Interest Rate Ceiling and Anti-Capitalist Mentality in Mongolia

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In spite of the fact that there have been several events that shocked Mongolian politics in past couple of months, with the new prime minister having been appointed and a government budget passed by the parliament, the most debated topic right now in the country is whether to reduce loan rates by a law. It is generally assumed that an average loan’s interest rate is overwhelmingly high that it can be considered to be exploitation. Although an average interest rate on loans from commercial banks is about 19%, according to Central bank of Mongolia, many still argue that this information is not accurate and misleading. Some members of parliament are proposing a legislation that restraints commercial banks from setting an interest rate above 18% and the interest rate cap is 35% for non-bank financial institutions.[1] As stated by the proponents of the bill, interest rates on business loans from commercial banks vary between 25% and 30% and this is the reason why they foster the plan.[2] These politicians also recommend the Central bank to lower its policy rate to single digit number (5%-6%) from current 11% in order to affect savings and loan rates and are hopeful and confident that the bill will be enacted into law since public support is dominated by individuals who are desperate to make these changes. There are polls and surveys regarding the possible legislation and they show that 4 out 5 people support this new proposal.[3] It is really likely that price controls will emerge in banking sector of Mongolia thanks to Mongolian people.

The laws and regulations that government enacts to regulate prices are called price controls, which include a price ceiling and a price floor. A price ceiling is made by a government to keep prices low for those who demand the commodity. The law forces suppliers of the product to sell their properties at prices for which they wouldn’t sell if there was not legislation and allows individuals to buy at new low price which causes high demand. When their cost of production exceeds their income, producers will leave the business so as to avoid profit losses. Which means, an increase in demand surpasses supply that is decreasing and shortage occurs due to this. This law makes the situation worse than what it had been before. In this case, ones who suffer the most are merchants and businesses that sell products and those who can’t manage to purchase those products. The policy will bring about the opposite result. Let me attach this theory to banking sector. A bank is a financial institution that accepts deposits from the public and creates credit.[4] Financial ability of bank is dependent on its depositors. Once the bill becomes law and the loan rates are lowered, banks will try everything in order not to turn money deposited in them into bad loan for fear of future risks such as bank run. For most of those commercial banks, they will dramatically enforce stricter terms on their loan requirements and as a result, loans will be unavailable to most potential borrowers. At the same time, people will turn their tugrik account into U.S. Dollar account and if any problem arises in doing that, capital in Mongolia will be transferred to another financially stable nations.  This capital outflow will be a huge strike to the country’s currency tugrik. Because Mongolian economy is desperate for foreign currencies as Mongolian economy is solely based on mining industry which accounts for 86% exports of the country.[5] Any plan to fix price is always counterproductive.

However, most of the businessmen in Mongolia demand that credit rate in the country should be lower than what it is now. As I wrote above, their desire to reduce loan rate artificially is the biggest trend right now in the country. When a credit crunch comes, there will be only one method for Mongolian government to use, printing more money with the help of Central bank of Mongolia. It will supply new money into economy as credit. This credit expansion is not only the reason for general increase in price and but also creates a crisis in which entrepreneurs make investments in capital goods to expand their businesses in the hopes that an economy will be good for them. Credit expansion that distorts the price signal leads people to believe therefore economy is growing and getting stabled. Meanwhile, due to inflation, there will be general increase in price and it aggravates the situation (in Austrian economics sense, inflation is a general increase in the money supply). During a boom when economy appears to grow, new jobs are created and the market gives high profits to entrepreneurs. But when the credit by a central bank stops, the economy shrinks, people lose their job and businesses close their door. This is a bust. If there is not any more government interference in economy after the economic recession, these jobs and businesses that are not supposed to be born will be dead for good and the economy will self-regulate itself which means the goods and services that more fit consumers’ needs will be produced and a structure of production will take a new shape. If not, the recession turns into depression. Longer the credit by central bank carries on, the stronger and fiercer the hit will be.

This interest rate law is a continuity of Mongolian government mortgage program, which started back in 2013. During the course of the mortgage program, every piece of what is written above happened. Due to the economic collapse, Mongolia acquired a loan from IMF within Extended Fund Facility program. “As part of the full implementation of this program, Mongolia will receive 440 million U.S. dollars from the IMF and 5.5 billion U.S. dollars from donor countries, including Japan and the Republic of Korea”.[6] As IMF reports, in terms of GDP, this is the fourth-largest package in IMF history.

If the bill is passed, this whole boom bust cycle will reoccur. Mongolian people don’t understand that they are already suffering from the consequence of what they insist. The idea that money is a thing which can be managed by central authority is the cause of Mongolian economic recession which will soon possibly turn into depression.

So what is the method to decrease interest rates in Mongolia and how it is set?

Interest rate is a price of money. The value of money is determined by supply and demand just like other commodities in market. Individuals tend to believe that economic stagnation and recession are through lack of money in the economy and if there is more money to use, they will spend and so trades will occur properly.

But production of commodities and services is the real reason of consuming. Money is something people choose to use as a medium of exchange ranging from cowries to gold and crypto-currency. As French economist Jean-Baptiste Say argued, transactions are made because of abundance of commodities, not due to abundance of money. He mentioned “Money performs but a momentary function in this double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another.” In Say’s time, a mass demanded men in charge of state to mine more gold and silver and in our time a mass demands their governments to print paper money backed by nothing. It explains and also proves that this is a classical error of mankind.

The only way to increase something to be borrowed is to increase its quantity. An increase of the production of goods and services raises a standard of living and therefore those factors make a capital accumulation possible. This capital accumulation is the origin of interest rate. If there is not enough capital to be used, price of it will be high or vice versa. Also we need to consider time preference of people. People value a current satisfaction rather than satisfaction in the future. For example, if the country A has a lower time preference than the country B, the rate of interest would be lower in the country A than in the country B.

If the material well-being is the cause of the issue now being discussed, a question “What is the solution to increasing the material well-being” must arise. The answer is capitalism. Capitalism is an economic system and an ideology based on private ownership of the means of production and their operation for profit. Opponents of capitalist system accuse it of encouraging greed but why is a greed bad when it doesn’t violate private properties owned by members of society. An intention to get more and more wealth and make life easier to live is the reason humankind has come here. The perfect quote to show it was said by Adam Smith which is “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”.

In capitalism, people trade what they have with what other people have. American economist Walter Williams said about it “Prior to capitalism, the way people amassed great wealth was by looting, plundering and enslaving their fellow man. Capitalism made it possible to become wealthy by serving your fellow man”. As Ludwig von Mises, the greatest economist in the history described, capitalism is essentially a system of mass production for the satisfaction of the needs of the masses.

In capitalist society, the only function of government is to protect right to life and right to private property through the military, police, and courts. But most people in Mongolia denounce capitalism while attacking the private property which is the fundamental base of capitalism by supporting not just this interest rate ceiling law but also other regulations on prices and quantities. As for the case discussed here, other side of the coin which is called banks are also to blame. The protectionism by commercial banks in Mongolia is very powerful that Mongolia is one of the few countries on the planet in which foreign banks aren’t allowed to operate. On this occasion, individuals have every right to storm against the bankers here. Banks use the terminology “national security” in defending their business from competition. Meanwhile, the government of Mongolia competes with business organizations for loan from commercial banks to close the budget deficit by issuing bonds with rate of 18%.[7]

The government setting and fixing prices, high tax and taxing rich more, changing laws regularly, protecting some businesses from its foreign and domestic competitors and many things which are opposite of capitalist ideology have been realized in Mongolia, thanks to majority of voters. They have a huge anti-capitalist mentality. According to Index of Economic Freedom by Heritage, Mongolia is placed 129th registered as mostly unfree.[8] Instead of promoting individual and economic liberty, Mongolians view more government interference as the solution and it will worsen the situation here as we live in the reality. The country is becoming Asian Venezuela.

References

  1. С.Эрдэнэ: банкны зээлийн хүүгийн дээд хэмжээг 18 хувь байхаар хуулийн төсөлд тусгасан, vip76.mn, 2017.12.13.
  2. Ж.Энхбаяр гишүүн зээлийн дээд хүүг 20% болгоно, chuhal.mn, 2017.11.01.
  3. Банкны зээлийн хүүгийн дээд хязгаарыг тогтоож өгөх хуулийн төслийг та дэмжиж байна уу?
  4. Bank of England. Rulebook Glossary
  5. Mongolia Turns the Corner with $5.5 Billion IMF-Led Financing Package, imf.org, 2017.05.31.
  6. Mongolian economy is rapidly recovering: IMF, xinhuanet.com, 2017.10.31.
  7. Урт хугацаатай згүц-ны хүү 11-18 хувийн хооронд хэлбэлзэж байна, bloombergtv.mn, 2017.07.21.
  8. The Index of Economic Freedom, Mongolia, 2018.01.24.

 

Kh.Bilguunbayar

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