High interest rates - the road to ruin
Published: Sunday | February 22, 2009
The Bank of Jamaica building in kingston
Back in early 1994, an acquaintance told me of a Bank of Jamaica (BOJ) United States dollar bond paying the incredible annual rate of over five per cent tax-free.
At the time, the exchange rate was volatile and loan rates were astronomical with penalty rates on overdrawn accounts topping 120 per cent. He opined that we were crazy to stay in business with all the attendant toil, stress, risks and uncertainty.
A short time later he sold his thriving business and invested most of the cash in bonds that paid close to 30 per cent annual interest.
In the 15 years since he hasn't done another day's hard work and has made a fortune speculating in the various financial instruments issued over the years by the ministry of finance and the BOJ to "mop up liquidity". Today, a smart, enterprising, relatively young Jamaican occupies his days lazing around, playing golf and travelling the world.
I was reminded of this a week ago when I read for the first time that there were serious doubts about Allen Stanford's financial empire.
The US Securities and Exchange Commission (SEC) deemed as "improbable" the interest rates offered by Stanford's company. The latest high-yield "certificates of deposit" offered by Stanford International Bank promised 4.5 per cent annual interest while the typical US bank paid interest of just under two per cent for a similar instrument.
The SEC's "improbable" comment begs the question of how that regulator would characterise the various financial instruments issued over the years by the Jamaican government. What I didn't predict back in 1994 was that a five per cent interest rate would be at the low end of the scale. Jamaica's "improbability" is that we are still mired in high interest rates 15 years later.
The seemingly unending cycle of macro-economic instability ameliorated by tough monetary policies have had a devastating effect on businesses by making capital very expensive.
The debilitating effects of years of high interest rates have been discussed and lamented in terms of their impact on the Jamaican non-financial sector, that is, the "productive" sector. Similarly, we have regretted the level of interest payments on the debt accrued, more than half of all taxes collected, in terms of the Government's inability to provide basic services such as security, education, health, physical infrastructure and so on.
We are yet to assess the impact on the national psyche in terms of the national attitude to entrepreneurship, investment, and work ethic, of the years of unearned income based on instruments with high interest and apparently low-risk aided and abetted by the State policy.
Chen and Stanford
This last impact is one of the key causes of the rapid rise and widespread acceptance of the unregulated financial organisations (UFOs) in the last few years. The appetite for and expectation of guaranteed high rates of return and the obliviousness to the attendant risk were fostered by years of living in our high-interest-rate regime. Years of earning high, seemingly risk-free returns has created a level of expectation that is unrealistic in a properly functioning economy.
Harsh monetary measures that were always envisaged to be short-term have had the unintended consequence of creating a psyche that works against productive investment that in turn retards economic growth and facilitates macro-economic instability.
It is instructive to look at the aggregate profits of the companies listed on the Jamaica Stock Exchange and compare the income earned from financial services with the total income earned from manufacturing, trading of goods, and non-financial services. Financial services earned more than four times the income made from the provision of all other goods and services combined.
not a sustainable situation
This is not a sustainable situation; banks cannot prosper if their customers are not prospering.
It may be argued that the banks can reduce their loans to businesses and individuals and simply invest in "government paper" with its high interest rates, low administrative costs and apparently low risk.
But somewhere along the line it seems that we have forgotten that government doesn't exist in a vacuum and we support the high interest rates with our taxes. If our individual and business prosperity becomes impaired, the Government's own ability to continue to pay will similarly be impaired.
The continuation of high interest rates, famously characterised by MP Ronald Thwaites as "the most massive transfer of wealth from the poor to the rich since slavery", is manifestly unsustainable.
Just as a bank cannot prosper if its customers are not prospering, so too it cannot prosper if its largest customer, the Government, is not prospering.
Government, financial sector, non-financial sector, and individuals are mutually dependent and no one will do well without the others doing well.
We need to ensure that the recent bonds, paying 24 per cent, a windfall for investors, but a disaster for borrowers and taxpayers, are only an emergency short-term measure. The country is in a bind, made worse by the global economic slowdown, so it may be the least bad option at this time and the alternative may well have been economic and social instability brought about by an unmanaged fall in the exchange rates.
But, we've been faced with this choice before and the harsh short-term measures have usually become long-term grief. The trick that we've not been able to master is how to break out of this ruinous cycle.
exchange rate stability
The path to exchange rate stability and low interest rates, not ends in themselves, but means to sustained economic growth, needs tight fiscal management and efficient government.
Ultimately, this is less likely to happen in our low-trust adversarial political culture. While the challenge may be economic, the solution has a significant political component. Many of the issues require the political will to make the difficult decisions that may be highly unpopular in the short term.
So a new type of politics will be needed to get out of this spiral; one characterised by consultation and responsible leadership that recognises that a social partnership may not be a panacea, but it's the best hope that we have at this time.
Wayne Chen is president of the Jamaica Employers' Federation. Feedback may be sent to firstname.lastname@example.org.