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Thursday, December 24, 2009

Savings in an Economy like Kenya

In Kenya, in order to save, you must invest.
Picture this, in the 1970s, one could buy a car with Kes 5,000. In the 1980s, one could only buy a motor cycle. It gets worse, in the 1990s, Kes 5,000 could only get you a bicycle. Now, Kes 5,000 is fit for only shoes. Imagine the individual who put aside Kes 5,000 in the 1970s and went to the shops to buy commodities. I think that the illustration gives on the picture. But this is a scenario played out in almost every country in varying degrees. The US Dollar is estimated to have lost more than 90% of its value over the last century. North Korea have just undergone a serious devaluation that has seen the holders of the current currency lose a significant amount of value.
One is therefore forced to ask why any government would think that destruction of wealth is a sure way to prosperity. Why would anyone save their money in a currency that is doomed to lose value? In other words, why hold your money in monetary form?
For those who doubt, the general purpose of a Central Bank is to, inter alia, hold prices steady in order to achieve a stable macro-economic environment. The main purpose of this is to instill confidence in the use of currency so that those who buy or sell are able to do so using local currency. Kenya’s Central Bank Policy is to hold annual inflation at 5% year on year. This means that the monetary authorities at Kenya’s Central Bank will allow a 5% reduction of the purchasing power of the Kenya shilling every year.
As earlier stated, the central purpose of a Central Bank should be to maintain stability in prices and the primary reason for this is to maintain currency as a credible store of wealth. For the general citizenry to be able to use currency, they should have faith that the value of their production is stored efficiently in whatever form until when they feel a need to exchange this value, commonly referred to as purchasing power, with another commodity or service that will satisfy their needs. In short, money is not held for its own sake, but to facilitate a transfer of value from one’s production to acquiring goods or services one needs in order to satisfy specific wants or needs.
One can already see the contradictions of the average Central Bank’s actions with its supposed role. A lot of Central Banks have adopted this inflationary policy that is sure to lead to metamorphosize into a currency crisis in the future.
The excuse a lot of Central Banks have given for this apparent inflationary policy is to sustain, nay, encourage economic growth. This is ostensibly done through two ways:
1. Inflationary policy aids in creating new money which can be used to make available credit to investors and consumers alike leading to higher investment and higher consumption; and
2. In some cases, this also helps hold down interest rates so that money can be ‘affordable’ to investors.
This inflationary policy has, however, its side effects. The first is that it can lead to a commodity boom. Low interest rates are fodder for speculation. In the international markets, this has been very apparent with money being used by large banks for speculation. Prior to the financial crisis, the world first witnessed a commodity boom which saw oil hit a high of USD 147/BBL. The commodity boom then went on to feed inflation into the general economy causing sever inflation. The commodity boom was, however, a bubble and just as the housing market earlier on, burst destroying a lot of wealth in the process.
Secondly, the low inflation regime was responsible for financing a lot of consumption and this was not sustainable as when the inflation rates forced interest rates up, there was a lot of demand destruction leading the economy to go into a depressionary spiral that threatened to turn deflationary.
Thirdly, the low interest rates discouraged savings which are essential to sustain investment and interest rates down and also helps temper boom-bust cycles.
In recent times, the governments and the monetary policy authorities have sought to intervene in order to ‘save the economy’ from the sever boom-bust cycles through stimulus packages and low interest rates. What we have then, is a highly unstable environment in which investors are supposed to conduct their economic activity. Interest rates are artificially low which is likely to lead to asset bubbles and later on inflation.
The fiscal stimulus is also likely to lead to inflated tax bills and possibly deflationary pressures in some industries when government is forced to withdraw its spending.
All this combined could lead to capital flight to safe currencies. However, seeing that the US Dollar, the Chinese Reminbi and the Japanese Yen face credibility challenges and the Euro, seeing the weakness in the Spanish, the Austrian, the English and the Greek economies, is also not very attractive, we may see people beginning to save in commodities, commodity stocks and in gold. I separate gold from commodities because, unlike other commodities, gold does is not consumed and therefore does not have a shelf life.
In summary, to save in the current world scenario, holding funds in local currency may lead to savings being wiped out. Government paper is looking more and more like the new sub-prime. We are only left with stocks and bonds. Bonds don’t look too good during inflationary times. This leaves stocks… especially commodity stocks and commodities as the only viable stores of wealth.

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