Deciphering financial jargon
23 September 2016
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On mobile, on digital, on demand, this is Old Mutual Live, Money Coach edition. Hello and welcome, my name is Chris Gibbons. How many of us, I wonder, listen to the financial news, stocks and shares, bonds and interest rates and so on. Without really knowing what the various words mean. There’s no doubt that the world of business and finance has more than its fair share of jargon.
So I thought it would be useful if we called in an expert to just talk us through some of the basics. To guide us, as it were, through the verbal minefield. We’re joined now by Dawie Roodt, Chief Economics at the Efficient Group. Dawie, welcome, thanks for your time. Where to begin? What would you say are amongst the most commonly misunderstood phrases?
Dawie Roodt: You know, economics is a really very simple and straight forward and easy to understand subject. For that reason economists get together quite often to think of difficult names. Because we realise that if people understand how easy economics is, we won’t have jobs anymore. So that’s what economists do, they make easy things really as difficult as possible.
The real meaning of inflation
If you ask me about the most misunderstood number, it will probably be the inflation rate. I’m sorry to say but I think there are many economists that don’t really understand what inflation means. Let me give you an example. The definition for inflation is the continuous increase in the prices of most goods and services.
If you listen carefully, and I ask you the question; if there’s an increase in the price of petrol, as an example, does that mean we have inflation? The answer is most people, most economists will answer, yes. That will mean that we have inflationary pressures, which of course, is wrong. That’s not all goods and services, according to the definition.
An increase, if you argue, the reason why we have inflation is because the petrol price went up. You can just as well argue the reason why we have inflation is because the beer price did not fall. That brings me to a better definition for inflation.
Maybe we shouldn’t be talking about inflation as a continuous increase in the prices of most goods and services. Rather inflation is the continuous fall in the value of a currency. That I think is a better definition for inflation. Be careful, inflation is one of those most misunderstood numbers out there. Quite often the public at large quite often think also that if there’s a fall in the inflation rate, it means that things are getting cheaper. That’s certainly not the case.
It simply means things are still getting more expensive, but at a slower rate. Do not think that inflation is caused by an increase in the petrol price. Inflation simply means that the value of the money in your pocket becomes less and the money loses its value.
What exactly is meant by ‘the markets?’
CG: One that I reckon is possibly misunderstood Dawie, ‘the markets.’ The markets are doing this, the markets are doing that, what do we actually mean when we say ‘the markets?’
DR: Who is this thing called ‘the markets?’ To quote our ex-Minister of Finance, our former Minister of Finance, Trevor Manuel; ‘what is this amorphous entity?’ The market is you and me, the market is everybody out there. The market is what everybody decides the market should be.
It’s all these forces out there, let’s call it the society. Because we all participate in the market. Quite often I hear people saying that there’s some sort of conspiracy somewhere. There’s a bunch of guys sitting in this smoke-filled room and they decide that the Rand is going to go wherever the level is or whatever. That’s not the case.
There are many, many millions, maybe even billions of people out there and they’re all trying to find their own best position out there in life. That is the market. The market is not only what happens to the exchange rate or the currency. The market is out there.
There’s a market for love, there’s a market for cars, there’s a market for just about everything. We are all just participants in this thing called ‘the market.’ If you want to limit the powers of the market and you want to introduce some sort of legislation to take away the effect of the market; essentially what you’re saying is that you want to limit the right of people to making decisions that will benefit them personally. I don’t think that’s right. I think what we need to do is to allow people to decide for themselves what they want. In the process what happens is that we create a market.
Government bond vs the bond on your house
CG: One that confuses a lot of people I know, government bonds versus the bond on my house.
DR: That’s a very tough and tricky one. This is an excellent example of how economists get together and give easy things very difficult and complicated names. Let’s have a look at government bonds and the different names for government bonds.
Essentially there are three kinds of instruments that government use to borrow money in the markets. The first kind of instrument is called Treasury Bills. That’s usually short-term instruments of which the repayment period is less than one year.
Another kind of instrument is foreign loans. Governments borrow abroad in Dollars or in Yen or Euro or whatever the case may be. The bulk of government borrowing happens on so-called bonds. What is a bond? A bond is typically an instrument with a maturity period of longer than one year.
They can go up to 30 years. In fact, some of them have no maturity date. They are perpetual government bonds and they can go on forever. Government bonds also pay an interest, but there are different names for government bonds. In South Africa we call them bonds and the most popular one, the most liquid one is called the R186.
The R stands simply for Republic of South Africa, the R186 is the most popular government. Other countries in the world have got other names for government bonds. The Americans as an example, call bonds TB’s or Treasury Bills, which of course is our short-term instruments. But for the Americans they call it TB’s, which is actually a long-term instrument.
The English call government bonds Guilds, while the German’s call their government bonds Uns. They all have different names. But essentially a government bond is a long-term instrument that government uses to borrow money in the market.
CG: That’s different from the bond on my house.
DR: That is completely different from a bond on your house. The bond on your house is a collateral in a way, that the bank takes over your property in case you do not repay your bond or the money that you’ve borrowed against your property. So that differs completely. Also, typically, bonds taken out over your house or property is not typically traded in a financial market. While in the case of government bonds, those bonds are traded all the time.
Stocks versus shares
CG: Now, stocks versus shares. I invest in stocks, you invest in shares, what’s the difference?
DR: Again, that’s a terminology that differs from region and country to country. In the case of the Americans as an example, quite often they also refer to stocks as actually government bonds. But stocks and shares are actually the same thing. Usually they’re referred to as a little share or a little part that you buy in a company.
These things are usually listed on stock exchanges, like for example the JSE. Basically they are the same thing. Quite often what happens in South Africa also, is that traders sometimes are using slang and referring to government bonds as stocks. But stocks and shares are basically the same thing and it’s a small share/slice that you buy in a company. That is typically listed on a stock exchange like for example the JSE.
CG: You’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. I’m talking to Dawie Roodt, Chief Economist at the Efficient Group. Dawie, a final question for you, one that comes up again and again, GDP, what does that mean?
GDP – is it an accurate reflection?
DR: Nobody really knows what GDP is because economists always argue what the thing called GDP is. But the idea behind GDP and by the way it stands for Gross Domestic Product. But the idea behind GDP is that somehow economists must be able to calculate what the size of an economy is. The question is, what should be included in this thing called the ‘size of the economy.’
Let me give you an example. What happens is that if you replace a window, if I break a window and we replace that window. Then that window is added to production, that’s part of GDP. But the fact that I’ve broken the window in the first place is not added to GDP.
Another example, if I make use of the services of certain women, then that is added to GDP. But if I should decide to marry this woman, it is not added to GDP. So it’s a definitional issue and economists argue all the time on what should be included in GDP or not.
However, whatever the arguments for or against what should be included in GDP are, is that GDP is probably single most important number out there. Because it gives us an indication on how the economy is performing and whether economy is growing or not. In rough terms, GDP simply means the total production of goods and services in an economy. The more that that thing increases, called GDP, the better off the people in that specific country usually are.
CG: And there we’ll leave it for the time being. This has been another edition of Old Mutual Live, Money Coach. My name is Chris Gibbons, with me on the line has been Dawie Roodt, Chief Economist at the Efficient Group.
Remember, please feel free to get in touch any time if you have any questions, any topics you’d like covered here on Old Mutual Live Money Coach. Feel free to send them direct to me at firstname.lastname@example.org, I’d be delighted to hear from you. Until the next time, thank you for listening. Old Mutual Live, on mobile, on digital, on demand.