Vol.3 No.20, 07 June 2003

The Danger of High Interest Rates

By Paul Malherbe

June 2003

Earlier this year it was in this column (SV3#4) that I questioned the use of high interest rates as a means of fighting inflation. In particular, I pointed out that apart from the economic uncertainty caused by the manipulation of interest rates, it did nothing for job creation, nor for the curbing of inflation. On the contrary, rents increased all round and competition was reduced as many small businesses failed. Now that the rand is once again losing its value against other currencies in expectation of an interest rate drop, it is appropriate to consider what has happened since mortgage rates were increased a year ago from 13% to 17%. Home owners immediately suffered a substantial increase in their cost of living. A family with a R400 000 bond incurred an interest cost increase of over R1300 per month. It has moreover been said that 75% of South Africans cannot afford to own their own homes. This is of course based on the outrageous assumption that 17% is an acceptable mortgage rate. It is usurious and extortionate, and it entrenches the disparity between rich and poor.

As expected, foreign speculators bought billions of rands, getting ten for each dollar as they cashed in on our high interest rates. Messrs Erwin and Manuel joined Mr Mboweni in self-praise at the WEF meeting in Davos over how well our currency had strengthened as a result of hot money flowing into the country. They happily ignored the fact that they had made home ownership impossible for most and that joblessness was as bad as ever. The increased payments like the R1300 per month for a middle class family had an impact really no different to that of theft. While the immediate beneficiaries from this loss were the banks, it ultimately went into the pockets of those rich foreigners who had poured their hot money into the country. And now that they are pulling their money out, they also enjoy a huge capital gain! And what a wonderful windfall it has been for them. Just think of it. How would you like to exchange a thousand dollars for ten thousand rand and a few months later exchange that ten thousand rand for 1250 dollars, plus earning an interest rate of 17% on top of it! Unfortunately that opportunity is not open to us, but only to foreign speculators who are benefiting at the expense of South African home owners. And it has all been deliberately engineered by the Governor of the Reserve Bank, Tito Mboweni, while our ministers sing his praises.

The theory is, of course, that to fight inflation you reduce the money supply, and the International Monetary Fund prescription so religiously followed by the Reserve Bank and many others is through increasing interest rates. But, as shown above, it makes life more expensive for many and puts our wealth into the pockets of foreigners. There is no reason why South Africans should be robbed of their hard-earned cash in this way. The manipulation of interest rates encourages speculation and does nothing for fixed investment. What I am suggesting is limiting mortgage rates to a maximum of something like 8%, which would do wonders for home ownership and for economic growth. And if a case develops for reducing the money supply, do it by the way of a loan levy percentage surcharge on income tax. This has four significant advantages over higher interest rates: what you pay is not "up front", as is the case with higher interest rates. You only pay a percentage of what you earn, not before you earn anything at all. Secondly, you don t lose title to what you have paid. You get it all back, plus interest, after about five years or so. In any event, South Africans are often accused of not saving enough, but then who can afford to save in the face of being robbed of so many thousands of rands as a consequence of high interest rates? Thirdly, the poor would not be penalised as they don t pay income tax anyway. Fourthly, a cut in the mortgage rate to 8% makes home ownership a possibility for thousands earning R4000 per month for whom a R60 000 house would amount to only one and a quarter year s income. This compares extremely favourably with international norms of four to six years income.

Another leg of IMF theory is that the inflow of cash resulting from high interest protects the exchange value of the rand. But if the inflow is the result of hot money rather than fixed investment, this protection will only last as long as we are penalised with these high interest rates, which is surely unacceptable. What we need is an environment attractive to fixed foreign investment. It will be recalled that when the rand crashed in the wake of P W Botha s infamous Rubicon speech, the government did something which helped, but which was certainly not among the prescriptions of the IMFs religion. It instituted the financial rand as a temporary measure. It meant that South Africans were more restricted in how many commercial rands they could spend outside the country than they are now. At the same time the cheaper and freely available financial rand greatly increased the incentive for fixed investments by foreigners. For those who would argue that going back to the financial rand would be a retrograde step in the light of the prevailing philosophy of maximum economic freedom I would point out that there is precious little economic freedom for our 40% unemployed. What s more, precisely because they are unemployed we have a high crime rate, which is a hugely negative factor for foreigners.

There also is the argument that the dual exchange rate enables unscrupulous people illegally to acquire commercial rands through the financial rand route, which is known as "round-tripping". Apart from such offenders being liable to criminal prosecution, it seems most unlikely that it could possibly be on a scale to rival the present legal round-tripping made possible by the wide fluctuations in exchange rates.

We should also bear in mind that the IMF s prescriptions have a very poor record of success. This is highlighted in an important book published last year under the authorship of Joseph E Stiglitz, "Globalization and its Discontents". Stiglitz, being a former Chief Economist of the World Bank, is obviously in a position to know. He shows most convincingly that those Asian nations that recovered most quickly from the 1997 crisis were precisely those that rejected the IMF s prescriptions of high interest rates and total freedom of international exchange. Our leaders should appreciate that with our high unemployment rate we are in a state of crisis. We just cannot afford to do otherwise than to regard the conquest of unemployment as our highest priority. ALL ethnic groups regard it as our biggest need. And if we have to ditch the IMF s prescriptions in order to succeed, so be it. But to continue making a fetish of high interest rates as the only way of fighting inflation and preserve the value of our currency is totally irresponsible. We are not a First World country, and should not pretend that we can afford to expose our economy to the same extent as that of the United States or Western Europe. This most certainly is not the way that a country like South Korea succeeded far better than South Africa in developing a really strong economy. Nor is it the way that China followed in reducing its percentage of poor people so impressively.

All parliamentary parties are evidently in favour of job creation. However, in view of the deafening silence on the question of high interest rates, it appears that they are no more able to see its connection with joblessness than our President is able to see the connection between HIV and AIDS.

On the contrary, rents increased all round and competition was reduced as many small businesses failed. Now that the rand is once again losing its value against other currencies in expectation of an interest rate drop, it is appropriate to consider what has happened since mortgage rates were increased a year ago from 13% to 17%. Home owners immediately suffered a substantial increase in their cost of living. A family with a R400 000 bond incurred an interest cost increase of over R1300 per month. It has moreover been said that 75% of South Africans cannot afford to own their own homes. This is of course based on the outrageous assumption that 17% is an acceptable mortgage rate. It is usurious and extortionate, and it entrenches the disparity between rich and poor.

As expected, foreign speculators bought billions of rands, getting ten for each dollar as they cashed in on our high interest rates. Messrs Erwin and Manuel joined Mr Mboweni in self-praise at the WEF meeting in Davos over how well our currency had strengthened as a result of hot money flowing into the country. They happily ignored the fact that they had made home ownership impossible for most and that joblessness was as bad as ever. The increased payments like the R1300 per month for a middle class family had an impact really no different to that of theft. While the immediate beneficiaries from this loss were the banks, it ultimately went into the pockets of those rich foreigners who had poured their hot money into the country. And now that they are pulling their money out, they also enjoy a huge capital gain! And what a wonderful windfall it has been for them. Just think of it. How would you like to exchange a thousand dollars for ten thousand rand and a few months later exchange that ten thousand rand for 1250 dollars, plus earning an interest rate of 17% on top of it! Unfortunately that opportunity is not open to us, but only to foreign speculators who are benefiting at the expense of South African home owners. And it has all been deliberately engineered by the Governor of the Reserve Bank, Tito Mboweni, while our ministers sing his praises.

The theory is, of course, that to fight inflation you reduce the money supply, and the International Monetary Fund prescription so religiously followed by the Reserve Bank and many others is through increasing interest rates. But, as shown above, it makes life more expensive for many and puts our wealth into the pockets of foreigners. There is no reason why South Africans should be robbed of their hard-earned cash in this way. The manipulation of interest rates encourages speculation and does nothing for fixed investment. What I am suggesting is limiting mortgage rates to a maximum of something like 8%, which would do wonders for home ownership and for economic growth. And if a case develops for reducing the money supply, do it by the way of a loan levy percentage surcharge on income tax. This has four significant advantages over higher interest rates: what you pay is not "up front", as is the case with higher interest rates. You only pay a percentage of what you earn, not before you earn anything at all. Secondly, you don t lose title to what you have paid. You get it all back, plus interest, after about five years or so. In any event, South Africans are often accused of not saving enough, but then who can afford to save in the face of being robbed of so many thousands of rands as a consequence of high interest rates? Thirdly, the poor would not be penalised as they don t pay income tax anyway. Fourthly, a cut in the mortgage rate to 8% makes home ownership a possibility for thousands earning R4000 per month for whom a R60 000 house would amount to only one and a quarter year s income. This compares extremely favourably with international norms of four to six years income.

Another leg of IMF theory is that the inflow of cash resulting from high interest protects the exchange value of the rand. But if the inflow is the result of hot money rather than fixed investment, this protection will only last as long as we are penalised with these high interest rates, which is surely unacceptable. What we need is an environment attractive to fixed foreign investment. It will be recalled that when the rand crashed in the wake of P W Botha s infamous Rubicon speech, the government did something which helped, but which was certainly not among the prescriptions of the IMF s religion. It instituted the financial rand as a temporary measure. It meant that South Africans were more restricted in how many commercial rands they could spend outside the country than they are now. At the same time the cheaper and freely available financial rand greatly increased the incentive for fixed investments by foreigners. For those who would argue that going back to the financial rand would be a retrograde step in the light of the prevailing philosophy of maximum economic freedom I would point out that there is precious little economic freedom for our 40% unemployed. What s more, precisely because they are unemployed we have a high crime rate, which is a hugely negative factor for foreigners.

There also is the argument that the dual exchange rate enables unscrupulous people illegally to acquire commercial rands through the financial rand route, which is known as "round-tripping". Apart from such offenders being liable to criminal prosecution, it seems most unlikely that it could possibly be on a scale to rival the present legal round-tripping made possible by the wide fluctuations in exchange rates.

We should also bear in mind that the IMF s prescriptions have a very poor record of success. This is highlighted in an important book published last year under the authorship of Joseph E Stiglitz, "Globalization and its Discontents". Stiglitz, being a former Chief Economist of the World Bank, is obviously in a position to know. He shows most convincingly that those Asian nations that recovered most quickly from the 1997 crisis were precisely those that rejected the IMF s prescriptions of high interest rates and total freedom of international exchange. Our leaders should appreciate that with our high unemployment rate we are in a state of crisis. We just cannot afford to do otherwise than to regard the conquest of unemployment as our highest priority. ALL ethnic groups regard it as our biggest need. And if we have to ditch the IMF s prescriptions in order to succeed, so be it. But to continue making a fetish of high interest rates as the only way of fighting inflation and preserve the value of our currency is totally irresponsible. We are not a First World country, and should not pretend that we can afford to expose our economy to the same extent as that of the United States or Western Europe. This most certainly is not the way that a country like South Korea succeeded far better than South Africa in developing a really strong economy. Nor is it the way that China followed in reducing its percentage of poor people so impressively.

All parliamentary parties are evidently in favour of job creation. However, in view of the deafening silence on the question of high interest rates, it appears that they are no more able to see its connection with joblessness than our President is able to see the connection between HIV and AIDS.

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