Vultures are circling the bank. The omens are not good. This article first appeared in Moneyweb.
The South African Reserve Bank (Sarb) is a clear target for capture by politicians intent on spending their way out of trouble.
This much is clear from the debate within the ANC over expanding the Sarb’s narrow mandate to curtail inflation, and growing pressure from more radical elements in the party that want the central bank nationalised.
The reality is that the Sarb is already on the slow path to nationalisation, says Russell Lamberti, economist at ETM Macro Advisors, speaking at a recent Free Market Foundation debate. It started in 2010 with amendments to the SA Reserve Bank Act, which effectively gave the state a swing vote on the board of directors. Prior to that, the board was weighted 7-7 between state-appointed directors and shareholder representatives.
The Reserve Bank Act already allows the central bank to purchase equities and properties, and to authorise gratuities and other benefits for Sarb employees. It can also make rules and delegate powers to any of its officers.
“As we have seen in Zimbabwe and Venezuela, central banks quickly become a honey pot for politicians,” says Lamberti. “Vultures are circling our central bank. Fiscal decay is a reliable predictor of monetary corruption. As things stand, the Reserve Bank could push Ctrl-P and start printing money. It has been rather restrained in recent years, but as political pressure builds, this is a very real threat.”
Former Zimbabwe president Robert Mugabe printed money with abandon when that country was unable to tax its way out of calamity. The same is happening in Venezuela.
When governments start down the path of money printing, it is highly addictive and difficult to stop, adds Lamberti.
“Inflation is running at 4.5%, but should be at zero. The goal of economic progress is to make things cheaper. That’s what the free market does.
“There are plenty other examples of where central banks have caused huge damage. In 2013 and 2014 the Ghana currency, the cedi, lost half its value when the central bank went on a printing spree, creating huge instability for the country.”
None of the Sarb’s new and expanded powers are particularly unique: the Swiss central bank is buying Apple and other stocks; the Japanese central bank is likewise a relatively new stock investor. What this means for SA is that the Reserve Bank is now perfectly within its rights to acquire private companies and other assets, leading to slow nationalisation of the economy, says Lamberti.
Theoretically, the bank could come under political pressure to acquire mining stocks as a form of nationalisation by stealth.
Or it could purchase Discovery Health as a way of capturing its cash flows and redistributing them to a national healthcare system.
The Reserve Bank’s powers are breathtaking in their scope. It is empowered to nationalise any payments system it chooses and can make unsecured loans. It can issue credits and guarantees, borrow any foreign currency, and set reserve requirements for commercial banks as a way of limiting their loan-making capabilities. It can also fine bankers for breaking rules, and investigate any company it suspects of being a bank.
These are very loose and broad powers that, if fully exercised, would be disastrous for the country.
The exercise of these powers would be a radical departure from the Reserve Bank’s traditional role as printer of notes and coins, and arbiter of interest rates – which it is constitutionally mandated to do in defence of the rand.
Fortunately, there are market restraints such as those imposed by the rand exchange rate (too much money expansion would devalue the currency and kill off businesses) and the commercial banks’ natural aversion to too much inflation and interest rate risk.
Commercial banks are empowered to create money through fractional reserve lending, but they generally do so prudently so as to avoid excessive bad debts. The only other source of money creation is the central bank itself, which creates physical notes and coins and creates reserves in the banking system using digital ledger entries on computers.
Current Sarb respected globally
The Sarb is venerated among its peers around the world as a beacon of transparency and independence, and Reserve Bank Governor Lesetja Kganyago has stood his ground with wayward politicians. When an ANC official called for a team to be established to look into quantitative easing (QE), Kganyago fired back that QE can only be considered when inflation and interest rates are virtually at zero.
As the graph below shows, the last great venture into a kind of QE was between 2004 and 2011. The graph also shows a high correlation between money supply and inflation.
Soure: Macrobond, ETM Macro Advisors
The perils of QE are less obvious: the Sarb purchased almost US$40 billion worth of US bonds by creating extra rands in the banking system, sparking a credit expansion that eventually resulted in the failure of African Bank.
Lamberti argues that the Corporation for Public Deposits (CPD), which holds roughly R70 billion in public sector deposits, is already functioning as a quasi-state-owned bank. Its directors are appointed by the minister of finance, and it is empowered to accept deposits from sources outside the public sector.
The Sarb should be increasing rather than decreasing interest rates, says Lamberti. SA offers marginally positive real interest rates on bank deposits. Contrast this with the rest of the world, where there an estimated US$15 trillion is invested in bonds at negative interest rates.
Central banks gone wild
“Central banks everywhere are behaving in an unconstrained fashion by keeping interest rates as close to zero as possible, and often below zero,” says Lamberti. “That is an invitation for capital misallocation and overconsumption, which never ends well.”
He adds that there is no immediate concern in South Africa that money supply and inflation will rise. “The problem with cutting interest rates now is that it removes a barrier to credit and money creation. This discourages savings and raises consumption, which diminishes growth potential. Moreover, 4.5% inflation remains too high and hurts poor households. What households now need is deflation, not inflation.”
SA’s measurement of money is also skewed: it measures deposits in the banking system, but excludes government and foreign national deposits in SA.
Inflation measures are also prone to bias. For example, if something gets too expensive, stores stop stocking them, and these items will no longer be counted in the Consumer Price Index (CPI).