditure. Retail sales fell sharply and thanks to this – as well as a bit of dumping of stock for below market prices to alleviate cash flow problems- inflation has become less of a concern for the Monetary Policy Committee.

The sad reality is that in South Africa we have had 3 decades of declining savings rates. That is not surprising when you consider how little incentive / compensation has been on offer for the savers. Even now, those with money in the bank wear a frown almost as big as the rest of our smiles every time the MPC decides to cut rates in the hope of stimulating an economy now in technical recession.

SO the question becomes: What gets done to solve the plethora of problems these causal relationships create? Well 3 things have been done and I will touch on each briefly:

1. Throw money at the problem. In the last 18 months an amount almost equivalent to half of the global GDP has been spent (thrown) at failing companies in the hope to keep sentiment and confidence from dissolving altogether. And of course to protect from job losses too. I fear this has not solved the problem- perhaps only postponed it. The majority of this expenditure has been on banks- and they lie at the end of the value chain, not at the beginning.

2. Slash interest rates to the bone. We touched on this already. In the hope of providing stimulation, savers are crippled.

3. And lastly money is raised by printing it. You can always print money but you can’t always give it value. The dollar has survived and kept strength mainly due to it being the ‘run-to’ currency in volatile markets. I will be interested to see what future the dollar has now that investors seem to be feeling more at ease in emerging markets again.

SARB lowers rate by 100 basis points. Tito Mboweni warns that this will very likely be the last of the rate cuts. COSATU says that the SARB is being greedy by cutting rates by so little when a bigger rate cut could be tolerated at this stage. COSATU has a point but what a rate cut does it to shift money from your savers to those who are in debt. The majority of South Africans are facing debt and so a rate cut is good news to them- but the granny who has her life savings earning less interest now also has to be considered in these matters. Monetary policy cannot cater for one type of person alone.

More than looking to the cut in interst rate alone to provide the necessary injection into an economy now in technical recession, other factors such as productivity and investment also need to be considered.

One interesting thing to note is that the Rand has gone from strength to strength since the beginning of the rate cutting cycle. When the Reserve Bank started cutting rates the Rand was at over 10:1 to the US Dollar. It is now sitting at below 8:1. This goes directly against exchange rate theory which  does not apply too neatly to emerging market environments. Most capital investment into South Africa is growth seeking capital and not yield seeking. And growth seeking capital enjoys a lower interest rate.

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