The banking system’s health is a function of the economy’s health
I ground my call for balance sheet deployment on incontrovertible evidence that proved a game changer in recession recovery but also in the structural transformation of nations
In October 2009, following the announcement of further job losses in the third quarter of 2009, minister in the presidency Trevor Manuel said the government had “underestimated the seriousness of the recession”. Despite this acknowledgment, there were to be neither fiscal nor meaningful monetary stimulus to support a wilting economy shedding one-million jobs.
What would instead follow were successive budget speeches proclaiming the virtues of fiscal consolidation by the Treasury. The SA Reserve Bank would assume the unmandated mantle of the structural reforms agenda, despite evidence showing that these remedies would have deleterious effects on a weak economy.
Shocked by the ever-sinking economy, at a July 2016 conference in Sandton, then finance minister Pravin Gordhan said: “What is very clear is that austerity, which we in some parts of the Group of 20 thought was absolutely necessary ... is not the answer. In SA as well, we have some austerity fans among our public commentators, and it is time to rethink”.
Instead of rethinking austerity by financially countervailing a collapsing economy, Malusi Gigaba’s budget cuts induced a 2018 recession. Tito Mboweni, who succeeded Nhlanhla Nene’s short stint at the Treasury, elevated calls for structural reforms and austerity, even after the International Monetary Fund’s mea culpa on austerity and its repudiation of structural reforms as remedy by its chief economist, Olivier Blanchard.
As blatantly contradictory and intellectually incoherent as these actions are, the business establishment, facing impairments, bankruptcies and reduced national profitability, keeps on supporting these failed remedies. Some academic and market watcher economists have also lent support to these ideological fallacies.
Against the precipitous slide in economic fortunes, last year and before, I proposed the urgent use of the Bank’s balance sheet — a call I repeated in columns weeks ago. I specifically pointed to the immediate deployment of the asset side of the balance sheet. I was, however, profoundly aware of how arcane the concept of a Reserve Bank balance sheet is. Whereas the Bank's recent purchase of gilts on the secondary market is a balance sheet operation, akin to an open market operation, its main action lies on the liability side.
Balance sheet dynamics
Unsurprisingly, in yet another sorry attempt at supporting the Bank, analysts have sought to repudiate the call for the vigorous use of the balance sheet, arguing instead for a once-off move to to stabilise the financial system and provide liquidity to the market. In other words, they suggest the Bank rescues the financial sector only, leaving the rest of the economy to face the cascading sequence of defaults and bankruptcies caused in large measure by the Bank’s own poor policy stance. Yet the banking system’s health is a function of the national economy’s health.
The vigorous use of the balance sheet has been decried on the basis that the issuing rand liabilities, which occurs when financing government expenditure or industry, will automatically be inflationary as per traditional monetary theory. It is further asserted that quantitative easing (QE) is meant to bring about inflation in instances where an economy is about to suffer deflation; therefore a case for imminent deflation has to be shown if QE is to be deployed.
These assertions, also shared by the Treasury and the Reserve Bank, are a myth. They hark back to the discredited notion that QE implementation requires near zero interest or inflation rates.
This misunderstanding of macrofinance led to some prominent US academic and market watching economists writing a letter to then US Federal Reserve confidently warning of the imminent danger of Zimbabwe/pre-war Germany type hyperinflation. The Fed rightly ignored their misguided warnings, which were borne of ignorance of central bank balance sheet dynamics.
Firstly, QE is about easing or expanding credit to government or the productive sectors, thus reflating an economy, and not about inflating it. QE is not about prices; it is about credit aggregates or quantities.
Secondly, when QE is operationalised as monetary financing of government deficit or direct Bank financial support to state-owned enterprises such as SAA, Eskom, the Land Bank or the wider economy, the fear especially from those still trapped in stranded monetary theories, is that the larger quantities of central bank (rand) liabilities generated by this act means a higher general price level for goods and services (inflation) in the economy. This received textbook “wisdom” passed through generations to today, is deeply flawed. All serious central banks have long recognised this flaw, hence their vigorous deployment of QE.
What really happens in this instance is that these dreaded “inflation causing” rand liabilities are created residually — they appear passively as an accounting by-product of the central bank credit creation process. It is the asset side of the balance sheet that is not only active but of primary importance with unparalleled macroeconomic implications. The feared liability side of the balance sheet becomes a mere sideshow, as a counterpart to the assets side and largely irrelevant for macroeconomic policy purposes.
It is this conceptual lacuna in monetary economics and policy implementation that has led most analysts to decry balance sheet use and thus offer misguided support to the Bank’s empirically untenable position. I ground my call for balance sheet deployment on incontrovertible evidence that proved a game changer in recession recovery but also in the structural transformation of nations.
Nine decades ago Japan’s treasury, under finance minister Korekiyo Takahashi, himself a former governor of the Bank of Japan, saved the country from the Great Depression. His deficit spending, financed by central bank money, proved central to Japan’s recovery.
Beyond the depression, Japan's central bank provided money for development. This was also the case with many other nations, including modern day Canada. For 40 years the Canadian Reserve Bank was at the centre of industrial and infrastructural development. Working with its government, it issued money to the central, provincial and municipal governments in the country’s bid to industrialise. Inflation was not an issue.
In these countries and the rest of the now developed East Asia, it is the deployment of the assets side of the balance sheet that proved miraculous. Bangladesh, a least developed economy, deployed QE at the height of the 2008 crisis. Inflation, standing at 12% just before QE, came tumbling down to 7% and later to 5% as the economy kept booming upon QE implementation from 5% to 6.5% and to 8% in 2019.
As Prof Atiur Rahman, then governor of the Reserve Bank of Bangladesh, said: “The narrow response by a conventional central bank has been to create more money and ‘helicopter’ the same to affected financial institutions without impacting greatly the real economy. On the other hand, the innovative central banks took the newly created money with ‘bullock carts’ to the ground and impacted real economy both from demand and supply sides. In the process, not only the domestic demand has been upheld but also the supply chains remain robust. The end result has been the desired stability of the economy with expected growth process remaining in motion without enhancing inflationary pressure.”
At a time when we are experiencing what the UK Reserve Bank calls “an economic contraction faster and deeper than anything we have seen in the past century, or possibly several centuries”, narrow ideological crisis responses pose a serious threat to national security.
• Nkosi is an executive director and research head at Firstsource Money, and founding executive board member of London-based Monetary Reform International.