After a long hiatus, I thought it prudent to blog once more. It is becoming a rarity these days and for that I apologise to the wonderful people that read this blog. Many of whom are expecting me to blog about the budget, but surely what has not been said? I can't really give any special insights. 

Nonetheless, I only have two issues; Analysts, international agencies and the government are usually first to trumpet Kenya's prudent macro-economic management. In all honesty, our macro-economic plans and commitments are first class and for that, we should pat ourselves on the back. However, the real work lies in our micro-economic management i.e. at the ground level. Until we sort out our public procurement systems, staff our implementation bodies and take other steps that will ensure that we can convert plans, proposals and designs into tangible objects, then no fancy budget will fix our woes.

Secondly, it is worth pointing out that from an operational level, our recurrent expenditure is fully funded from our income sources i.e taxes, levies and earnings from parastatals. We are thus only borrowing to fund our development expenditures. This is a positive development and should be followed up by an improvement in our public pensions systems to ensure that we are not funding pensions from the consolidated fund ala the Portugal Ireland/italy Greece Spain. 

Speaking of borrowing, the only insight I have to share concerns the cost of borrowing/capital i.e. interest rates. Now, a number of people really don't understand what interest rates are. Even brilliant economists can explain them perfectly in economic and financial jargon, however they do not have a tangible grasp on what interest rates are. To explain them, I decided to put them into perspective, using issues that are removed from the financial markets and with the little or no financial jargon. 

To begin with, interest rates are to finance what gravity is to the physical world. Gravity gives objects their weight, whereas interest rates give assets their worth. Whether, it's land, shares, bonds, options, houses and any other productive asset you can think of. Interest rates are what primarily determine their value. The reason this is so stems from the fact that you can invest in an a risk-free asset (T-Bond, as long as its not Greek) and earn a return. This return is the interest you receive from that Bond or Bill. Given that you are earning a risk free rate, then this rate will now determine what you would expect to earn given some risk.

For example, if you earn 12% from a T-bond over say 10 years. Then to take any extra risk, you will require to earn above 12%. In practice, lets say that you want to put up flats to earn rental income. You have Kshs 10 million as capital, if you earn anything less than Kshs 1.2 million per annum as rent, then that is not a good investment given that you can earn the same 12% by investing in a bond. In an efficient market, investors will stay away from the property market and put their hard earned cash into the bonds. This movement away from property will drive property prices down and as such, their worth will have been determined by the 12% interest offered by bonds. 

To explain this phenomena, imagine a world where the only assets in the world are wives. Their worth is determined by only one factor, their beauty. Now, forget about beauty being in the eyes of the beholder and just think of beauty as something standardised. The return an "investor" earns from getting a wife will primarily be determined by how beautiful the woman is. Investors will then try as hard as possible, through charm and wit to get the most beautiful woman alive. 

However, it won't be that straight forward. A few issues will emerge in the investors mind; how beautiful is the average girl? and importantly how many women are there per investor? If the average girl is very beautiful, and almost as beautiful as the most beautiful woman. Then the investor will infer that firstly, there are very many beautiful women in this land and secondly, he won't break his back to get the most beautiful woman. The latter stems from the fact that he will be getting a girl just as beautiful without much effort. In terms of how many women there are, this factor will determine the investor's willingness to either settle for a homely wife or strive for a very beautiful one. If the ratio of investors to women is 3:1 i.e. there are 3 investors for every woman, then investors will be more likely to settle for homely wives. (NB, just so you know, homely is a nice term for ugly). If the ratio is the other way around, then investors are likely to be more picky and will only settle for very beautiful women.

If you can understand this, then you can begin to understand monetary policy, interest rates and their effect on investments. As much as this analogy is dramatically over-simplified, to me it presents a clear way of thinking about things. If the monetary authorities increase the money supply, like the Fed did with their quantitative easing policy, then there is more money in the system (more investors), thus interest rates fall  (investors are more willing to accept homely girls, remember the aforementioned ratios). Given that interest rates have fallen, the demand for alternative assets rises as investors seek higher returns. Prices for commodities, shares, real estate and other assets will rise reflecting more investor demand. In our analogy, our investors become more and more charming and seek all means possible to get beautiful wives. 

Again in our analogy, the average girl ends up determining how hard these investors will work to get a beautiful woman. The average girl being the risk-free rate, you can get her without trying. Now before you invest, always consider how beautiful the average girl is. If she is very beautiful then don't bother getting the most beautiful girl. Secondly, consider how many other 'investors' there are. If there are a number of them, then you should consider upping your game, if not don't bother. Primarily though, don't risk ignoring the average girl to get the more elusive beautiful one if you are not charming enough. If you can follow these principles, then you stand a chance of being a more successful 'investor'.