ECONOMICS 101: Editorials: Edition: June / August 2020

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Money galore

So many billions of rand are suddenly appearing, in response to Covid-19,
that the phenomenon begs understanding. STANLIB chief economist
Kevin Lings obliges with answers to questions that TT wasn’t too shy to ask.

TT: How does a government “print” money?

Lings: In general, the government is not responsible for printing money. This is normally determined by the country’s central bank (CB). In some countries, it’s possible for the government simply to instruct the CB to print more money. But then the CB would not be considered independent and monetary policy will most likely be conducted irresponsibly.

The CB prints a certain amount of physical cash in order to allow the economy to function. This is normally determined by the size and performance of the economy, as well as the extent to which the society has moved to a cashless economy.

The CB can also “print” money in order to manage the liquidity in the financial system. This is now referred to as “quantitative easing” (QE). In this instance the CB simply creates a positive balance in its own “bank account”, sometimes referred to as a Reserve Account. It then uses this account to buy financial instruments (e.g. government bonds) in the market.

By the process of buying government bonds, money is transferred from the CB into the economy. In return the CB receives government bonds, which it then owns. In this way money (liquidity) is injected into the economy.

The CB is buying these bonds from private-sector investors who already own the bonds (referred to as the “secondary bond market”). In SA it is illegal for the CB to buy bonds directly from the government.

When the CB buys government bonds in the secondary market, it is also indirectly assisting the government in its efforts to issue more bonds. However, this is not the primary motive when the CB undertakes QE.

Is SA (govt or SA Reserve Bank) now printing money or not printing money?

Recently the SARB (SA’s central bank) acknowledged that it had decided to buy government bonds in the secondary market and to fund these purchases through the “printing” of money. It has not indicated the value of the bonds purchased or what total value of bonds it is willing to buy. SARB undertook these purchases to improve liquidity in the bond market, which is its responsibility.

Then how is all this new money being created for disaster relief?

Finding the disaster-relief money is the responsibility of government, not the CB. In this instance government is using a combination of sources to fund the programme. This includes re-directing money from existing government budgets, asking the International Monetary Fund for money, as well as borrowing money from the New Development Bank.

Government will also raise additional funds in the domestic bond markets. It has not asked SARB to help through the direct buying of government bonds. That would be illegal, and the SARB would be unwilling to get involved.

Since it appears so easy to create new money, why have we been worrying for so long about the debts of Eskom, SA Airways, SABC etc? Could new money not simply have been created to pay off these debts?

While this appears to be a possible solution, there are a number of problems with it. Firstly, SARB is only allowed to buy bonds in the secondary market. It means the government would become significantly more indebted as it tried to undertake this funding. It would also increase the cost of servicing debt — already the fastest-growing component of the government budget — leading to a debt trap.

Secondly, with SARB buying a large amount of government bonds and injecting more and more liquidity (money) into the economy, it is highly likely that the rand would start to weaken very dramatically, resulting is a substantial increase in inflation.

By contrast, the US Federal Reserve can “get away” with printing a huge amount of money since global investors are more than willing to own a large amount of US dollars although the Fed is printing trillions more. This psychology is unlikely to hold when it comes to the SA rand.

Massively increasing the supply of rand would most likely substantially weaken the rand. There would be other implications including a further negative impact on SA’s credit rating.

So why can the US do it and not SA? In this sense the world is unfair. It trusts the US dollar way more than it trusts the SA rand despite the Fed printing significantly more dollars.

Is high or hyperinflation likely to be a consequence from the way(s) that new money is now being created? If not, how can rising inflation be averted?

Yes, hyperinflation is entirely possible if you simply keep printing more money. The SARB has made is clear that in time it will withdraw the liquidity it recently injected into the economy. This is to avoid it becoming inflationary.

It would appear, however, that under exceptional circumstances a CB could support the economy/ markets more directly through QE, especially if the CB has a fairly high level of credibility (which the SARB has). This is especially so if market participants understand and trust that SARB will withdraw the additional liquidity over time. The idea is gaining support amongst some emerging markets, but remains largely untested.

When monies are allocated by government for various projects (e.g. food parcels, social grants that produce no financial returns) from various investments by agencies under government influence (e.g. Unemployment Insurance Fund, Public Investment Corporation), will these monies eventually require replenishment? If so, by taxpayers?

Yes, they will have to be replenished. In effect the government is borrowing from the future. Many governments do this. But clearly there are risks. When the good times return there is a tendency not to replenish these funds. The hope is that, once SA is past the crisis and the economy is growing again, tax revenue will increase and so making is possible to replenish the funds. It is important that society holds government accountable for this replenishment, otherwise future generations will pay the price. Politically, this is not always easy to achieve.

SA pension funds buy SA government bonds. Who or what backs the interest payments and capital redemptions on these bonds? Since the ratings agencies have downgraded SA debt, isn’t junk status indicative of a real risk that the SA government might default on its loan obligations?

Yes, the risks are rising that government could default. That is what the downgrade of the credit rating is telling investors. The government promises to pay the interest and capital redemptions on money it borrows. But clearly, if tax revenue continues to weaken due to rising unemployment and low growth, the risk of default rises — especially if at the same time the level of government debt continues to increase. This is exactly what is happening in SA. Hence the credit rating downgrades.

Government would always have options to avoid default. The question is whether it is willing to make hard choices. For example, in SA the options would include selling state assets, reducing the number of people government employs, asking the IMF for financial assistance etc.

All of these decisions can help government avoid a debt default. But there are political costs associated with all these hard choices. Many governments default because they are unwilling to make a hard choice. Or they make the choice too late and default anyway.

How might SA pension funds assist government to reduce its borrowing costs? Are there alternatives to prescribed assets?

SA pension funds already own a significant portion of SA government bonds. Increasing their holdings would indirectly support government and most likely result in a lower yield. But this is not solving the problem. It is just delaying an even bigger problem.

Government could introduce prescribed assets. While this would also provide short-term support for government bonds — as investors (pension funds) are forced to buy more government debt — it would have many unintended consequences that would most likely inflict even greater damage on the SA economy and government finances. They’d include discouragement of foreign investors and a further increase in local residents wishing to externalise their assets.

What alternatives are there?

The best answer is higher economic growth which leads to job creation. There is no alternative to this simple imperative. Without economic growth and job creation, all economies will stagnate and struggle to raise citizens’ standard of living.

We must fully understand why SA is struggling to generate higher economic growth and employment, and then be willing to implement the structural reforms needed to remove these obstacles. Unfortunately, yet again this would involve hard political decisions.

Strangely, if making the hard political choices leads to higher economic growth and job creation, then they become good political decisions.