Uncle Sam uses defibrillator to great effect

The steps taken in the US to counter the destruction of incomes and output caused by the Covid-19 lockdowns must be regarded as a resounding success. Real US output is now ahead of pre-Covid levels. By the end of the year GDP may well have surpassed that which may have been expected without the lockdowns.

It took lots of income relief — cheques in the post from Uncle Sam — supplemented by generous unemployment benefits and relief for businesses. The extra income means extra deposits with the US banks, to be spent later or exchanged for other financial assets: real estate, bitcoin or precious metals.

Money in the form of deposits held by banks with the Federal Reserve System has increased 85%, and deposits at the commercial banks have grown 26% since March 2020.

The source of the extra cash has been additional purchases of government bonds and mortgage-backed securities in the debt markets from the banks and their clients — insurance companies and the like — which are being maintained at the rate of $120bn a month.

The assets and liabilities of the Fed have increased 36%. It has been money creation on an awe-inspiring scale, and it has worked as intended to promote demand for the goods and services businesses are stimulated to supply, and to employ more workers to help do so. The fact that they are struggling to keep up with demand, and struggling to add to payrolls, has meant upward pressure on prices.

The contrast between the Fed and the SA Reserve Bank is striking. The Reserve Bank’s balance sheet contracted between March 2020 and May 2021 by R115bn, or 10.8%. The sum of notes issued plus deposits of the banks with the Bank (the money base) have declined 6% since January 2020. The M3 supply of bank deposits has grown by a paltry 4% and bank credit by just 2% since then. These are truly shocking figures for an economy struggling to escape a deep recession of the government’s making.

The Bank must be of the view that money and credit do not matter for the economy, that changes in interest rates are the only instrument it has to influence the economy — and that rates have declined far enough. These are serious errors of judgment that have punished the economy unnecessarily severely.

The Reserve Bank likes to believe its lower interest rate settings have been accommodative and therefore helpful to the economy. Higher interest rates would have been very unhelpful, and lower rates were called for. But the money and credit numbers indicate only deeply depressing influences on the economy, and that the Bank could and should have done far more to relieve the pressure, following the US example. There is more to monetary policy and its influence on the economy than movements in interest rates.

It would be easy to despair over the prospects for the SA economy given the trends in the supply of money and credit — but for the possibility that the US cavalry, with some Chinese assistance, may well rescue us in the form of rising prices for metals and minerals.

Metal prices have always led the SA business cycle in both directions. They may well lead us out of the current morass.

The supply of money and credit will then pick up momentum to reinforce the recovery, as they have always done in a highly procyclical way. The responses to the lockdowns have made it clear how our monetary policy leads with, not against, the winds blowing from the real economy. A favourable wind from offshore may lift the money supply and bank credit — without which faster growth is not possible.