If history truly repeats itself, you should know what the 2008 and 2016 financial downturns can teach us about 2020 financial trends. It is a known secret that low-interest-rate environments are a precursor to a recession or just a gloomy time in the economy - Remember 2016 felt weird but we were not really in a recession? Yes, something like that. It is understood as part of a balancing act that the economy does and is deeply driven by the principles of capitalism.
However, we just fail to learn from history and to understand how so, let’s use the 2008 global financial crisis, and South Africa’s monetary policy response during the Covid-19 pandemic.
How the 2008 crisis began
In the years leading up to 2008, a lot happened especially in the US. The part to pay attention to is how the Federal Reserve controlled interest rates. For a while, US interest rates were dropping by quite some serious margins. As the rates dropped, it became cheaper to borrow until banks actually started running out of customers with good credit. For many reasons, banks started lending to customers with bad credit for mortgages – relatively speaking, they can afford it right? Well, at the time maybe. Not forever. As soon as the economy was under too much pressure, the Fed increased rates. Long story short, people who could only afford mortgages only because they were “cheap” started defaulting on loans and that also affected property prices, and the US housing market sank through the soil, notably taking Lehman Brothers with it.
Failure to balance
Fast forward 12 years later, we are facing a very unique pandemic. In our lifetime, we have never seen entire cities in a standstill, borders closed off, production almost at a full halt – all at once. Governments scrambled to save their countries with a variety of policies, and here is what the South African Reserve Bank did:
In the early stages of the pandemic, they started dropping rates in an attempt to curb the impact of the lockdown regulation. Now, watch the problem. The entire point of dropping interest rates is to get the economy moving, get people to borrow money and spend more. However, look at the math behind this rationale – in regular times, this is possible because people still have their jobs and people are free to move and queue up at shops in whatever numbers possible… everything that the lockdown regulations did not allow.
First, people lost jobs. You lose borrowing capacity when you are unemployed. In fact, you are a high default risk to a bank if you have any loans. Second, lockdown regulations dictated limited numbers of people in a shop, and limited quantities on selected goods. The problem presented here is where the math doesn’t work. This meant a shop is able to take much fewer customers than usual. This affects the movement of money and demand for goods in general. Third, consumers were faced with scepticism and uncertainty. For some, it was a good time to pay off loans but as for borrowing more money? That was a risk a lot were not willing to take.
The impact of Covid-19 in future was an unknown, and who wants to be caught up with big debts should things go sour? This then begs the question: What good is it to drop rates? No good at all. Rather, it is putting a lot of people at risk. Because when the pandemic blows over, rates will have to increase again. And those who unfortunately took big loans during low rate periods will suffer the same fate as the people in 2008. Markets will sing praises only to those who listen to their history.
For more to the beat financial articles that make sense of your financial world, keep an eye out for our weekly blog posts that go out every Monday, as well as other content to sharpen your financial literacy as you strive towards financial freedom. Follow us on Instagram and Facebook for updates.
Author: Nkanyiso Nyawose