Is There Really a Bubble in South Africa?
An Economic Bubble in South Africa?
A Special By: Tristan Winters.
This week Forbes published a controversial article entitled “A Guide to South Africa’s Economic Bubble and Coming Crisis”.
The article makes the case that South Africa’s recent economic growth has been fuelled by unnaturally low interest rates.
This low interest rate environment, in South Africa and globally, is said to have caused the necessary economic distortions to drive a massive credit bubble.
I’d like to summarize the piece and provide some academic background to the arguments for our readers. Here it goes.
Interest rates are supposed to represent the price of borrowing money (savings). In a normal, un-manipulated economy, people work and save. They hold those savings in a bank.
The bank then offers those savings to borrowers who need capital to build businesses and make the economy grow. If there is only a small amount of savings, then interest rates are high.
This is because lots of borrowers must compete for the small amount of savings. If there are a lot of savings, interest rates are low. There is an abundance of funds to borrow for investment.
Interest rates are, therefore, a function of savings and demand for them by entrepreneurs.
When there is a central bank this gets all screwed up.
The central bank can distort this natural situation. By printing money they trick the economy into thinking there are more savings than there really are.
This sends the wrong signal to the market and interest rates go very low.
But these are not real savings, just printed money. So the end result is simply inflation. Prices rise as the fake money flows into strange parts of the economy and does strange things: as the economy receives false signals about the levels of savings available.
That is the theory.
Now, this seems to be what is happening in South Africa’s case. The Forbes article argues:
- US, Japan and Europe print money and the economy thinks there are more savings available for investment than there are.
- Fake savings (printed money) cause the price of money (interest rates) to go unnaturally low.
- Investors borrow the cheap money at low rates and look for high returns around the world.
- Investors send the cheap money to South Africa where there are good returning investments. They make money on the difference between cheap printed money and high South Africa investment returns.
- This money also flows into local Government bonds. So, there is plenty of cheap money for the South Africa Govt. And use it!
- Govt. spends this money on infrastructure and various projects. Govt. never spends money efficiently as it has no profit motive.
- South Africa Govt. bond price (Govt. borrowing) hits an all time low. Money is cheap for the Govt. and they use it!
- South Africa Govt. goes into debt, on behalf of its people. The programs are largely useless. Govt. never spends efficiently.
- Interest rates across the whole economy decrease, in a cascading effect. There is lots of cheap money for everyone now!
- The banks then need to lend out all this cheap money. So they start predatory lending.
- The money borrowed finds its way to housing, as it always does. House prices rise sharply, without any increase in underlying value. It is pure inflation.
- The debt of all South African’s rises. Not just the Government.
- The economy, especially the public sector, is dependent on the ‘cheap money’. It’s addicted.
- The cheap money will only flow if interest rates stay low. (i.e. the US, Japan, China and Europe need to keep printing).
- Of course, interest rates cannot stay low forever.
So there you have it, the theory and the practice: in plain terms.
This cheap money flowing globablly, chasing high returns and distorting economies, crippled Iceland.
The Forbes article claims it will do the same thing to South Africa and all emerging markets. It is only a matter of time. We at iceCUBED tend to agree.
The laws of economics at work here are like the laws of physics. They are immutable, regardless of your “economic school of thought”.
We at iceCUBED like Bitcoin and Litecoin because a central entity, influenced by the profit seeking lobbyists, cannot simply ‘print more money’ and distort or destroy economies.
We are proud to give all South Africans the choice to take part in the alternative option that Bitcoin offers. Losing money to inflation is a bitter pill to swallow.
Bitcoin and Litecoin offer interesting choices. To learn more register here.