In the wake of the credit crunch, central banks worldwide have embarked on a strategy on ‘Quantitative Easing’ and lowering interest rates – all in an attempt to relax and extend credit to bank who were then wary of extending any credit at all. With lowered cost of lending and borrowing, the theory went, there is less risk, and a greater appetite for credit. But there is another side of the coin that was not considered, and this is now starting to rear its ugly head after years of artificially low credit.
It is understood generally that
banks generate their revenue by the spread between their lending rates, and
their deposit rates, the deposit rates being lower than the lending rate.
However, if the lending rate has been pushed lower and lower, it is obvious
that the deposit rates followed likewise. Hence the return on savings have
dropped as well.
People generally save mostly for
their retirement – and retired individuals live off the savings they made
during their lifetime. Consider a person who saved N$ 1 million during his or
her career over 40 years. (That’s about N$ 25 000 saved for retirement per
year.) At current rates (4.75%), a fixed deposit investment would net them N$
47 500 interest per year, or about N$ 4 000 per month. It’s not a
lot, but if you have no other expenses, with your house and car paid off, that
is enough to support you.
Now consider that the lending
rate in countries such as the United States have dropped to 0.25%. For that
same investment of N$ 1 million, this translates to N$ 2 500 interest per
year. Or only N$ 200 per month. This is even less than our current government
pension. And this means you will probably start to live of your capital,
instead of your interest income. You will be spending your savings.
You will start living quite
frugally – not spending much, perhaps even start working again. Multiply this
by an entire economy, and you’ll find economic growth slowed, increased
unemployment amongst the young, since the elderly are no longer retiring, and
ultimately… deflation.
A basic principle of investment
management is that your savings should grow at a rate greater than inflation –
otherwise, the purchasing power of your savings is eroded. And in most of the
so-called developed economies, this is no longer possible, even with record low
inflation. And this is pushing those economies into a deflationary spiral –
they’re in a liquidity trap.
First conceptualized by John
Maynard Keynes, it refers to a situation where interest rates bottom out, and
cannot be used to stimulate the economy anymore – after all, who will lend 100
dollars if they cannot get at least 100 dollars back. The Nobel Prize winning
economist Paul Krugman has stated repeatedly that much of the developed world
is currently in a liquidity trap – after all, the tripling of the US monetary
base via quantitative easing over the past few years have failed to affect
either US price indices or dollar-denominated commodities.
And this deflationary effect can
quite clearly be seen in the government bond markets in Europe. Buying
government debt in Austria, Sweden, the Netherlands, Finland, Denmark, Germany
and Switzerland can result in you having a negative yield. In other words, you
are literally paying the government for the privilege to lend them money.
Inflation is thus expected to be negative, or deflationary. And as the economy
of Japan has shown over the past two decades, a deflationary spiral is both
crippling to an economy and very difficult to break out of.
Deflation means money is worth
more tomorrow – and thus consumers put off spending now, and would rather spend
tomorrow. There is thus lower demands for goods and services, which results in
lower production and lower prices, continuing the spiral.
Namibia and the Southern African
economies still appear safe from these effects, but we should remain wary. Africa
remains a very export-oriented economy, and with an integrated global financial
system, the effects could soon be felt here as well. And if you’re saving for
retirement, perhaps now is the time to start focusing on more local, rather
than off-shore, investments.
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