US economy under siege – or not?

South African farmers should take the possibility of a stronger rand and higher interest rates into account in their plans for 2008.
Issue Date: 30 November 2007

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South African farmers should take the possibility of a stronger rand and higher interest rates into account in their plans for 2008.

US consumers have spent and borrowed themselves into trouble. A buoyant property market and low interest rates encouraged them to overspend money borrowed on the inflated house values. In a low-inflation, low-interest-rate economy with high growth, consumers found it easy to repay the higher loans. US banks were happy to loan whatever the borrowers wanted as they were largely able to get government-funded housing organisations to guarantee the loans. T hen the Federal Reserve started increasing interest rates, raising loan repayments. Highly leveraged US consumers suddenly found it difficult to pay.

Housing foreclosures rose and in August 2007 house prices had dropped 5% compared to 2006 – the first decrease in the average price of houses on record. Analysts predict between 500 000 and 2 million Americans may lose their homes by year end.

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Housing downturns preceded eight of the last 10 US recessions and the present slump is the deepest in history, but while some believe the US faces a huge economic crisis, others believe their economy’s inherent growth potential will prevent a general recession. In spite of the growing housing crisis, the US economy still seems more or less on track, and grew 3,9% in the third quarter of 2007. The Federal Reserve cut interest rates 0,5% in September and again by 0,25% in October, in efforts to forestall some of the housing crisis’s adverse effects on the broader economy. Unemployment during October also remained largely unchanged. O n the negative side, demand-driven oil and food price inflation, and weaker results from some of the major US banks, made the price of banking shares drop sharply. Auditors’ insistence on fair valuation of the mortgage-based derivatives they own, accelerated the process. he US economy faces serious problems. Chances are the US dollar will weaken further in coming months.

Prospects for SA economy

The SA economy faces a weaker US dollar, as well as high oil and food prices. Higher prices and strong consumer demand led the Reserve Bank to significantly increase interest rates. hough some economists doubt their wisdom, the Bank’s mandate is to keep inflation below 6%. Consumers overspend on durable and semi-durable goods, thereby creating excess demand.

The only tool the Reserve Bank can use to limit consumer spending is the interest rate. If inflation remains above 6% we can expect another 0,5% increase in December. he main effect of the US sub-prime crisis on SA is the stronger rand, which is difficult for producers in agriculture, manufacturing and mining to handle. s the rand’s strength is caused by dollar weakness, commodity prices tend to rise in dollar terms. This happened with gold, oil and to some extent with grain, although other factors also played a role. If the US weathers the storm, we may see the rand return to more sustainable levels of R7,00+. If the US crisis continues, it will result in a long-term exchange rate of around R6,50 to the dollar. Farmers should take into account the possibility of higher interest rates and a strong rand. Rather plan for the worse and be surprised by the good, than vice versa. Dr Koos Coetzee is an agricultural economist at the MPO. All opinions are his own and do not reflect MPO policy. |fw • global farming South African farmers should take the possibility of a stronger rand and higher interest rates into account in their plans for 2008. US economy under siege – or not? by koos coetzee