Finding financial stability

Nov 06 2013 07:33
*Edward Ingram
WHEN the rand changes its value, never mind whether it is going up or down, everything has to adjust.

We change our holiday plans, we adjust our price and profit forecasts, we hire more people here or we sack people there. Our whole national planning at this level - and it is a significant part of our economy - gets confused and dislocated.

According to surveys, the rand is among the most volatile currencies in the world and recently it has topped the list.

The economist Leigh Harkness has written about currency instability in little known and little understood papers published on his website, and has kindly agreed to join my international team of professors and others looking into the question.

Put simply, the price of anything can perform one function only. In this case, the price of our currency is trying to satisfy the needs of international investors while simultaneously attempting to adjust to the right price to create a balance of trade.

And this is just one major part of finding out why the world’s economies are too unstable to be managed.

The other parts are: (a) unstable mortgage finance, which I discussed briefly last week in the property section under the heading UK Mortgage Muddle, and (b) the way that governments all around the world raise money - and they are not alone.

Businesses and mortgages do it the same way, using fixed interest rates as if investors just wanted their money back and had no interest in maintaining its worth; or competing with investments in the likes of property which tend to increase in value as average incomes rise, as do equities, rentals, turnover and every other price that you can think of, except where efficiency steps in to make prices cheaper and all of us richer.

Imagine that you were saving for retirement and wanted to preserve your savings to receive a pension that was somehow related to average incomes at that date. Where can you invest?

The choice is equities, which have a link to average incomes because as they rise, turnover in the shops increases, profits go up and dividends lift, taking share prices along with them.

But the volatility of share prices is unhelpful, especially in the later years. You can try property - but that has similar, if more muted, problems. Or you can try fixed interest, whose value for retirement purposes is completely at the mercy of inflation/rising incomes.

Fixed interest: a few ways to be caught out

And it is not just investors who are at risk. There are some ways in which borrowers can be caught out badly by fixed interest.

1. Investors and lenders have to have a margin to insure their inflation risk – they are looking at equities, property, and pension fund objectives, so they are considering average incomes and what may be called ‘incomes inflation’ as their benchmark – or they should be.

So on average, you are going to pay an additional interest rate to borrow that way. You will borrow less.

2. Lenders can lend you too much to be safe when interest rates are low, as discussed in the previous article. Property prices respond and you over-pay for the home that you want to buy.

This has destabilising effects on your personal plans as well as on the wider economy, through what is called the ‘wealth effect’.

3. There is something called the ‘true rate of interest’, which is the marginal rate above the rate of incomes growth, or earnings inflation (average earnings growth). When this marginal rate is high, it adds income to the amount that you have to pay for your loan, or even a government debt.

With fixed interest bonds, this marginal rate can be extremely variable and that can be very destabilising for both investors and borrowing governments, etc.

If you add all of these instabilities together, you find that pretty much all of the world’s borrowing costs and all of the world’s investments and their economies are made unsafe, whereas in fact it is quite possible for a borrower and an investor to get together and take out this instability by using average earnings growth incomes as a tax and investment benchmark.

This is the theme upon which I and my research team are working. If we can manage to resolve all of the above issues, we will get financial stability for everyone: for borrowers, for investors, and for significantly more sustainable economic growth, in almost all circumstances.

Source: Oanda – www.oanda.com

 - Fin24

*This is a guest post from Edward Ingram, a leading specialist in mortgage finance and macro-economic design for sustainable growth who is involved in studies in macro-economic reforms.



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