The economy equals the sum of all transactions inside of it. These transactions are small, but repeated over and over again. Adding all these smaller transactions together is how we get the sum of all transactions in the economy.
Each transaction needs a seller and buyer, where we exchange money or credit for goods/services
What is Money and Credit?
Credit is borrowed money, think of the loans you get from the banks or the credit cards you use.
Money (currency) is the cash you have available to spend, this is what belongs to you.
Each day, market participants (you/businesses) spend money in one form or the other.
This means that total spending in the economy equals money + credit
(Total spending = Money + credit )
It is this total amount of spending that drives the entire economy, and this all happens in the market, which comprises of all buyers and sellers.
(Therefore, the market = all buyers and sellers)
What is a Market?
Markets facilitate trade and enable the distribution and resource allocation in a society. A place where buyers and sellers can meet to facilitate the exchange or transaction of goods and services.
Examples:
- Corn / Wheat / Fruit / Fish
- Cars / Steal /
-Oil / Chemicals
- Gold/ Platinum
Markets make up the economy. Each market has their own transactions within the larger economy. Add each markets transaction all up, and you get prices.
(Total spending ÷ Total quantity = price)
Main forces that drive an economy.
1. Productivity Growth
2. Short Term Debt Cycle
3. Long Term Debt Cycle
Each country has a central bank which plays a vital role in the stability of maintaining their economy. They dictate interest rates and control the flow of credit, which impacts productivity growth and these cycles.
In short, it flows from the top down,
Central banks to commercials banks, then to us.
Read more about how inflation dictates interest rates by clicking here
Interest rates and the bank lending rate
In South Africa, interest rates are decided by the central bank. Check the historical chart below. Interest rates have been falling since 2000, meaning financing is cheaper. Theoretically, lower interest rates should have been contributing to economic growth, but in the case of South Africa it hasn’t
However, this may soon reverse, which means debt becomes more expensive and further contraction could be expected. You can click here to read more about debt and how government finances their deficits.
Current rates:
Repo rate: 3.5%
Prime rate: 7%
What’s the difference?
The repo rate is the rate the Central Bank lends to other banks as last resort. SARB lends to FNB, ABSA, Standard Bank, etc.
We don’t get this rate, it ensures commercial banks make profits off of our labor.
Prime rate: This is the benchmark rate at which banks use to price the risk of lending. This is the rate they start lending to us, however, the rate we usually get depends on our credit risk, which could be prime+ 2.
You can see the major problem here of this top down structure, the working class are at the mercy of the banking elites. This is how our economic production is stolen from us.
Economic levers
An economy has 4 levers at its disposal to handle economic downturns or to use to boost economic growth. Usually their results are negative and the working class suffer in the process because money flows to the bottom towards the end of the cycle. Those lower down don’t benefit, but rather pay the price of bad economic policies.
The 4 levers are to:
1. Cut spending
2. Reduce Debt
3. Redistribute wealth
4. Print money
All 4 levers have their benefits and disadvantages:
1. Cut spending
Also referred to as austerity. An economy that cuts spending must take capital away from something else. For instance, they may want to boost infrastructure spending, so they take away finances allocated to education. If they want to maintain their spending + more, as a nation we have to increase productivity or take on debt (deficit). Government can take on debt by issuing bonds
Austerity appeases investors, but causes stagnation in the economy. It ultimately slows down the velocity of money.
2. Reduce debt
Countries spend more than they earns = deficit = more debt. Think Covid, debt increased because we had to protect our economy.
Debt = % to GDP.
Reduce the debt and you have less money for things that matter. Running a deficit to maintain spending can be a very painful experience, especially if the economy doesn’t grow. The pain may not be now, but it is coming.
It comes in the form of inflation or currency devaluation. The only way to increase spending is if it is offset by new production. If you reduce debt once the economy becomes reliant on it, it inevitably leads to a contraction.
Below is South Africa’s debt to GDP ratio, by 2026 it will be 100%.
From 2016 to 2026 (10 years) it would have doubled.
3. Redistribute Wealth
Taxation is a common tool used to redistribute wealth, usually it leads to the ‘haves’ resenting the ‘have nots’.
Increasing taxes too often/rapidly leads businesses to question their viability of staying in the economy, because ultimately taxation is confiscation. The higher the tax the less incentive there is for people to want to stay or invest. If there is no net benefit to taxation, i.e. free health care, free schooling, then soon astute businesses/investors decide to pack up shop. It really is a balancing game.
Taxation has a role in the economy, no doubt, and is important to redistribute wealth, but eventually, if it is overused it will force higher rates of emigration. As the debt to GDP rises and productivity drops, it becomes increasingly difficult to stop spending when so many become reliant on what has been promised or what is needed, that the inevitable is wealth destruction in the form of inflation or currency devaluation.
It is why money in the future is worth less than today. It is why bread cost R10 in 2010 and now R16 in 2021, it isn’t the price of bread going up, it is the value of the currency going down. (FV)
4. Print Money
Printing money can lead to the expansion of an economy. If a country prints money to fund economic production, then inflation should be offset by this productivity.
For example:
If I produce more jobs and more apples from this new printing, then I am creating economic expansion. So, Productivity is key to offset this inflation that comes as a byproduct of increasing the money supply.
If I use loans to increase capacity on my apple farm, then not only does it create expansion, but it creates more employment and more apples for me to sell or to export.
However,
Inflation can be good and bad for an economy.
It can be bad because the costs of things begin to rise, and can lead to higher interest rates. Higher interest rates = less loans, lower interest rates = more loans, this is a monetary tool used to stimulate an economy and to control inflation.
It can also be good because inflation can be signalling growth, an increase in the money supply leads to bad inflation if there is no productivity from it, however, if the increase in the money supply leads to building more factories that produce more items/apples/food, then it has the ability to inflate debt away. As the GDP rises, the debt to GDP shrinks because of this new growth.
This is why it is important to understand good debt vs bad debt, once you can do that, then you are equipped with the knowledge of how to capitalize from this debt based system.
Let me end this off with quickly explaining why again,
It comes down to the future value of money (FV)
Money in the future is worth less than today.
If I borrow R10 000 today to buy a popcorn machine. I am buying an asset that generates cash flow, which I can use to service my debt.
Over time, I can increase my popcorn prices in line with inflation (prices rising because of this fiat devaluation)
Because of inflation, I am also able to inflate my debt away. R10k in the future isn’t worth as much as R10k today.
So, I’m using money now that is worth more (purchasing power) and I’m paying back debt in the future that is worth less. That’s the concept.
It’s why owning assets and equity in businesses is so important, because if you are saving in cash and only earning a salary, you will never get out from this race. It is designed to keep us trapped.
Stay safe, everyone,
see you next week ;)