Thursday, April 17, 2008

Financial Stability not Profligacy

[Not having] a savings culture, we were tempted into large external imbalances. Although comfortably funded [by outside investment inflows], we became alarmingly concerned about the implied risks, remembering our own 2001. What if the world lost interest in us, turning on us because of our profligate ways and indiscipline?

What price would we pay if capital were to be suddenly withheld, the Rand going into cardiac arrest but instead of inflation exploding (as in 1985, 2002) and abruptly higher interest rates calling us to account? It in fact happened again to Iceland this year.

Such anxieties have already these past two years induced us to make domestic changes, reining back consumption through higher interest rates, fiscal surplus and new national credit act. But instead of an external 'sudden stop' ambushing us, abruptly withholding access to foreign capital, which didn't happen, the global windfalls did carry yet another form of toxicity.

Higher commodity prices became carriers of a virulent inflation virus. The consequences are most unpleasant.

Our CPIX inflation has exploded from 3.5% to 9.5%, with a peak nearer 12.5% imminent. Two-thirds of this rise can be blamed on global oil and food prices. Also, on the weaker Rand (its weakness partly reflecting global risk aversion as banking crises hit, and our own uncontrolled appetites through trade and savings shortfalls).
The other one-third inflation rise is an own goal, mainly electricity linked. Only minimally so far have our labour and businesses sinned.

But such sinning may become problematic. We try defending ourselves against the impoverishment implied by the windfall toxicity, having to pay steeply more for oil, food, imports and electricity, outpacing our current price and salary structures. Thus we stand ready to raise our inflation expectations and wage and price demands.

This compels the SARB to raise interest rates yet again, trying to contain such urges. We should accept that windfall toxicity impoverishes us and that we should adjust our spending and saving, importing and exporting, rather than making greater inflation demands in a forlorn attempt to square the circle.

Wage-price spirals don't solve anything. Indeed they only make things worse. Thus more rather than less discipline.

This quote comes from Cees Bruggemans’ email newsletter; he is Chief Economist at First National Bank. In his most recent letter he puts forward the dangers inherent in high commodity prices for us South Africans because of our particular national weaknesses i.e. high spending and no saving. In other words ‘eat drink and be merry’ but we leave out the ‘and tomorrow we die’ bit because we do not want to die, who does? So when the financial crunch comes in higher interest rates etc we start agitating for higher wages and other inflationary actions without stopping to look at our contribution to the problem.

National financial discipline, rather than financial profligacy, is a cornerstone of a successful society and we all want South Africa to be a successful society. Such discipline must start with the individual and spread out from there to embrace all of society. It must also be evident in the life styles of the leading people in society who set the example for the rest of us. Unfortunately this is far from the case in the South Africa of today where profligate consumption by the cream of society is the order of the day.

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