Scapegoating “Inflation Targeting”.

In the past couple of years, “Inflation Targeting” by the Reserve Bank has become a kind of mantra for COSATU and the SACP. It is bad, they say. It is an evil conspiracy between the fat-cat Governor Tito Mboweni and the ruling classes to defraud the poor. Arise, ye wretched of the earth, and destroy inflation targeting!
Oddly enough, the ruling classes say almost the same thing. They do not say that they are conspiring with Mboweni. They say, instead, that they want to get rid of Mboweni because “inflation targeting” is not working and he is wrongly applying it when and where it should not be applied.
When the ruling classes and the purported leftists are all in agreement about economic policy, it’s time to put both hands in your pockets to protect your cash.
Let’s ask a simple question: what is inflation? Inflation is when the increase in money supply outstrips the accepted value of work done within an economy. “Accepted” is a loaded term, because who is doing the accepting? Usually it’s the rich and the ruling class, usually within a country but sometimes much broader. Thus in Zimbabwe the value of work done within the economy fell to virtually zero between 2000 and 2008, even though there were still plenty of people producing commodities and ready to buy them. The global ruling class had decided that the Zimbabwean dollar should be worth nothing, and they weren’t going to let the supposed laws of economics get in their way.
Inflation means you have to spend more money to buy stuff. Therefore, you have to be paid more in order to live the same life. If you have money in the bank, the bank has to raise the rate of interest on that money proportionally to the rate of inflation, or your money will gradually become worthless.
Part of the problem with inflation is that people won’t just raise their salaries in accordance with inflation. They’ll raise them more, for fear that inflation will accelerate. The trouble is that then they’re being paid even more for the same work, increasing the discrepancy between money supply and productivity, and so inflation does indeed accelerate. Inflation tends to breed more inflation.
More seriously, however, sometimes people don’t get their salaries raised in accordance with inflation and don’t get their interest rates increased. Inflation provides a great excuse for a manager to rip off the workers; if you give salary increases below the rate of inflation, meanwhile raising the price for your goods or services at or above the rate of inflation, your profits go up. Ditto banks; if you don’t increase interest rates along with inflation, you don’t have to pay so much money into your clients’ accounts and can spend it on other things, such as Honduran war bonds. That tends to rip off the middle class, who tend to be the people who keep their money in savings accounts. The rich can usually ensure that everything they do is linked to inflation — the return on bonds is almost inevitably linked to inflation, for instance — and the rich, of course, are always the ones doing the ripping-off.
Hence inflation is almost invariably better for the rich than for the middle class or the poor. In Germany in 1923, when hyperinflation destroyed everyone’s savings and people were taking shopping-trolleys full of banknotes to the market, the rich made out very nicely, thank you. Nor do we see the Zimbabwean ruling class rattling tin cups on Harare sidewalks; they’re doing just fine preparing to privatise what remains of Zimbabwe’s state industries. Don’t believe the balderdash which says that inflation hurts everybody; that’s strictly spin.
But on the whole inflation is bad because it provides occasions for people to be ripped off. Also, it creates economic uncertainty; should I do anything at all, if inflation might make it worthless? It pushes up bank interest rates, which creates the impression (not necessarily true) that it’s a bad time to borrow or invest money. It’s worst for the rich but not good for the poor, so it needs to be combatted. But how to do this?
The best way to ensure that inflation does not happen is to ensure that the creation of money does not outstrip the creation of value. In other words, money must be sensibly invested. This is a difficult thing to ensure, of course. If a fool borrows billions and wastes them, inflation is almost inevitably created. Worse still, a great deal of financial speculation entails borrowing money and then artificially creating more money, and this also leads to inflation in the end.
Meanwhile, if the currency weakens against more powerful foreign currencies in which international trade is performed, then the currency becomes less valuable, relatively more of the currency has to be spent on buying the same foreign goods — and that fuels inflation.
So the currency has to be kept stable relative to other currencies, and wastage of finance capital has to be kept to a minimum. It might seem easy to do both. It might seem ideal to do both with one instrument. But how would this be possible?
Interest rates.
How in the world can controlling the rate at which banks lend money possibly have anything to do with a) the value of that money, or b) the way that money is spent? Welcome to the magical world of monetarist economics, where such things are possible.
The idea is that people will borrow money sensibly if they have to pay it off at a high interest rate. At low interest rates, people will borrow money frivolously, and just waste it on silly things, and that creates inflation. Of course, at high interest rates, people are also discouraged from borrowing money at all, and if they don’t borrow any money, then of course no money is created relative to production and therefore there should be low inflation. High interest rates therefore mean that your money is worth more. Of course, you can’t get hold of it because the interest rates are so high, but if you only could afford to borrow any, the things you could buy with it!
Now, if interest rates are high, the banks are supposed to pay you a lot of money in return for your sticking your cash in them. Therefore, you would expect more and more people to put their money in the bank. Of course, that creates money, which theoretically might create inflation, too. But it won’t be perceived as inflationary so long as it isn’t spent (which it probably won’t be — because reinvesting it in the bank will be more valuable — to a financier, anyway — than buying a crate of Laphroaig). So money will be pouring into the banks faster than it will be flowing out in interest payments. Of course, if everybody wanted to spend their money, there would be a run on the banks, which wouldn’t have enough money to sustain that rate of withdrawal — but there’s always a danger of that, since no bank keeps its whole reserve of cash on hand.
If people want to put money in the bank, that money is perceived as hard and stable. If it’s hard and stable, and if there’s a bigger return on investment than in other economies thanks to the high interest rates, then presently people will start to want to put their money in those banks from elsewhere. You will have people with dollars and euroes buying rands. To be precise, they will be buying South African securities, which are repaid in rates related to the interest rate. That means that hard foreign currencies will be propping up the South African currency, perceived as hard. And therefore, high interest rates tend to strengthen the currency.
Aha! That makes high interest rates look good. Except for the bit about not being able to borrow money to invest in anything productive. That doesn’t look so good. It basically means that with high interest rates you are almost necessarily putting the brakes on economic growth. Low economic growth should mean low inflation — although, interestingly, it doesn’t have to be. Contrary to the monetarist economists, it is actually possible to have both — if you have high inflation coming into the system (say because of increasing prices of essential commodities such as oil), and you jack up interest rates but the inflation doesn’t go away immediately, people will want to be paid more and that extra pay (for no extra production) creates inflation. Meanwhile, you can’t run a functional economy without any investment at all, so someone has to borrow money, at those high interest rates, and the high interest rates create extra expenditure which, if the money borrowed doesn’t create a lot of extra value, will generate extra inflation. This used to be called “stagflation” in the 1970s, and high interest rates didn’t manage to stop it. Eventually they solved the problem (after a fashion) by jacking up unemployment and then pretending they hadn’t. Ouch.
So this is what they are trying to do with “inflation targeting”. Well, fair enough. But wouldn’t it be sensible to bring down the interest rates a lot? Then people can borrow money for productive investment and the economy will boom. Admittedly, if the interest rates come down then the foreigners will pull their money out of the country. That means that the value of the currency will fall. That means that imported goods will cost more, in rand terms, which means that inflation will go up. Which means that you will have to borrow more money to make the same investment. But, at least you won’t have to pay loads of interest on it.
But there’s a problem. With low interest rates, people are liable to put the money into bad investments because they don’t have to pay interest on it. Banks are liable to lend money to people who can’t pay it back, because the interest rates are low and it isn’t a problem. This is exactly the problem which led to the banking crashes in America and Western Europe, because the banks eventually got into the habit of playing silly buggers with money until someone asked for it back and they didn’t have it.
OK, that might not be, doesn’t have to be, could conceivably be seen as other than, a problem. The other problem, the crucial problem, is that while you’re dropping interest rates and thus fuelling inflation (and causing problems for the foreign exchange reserves), how do you know that the money borrowed is being used productively? In recent years, South African interest rates were a lot lower than they are now, or than they were in the 1990s. Yet, strangely enough, the rate of capital investment in South Africa was remarkably low during that period, apart from government-sourced investment. It seems as if the South African business community doesn’t much like spending its money at home. If it does spend its money at home, it likes spending it on socially unproductive investments, such as shopping centres, luxury accommodation, golf courses and suchlike things, because the return on such things is greater than the return on factories or fleets of trucks.
In other words, reducing interest rates is liable, paradoxically, to create a situation where money is being invested, yes, and invested on profit-making enterprises, no doubt, but that these enterprises do not create jobs, nor do they significantly add to the gross domestic product. Simply put, if you invest in a golf course or a gated residential complex rather than a factory or a farm or a mine, the end result is that little money is circulated, and therefore you are not truly contributing to economic growth even if you appear to have added value to the country.
The conclusion is that cutting interest rates is only part of the issue. What is really needed is, firstly, to abandon the floating of the currency, to peg the currency to an arbitrary level and keep it there and prevent speculation in the currency — which means that inflation from the changing relative value of the currency ceases to be a problem. Having done that, you prevent currency from being sent out of the country, and that ensures, again, that money generated in the country stays here and can be put to good use; part of our problem is that so much of our money gets used elsewhere. (The profits from many of our industries go abroad, too, but that’s another story.)
Then, it should be possible to bring expenditure under control. Subsidies don’t seem to work. However, if you can control the way money is lent — if the central bank has the right to slap special interest rates on certain loans, for instance — then you can, for instance, allow easy credit for some loans and tough credit for others. You can say “Here’s a five per cent loan for your manganese smelting plant, you splendid wench!” at the same time as you say “Here, take your damned loan for your polo lounge, but you’re paying fifteen per cent, you atrocious trollop!”. Under such conditions, manufacturing could boom and luxury consumption contract. This, more or less, is the way that Japan and South Korea and Taiwan got to where they are today.
Isn’t it strange that people are getting so excited about “inflation targeting”, but making absolutely no effort to promote either currency controls or credit regulation? Maybe this is because those people in the SACP and COSATU and suchlike places are almost all speculating in currency and in luxury property deals? Or is this just some kind of coincidence?

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