Moving forward

Last night I watched the documentary Zeitgeist: Moving forward. It reminds us of how ill this world is. You most likely know this. The documentary has a central theme - instead of focussing on a human value based system the world has adopted a money value based system. This is easy to observe when viewing business models, economic models and trying to understand how the monetary system works. It ascribes many of the world's problems, such as ecological disasters, poverty, inequality and war, to the failure of the market economy to address true human needs. The documentary highlights how the market economy ignores many aspects of being human - caring, cooperation and love. People only have the right to eat in as much as they can pay for food, or own land or are able overcome hunger by little welfare benefits from the state. The market economy is pretty harsh on individuals who are born in poverty. The chances for the poor to attain a good education are small. Thus the probability of escaping poverty is also small.

The documentary offers some solutions. Referring to the work of Jacques Fresco, we ought to embrace technological progress, resist the lures of money and status, build cities that maximise ecological sustainability and enhances human welfare, and build a system of environmental inventory to monitor the global use of natural resources. This means that we take only what we really need and enjoy life while artificial intelligence does the work for us. In theory this sounds plausible and even wonderful. I just don't know whether humans have the capacity for such a change.

I agree with the documentary in many areas. I think the world monetary system is one that enslaves. I think freedom, as promoted by this system, is an illusion. At the heart of this system lie interest rates. We charge interest for many reasons. The time value or opportunity cost of money in one person's hand is compensated by interest paid by another person who borrowed money. These interest rates are not equal between borrower and lender. Financial intermediaries (banks) put premiums on loans in order to cover their operating costs and maximise their business profits. This is why there is such a massive distinction between deposit, lending and interbank rates. Furthermore, the way interest rates are charged is perverted. The current model charges higher interest rates for people deemed riskier (i.e. people with a high probability of loan default). The problem is that higher interest rates increase an already high probability of default. The perversion is further exacerbated by forcing poor people to take out loans in the first place, otherwise they do not have a roof over their heads or food or a warm bed (some of the most basic things humans need). The idea that charging interest rates is a bad idea is nothing new (the Bible and other religious texts prohibit usury).

Fundamental to all of this is pride. The bad world we see today goes much deeper than flawed monetary systems. It goes to the very heart of human desire. Our desire is never filled and is an ever growing spiral into nothingness. We consume, we cheat, we lie, we steal, we murder, we are myopic, we are unsympathetic and we are self-absorbed; All because we put desire above everything else. No one is as important as the "I". 

There is really no peace to be found when desire consumes us with flames of empty promises. I am not as optimistic as the creators of Zeitgeist. To me it seems inevitable that man self-destructs. Of course I hope that this will never happen. Despite our feelings about the world we might as well try to make it a better place. Put aside the gloomy picture of the future and focus on things that are good. Truly care for those in need and care for the environment in every possible way. Let go of the desires of being wealthy, powerful and popular; these desires make the soul very sick and is never satiable. Focus on spiritual growth. We do not do good and do not feel well because we have neglected a fundamental part of being human - spirit. We pay too much attention on mental and physical well-being and think very little of caring for the spirit. I have followed the suggestion of a friend and started reading the The ascent of mount Carmel by St. John of the cross. His work has definitely put many things in perspective.

But perhaps easiest of all to remember, and definitely the most important, is to follow God's commandments. Love God with everything and love your neighbour as yourself. There is no place for pride when we do this.

The SARB hike might just be justified

The recent interest rate decision by the South African Reserve Bank (SARB) was not all that surprising. The SARB, with its forward guidance policy, has signalled a bout of rate hikes when the repo rate increased by 50 basis points in January 2014. That hike was a bit surprising given low growth expectations among high rates of unemployment in various sectors. But, it was also surprising because some might argue that the rate hike happened too late - if the SARB forecasts inflation above 6% in period t+6 (quarters) then it ought to increase interest rates in period t. This is if we are to believe that it takes about six quarters for monetary policy to influence aggregate consumer prices.

The rate hikes would thus seem justified - the SARB is only following its guiding law of low and stable prices. Unfortunately this leaves us with a few unanswered questions: The SARB tells us that SA has a negative output gap (GDP < production capacity), should we not then expect minimum pressure on prices from a demand side? We know, however, that South Africa has been bombarded by a weaker currency and by persistent high oil prices. Thus there have definitely been some supply-side shocks. No doubt that the SARB will be worried about second round effects of inflation (perhaps that is why the interest rate hike took so long).

We need to balance weak demand with strong supply shocks regarding inflation. A hike in interest rates imply that the SARB believes that inflation will rise even further. The increase in interest rates will help (hopefully) anchor inflation expectations. In this case it will delay or even halt importers to pass the weaker rand onto final goods. This supports demand from decreasing even further. On the other hand the hike in interest rates will lead to a decline in demand through lower credit and higher debt payments that reduces overall consumption. Thus the demand benefit from increasing interest rates needs to be balanced by the demand loss from raising rates.

At this point you should have been wondering why the SARB raised rates by 25 basis points. It could be due to a numerical solution from some model, it could be due to possible fear that increasing interest rates by too much will hurt the economy, or it could be another reminder of further interest rate increases.

The problem with 25 basis points is that it does little to reduce inflation. Using a simple semi-structural model of inflation (this is just for illustrative purposes) shows that a 100 basis points hike reduces inflation at most by about 0.4 percentage points (as an example from 6% to 5.6% inflation). And this is based on an assumption that interest rates have a large weight in the New-Keynesian IS curve. Figure 1 shows what happens to the model economy when interest rates increase by 100 basis points.  Alpha is the weight on the interest rate in the IS curve. Output is the level of GDP. The shocks are deviations from baseline which is assumed to be the steady state. This means that the model does not take into account nonlinearities such as the response of output in an already depressed economy. The point about the figure is that 25 basis points hardly has any impact on inflation. Or perhaps it is exactly the right number that balances a very sensitive economy from collapsing while keeping inflation in check. This is pure speculation.

Anyhow, the interest rate is the least of South Africa's problems. Constant strikes (Toyota and Ford have shut down some operations), unproductive people (those that do nothing at one of the many district or local government municipalties), bad employment policies (yes I think the current format of BBBEE is doing harm to the economy) and corruption undermines all the good macro and micro economic policies in place. Economic policy makers can only juggle a sensitive economy for a short period of time before the fundamental problems unravel all that is good.