The SARB should be warned: There is no easy way out

In mid-March, the Federal Reserve cut its central rate to zero (2.5% lower than it was in January), unleashed trillions of dollars of repo funding for banks and $700 billion of direct purchases of government bonds and other securities, including for the first time junk rated corporate paper. 

Its assets have expanded by about $1.14 trillion between 18 March and 31 March alone — a pace of just over $1 million per second.

Lagarde’s swift solution of bond buying

European Central Bank (ECB) president Christine Lagarde in Frankfurt has done her best not to be outdone. In contrast to the slow reaction of the ECB in the previous eurozone crisis when it took Mario Draghi almost two years before he finally declared he was willing to do “whatever it takes” to preserve the single currency, Lagarde has moved swiftly with a €750 billion programme of bond buying.

Many expect this will not be the end of it.

“We doubt that policymakers will tolerate peripheral [European] sovereign spreads remaining so high for very long,” said Capital Economics’ Oliver Jones, who expects the central bank to increase their programme soon.

Likewise, the Bank of England and the Bank of Japan have also announced their own substantial programmes of quantitative easing.

‘Eye-watering scale and bluntness’

The scale and the bluntness of these measures are eye-watering. It would be hopeful at best and myopic at worst to argue that the medium- and long-term economic consequences of this will not be profound.

Additionally, it has become increasingly implausible to claim that the world’s central banks are not monetising the deficits of the largest economies, as they climb inexorably to cover the social and economic costs of the most rapid economic collapse of supply and demand in history. 

What will the effects of this be? Some, like Larry Summers of Harvard University, argue it will be Japan 2.0-style decade-long deflation and “secular stagnation”.

Others, such as Stephen Roach of Yale University, claim it will lead to a protracted period of 1970s-style “stagflation”. 

SARB must implement ‘monetary response of magnitude’

But where then does this leave South Africa? Surely, South Africa should join in this mass explosion of central bank balance sheets and allow the South African Reserve Bank (SARB) to do the heavy lifting in carrying the economic and social costs to fight this virus?

It seems only right that the scale and severity of this economic collapse should be met with a monetary response of similar magnitude. 

Deputy finance minister David Masondo seems to think so. He was quoted in last week’s Sunday Times arguing that to avert a 1930s-style depression, the central bank should buy government bonds directly to fund the country’s deficit during the coronavirus crisis.

Three reasons why SARB must proceed with extreme caution

I would, however, suggest that SARB governor Lesetja Khanyago treats such a step with extreme caution, and for three reasons.

Reason No 1

Firstly, such is the collapse of the “money multiplier” in the US and Europe (the transmission mechanism by which dollars deposited by the central bank in a commercial bank finds its way into the real economy and people’s pockets) even with the expansion in money supply the net growth in total money is almost zero.

Money created by central banks is simply horded by commercial banks as they look to shore up their balance sheets and pull back on private sector lending. 

The net effect is therefore negligible. 

In a developing market like South Africa, the demand for credit is exponentially greater, and therefore it would be far more likely that such a policy would have inflationary effects in the near term.

Reason No 2

Secondly, unlike economies like Europe and the United States (US), South Africa depends on foreigners to fund our government with around 40% of government debt owned by non-SA investors.

Were they to lose confidence in an African developing country embracing Zimbabwean-style economics, there would be a vicious upward spiral in interest rates. This would be impossible to control without further printing of money, leading to hyperinflation.

Reason No 3

Finally, unlike the euro and the dollar, the rand is not a “hard” currency, which is seen as a store of value in times of market uncertainty. Despite the market turmoil and the measures outlined above, the dollar’s appreciation has been “unprecedented this early in a recession,” wrote Daniel Hui, global executive director of currency-exchange strategy at JPMorgan Chase & Co.

The ZAR, however, is already down 30% year to date against the dollar.

Between a rock and a hard place

Sadly, for South Africa the costs of the crisis can only be managed through two ways. Either the government embraces prudent economic management, structural reforms and a return to economic growth, or they resort to hyperinflation and the destruction of the capital base of the South African economy.

There are no easy options.