Fat interest rates a thing of the past

THE most common question in financial-planning seminars is: “When will higher interest rates return?” To look for an answer, let us examine celebrated economists.

Keynesian general theory helped to bring the world back from the Great Depression. Governments spent money like crazy and the wheel turned, causing the multiplier effect. Inflationary side effects were not a major consideration because the scarcity of resources was not an issue.

After the 1974 oil crisis, inflation rates became a major worldwide problem. Initially, governments sought to control inflation by applying the monetary economic ideals of economist Milton Friedman. In short, monetary policy seeks to curb consumer demand by regulating the money supply and increasing interest rates, resulting in a decline in inflation rates.

A benefit of monetary strategy is that high real interest rates can successfully underpin a financial plan. The downside is that it simply strangles the consumer and the economy. This can result in higher tax rates and increased government deficits. Furthermore, it places home ownership beyond the means of most, further straining government resources.

Former US Federal Reserve Bank chairman Alan Greenspan made sure that harsh monetary strategy was largely abandoned during Generation Y. The resultant lower interest rates stimulated consumer spending and many economies benefited. But the bubble burst in the global credit crunch of 2008.

Chris Stals was the South African Reserve Bank governor from 1989 to 1999. He was a monetarist and also applied interest rate strategy to protect the rand against speculators. Stals seemed to have a far greater say in South Africa’s economic policy than the ministers of finance at the time. Today’s Reserve Bank governor, Gill Marcus, has to accept that increasing interest rates will strangle the economy, wreck Finance Minister Pravin Gordhan’s tax collections and cause a war with the Congress of South African Trade Unions.

Today it is simply not possible to create a financial plan based on risk-free interest rates. Those days are gone and they are not coming back. Investors have to lower their return expectations from 20% a year to 10% or less.

Originally published in the Sunday Times: Money & Careers Tax Talk column.

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