By David Crossley
It’s common to hear people moaning about how expensive everything’s getting. But we might be even worse if the price of groceries and petrol remained the same for an extended period.
When I first arrived in South Africa, towards the end of 1972, everything was a lot cheaper. I bought my first car in 1973 for the princely sum of R200 and I remember how nervous I felt as I wrote out the cheque (if you don’t know what a cheque is or was, please consult your grandparents!)
Petrol was 9 cents a litre in 1973 and on one occasion, I treated myself to a T-bone steak and chips at a local restaurant. It cost me R1.75!
But less about my early buying experiences and more about inflation.
What is inflation?
A simple definition would be “A general increase in prices and fall in the purchasing value of money.” To understand Inflation even better, we can back to 1961 and compare the prices of a basket of goods against what you would pay for the same items today.
The figures look hideous, but if you were to use a financial calculator on, say, the coffee price, you’d see that there’s been an average increase of 9.09% every year – still high, but a little less frightening. (As a side note, this illustrates in glorious technicolour that compound interest is a friend when you are saving and a foe when you are paying off debt.)
What can governments do about it?
It is essential that a government controls the rate of inflation and they do this is a number of ways:
The Covid pandemic precipitated a meaningful reduction in the repo rate (the rate at which the SA Reserve Bank lends to commercial banks). This was largely to assist consumers struggling with high debt levels, as well as to incentivise businesses to borrow and expand to offset the economic decline. Generally, a reduction in interest rates will cause inflation rates to increase because people borrow more and, as a result, demand for goods will increase, generally driving up prices.
Another effective way of controlling inflation is to limit the supply of money in the economy by decreasing bond prices and increasing interest rates. This will encourage people to save rather than spend.
An overall increase in the competitiveness and efficiency of the economy makes the price of goods and their production lower.
If we look at historic inflation rates in South Africa, we can see the results of the Covid pandemic. The 2019 inflation rate was 4.13%, while the rate in 2020 was 3.27% – the lowest annual rate in three decades. Remember that the lockdowns prevented people from purchasing many items (alcohol, holidays and travel being but a few), resulting in demand being low. If we look at the inflation rate for 2021 to date, it stands at 4.47% and is forecast to rise in 2022.
Burden or opportunity?
Now that we understand a bit more about how inflation works, let’s consider whether it’s a good or a bad thing. One thing that all experts agree on is that excessive inflation is the enemy of any economy. But beyond this, things get complicated.
Governments often target a modest annual rate of inflation because they believe that gradual price increases keep businesses profitable and encourage consumers to spend their money (as opposed to putting it under the mattress). Some economists believe that the primary function of inflation is to prevent deflation.
But other experts contend that inflation isn’t that important and some even say that it can be a net drag on the economy. These people argue that price increases make it harder for consumers to save, which results in people having to resort to riskier investment strategies to accumulate wealth. Some economists belief that inflation unfairly benefits some businesses or individuals while hindering most others.
The bottom line
The position of the SARB is that modest inflation is desirable as it creates a balance between wage increases and the price of consumer goods and has a positive effect on economic growth. Over the past decade the South African inflation rate has largely remained within the 3% – 6% range targeted by SARB.
But what about the price of a T-bone and chips in 2021? This is R159.90 at Spur (350 grams), so my steak purchased in 1973 for R1.75 has increased by 9.86% per annum. This, experts will agree, is too high, and is largely a result of the economic and political turmoil of the 80s and 90s.
David Crossley is a Certified Financial Planner, and Practice Manager at BDO Wealth Advisers