• Sharebar
Economy
Friday, June 1, 2007
Chain of events

Why our economy is where it is today might be simply explained by the following chain of events:
• Low inflation rates worldwide have allowed for low interest rates.
• Low interest rates have fed the strong demand for credit.
• Cheap credit has afforded access to cheap capital
• Cheap capital has allowed businesses globally to invest in better and more productive capacity.
• Larger production (higher consumer demand) has increased employment and reduced unit costs of production (so goods are more plentiful and cheaper).
• Returns on capital have been very good, easily able to beat the lower rates of inflation (investing in shares is better than leaving your cash to wallow in a deposit account).
• Equities have boomed with rising capital values; dividends have remained strong because business has been good.

This surely demonstrates that low interest rates must be good for growth. And we don’t want the opposite!

Shaun le Roux of Alphen Asset Management notes that, “The textbooks will tell you that such surges in demand for credit usually show up in increases in the cost of labour and general consumer price inflation.
“Yet to date, consumer price inflation around the world has been remarkably benign and the transmission mechanisms that usually see strong consumer demand, rampant asset prices and tight labour markets spill over to higher consumer prices have not been true to form.”
He suggests the reason for this is that the economic forces of globalisation; higher productivity; the emergence of a low-wage labour market in the East; and a glut in global savings have conspired to keep inflation low and rates suppressed.
However, he thinks that may all be about to change. Some of the warning signs, he says, that consumer inflation may be turning upwards include:
• Surging food prices;
• Extremely high commodity prices, especially metals that are driving producer prices skywards;
• High fuel costs feeding through to transport and distribution of products;
• A global shortage in skills, which when combined with tight labour markets imply pressure on wages;
• Factory capacity levels are at their highest level in decades as a result of a combination of under-investment in capacity expansion over recent years and surging demand; and, finally, the China question:
• Higher consumer prices there will drive workers to raise the cost of their labour and ultimately put further pressure on the Chinese yuan to strengthen, and this would raise the cost of Chinese exports, exporting inflation to the rest of the world.

Of course, this clutch of ‘signs’ would essentially drive demand down for commodities, oil, skills and so on, though a lot less so for food – without any need to change interest rates. Which begs the question, why should the South African authorities be threatening to raise interest rates further? A high cost of borrowing seriously damages any economy. One reason being that it changes the price of something you have already bought: ie a bank loan or a mortgage bond. Instead, a change in the price of goods, and in particular of oil, are far more effective arbiters of supply and demand. 
The authorities should do far more toward aggressively asserting the need to import large amounts of skills to this country so they can start reducing the infrastructural bottlenecks. As it is, interest rates in this country are still too high! By Nigel Benetton
 

Copyright © Insurance Times and Investments® Vol:20.5 1st June, 2007
680 views, page last viewed on April 7, 2020