/ 27 November 1998

Look forward to a real recession

The David Gleason Column

The great conundrum for all South Africans as the year winds down is what will happen to interest rates and why are they still so incredibly high.

Before May this year, international investors saw South Africa as one of the more reliable and stable of the emerging markets. They invested heavily, mostly in bonds but also in equities. Then, after months of speculation and warnings, world commodity prices began to collapse. >From the perspective of international investors, South Africa began to resemble Australia, only worse.

Once the first whiff of trouble floated across the markets in May, the rand set off headlong on one of its more spectacular collapses. In circumstances like these, what do you do if you’re a central banker? You are constitutionally required, in this country at least, to defend the currency. And that’s exactly the course Reserve Bank Governor Chris Stals chose to follow.

He has argued that his primary concern, now that he’s got inflation under control, is to keep it there. To do that when the currency is in free fall means he had to resort to ever higher interest rates. And, as we all know, interest rates went ballistic.

>From the repo rate’s low of 14,9% it very quickly zoomed up to 18%. June was a truly dreadful month, accompanied as it was by the extraordinary sight of the Reserve Bank chickening out on its own policy – actually pleading in public with the commercial banks not to increase their rates while being required to take the punishment the Reserve Bank was handing out. During this farce, the repo actually fell to 17,5% for a few days.

Then Stals gave up. If gently-gently wouldn’t work, being hard-arsed would. The repo rocketed to 21% and actually peaked at 22%. At that level, the prime overdraft rates were a cool 25,5%, producing the highest real interest rates ever recorded in this country.

One of our problems is that the bogeyman called inflation continues to be a major factor in this country’s economic development. Stals is very clearly a member of that coterie of European bankers – led by the Bundesbank’s Hans Tietmeyer – who stubbornly cling to the belief that inflation is the only problem worthy of their opposition. And the Europeans should know – their own economy is dropping like a stone while every central banker tries to out-hawk the rest.

Tietmeyer doesn’t really want the inconvenience of having soft-money advocates (like the Italians) on the board of the new European central bank. He has already rebuffed his own new German Chancellor Gerhard Schrder and finance czar Oscar Lafontaine. The message is out. Now Wim Duisenberg, governor-elect of the European Bank, is saying he doesn’t see any need to reduce interest rates.

Each country’s circumstances are, of course, unique. But a common economic theme runs through many. The danger this time is of a deflationary spiral and the collapse which would accompany that.

Anyone in the Thirties leading a fight against inflation would have been conducting a war in the wrong period. As stockbroker Merrill Lynch’s economist Jos Gerson notes, committing every resource now to a relentless war on inflation is 20 years out of time – these are modern generals fighting old battles.

The course adopted by Stals – to defend the currency at almost any price – means that the Reserve Bank’s forward book grew hugely between May and August this year and now stands at about $23-billion. He is in good company since most South American countries took the same route, as did Canada.

Australia, however, decided its currency’s problems were being driven by external events over which it could exercise no influence. In those circumstances, it took the view that it was quite proper to refuse to defend its currency. As it turned out, this was probably the right course.

No one should be under the misapprehension, especially not after the economic indicators for the September quarter released this week, that we are in the midst of an economic recession – recession defined not classically but by Americans as two successive quarters of negative growth. What is a recession and what isn’t remains, of course, a matter of perception. Ronald Reagan left us with the best definition: a recession is when someone else loses his job; a depression is when you lose yours.

As to prospects for large reductions in interest rates, we must anticipate that the Reserve Bank will dig in its heels and play hardball at least until its financial year-end (March) has passed. No one should expect much relief from this quarter.

l The Reserve Bank’s forward book is written when it promises to make available to importers and other traders at some time in the future dollars which it doesn’t have; normally, dollars would be sold by the Reserve Bank to buy rands, so propping up our currency – if the dollars aren’t available, it just makes promises to supply them in the future.