Share

Creating long-lasting financial stability

QUOTING from an article on Fin24: "Nedbank CEO Mike Brown said market prices may continue to fall until a US Federal Reserve rate increase prompts investors to review their outlook. After an increase, 'there could be some reassessment of the risks' in both emerging and developed markets with some investors being attracted by lower prices in developing nations, he told Bloomberg." 

“Nedbank has very little direct exposure to rand weakness, with the impact likely to be felt through higher inflation and therefore interest rates over time,” Brown said. “We expect our clients to likely be more cautious.”

READ: Market slump may persist until US rates rise, SA bank says - as it happened

Well, this is ridiculous - rand weakness will cause interest rates to rise as a result of higher inflation - oh my word. Do they think that when the cost of imports rises, making things harder for local businesses and raising prices which will slow the economy, the central banks should decide it is time to slow the economy by raising interest rates? Who is being ridiculous - Nedank, the central bank or some other party?

In fact it may be the mandate given to the central bank, the South African Reserve Bank. Most central banks are expected to target inflation so as to keep the value of money stable. But that is the wrong target. The function of prices is to distribute the goodies among those most able to afford them, because they need them more than others or can make better use of them.

Prices are there to adjust and create a balance between the supply and the demand. If the central banks - whose mandate ought to be to ensure that spending levels do not rise out of control through the creation of too much credit, for example - were doing that job, prices would look after themselves.

But if they respond instead to rising prices, they will get whiplashed. They will slow the spending level instead of maintaining the spending level. Then all kinds of problems will arise, like falling tax revenues and falling employment levels, which will then signal them to do the opposite. They get whiplashed.

The correct mandate for central banks is to manage the supply of credit, not the rate of interest which is a price, and to keep that supply of credit and printed money (we need both), rising steadily so that the economy can steadily grow and employment will grow. I keep on trying to write the book about all this. Below is what I have just written as an introduction.

A new tract on financial stability

A science can only develop properly if it uses the right measuring rods. When John Maynard Keynes wrote his Tract on Monetary Reform in 1923, the world was a different place. The paper was brilliant. It was all about financial stability and how to create that.

But the world still does not have financial stability. One reason for this is that the only measuring rod available to Mr Keynes was the prices index. He recommended that everything should use that measuring rod. At the time this was a huge step forward, but it was not enough.

Since then the amount of borrowing has transformed the world and international trade has transformed the world. In this update of what Keynes wrote, a new measuring rod is used. This is the level of spending which, with some undulations, comes from what people earn. The new measuring rod requires prices to respond to changes in the level of spending and, as a close approximation, to those ever-changing National Average Earnings, NAE.

When we look at borrowing that is repaid out of earnings, pension funds that are stored earnings, turnover which comes from spending, and the pricing of currencies which are not able to make the right adjustments at all, and we view all of this through this entirely different lens, what do we see? 

What we see is a range of prices and costs and values that cannot adjust proportionately and timeously to this ever-changing measure. When they fail to adjust timeously or proportionately, we get an imbalance  - too much of something or too little. Imbalances become financial instability. If the world of prices in all its forms were to be able to adjust properly to this measure, to spending per person, per consumer, per earner, there would not be any of the major economic problems that we see today.

This paper discusses the resulting analysis and makes suggestions about what can and should be done to create long lasting financial stability.

Fin24 users can just read my past and future essays.

What is financial stability all about?

You have got financial stability in an economy when, based upon a new financial framework and a new management system, the following indicators of financial stability are established. Don't blink. This is achievable.

Here is the picture: Your mortgage payments do not jump around, property prices are fairly reliable, your pension plan delivers about what you expect it to, there are no major recessions or pricing bubbles and bursts, all your business and personal financial plans work out more or less as expected and the price of your imports and exports does not rise or fall a great deal.

Unemployment levels are low and stay low, and savings are safe from inflation even from fairly high inflation if that occurs. But you remain free to take the usual business risks and make other mistakes, like borrowing too much on credit cards, etc.

Central banks have been asked to steer their economies towards financial stability. The reason for this is because financial instability is expensive both economically and politically. It can lead to extremist movements and even to war. The cost in human misery, social, and business failures, is of gargantuan proportions.

Next week I will explain a bit more about the idea of creating a limited money supply and allowing interest rates to look after themselves.

* Edward Ingram is a leading thinker on the world stage of  macro-economic design and has written a series of essays for Fin24.

We live in a world where facts and fiction get blurred
Who we choose to trust can have a profound impact on our lives. Join thousands of devoted South Africans who look to News24 to bring them news they can trust every day. As we celebrate 25 years, become a News24 subscriber as we strive to keep you informed, inspired and empowered.
Join News24 today
heading
description
username
Show Comments ()
Rand - Dollar
18.94
-0.9%
Rand - Pound
24.10
-0.9%
Rand - Euro
20.59
-0.7%
Rand - Aus dollar
12.42
-0.9%
Rand - Yen
0.13
-0.8%
Platinum
915.75
-0.8%
Palladium
1,028.36
-3.5%
Gold
2,159.96
+0.2%
Silver
25.03
-0.6%
Brent Crude
85.34
-0.1%
Top 40
66,252
0.0%
All Share
72,431
0.0%
Resource 10
53,317
0.0%
Industrial 25
100,473
0.0%
Financial 15
16,622
0.0%
All JSE data delayed by at least 15 minutes Iress logo
Company Snapshot
Editorial feedback and complaints

Contact the public editor with feedback for our journalists, complaints, queries or suggestions about articles on News24.

LEARN MORE
Government tenders

Find public sector tender opportunities in South Africa here.

Government tenders
This portal provides access to information on all tenders made by all public sector organisations in all spheres of government.
Browse tenders