Eskom tariff hikes are NOT inflationary

We’ve said it before and we’ll say it again: The Eskom tariff hikes coming in 2010 are NOT inflationary.  If anything, higher electricity prices in a low-to-no money and credit growth environment will leave the general price level unchanged but many product prices will fall.  Here’s what we wrote about it back in November.

Now, armed with the information presented above, we can safely say that Mr. Mboweni is either a) ignorant of what real inflation is (unlikely), b) thinks that Eskom controls the money supply (impossible), c) is using Eskom as a scapegoat to print more money out of thin air (possible), d) is trying to mislead the public (also possible) or e) some strange combination of a), c), and d).

Let’s break this down a bit further:  Suppose the quantity/supply of money in the SA economy remains stable (or roughly stable) in 2010.  In other words, the government does not print any new money next year.  Now, let’s suppose that Eskom raises its tariffs across the board by 45%.  Let’s assume that because electricity is such a necessary good, demand for electricity by households and companies only falls a little bit, and also that because Eskom is the sole supplier of coal-powered energy, there is no option to go to a cheaper supplier.

Let’s say this causes households to spend $20 billion more on electricity in 2010.  Let’s also assume that companies spend $50 billion more on electricity in 2010, and the particularly energy intensive producers want to pass these extra costs on to their customers.  Without an increase in the money supply, how will households keep paying for other goods and services with all these cost increases?  Once they’ve diverted income to their own electricity usage, and then diverted more income to those products that have now become more expensive, how much income will they have to spend on everything else?  Not much.  On those non-electricity intensive goods, prices will most likely fall and inefficient producers will be forced to liquidate until the market clearing price is reached.  

The general price level on balance will be unchanged.

Folks, Eskom tariff hikes are not inflationary, they simply divert more resources to electricity, which if used inefficiently makes the entire economic system worse off, but if used most efficiently makes the system better off.

As recently as October 2009 South African Reserve Bank (SARB) governor Tito Mboweni in his Monetary Committee Policy (MPC) statement said that he was worried about the adverse effect of Eskom’s electricity tariff hike on inflation. 

Unless money supply and credit growth get a kick in the pants soon, 2010 is going to see very low price increases, if any.  Definitely lower CPI increases than most expect, probably lower than 3%, and very possibly even price declines (often incorrectly called deflation).  Does this mean more rate cuts in 2010?  You bet.