Why it is hard for foreign investors to be bullish on South Africa

Mandela’s memory still evokes respect. But managing money involves a cold-eyed calculus

The first question to consider in any reckoning of South Africa is whether you can get through it without a story about Nelson Mandela. You can’t, of course. So here is one that seems apposite. Mandela and his fellow prisoners on Robben Island were allowed one book other than the Bible. They opted for the collected works of Shakespeare. Each marked a favourite passage. Mandela chose one from “Julius Caesar”: “Cowards die many times before their deaths; the valiant never taste of death but once.”

Fast-forward from the struggle against apartheid to today. South Africa’s economy has shrunk in two of the past three quarters. The state-owned power company has announced a series of rolling blackouts. An unchecked budget deficit means public debt is on track to rise above 70% of gdp by 2022. The national airline has sought protection from its creditors. The country’s investment-grade credit rating is hanging by a thread.

The situation cries out for a valiant response. Remedies have been discussed ad nauseam. If the production of reform blueprints were the key to wealth, South Africa could be the world’s richest country. Instead it suffers an unending series of small deaths. It is why, for many investors, it is often a tactical trade but never a strategic one. It is a reform story endlessly sketched out but never written.

The need for fixes is increasingly desperate. This year will be the fifth in which gdp growth has failed to keep up with population growth. The unemployment rate is 29%, a grim statistic that does not fully capture the extent of joblessness. One legacy of apartheid is that many blacks live far from where the jobs are. Since poor public transport makes searching for work costly, many simply drop out. The trouble runs even deeper. South Africa is a cartelised country, in which insiders—big businesses and their employees; government workers—flourish and outsiders languish. Labour laws intended to reduce inequality have instead reinforced it. Wage deals are fixed by unions and big firms. Small firms must comply, but struggle to do so. Startups and the jobless suffer as a result.

The fixes are well-rehearsed: an end to restrictive labour practices; a dose of competition in industry; a clean-up of state-run power-transmission and transportation monopolies. Countless commissions and development plans have urged such measures. In its annual health-check of South Africa’s economy in 2018, the imf concluded that “bold structural reforms are urgently needed”. It was hardly a new message. In 2011 the fund had deemed reforms “critical”; by 2013 they were “imperative”; by 2016 “urgent and imperative”. But little has changed.

The wonder is that these simmering problems have never boiled over. A system of welfare grants helps contain some of the population’s anger, but weighs on public finances. South Africa is thus vulnerable to a shift in investors’ mood. It runs a persistent deficit on its current account. It relies on overseas capital to bridge this gap between what it spends and what it earns. Ideally this would come through foreign direct investment, which would add to the country’s capital stock and create jobs. But it is hard to attract such investment when you do not have a reliable power supply.

So South Africa relies on portfolio inflows to stocks and bonds. It has had enough residual appeal to keep these coming. It has a range of well-run companies that are not especially sensitive to the struggles of the local economy, says Rob Marshall-Lee of Newton Investment Management. Oligopoly in many industries makes for handsome profit margins. Bond investors, with one eye on the country’s credit rating, are able to earn higher yields than are available elsewhere. There is still confidence in South Africa’s key institutions, says Yacov Arnopolin of pimco, a big bond firm. The central bank has stuck to its task of controlling inflation. The Treasury has shrewdly extended the average maturity of public debt to 13 years, which buys the country a bit more time to deal with its problems.

The buying of time seems to have become an end in itself. There is still a great deal of goodwill towards South Africa among the money-men. The memory of Mandela still evokes respect and admiration. But the management of money involves a cold-eyed calculus. Investors are tactical on South Africa; they will buy if the gloom seems overdone or the rewards eclipse the risks, even if barely. Few are valiant enough to be outright bullish. They do not wish to taste of career death even once.

The coming months will test OPEC's sprawling Alliance

It has been a difficult time for anyone betting on oil. Climate change threatens long-term demand. In the past year ample production, trade disputes and fears of an economic downturn have weighed on the price of crude. On December 3rd Brent crude fell to $61 per barrel—18% below its April high. Yet by mid-December forces were aligning to support oil prices again. The Organisation of the Petroleum Exporting Countries (opec) and its allies agreed on December 6th to lower output by more than 2.1m barrels a day.

Adding to the optimism, Saudi Aramco, the world’s biggest oil company, listed 1.5% of its shares. On December 12th its market value surpassed an astonishing $2trn. And on December 13th President Donald Trump announced a preliminary trade agreement with China . That bumped oil prices higher. As The Economist went to press on December 18th, Brent crude had risen to $65.74.

Even so, oil gamblers are wrestling with two big uncertainties. The first concerns America’s output. The country pumped 17.8m barrels a day in November, compared with an average of 15.5m in 2018 (see chart). But investors have grown impatient with frackers’ meagre profits. The cost of capital for American exploration and production companies has jumped by about 50% since mid-2016, according to Goldman Sachs. At the start of December 663 rigs were operating in America, about a quarter fewer than a year earlier. America’s oil output will not shrink in 2020, but its growth may slow. The question is when, and by how much.

The second uncertainty concerns whether the members of opec’s 23-country expanded alliance will stick to their new deal. The past 12 months give reason for scepticism. In December 2018 opec and its partners agreed to reduce output by 1.2m barrels a day. Iraq, Nigeria and Russia, among others, have regularly exceeded their allowed limits. To compensate, Saudi Arabia, opec’s most powerful member, slashed its own production by an average of 500,000 additional barrels a day, according to the International Energy Agency.

Analysts at Morgan Stanley estimate that in 2020 1.8m additional barrels a day will be pumped in countries outside the opec alliance, including Brazil, Guyana and Norway. In the run-up to opec’s meeting in Vienna in December, it was doubtful whether the group would sustain the cuts agreed to a year earlier, let alone go further.

In the end Saudi Arabia’s new oil minister, Abdulaziz bin Salman, wrangled an impressive deal. The alliance’s 1.2m-barrel cut will extend to 1.7m in January. Additional reductions led by Saudi Arabia will push the total to 2.1m barrels a day. The broader group’s collective output will be 1.3% below its level in November. It remains to be seen, however, if the cuts will materialise—or last. The new agreement covers only the first quarter of 2020. It also allows Russia to increase its output of condensate, a type of light crude.

Saudi Arabia remains keen to support prices, both for its budget and to make Aramco’s listing a success. The firm’s soaring valuation in early trading may not be sustainable. Many big global investors were repelled by its low dividend yield, security risks and state control. But local retail investors piled in, attracted partly by the sweetener of an extra free share for every ten they buy and hold for six months. If Saudi Arabia’s allies fail to stick to their promised cuts, the kingdom will have a choice: slash its own production further or let prices fall. Neither is appealing.

2019 in review: trade wars and tech battles

Politics and technological disruption fray the economic order

THE OVERARCHING story of 2019 was trade—to be precise, trade war. China’s rise, technological innovation and above all the protectionism of America’s president, Donald Trump, forced companies to rethink supply chains, especially within NAFTA, the three-country block that for a quarter-century knit America, Canada and Mexico into something close to a single market for goods. Just before the year ended the Trump administration’s negotiators got their reworked replacement for NAFTA, the USMCA, over the line—a rare moment of alignment between Democratic lawmakers and the president they are trying to impeach. The year ended with far higher tariffs on Chinese imports to America; China sought new export markets with surprising success. As American trade negotiators followed painstaking, formal processes, the president delighted in hurling online grenades, announcing unexpected tariffs by tweet. The resulting uncertainty weighed on investment and the global economy.

The global, rules-based trade system frayed at the edges. The World Trade Organisation, seen by America as a constant source of irritation and overreach, finished the year without a functioning appellate body, as the Trump administration blocked new appointments. Future disputes will go through hearings of first instance, and then countries will be back to bilateralism. Nothing will fall apart immediately, but even as the world becomes more protectionist and populist, the loss of an independent referee dealt the trade system another blow.

The trade war sent global markets see-sawing. The year started with renewed hopes that the Trump administration would come to an accommodation with China, and markets surged. When those hopes proved premature, fears of a global recession increased and investors rushed to the safety of bonds. They became accustomed to a new normal: negative bond yields. But by the end of the year there were signs of stabilisation in global manufacturing, and investors regained their appetite for risk, returning to commodities and emerging-market currencies.

As the world economy slowed, the Federal Reserve began cutting interest rates. America’s economy resisted the pull of recession, and the easing gave emerging markets some respite after a difficult few years. Despite the slowdown, China resisted the urge to unleash a large-scale stimulus. In Europe, Christine Lagarde replaced Mario Draghi as boss of the European Central Bank, where she inherits the job of using monetary policy to gin up the continent’s lacklustre economy. Germany’s manufacturing sector started the year in bad shape and found no respite. The country barely escaped recession.

Throughout the year, the race between banks and fintechs continued to accelerate. Nimble startups nibbled away at conventional lenders’ market share in the extortionate business of moving money across borders. Boosted by e-commerce and the popularity of contactless payments, behemoths once seen as dreary thrived and merged, raising questions about modern societies’ readiness for a largely cashless future. The technophobic insurance industry faced rising perils, from reinsurers eager to cut out the middlemen to catastrophic losses caused by climate change. But the biggest threat of all came from the giants that rule smartphones—Google, Apple, Facebook and Amazon—whose attempts at entering financial services may well hollow out the champions of old.

A Farewell To Paper Money?

A decade or more ago, I began to discuss with associates the possibility of governments and banks colluding to eliminate physical cash. Back then, the idea struck most everyone as poppycock, that governments could never get away with it.

I didn’t write on the subject until 2015, when several countries had begun to limit the amount of money a depositor could extract from his bank account. At that point, the prospect that central banks might conceivably eliminate cash was looking less like an alarmist fantasy, and it became possible to write on the nascent issue.

In a nutshell, today, in most of the world’s most prominent countries, the people who control banking are the same people who pull the strings in government. A cashless system therefore seemed to me to be a natural, as it dramatically increased both profit and power for both banking and government – an opportunity that can’t be passed up.

The Benefit to Banking

Some banks have been delving into negative interest rates, which is a euphemism for charging you to keep your money in the bank, so that they can loan it out for their own profit. You actually lose money annually by having it on deposit.

Of course, some people accept negative interest rates in order to retain the imagined safety of having their cash in a bank vault, rather than at home. Others tolerate it because they value the convenience of using ATMs and chequing.

But anyone else may simply decide to store their money at home and save the “reverse interest” charges.

But what if cash were eliminated? No one would have a choice. They’d have to have a bank account and use it for all transactions, or they couldn’t purchase goods or pay bills.

Once everyone accepted the concept that bankers had total control of transactions, that this was “normal,” banks would be in the catbird seat. They could raise the transaction fees considerably over time and the depositors would be unable to exit the system.

The Benefit to Governments

Governments would thoroughly endorse the idea, because it would mean that, for the first time, they’d have access to all information on your economic activity. The necessity of allowing people to file for income tax would vanish. In future, they could assess your annual tax themselves and take it from your account by direct debit. They could also begin taxing you monthly rather than annually, “for your convenience.”

And in the bargain, we could anticipate that the charges would be numerous, confusingly worded on the monthly statement and difficult to figure out. That would allow both the banks and the government to periodically effect incremental increases.

Once all your transactions were monitored, those that are “suspect” could be noted and even refused. Purchases at gun shops could be classified as “terrorist-related.” A transfer to a realtor in Panama could be classified as “money-laundering.”

Since the War on Cash has become recognized in the last few years, many people have turned to cryptocurrencies as a means of retaining monetary freedom.

However, as the future of financially pillaging the populace depends on ensuring that the populace have no option other than banks, will governments allow cryptos to flourish?

Not if they can stop it. But can they?

It’s been my contention that banks will at some point, launch their own cryptos, whilst doing all they can to discredit non-central bank cryptos as being potentially criminal.

The Bank of Canada is now considering launching a digital currency that it says would help it combat the “direct threat” of cryptocurrencies. It would initially coexist with paper money, but would eventually replace it completely.

They state further that banknotes are becoming obsolete as a means of payment, creating problems for the banking system as a whole: “The time may come that merchants/banks find it too costly to accept banknotes.”

Translate that to mean that, if you insist on using banknotes, the bank will have no choice but to charge you a premium for their use.

This has come on the heels of the plan by Facebook to release libra, its own cryptocurrency. The Bank of Canada states that “Facebook’s digital offering is losing key backers and facing scrutiny from regulators worldwide, including the Bank of Canada.”

It suggests that central bank digital currencies allow banks to collect more information on Canadians than is possible when people use cash. “Personal details not shared with payee, but could be shared with police or tax authorities.”And if there are any remaining uncertainties to the benefits of non-central bank cryptos, they added, “Cryptocurrencies may become a direct threat to our ability to implement monetary policy and lender of last resort role.”

On the surface, the statement from Bank of Canada appears to be an announcement of banking progress, for the betterment of depositors. But it’s the first report, to my knowledge, in which a bank declares bitcoin and other non-central bank cryptos as a “direct threat.”

The above statement is a forerunner to declaring non-bank cryptos to be criminal in nature. Cryptos offer the hope of monetary freedom and that can’t be allowed.

At some point, we can expect banks to disallow any payment for cryptos such as bitcoin through central bank cryptos and refuse accounts to anyone who has a history of dealing in non-central bank cryptos. The objective will be to eliminate the possibility that your grocer or gas station, along with any other bank depositor, might accept bitcoin. The intent will be to send bitcoin to the crypto graveyard.

Unlike gold, bitcoin is intangible and cannot simply be stuffed in the mattress until such time as it regains its acceptance for convertibility, as gold has in the past. It doesn’t exist in physical form and only has a perceived value if another party is prepared to accept it in payment.

The War on Cash is a war on your economic freedom. At present, most people still retain the ability to remove their wealth from the system, move it to a more wealth-friendly jurisdiction and hold it to forms that will retain value in the future.

That window may close sooner, rather than later.

The Stock Market Has Become A Private Club For The Elite

A recent Peter G Peterson Foundation poll, as reported by the Financial Times, revealed a statistic that we have suspected for quite some time. To wit:

“Nearly two-thirds of Americans say this year’s record-setting Wall Street rally has had little or no impact on their personal finances, calling into question whether one of the strongest bull markets in a decade will boost Donald Trump’s re-election chances.

A poll of likely voters for the Financial Times and the Peter G Peterson Foundation found 61-percent of Americans said stock market movements had little or no effect on their financial well-being. 39-percent said stock market performance had a “very strong” or “somewhat strong” impact.

The survey suggested most Americans are not aware of market movements, with just 40-percent of respondents correctly saying the stock market had increased in value in 2019. 42-percent of likely voters said the market was at “about the same” levels as at the start of the year, while 18-percent believed it had decreased.”

Another article by Shawn Langlois via MarketWatch revealed much the same discussing a recent publication from the Economic Policy Institute. That study also revealed the increasingly inadequate retirement savings of Americans, as well as the dispersion of wealth among income earners.

As Shawn penned:

“The big gap between the mean retirement savings of $120,809 and the median retirement savings is yet another example of how the rich are getting richer and the poor are getting poorer in this country.”

This isn’t anything new.

We have been reporting on this issue over the last few years, and just recently dug into current details in our discussion on the “Savings Rate.” To wit:

“The calculation of disposable personal income (which is income less taxes) is largely a guess, and very inaccurate, due to the variability of income taxes paid by households. More importantly, the measure is heavily skewed by the top 20% of income earners, and even more so by the top 5%. As shown in the chart below, those in the top 20% have seen substantially larger median wage growth versus the bottom 80%. (Note: all data used below is from the Census Bureau and the IRS.)”

The reality is the majority of Americans are struggling just to make ends meet, which has been shown in a multitude of studies.

“The [2019] survey found that 58 percent of respondents had less than $1,000 saved.” – Gobankingrates.com

Such levels of financial “savings” are hardly sufficient to support individuals through retirement, much less leave enough savings to actively participate in the “booming stock market.” Such confirms the Peterson study that the “longest bull market in history” has largely bypassed a vast majority of Americans.

It also confirms why, after a decade-long bull market, that a rising trend of individuals over the age of 55 remain in the workforce. 

“Growing numbers of U.S. ­boomers—currently 55 to 73—are working beyond the traditional retirement age, going back to school, and choosing to age in place in familiar neighborhoods instead of moving to senior communities. 

For the first time in history, there are multiple generations alive together for long stretches of time.“

It’s not that “Boomers” don’t want to retire, it’s because they “can’t afford to.”

The Expanding Problem

Despite Central Bank’s best efforts globally to stoke economic growth by pushing asset prices higher, the effect has been entirely consumed by those with actual savings, and discretionary income, available to invest.

In other words, the stock market has become an almost “exclusive” club for the elite.

While monetary policies increased the wealth of those that already have wealth, the Fed has been misguided in believing that the “trickle down” effect would be enough to stimulate the entire economy.

It hasn’t.

The sad reality is that these policies have only acted as a transfer of wealth from the middle class to the wealthy and created one of the largest “wealth gaps” in human history. Via Forbes:

“‘The top 10% of the wealth distribution—the purple and green areas together—hold a large and growing share of U.S. aggregate wealth, while the bottom half (the thin red area) hold a barely visible share,’ Fed economists write in a paper outlining the new data set on inequality, which is more timely than exisiting statistics. The chart show that ‘while the total net worth of U.S. households has more than quadrupled in nominal terms since 1989, this increase has clearly accrued more to the top of the distribution than the bottom.'”

Lack Of Capital

The current economic expansion is already the longest post-WWII expansion on record. Of course, that expansion was supported by repeated artificial interventions rather than stable organic economic growth. As noted, while the financial markets have soared higher in recent years, it has bypassed a large portion of Americans NOT because they were afraid to invest, but because they have NO CAPITAL to invest with.

The ability to simply “maintain a certain standard of living” has become problematic for many, which forces them further into debt.

“The debt surge is partly by design, a byproduct of low borrowing costs the Federal Reserve engineered after the financial crisis to get the economy moving. It has reshaped both borrowers and lenders. Consumers increasingly need it, companies increasingly can’t sell their goods without it, and the economy, which counts on consumer spending for more than two-thirds of GDP, would struggle without a plentiful supply of credit.” – WSJ

I often show the “gap” between the “standard of living” and real disposable incomes. Beginning in 1990, incomes alone were no longer able to meet the standard of living, so consumers turned to debt to fill the “gap.” However, following the “financial crisis,” even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $2600 annual deficit that cannot be filled. (Note: this deficit accrues every year which is why consumer credit keeps hitting new records.)

The debt-to-income problem keeps individuals from building wealth, and government statistics obscure the basic reality. We discussed this point in detail in “Dimon’s View Of Economic Reality Is Still Delusional:”

“The median net worth of households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016, the latest available data. For households in the top 20%, median net worth more than doubled to $811,860. And for the top 1%, the increase was 178% to $11,206,000.

Put differently, the value of assets for all U.S. households increased from 1989 through 2016 by an inflation-adjusted $58 trillion. A third of the gain—$19 trillion—went to the wealthiest 1%, according to a Journal analysis of Fed data.

‘On the surface things look pretty good, but if you dig a little deeper you see different subpopulations are not performing as well,’ said Cris deRitis, deputy chief economist at Moody’s Analytics.” – WSJ

The One Problem The Fed Can’t Fix

The problem with the Fed’s ongoing liquidity interventions is that they continue to benefit those in the top 20% of population which exacerbates the wealth gap between them and everyone else.  Importantly, the current gap between household net worth and GDP is the greatest on record, and those previous gaps were filled by reversions with the most painful of outcomes.

While such a reversion in “net worth” will have the majority of its impact at the upper end of the income scale; it will be the job losses through the economy that will further damage and already ill-equipped population in their prime saving and retirement years.

Compound that problem with the massive amount of corporate debt, which if it begins to default, will trigger further strains on the financial and credit systems of the economy.

The reality is that the U.S. is now caught in the same liquidity trap as Japan. With the current economic recovery already pushing the long end of the economic cycle, the risk is rising that the next economic downturn is closer than not. The danger is that the Federal Reserve is now potentially trapped with an inability to use monetary policy tools to offset the next economic decline when it occurs. Combine this with:

• A decline in savings rates to extremely low levels which depletes productive investments
• An aging demographic that is top heavy and drawing on social benefits at an advancing rate.
• A heavily indebted economy with debt/GDP ratios above 100%.
• A decline in exports due to a weak global economic environment.
• Slowing domestic economic growth rates.
• An underemployed younger demographic.
• An inelastic supply-demand curve
• Weak industrial production
• Dependence on productivity increases to offset reduced employment

While the stock market may be an exclusive club for its members currently, the combined issues of #debt, #deflation, and #demographics is a problem the Fed can’t fix.

It isn’t a question of “if.” It is simply a function of “when.”

The next crisis will repair the “wealth gap” to some degree only because 2/3rds of American’s never participated in the bull market to begin with.