Capital destruction in the name development
Destroying the capital of one group in the hope of creating capital in another is not economic development. It is wealth transfer.
As of today, Malawi’s savers scrape between 4.0% and 8.75% per annum at the country’s largest bank, this range being controlled by the central bank. However, with inflation officially averaging 32% over the past year, this means savers suffer compulsory wealth confiscation of between 23.25% and 28.0% per annum. And since the greater proportion of people’s outgoings is on food which, officially, averaged 40% over the same period, the damage is likely much worse.
Unsurprisingly, this motivates one of the lowest savings rates in the world at 11%. People are forced to seek alternative means to protect their capital, and that is what they do.
We find everything from maize and goats to houses and land monetised, used as alternative stores of value. This is mostly unproductive, often counter-productive, leading to scarcity and unaffordability of even basic necessities like food and shelter. And the goats — the store of value that destroys all value — are a whole story in themselves.
This is a big problem in one of the world’s least developed countries. Economic progress depends on capital formation, not capital destruction.
Meanwhile, the banks face relentless pressure from everyone — government, small business groups, the public and, of course, the Donorati, especially the Donorati — for simply not doing enough to support economic growth in the country.
With what?
The interest rate on the Malawi Government’s ‘All Type Treasury Bill’ is 20.7%. Government debt is usually considered ‘risk free’, so when compared to their cost of capital (for simplicity let’s take 6% based on the savings rate), the banks’ spread is 14.7%. A 364 day T-Bill offers the highest yield at 26%, a 20% spread. On current account balances, which pay no interest, there is no cost of capital.
72% of domestic credit is thus sucked up by the government, whose borrowing ballooned by 49% last year, an untouted but plausible (probable) explanation for the 51% growth in the money supply and, ergo, inflation over the same period. If we include the debt of state-owned enterprises, the public sector accounts for 79% of domestic credit.
Naturally, it is the well-established businesses with long-standing relationships with the banks, and balance sheets strong enough to secure the funds, that take what is left.
The entrepreneurs who could kick-start economic progress are much higher risk propositions, and typically have no suitable assets to offer as collateral for a loan.
But the bank is unable to account for this risk because the central bank also sets a minimum and maximum interest rates for lending, currently between 25.4% and 36.12%.
These rates might sound high to the Western reader, but if we compare the ‘risk-free’ rate to this 36.12%, the bank has just over 15% wiggle room within which to absorb the additional risks and costs while making an acceptable return for their shareholders — and this in a rapidly depreciating currency.
You can’t expect banks to step in with their own capital when the real interest rate is between negative 6.6% and positive 4.12%.
Would you?
So the status quo limps on, not because of the evils of the established, but because no capital has been accumulated to support the entrepreneurs. Credit, whether to government or the private sector, is made possible only by the hugely negative real interest rate paid to savers.
What do the Donorati have to say about this?
Specialising in solutions to second order effects, they inject funds from overseas to artificially increase the supply of capital. They then invite entrepreneurs to apply for these funds at favourable rates. Typically, this entails a 50–70% grant (the remainder can be offered in kind), or a 5–7 year local currency loan at a 10% interest rate. (Remember, inflation is officially 32%.)
This all sounds great, but only if we ignore the second order effects of their solutions.
First, this money is far from free — the Donorati Dollar comes with strings attached. To qualify, your company must align with their gender agenda, youth job creation, climate-smart solutions, and ‘digitisation’ (but under no circumstances can digitisation include bitcoin). Thus, the idea, the dream, of creating a product that will transform people’s lives — surely the whole point of entrepreneurship — fades away, replaced by the realisation that there’s a lot more money to be made serving the Donorati’s interests.
Second, funding an entrepreneur to serve an agenda and not a customer can only mean capital misallocated to projects that would otherwise never have found funding. Any company, large or small, that earnestly chose to focus on its customers, chose the wrong path. Having forgone the Donarati funds, the forlorn now face (unfair) competition for labour, raw materials, equipment and land. The artificially increased scarcity of these factors of production pushes up their prices, except, of course, for those who dine with the Donorati. They see only discounted scarce resources flowing to them.
Third, the cheap Donorati funds erect huge barriers to entry for those who miss out, creating monopolies, whose USP can only ever be reliable submission of gender and climate data to the Donorati’s Ministry of Foreign Interference. Eventually, the chosen ones become Too Big To Fail because the salaries and lifestyles of their Donorati sponsors depend on their ‘sustainability’.
In the West, we have the Cantillionaires, those positioned next to the central bank money printer, from where they access cheap funds at the expense of everyone else. In Malawi, we observe a similar phenomenon, delivered in the name of Development. These companies, sipping from the Donorati spigot, are the Cantillon Companies.
Having turned a blind eye to the root cause of scarcity, the Donorati have inadvertently introduced yet more barriers to economic progress.
Scarcity is a fact of life, imposing limitations and necessitating (sometimes difficult) choices. With only one day left of your holiday, you have to choose how best to spend that time. When goods become scarce, they tend to increase in price. This higher price acts as a signal, perhaps motivating an entrepreneur to devise a way of producing the good for less, or those who don’t care for it so much to reduce their consumption of it.
Artificially lowering the good’s price or increasing its supply will not solve the root cause of its scarcity.
In Malawi, capital is scarce, and so it follows that its price would be high. A high price would regulate its flow to only those projects worthy of the scarce resource, avoiding misallocation, and forming the foundations of economic progress.
The central bank’s act of artificially lowering the price of capital (i.e. the interest rate) has the effect of increasing its scarcity by incentivising capital to be (mis)allocated into non-productive (and even destructive) assets. And setting a maximum interest rate for loans makes it difficult, if not illegal, to lend to projects above a certain level of risk. The opportunity cost of this is that entrepreneurs cannot access funds for projects that could otherwise have begun turning the country around.
The Donorati’s act of artificially increasing the supply of capital and cheapening it still further, enriches the owners of the Cantillon Companies (and of course the Donorati’s army of employees and consultants) but at the expense of everyone else.
What, then, is the solution?
Starting from the point of view that borrowing from somebody and then repaying them less than the amount borrowed would amount to default, the interest rate must at least match the inflation rate if we are to motivate and compensate savers. If the entrepreneur thinks this is too expensive, then he either does not truly believe in his project or he wishes to default. In either case, the project should not be financed.
Since lending is not typically peer to peer, but relies on banks to pool savers’ resources and identify viable projects, the interest rate must be higher still. But the current maximum allowed rate of 36.12% provides no room for banks to cover costs, price in the risk of default or make a return. The only way to finance anything is to destroy the capital of savers.
Destroying the capital of one group in the hope of creating capital in another is not economic development. It is wealth transfer.
The solution (pending a return to sound money) is to allow interest rates to be freely negotiated. This will increase the supply of savings, reduce the monetisation of unproductive assets, and enable more projects to be financed.
There is no way of knowing in advance what these rates would be. But the best projects should be able to beat inflation and provide sufficient compensation to the banks to draw in and reward the savers.
Interest rates, therefore, must be substantially higher than they are now.
While at first the supply of projects at these higher rates would likely be small, this would ensure that only the soundest, most economically viable projects would be funded.
Then, as the propensity to save grows and capital is reallocated from the unproductive to the productive, interest rates will begin to fall, and the seeds of economic progress will finally have been sown.