Has the future just grown bleaker? A view from South Africa

So far 2008 hasn't proven itself to be a very friendly and happy year. Political turmoil in South Africa with a government that seems to have lost direction. Soaring inflation fuelled by ever increasing oil and food prices seems to have taken root. Higher interest rates biting deep into the pockets of anyone with a home-loan, car loan, an overdraft or credit-card debt. And then there is the electricity crisis.

And now, to cap it all, we have a wave of xenophobia sweeping the land. The army has been called in to help the police retain control.

Could we ask for anything more?

There is little hope of a lower oil price. Even though we use Sasol to a large extent, the price is tied to the international oil price. Every increase in the price of a barrel of the real thing puts a smile on every Sasol shareholder and of course a happier bank balance. What is to blame for the sharply rising prices? Perhaps in part it is the realisation that oil supplies will not last all that much longer - so make as much as you can right now. The massive growth of the Chinese economy and especially can take part of the blame. Demand for oil has never been higher. As the Chinese economy grows so to does its demand for oil driven cars and electricity.

The world has been very slow in seeking out alternatives to fossil fuels. Solar energy is ideal for South Africa but with an abundance of coal why bother with solar power? The motor industry has made some progress towards oil alternatives, but not much. With buzz-words like 'think out of the box' people generally stick with what they know. Why reinvent the wheel?

The fuel crisis has also led to the current world-wide food crisis. Agriculture has turned away from producing food to producing fuel. Bio-energy has reduced the food producing capacity of the planet. At least part of the blame must lie with the US government that has provided huge subsidies to produce fuel instead of food.

But there is a glimmer of hope for South Africa. A return to democracy in Zimbabwe will give us a boost and boost the entire region. The 2010 Fifa World Cup provides massive opportunities for growth and economic development.

The main obstacles are to restore order in the country. The government must find ways to deal effectively with the refugee crisis and those that have taken on racist and xenophobic activities. The reserve bank must think twice before adding to the interest burden of the country. And we must refocus our energy on renewable sources.

The cost of money in the South African economy revisited

I am not an economist and make no claims to be one. I have an understanding of some elements of economic theory. I also believe that the policy of inflation targeting is generally correct.

In an earlier blog I suggested that high interest rates can in themselves be inflationary. Perhaps there is a point at which raising interest rates becomes counter productive.

I do understand that imported inflation fuels local inflation. Pressure is placed on suppliers to pass on the costs. Reducing aggregate demand by raising interest rates will reduce the inflationary pressure. The laws of supply and demand apply. The recent property boom was slowed dramatically by increasing rates. House prices have stabilised and perhaps even fallen as a result.

Higher interest rates also serve to make the local currency more attractive to foreign investors. This helps to strengthen the currency thereby reducing the extent and impact of imported inflation.

Under a previous governor of the Reserve Bank many years ago, interest rates soared to about 26% in a futile effort to calm inflation. It didn’t work. Is there a point at which high interest rates actually become inflationary? When the rate of interest becomes a significant cost factor can it contribute towards cost-push type inflation?

Another observation is that when we see interest rate changes in the US, these are usually in steps of 25 basis points. Our interest rate adjustments have all been at 50 basis points. Perhaps we should adapt a more cautious approach?

BM