July 24, 2010
 By Bruce Cameron
The National Credit Act (NCA) has been getting the blame for a lot of things recently, from the slow-down in the economy to the non-profitability of banks.
Last week, Duggan Matthews, an investment professional at Marriott Asset Management, issued a statement about the slow-down in future investment returns. One of the reasons, he says, is that the NCA, with its clampdown on credit, is at odds with the Reserve Bank, which is trying to encourage economic growth by lowering interest rates.
Somehow, I do not think that Reserve Bank governor Gill Marcus regards her policies as being in conflict with the NCA. The lowering of interest rates has nothing to do with irresponsible lending by banks and retailers or with irresponsible borrowing by consumers.
In fact, the NCA was a national hero when economies around the world were collapsing as a result of banks’ irresponsible lending to the subprime property market in the United States. The equally irresponsible investment banks were selling this toxic debt to investors.
The NCA was credited, along with exchange controls, for having saved South Africa from much of the evil of the subprime crisis.
In his statement, Matthews was not actually criticising the NCA; he was simply saying that it is one of the reasons we will not see the JSE repeat its stellar performance of the past 10 years over the next 10
years.
In a nutshell, Matthews was saying that people will not be using debt to buy and therefore businesses will be making lower profits, as will banks, which will not be earning interest on that debt. It also means that manufacturers will be producing fewer goods. All this can result in fewer jobs and contribute to slow or negative economic growth.
There is no right or wrong to this argument. Borrowing is good for economic development. But it is the kind of borrowing that matters. It is a bad thing if we borrow to meet our wants, such as to buy luxury items we do not need, and we incur excessive debt as a result. This is what happened in the subprime crisis. Money was lent to people who were highly unlikely to repay it.
Initially, borrowing looks like a good thing. There is more money in the economy, people spend more and more, shops sell more and more, factories produce more and more, and everyone is very happy. Then people start to default on their monthly debt repayments, and, when sufficient numbers start defaulting, the whole process goes into reverse. There is less demand for goods and services, shops sell less and less, and factories produce less and less. More people lose their jobs, so they default on their loans and spend less, until we have a contagious subprime crisis that spreads like wildfire around the world. This is why we have the NCA: it stops irresponsible lending and borrowing.
OTHER PROBLEMS
There are a number of other problems associated with having excessive debt. They include:
Inflation. If too much money is chasing too few goods, the result is inflation. Inflation is spurred by excessive debt.
Inflation is not good for a number of reasons. The most important reason is that it reduces people’s buying power – that of pensioners in particular. Take for example the atrocious way in which Transnet handles a fair number of its pensioners. It has limited increases in the pensions of the 80 000-odd pensioners of the Transnet Second Defined Benefit Fund to two percent a year. The higher the inflation rate, the more impoverished these pensioners become.
Inflation filters through to things such as capital gains tax (CGT). For example, you have an asset worth R1 million that increases in value at a rate equal to inflation for 10 years. At the end of five years, you sell it for R2 million. In real terms (after inflation), you have not made a cent in profit (ignore the exemptions). But the taxman sees the R1 million you made as a capital gain, and if you are on the top marginal tax rate, you will pay 10 percent of the R1 million “profit” in CGT. In effect, CGT is often an inflation tax.
Volatile interest rates. If there is excessive debt, we move through constant boom and bust cycles, with interest rates going from sky high to rock bottom.
The main task of the Reserve Bank is to protect the value of the rand. In other words, it too must not permit
irresponsible lending that allows the inflation rate to get out of control. It does this by ensuring that banks hold fixed levels of reserves and by using the repo rate (the interest rate at which the Reserve Bank lends money to banks) to influence all other interest rates.
In many ways, however, the repo rate broadly follows market forces. If people are borrowing less, the demand for money falls and so will all interest rates, including the repo rate.
If the Reserve Bank can maintain inflation within a narrow low band, life becomes a lot easier for everyone. And this task becomes easier for the Reserve Bank if there is no excessive debt driving a spiralling inflation rate.
Low economic growth. South Africa is a capital-starved country. In other words, we do not have the savings to meet the demand for
development. We have to borrow in international markets. And, as is the case with an individual who is short of money and over-borrowed, the country needs to pay more for that money. If we save more, there is more money in the kitty for development and economic growth.
A point on which Matthews is absolutely correct is that South Africans are borrowing less because of the insecurity created by the economic downturn (and the potential for job losses), as well as the possibility that interest rates will rise again (as they surely will).
Excessive debt not only causes economic problems for the country, it also causes personal problems.
No one can save if they have excessive debt. People with excessive debt suffer from many consequences in the long term:
Personal tragedy. High debt causes fractious relationships, often resulting in divorce, substance abuse and even suicide.
You lose your bargaining power to negotiate for lower prices.
You pay higher interest rates when you borrow money because of the risk that you may default.
You struggle to pay for essential things, such as your children’s schooling and tertiary education.
In retirement, you will join the millions of elderly people who have to survive on the social old-age grant of R1 080 a month.
It is better for you and the economy to restrict your debt and save more. In this edition of Personal Finance, we mark National Savings Month by explaining how to borrow wisely and how to save (see related article below). It is an event worth taking very seriously.
  
 
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