SANE Views

Vol.3 No.4, 31 January 2003

Interest Rates and Inflation

Herewith a submission by SANE Views reader Paul Malherbe, author of the book "A Pragmatic Approach to the Creation of Prosperity". He sent us this spoof which exposes the illogic of using interest rates to control inflation and protect the rand. Let us hear how Malherbe's Banker explains it to Koos van der Merwe.

Aart Roukens de Lange,
Editor, SANE Views

INTEREST RATE AND INFLATION (For the uninitiated)
by Paul Malherbe

Van: I am puzzled. I am told that Tito Mboweni has increased the bank rate by 3 percentage points in order to fight inflation. But this has made things far more expensive for me. I now have to pay R12000 per year more in bond interest, so I have had to cancel all charity giving and I now also ignore beggars. I also understand that as farmers are heavily indebted they will now either go bankrupt or have to charge more for food. And I hear that small businesses are also going bankrupt, so how does all this lead to less inflation?

Banker: Well, you see, the IMF has provided us with a new religion and it has Tito enthralled. You must know what happens when somebody gets religion and you must also realise that new converts are the most enthusiastic believers of all.

Van: But what is the theory behind this religion?

Banker: It is quite simple. When you have money in your pocket you will spend it, thereby increasing the demand for goods, and when demand increases, prices go up, and that is inflation.

Van: But surely, as I pay more in interest the money is just transferred from my pocket to somebody else's.

Banker: Sure, the bank gets the increased interest. And it will also get deposits from the very rich international speculators who have plenty of money to lend to the banks when our interest rates are high. Tito also believes the bankers are much wiser than you in how money should be spent.

Van: Do you really believe that?

Banker: No, there is no proof of that, but with religion you rely on faith, and to ask for proof may be regarded as tempting God, and that would be a great sin.

Van: I thought that there is a difference between cost-push inflation and demand-pull inflation. What do we have here?

Banker: Yes, there is a difference. What we have here is cost-push, created by events outside the country. Demand-pull is when there is too much money chasing too few goods, in other words, goods are in short supply.

Van: So what goods are in short supply?

Banker: No, nothing other than housing and money itself. As long as you have money you can buy anything in South Africa. As I said, our inflation is cost-push, not demand- pull.

Van: I think I am beginning to understand. Taking money out of the people's pockets means that they will have less to spend so prices will come down?

Banker: Not directly, because as we have noted, food costs will rise. But lots of hot money will come into our banks as the big foreign speculators will cash in on the high interest rates, and the rand will become worth more in terms of foreign currency. So when these speculators take their hot money out of the country they will get more dollars for it than they had to pay for rands in the first place. And then the value of the rand will drop again.

Van: Is that good for South Africa? Does it create jobs? And does it help the housing shortage?

Banker: Who is talking about job creation and housing? That is not Tito's brief. He is expected to follow the IMF religion on fighting inflation. Also, his religion does not allow him to distinguish between the two forms of inflation. So, in his book, what is good for demand-pull is also good for cost-push. As far as housing is concerned, bonds will be much more costly. So people will have to think in terms of very small houses, and that is excellent for character building.

Van: But I thought that a recent survey showed that the overwhelming majority of South Africans of all groups regard joblessness as our most serious problem.

Banker: Possibly so, but you are talking about popular opinion, and it is very dangerous to rely on a populist approach. It is far better to talk about what is best for people rather than to rely on what is popular. Tito knows far better what is good for people than they can possibly know themselves.

Van: So do all countries subscribe to this new religion?

Banker: No, not all. China, South Korea and Malaysia sent the IMF packing and did things their own way. It was Russia and Thailand that accepted the IMF religion. They also raised interest rates and allowed hot money to go in and out as it pleased.

Van: And what was the result?

Banker: Russia and Thailand ended up with huge negative growth and unemployment. China, South Korea and Malaysia have very successfully survived the Asian financial crisis and now have strong economic growth with many new jobs.

Van: Then why do we follow the IMF's advice on interest rates?

Banker: Sorry, but I told you that there is no point in arguing about religion. What you need is faith in the infallibility of the truly converted. The IMF religion is every bit as valid as a religion that preaches that it is possible to make the sun stand still, create the whole universe in 6 days and part the waters of the sea by waving a stick at it. And if you can believe that, surely it is not expecting too much to have you believe in the religion of Tito and the IMF. In any case one should not just focus on what is around the nearest corner. How do you know that Russia won't be far better off than other countries in a hundred years' time? Get with it, Van! Have faith!

Van: I think you have just turned me into a convicted atheist! I hate to think what the dominee will say.