The Great South African Bubble
A recentarticle in Forbes caused a stir. The piece was entitle “A Guide to South Africa’s Economic Bubble and Coming Crisis”. The article lays out the economic case that current South African economic growth is illusory: fuelled by ‘hot money’ and a resulting credit bubble that is ready to pop.
It is argued that a global economic environment of low interest rates has resulted in the necessary economic distortions to drive this massive credit bubble.
Interest rates should represent the price of savings in an economy. People either save or spend their earnings. What isn’t spent is saved. Those savings are held in a bank or savings institution. The bank then offers those savings to borrowers who need capital to build businesses and fuel real economic growth.
When savings are low, interest rates are high: as borrowers compete for the limited savings. If savings are plentiful, interest rates are low: as borrowers compete for a relatively large pool of funds. So interest rates are a function of the amount of savings in the economy and the demand for them. This is the usual case in an economy with a sound monetary unit of account.
When there is a central bank this can become very distorted, very quickly. By printing money the central bank can fool the economy into believing more savings are available than actually exist. This sends all kinds of incorrect signals to the marketplace. Interest rates go unnaturally low as the market judges there to be plenty of savings available for investment.
However, these are not real savings, just printed money. So the end result is simply inflation. Prices rise as the fake savings flow through the economy. This money can cause asset inflation in unpredictable sectors of the economy, as the economy receives false signals about savings.
According to Forbes this is where the South African economy finds itself.
Forbes argues that major global players like the US printed too much of their own currencies, in a quest to keep interest rates lower than they otherwise would be. The economy received the false signal of excess savings. The price of savings (interest rates) dipped to unnatural lows: all very predictable according to theory.
Investors all over the world have borrowed this ‘cheap money’. In search of high returns they have sent it into emerging markets like South Africa.
South African Government bonds in particular have been the recipients, providing plenty of cheap borrowing for the S. African Government. They have spent this borrowed money on infrastructure projects. Government never spends money efficiently, as it has no profit motive.
The South African Government has gone into debt. Yet the output from this debt spending has provided no real economic growth. This should always be expected of government spending.
In the years following 2008 interest rates across the South African economy decreased substantially, in a cascading effect. The banks now had an excess of ‘cheap money’ for everyone. They started predatory lending practices, similar to the subprime mortgage lending practices of the US, pre-economic crisis.
The predatory lending unique to South Africa has its own flavour. It has been uniquely aggressive. The borrowed funds found their way into the housing market, as is so often the case. Real estate prices rise and there is a wealth effect that has everyone feeling high for a while. Of course, it is only inflation fuelled asset appreciation and there is no increase in the real underlying value of the assets themselves.
Forbes argues that the entire economy is now dependent on ‘cheap money': a vicious addiction. Like heroin, it takes ever-increasing dosages to have the same effect and the need is eternal. Of course, interest rates cannot stay low forever. The ‘cheap money’ will become expensive again.
As printed money flows globally, seeking increasing returns, it distorts economies. This is exactly how the Iceland story played out. Forbes argues the same is happening in emerging markets like South Africa at the moment. It is all playing out in a perverse Déjà Vu.
The laws of economics, like the laws of physics, are immutable. Savings cannot be faked. They are the denominated evidence of human sacrifice. When we save we are forgoing present consumption so that future generations can live better.
Savings are the ultimate representation of what it means to be human: they separate us from all other mammals. The idea that you can print human sacrifice at no cost is ludicrous. That is only inflation, and you should only expect the social ills that come with debasement.