Loan Shark

Borrowing dulls the edge of husbandry, and the loan oft loses both itself and its friend. So spake the wise Polonius to his son, Laertes, in a pre-capitalist era. But now, Shakespeare’s sage advice seems hopelessly outdated. Debt is now so deeply entrenched in our society that it is almost impossible to imagine a world without it.

I am currently attending the Global Philanthropy Forum in Washington, a gathering of remarkable people drawn together from around the world with one main objective: to find ways of improving the human condition. Much discussion has centred around the success of the microfinance movement in developing countries: the positive impact of providing poor people with small (and hitherto unavailable) amounts of credit which enable them to improve their lives. Microfinance advocates use heart-warming anecdotes to illustrate its success in lifting individuals out of poverty. It makes a great story.

In this morning’s newspaper, my eye was taken by a headline concerning a Presidential probe into US credit card interest rates. President Obama is making good his campaign promise to investigate the high cost of consumer debt at a time when, we are told, it is ever more important to raise consumer spending and unfreeze the market for credit. Apparently, many credit providers have recently hiked the cost of debt, in some cases to 30% per annum. Make no mistake, with inter-bank lending and depositor saving rates close to zero, this looks like exceptionally good business for financial institutions, laced with more than a dash of market failure. Bring on the regulator!

And yet interest rates at or above 30% are the norm in the world of microfinance, the latest “donor darling”, which seems to suggest that this cost of money – so unacceptable to policy-makers in the USA – is somehow entirely acceptable across the developing world. The fact is, that unless inflation is high, it is almost impossible to use expensive finance like this for anything other than short term trade finance or urgent consumption requirements, like health care or school fees. While this is unquestionably useful, in that it does provide access to short term money, it is harder to identify any systemic impact on poverty – if anything, interest rates like this will impoverish rather than enrich borrowers.

In defence, Microfinanciers say that these interest rates are fine: people are willing to pay even higher rates. They quote a willingness to pay rates of 50%+, but they seem to have missed the simple point that poor people in desperate need of cash have always borrowed unwisely: loan sharks and tallymen have always found a ready market in poverty.

Certainly, in East Africa, my own experience suggests that microfinance seldom, if ever, leads to increased employment. The small size of loans, allied to extremely high interest rates, usually means that microfinance is restricted to sole traders. With the best will in the world, a thriving economy cannot be built on sole traders alone. If we are going to have a real and long term impact on poverty, we need businesses that can generate employment for others, which means more small and medium-sized enterprises. In an environment like East Africa, where, as a result of rapid population growth more than 2 million people will be entering the labour market every year for the forseeable future, the need to create jobs is essential.

The dismal science

It seems to me that economists have a great deal to answer for. Despite all the theories, very few economists predicted the rapid onset of the credit crunch during 2008. Most people in the real world know that if something is too good to be true, it is probably untrue, but this simple piece of common sense appears to have eluded two categories: the credulous victims of conmen (of which more later) and economists. Alongside their failure to predict the economic woes of 2009, though, goes another heinous crime: the spawning of a deeply unpleasant lexicon, two recent examples of which are "deleveraging" and "quantitative easing". The first simply means the reduction of borrowing; the second, I think, means printing more bank notes in order to increase the money supply.

Gerard Baker, writing in the Times newspaper, described the potential adoption of "quantitative easing" as a revolutionary shift in policy and a new dawn in macro-economic management (though this brilliant journalist and commentator did leave the reader in some doubt as to whether or not this will represent a real or a false dawn). Even after allowing for journalist hyperbole, however, to call it "revolutionary" is over-stating the case - the Zimbabwean central bank, after all, seems to have been doing little else for the past few years - with the appalling consequences of hyper-inflation, just as occurred in the Weimar Republic in the 1920s and, before that, in the aftermath of the French Revolution. No doubt the Federal Reserve and the Bank of England's more modest injections of cash into the economy will not have quite such disastrous results, but if history teaches us anything, it suggests that quantitative easing is a dangerous policy to follow.

History would also suggest that in times of quantitative easing, real property and tangible assets are the best places to invest. There is an amusing (and probably apocryphal) anecdote which tells the story of a certain Emil Schultz who received his weekly salary during the worst period of the Weimar Republic in so many bundles of small-denomination notes that he was unable to carry them all home. He therefore borrowed a wheelbarrow from a friend and, on his way home, stopped at a small shop to buy some food. On leaving the shop, he found the money neatly stacked up on the ground, but the wheelbarrow stolen....

This anecdote brings me on to the subject of fraudsters and their credulous victims. Last week, in Kampala, I received an interesting approach from a certain Engineer K, who claimed to work for the National Water and Sewerage Corporation (NWSC) of Uganda. K explained to me at some length that the NWSC were sourcing spare parts for an urgent repair from Sweden, at great expense, while these same parts were available from a Kampala-based contact of his at a fraction of their imported cost. If I could be so kind as to go to his contact and buy the said spare parts, Engineer K would then arrange for the NWSC to purchase them from me at the import parity price, and I would make a tidy profit (to be divided between the two of us). Call me a cynic, but I think this is one of the oldest hustles ever invented. Once I have allowed greed to get the better of my common sense, I go to the contact and buy the spare parts. Engineer K and the contact then disappear, leaving me to discover that the parts I have bought are in fact worthless….. Of course, I am speculating here – maybe this time Engineer K is really telling the truth.

Recently, of course, this simple scam has been played out on a much larger and more damaging scale, the best example of which is the Madoff scandal, where so-called expert investors appear to have been seduced into believing that the delivery of steady year-on-year returns of 10% was somehow achievable through the alchemy of a secret investment management formula…… However, it also lies at the heart of the sub-prime debt crisis and the subsequent credit crunch, recession, mass unemployment and general financial misery, for which many economists and central bankers now suggest that quantitative easing is the best remedy.

Forgive me for my skepticism, but remember: if it looks too good to be true, it probably is.

The mystery of the devaluing Shilling

People keep asking me the same question. What will the impact of global economic turmoil be on Africa? How is it going to affect our economies? The general consensus seems to be that short term risks revolve around (1) a possible contraction in remittances from the African diaspora (2) reduced demand for commodities and African exports - including tourism and (3) a possible reduction in aid flows due to changes in allocations of donor country budgets. This sounds sensible, but you would think that each of these risks would take some time to affect the actual supply and demand of foreign exchange in East Africa - that the impact would not be immediate.

So what's happened? Well, over the last two months or so, both the Kenyan and Ugandan Shillings have lost more than 20% of their value against the US Dollar - after both having had a long period of stability (indeed strengthening) aganist the Dollar. It's hard to believe that the Dollar supply side has contracted sufficiently rapidly in such a short period, so it must be demand-driven. Bu where's the demand coming from? I'd like to know.

The next question, of course, is about impact, winners and losers. Exporters are quietly celebrating. For a long period during which local inflation was causing wage pressure without the benefit of any depreciation in local currency, exporters of major commodities (tea, coffee, horticulture and other agricultural products) have been struggling. Suddenly, the twin effect of a depreciating currency and rising international commodity prices look set to provide a substantial windfall. Importers, on the other hand, will struggle to pass on increased costs to consumers - and this presents a serious risk, especially in relation to oil and oil derivative imports. Inflation will rise, which will raise the cost of debt (which had been coming down slowly, even if still high by international standards).

Let's hope the exporter windfall brings in enough forex flows to stabilise the currencies. If not, then there's a real risk of forex shortages causing further depreciation, stimulating inflation and causing real damage to the regional economy. Let's hope!