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Tuesday, July 1, 2008
Please, not another guru

I can’t believe Alan Greenspan when he says we need to increase interest rates to control inflation. What does he know? He’s the previous US Federal Reserve Bank chief who enjoyed celebrity status, not because he was necessarily good (perhaps he was), but because he presided over good economic times. Of course no one can say for sure whether any of his policies might in any way be implicated in the current US meltdown (see below, his remarks at a 2004 conference). Maybe it is a cyclical thing; then again, one has to ask, how was it the sub prime market could (so far) dump one in five American homes into debt default territory as a result of borrowing when Greensplat was in charge of the banking system?
Meanwhile his new incumbent, Bernanke, is reducing US interest rates to control inflation. Indeed, rates have so far been slashed seven times. Hello? Anyone taking notes here?
Greensplat wants Mboweni to increase rates to control inflation. So far Tito’s done it five times. It doesn’t make sense.
I’ve written before on the fact that interest rates are the cost of money. Put the price of money up you contribute to inflation, not reduce it. Home loan rates in South Africa, for example, have now gone up about 36% since June 2006. You need to be brain dead if you think this won’t filter through to other prices.
The cost of money is different to, say, the cost of a television set, or a motor car. The last two items you can decide not to buy if the price goes up too much; a loan, on the other hand, well that’s just the point, each month you have to keep buying it. Unless you can repay your R500 000 bond back overnight (like maybe one in a million people), you ain’t got much choice: you have to go on buying it every time the price goes up.
I don’t know where the theory comes from that increasing interest rates reduces borrowing; it will work over, say, a two or three year period – provided all other things remain equal. But in the interim it kills everyone off.
Fuel has gone up 34% since the beginning of this year (diesel by 28%); and electricity is going up significantly – in Cape Town by around 35%. Other administered prices are adding to the assault on the consumer. Monopolies are at it as well. Steel has gone up 65% since the start of this year. It’s no surprise the producer price index has reached 16,4% year-on-year. Food is officially around 17% up on the year, though it is probably higher. The official inflation rate is just shy of 12% as at May 2008, but it excludes home loan repayments. Incidentally, Stats SA now wants to reduce the weightings of food and fuel, to reduce the ‘official inflation rate’! This at a time when people are spending more of their household budget on those items. Why don’t they just exclude fuel and food as well, and ignore the problem completely.
With such an assault on the household budget, how on earth can anyone find spare cash to repay debt? The answer is, they can’t. All South Africa’s monetary policy is doing is causing a rising unemployment, disrupting the housing market and upping crime.
On 23rd February 2004, in an address to the Credit Union National Association in Washington, Alan Greenspan suggested that more homeowners should consider taking out Adjustable Rate Mortgages (ARMs) where the interest rate adjusts itself to the current interest in the market (the common system in SA). The fed’s own funds rate was at an all-time-low of 1% at the time. A few months after his recommendation, Greenspan began raising interest rates that would eventually bring the funds rate to 5.25% about two years later.
Greenspan’s recommendation therefore came at a time when interest rates bottomed out making it a particularly bad time to take out an ARM. A triggering factor in the 2007 subprime mortgage financial crisis is believed to be the many subprime ARMs that reset at much higher interest rates than the borrower was paying during the first few years of the mortgage.
So I really think we should ignore Alan Greenspan. Why can’t we do what Ben Shalom Bernanke is doing instead? By Nigel Benetton, Insurance Times & Investments

Copyright © Insurance Times and Investments® Vol:21.6 1st July, 2008
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