Explained: Quantitative easing – and why Ace Magashule caused a crisis by mentioning it
- ANC secretary general Ace Magashule announced that the party's National Executive Committee had asked government to appoint a task team to explore quantitative easing.
- Quantitative easing is the process through which central banks boost struggling economies.
- Essentially, they create money out of thin air - and buy all kinds of assets, to bolster demand and inject money into the market.
- It worked for the US and Europe – but South Africa is a different kettle of fish.
- For more, go to Business Insider South Africa.
On Tuesday, ANC secretary general Ace Magashule sent a jolt through financial markets across the world with two words: quantitative easing.
In a press briefing following the National Executive Committee’s latest Lekgotla, he said the ANC had decided that the South African Reserve Bank’s mandate should be expanded.
See also: SA’s economy is shrinking at an alarming rate – and only oranges and interest rates are offering hope
"It also directed the ANC Government to consider constituting a task team to explore quantity (sic) easing measures to address intergovernmental debts to make funds available for developmental purposes," Magashule said.
The rand, which was just stabilising after the shock news that the SA economy shrank by more than 3% in the second quarter, immediately started falling again.
Finance minister Tito Mboweni later rubbished Magashule’s statements on Twitter:
Government sets the mandate for the SARB. There is no quantitative easing thing here. The primary mandate of the SA Reserve Bank is to “protect the value of the currency in the interest of balanced economic growth and development”.— Tito Mboweni (@tito_mboweni) June 4, 2019
He also issued a lengthy defence of the SA Reserve Bank on Facebook:
It is worth comparing @Magashule_Ace’s incoherent paragraph on making the @SAReserveBank print money (“Hello Zimbabwe”) in the @MYANC statement with this succinct post by Finance Minister @tito_mboweni. Frankly, Magashule should not be allowed to speak on economic matters. pic.twitter.com/xtf6Uv9UsL— Justice Malala (@justicemalala) June 4, 2019
Meanwhile, the chair of the ANC’s economic transformation committee, Enoch Godongwana, also issued a statement to say that Magashule's comments about quantitative easing were "inaccurate". There was also no decision by the ANC to expand the mandate of the SARB, he said.
Note - the ANC isn't anywhere close to imposing QE any time soon. It can literally barely spell it. It's more a signal that posturing over the central bank is going to go on and Ramaphosa hasn't 'won' that factional battle yet.— Joseph Cotterill (@jsphctrl) June 4, 2019
Still, it's clear that investors remain spooked by the mere mention of quantitative easing - the rand, currently around R14.70/$, is almost 30c weaker compared to yesterday morning.
What is quantitative easing?
QE is a way for central banks to boost a struggling economy.
It usually works like this: a central bank creates money out of thin air, electronically, by simply typing in new amounts on its balance sheet. This is a unique super-power of central banks.
Using this newly created money, the central bank usually buys assets from banks and other companies. These companies then use the cash to invest in other assets – giving the economy a boost.
Usually the central bank buys government bonds from financial companies, but different central banks have bought different things – like mortgage-backed assets (which helped the US housing market) and bonds issued by private companies.
The bonds are then added to the bank's balance sheet as assets. This causes bank reserves in the financial system to increase.
The American Fed expanded its balance sheet by about $3.5 trillion via quantitative easing, while for the European Central Bank it was more than €2.5 trillion.
Does it work?
QE is credited for bringing the US back from the brink after the financial crisis, while it played an important role in saving the EU from the European bond crisis.
The trillions in new money created meant that there was enough money sloshing around in markets to maintain demand for investments – even as many people were panicky. This kept markets from seizing up, and the economy went ticking on.
The big fear was that creating new money would spark inflation: printing money usually does. But that didn’t happen.
So why are markets freaking about South Africa considering QE?
In short, South Africa is not the US or the EU. It doesn’t have a strong and stable currency, investment-grade bonds, or super-low inflation.
South Africa's inflation rate is above 4%, compared to around minus 1% in the US before that country kicked off QE.
Creating money out of thin air in an unstable economy, where investors are already concerned about government debt and the value of the currency, can be a recipe for hyper-inflation and, often, disaster. Zimbabwe is a case in point.
In addition, the NEC suggested that the money created by the central bank would be used to pay off government's debts, and that the money saved on repayments would be invested in developing the economy. This is not EU- or US-styled QE - and would put South Africa in uncharted territory.
Also, QE is usually only an option when a central bank can’t cut interest rates any further.
South Africa still has a long way to go on that front. The repo rate is currently 6.75% – compared to the UK (0.75%), Australia (1.25%) and the US (2.50%). Countries like Switzerland currently offer a negative interest rate – in effect, you have to pay its central bank to own the bonds.
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