Central Banks have more to offer a distressed economy than lower interest rates. They can supply their economy with much more of their money in the form of the deposits they supply to their private banks. They can add as much money to the economy as they deem necessary, by lending more to their governments, private banks and businesses.
If the banks and their borrowers respond favourably to these monetary injections, the supply of private bank deposits and of bank credit will increase by some multiple of any additional central bank money. The extra money and credit created will then be exchanged for goods and services, the labour to help produce them and exchanged for other assets. Higher share prices, more valuable long dated debt, and real estate, translates into more private wealth, leading to less income saved and more spent. Helping to relieve distress.
Lockdowns have disrupted output and sacrificed the incomes of businesses and the households and governments on a large scale. Getting back to an economic normal requires a mixture of increasing freedom and willingness to supply goods services and labour. It also needs more spending to encourage firms to wish to produce more and hire more workers and managers. Money creation on a very large and urgent scale is helping to stimulate demand almost everywhere. M2 (that is bank deposits) in the US have grown by nearly 25% over the past twelve months. QE is working very rapidly this time round.
The SA Reserve Bank has adopted a very different strategy and rhetoric. It has decided that it has done all it can for the economy by cutting its repo rate by 3 percentage points to 3.5%. It has rejected any QE that might have reduced pressure on interest rates at the long end of the yield curve. It argues that a structural inability to supply over which it has limited influence, is the cause of our economic distress, not the weak state of demand. Go figure as they would say in New York
Yet perhaps all is not lost on the SA monetary front. The deposit liabilities of the banks (M3) had grown by about 11% by August and the supply of Reserve Bank money is up by 12.5% p.a. in September compared to the year before. This represents a marked acceleration. Much less helpfully bank lending to the private sector was up by only 3.9% p.a. in August. The difference between the growth in bank deposit liabilities, up 11% and assets up by about 4%, is accounted for by a large increase in the free cash reserves of the banks, of about a net R60b in 2020. That is the cash on their books less all their repurchase agreements with the Reserve Bank and others have become less negative.
The banks have been provisioning against loan defaults on a large scale. These provisions reduce their reported earnings and therefore dividends. It therefore increases their cash and free reserves that are reflected as an increase in equity reserves. A process that is reversed should the bad debts materialize.
The banks invested a further and significant R110b in additional government debt between January and June 2020. Very helpful to a very hard pressed fiscus, but also crowding out lending to the private sector. The currently very steep slope of the yield curve adds to the attraction of borrowing short to lend long to the government. It also implies that short rates are expected to increase very dramatically over the next five years. Unless inflation or real growth picks up very surprisingly, the very much higher short rates implied by the yield curve seem unlikely. Borrowing short to lend long seems like a very good and profitable strategy for SA banks and others. Borrowing short and rolling over short term debt rather than borrowing long, at much higher rates seems like a good idea for the RSA.
This all leads to an undeniable conclusion. Any revival of the SA economy will depend on realizing lower real long-term interest rates and flattening the yield curve. It will bring lower real required returns for any business that might invest more in the SA economy, essential if the economy is to pick up any sustainable momentum. Only a credible commitment to restraining government spending over the longer run can lead SA out of the stultifying burden of very expensive capital.