“In 1968 when I arrived at UCT, a beer at the Pig and Whistle in Rondebosch cost 21c. At The Hussar (which still exists I think), a “Hussar Giant” steak with trimmings, which was the most expensive item on the menu, cost R2.75. In 1972 I earned gross R114 and net R107 after tax per month, out of which I had to pay all of my living expenses: rent, food, clothes, transport, Varsity fees…”

Those are my dad’s words – I’m sure your parents and grandparents said similar things to you.
And it’s basically a given that you will say these sorts of things to your own kids. Because, for as long as you’ve been in charge of buying your own groceries, you’ve noticed that the prices only ever go up, right?

Most of us are probably pretty comfortable with the reason why a beer at the Pig and Whistle doesn’t cost 21c anymore – it’s inflation. But what is that, actually? There are many complicated ways to define inflation, but here’s a good short one: inflation is too much money chasing too few goods.

For example, if you identified a terribly poor and derelict rural village, and decided to help out by air-dropping a pile of cash on the (very confused) inhabitants, you won’t have solved their problem.

Taken in complete isolation, all you will have done is make prices go up – there will still only be 3 scrawny chickens to eat, but instead of competing to pay 16 Rands per chicken, newly cash-wealthy villagers will be fighting to pay 16 000 Rands per chicken. Nobody actually gets more food, more opportunity, or more of any of the things that money should bring (demonstrating the point, maybe, that you can’t solve poverty just by throwing money at it). You’ve increased the money supply, but you haven’t made anybody rich – all you did was cause massive inflation.

Now, I’ve been paying close attention and nobody has dropped any cash over my neighbourhood, so why is there still inflation?

Firstly: I’m going to keep things simple and ignore the actual cost reasons for some price increases (like how fish is getting more expensive because the oceans are literally running out of fish). Secondly: It’s important to understand that a small amount of inflation is a very good thing for an economy, and as part of their “let’s have healthy inflation levels” agenda, Finance Minister Nhlanhla Nene and the Reserve Bank constantly tinker with the money supply to keep our economy stable and growing. But they don’t need to dump physical cash on people to achieve this.

In a local market (so let’s pretend the rest of the world doesn’t exist) there are four basic ways to tweak the money supply:

Printing Money
Yes, actual printing. Not as popular as it used to be, but printing money was all the rage in the 20th century, and a great way to (temporarily) make your country feel richer and (longer term) turn your national currency into worthless paper – see Germany in the 1920’s, Hungary and Greece in the 1940’s, Yugoslavia and Peru in the 1990’s… the ‘hyperinflation club’ is an unhappy club to belong to. Zimbabwe joined it in 2007/2008. Go easy on the printing, Minister Nene.

The Reserve Ratio
When last did you draw cash from one of your bank’s ATMs? Did the ATM have enough money in it for your withdrawal? Excellent! That’s what the reserve ratio is for – it’s the mandatory minimum amount of cash that banks have to have on hand to dish out to their customers on request (when you want to withdraw it). Aside from that reserve, the banks can use the rest of that money however they please – lending it to other people, other banks, or invest however they like for as long as you leave your money with them.

The current reserve ratio, set by the South African Reserve Bank, is just 2.5 percent. So, out of every R100 held in deposits, banks must keep R2.50 in cash in case someone wants to withdraw.

Now, if we were to cut this rate to 1.5 percent, then banks would be able to spread that extra cash around, lending it, investing it, and boom, the money supply increases.

[I dunno about you, but 2.5 percent feels low and makes me want to keep cash under a mattress. Take a look at other countries’ reserve rates here.]

The Bond Market
When the government buys or sells bonds, they change the money supply. Think about what happens when the government issues bonds – people line up to give the government cash, and the government gives them a shiny certificate in return. All that cash flowing one way (to the government) and just certificates flowing back. When governments sell bonds, they suck cash out of the economy like a straw in a milkshake, but when the government goes out into the market to buy back bonds or pay out when a bond is due, they’re pumping cash back into the economy – and the money supply grows!

Interest Rates
I’ve been looking at buying a house lately. From what I’ve seen, I’m pretty sure that I’ll rent for the rest of my life, but it’s clear that the interest rate you get on your home loan is, you know, important. If you’re lucky you might get the Prime interest rate – currently 9.25%. The banks themselves lend to each other at 5.75% – the Repo Rate (lucky bastards).

The prevailing interest rate has an effect on money supply when it changes – drop the rate and debt is cheap: mortgages seem affordable, credit cards aren’t so scary, people spend, spend, spend. All that spending means more money flushing around the economy, increasing the money supply, chasing goods, driving prices up.

Right so, those are tools for tweaking, but where are we now? How is South Africa’s inflation doing?
Not too bad to be honest! Right now, per the Reserve Bank, inflation is hovering around 4.6 percent, in the self-declared “green zone” for a developing economy of our size.

Inflation rates

Source: South African Reserve Bank

Still, all that inflation adds up as the years go by – here’s a chart showing a good long history of inflation in South Africa.

inflation

 

So, roughly speaking, what you could get for R1 in the 60’s, you would have to pay R100 to get in 2012.

It’s a strong reason to look at something like, say, annual salary increases and see how they match up to the inflation of the same time (you can mostly get away with very simple maths – just minus inflation). Did you get an 8% raise this year? Well with inflation at 5% this year that’s… uh… a 3% increase – do you still feel so great about the raise? Do the same with returns on your investments – if you have a share portfolio (locally) then take the annual growth rate (maybe 12%?) and deduct inflation – 7% is a bit less impressive, isn’t it?

Inflation isn’t going away, and rents will rise and beer will reach ridiculous prices within your lifetime. But maybe, if you’re lucky enough to be buying a house now, you’ll be laughing in 2040 about how ‘cheap’ property was back then in the good ‘ole days. And your kids won’t believe what you used to pay for beer.

 

Photo by: Eric Ward, Mass Ascension via flickr.com, CC BY 2.0.