Posted by: michaeldavidpower | November 1, 2011

Scrum down for the next XV!

My recent presentation can be viewed – side-by-side with my voice-over at the following address:
http://investecam.kuluvalley.com/view.gsp?p=OtOoJShr0r

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Posted by: michaeldavidpower | November 1, 2011

Advance Australia Fair!

“The farther back you can look, the farther forward you are likely to see.” So wrote Winston Churchill, thereby justifying the continuing value of history.
Given the tectonic shifts currently reshaping the world as we know it and the now repeatedly asked question of “What next?”, this is surely good advice.
What era then do today’s shifts in the global centre of economic gravity most resemble?
My answer would be the Age of Discovery from 1488 to 1500, when the West truly came to know about the Rest. In the late 15th Century, the West’s view of the world was a misty mix of Ptolemy’s Egypto-centric perspective and Marco Polo’s fantastical tales of Cathay.
Then in 1488, Bartholomew Diaz rounded Africa’s Cape of Good Hope and heralded an era of rapid change not unlike our own today.
In the 12 years to 1500, Europe’s outlook – and especially the perspective of European capital and the profit opportunities open to it – had been vastly expanded thanks to Cabot’s 1497 rediscovery of the route to Newfoundland had opened the way to North America, da Gama’s 1498 voyage had defined the shape of Africa and opened the sea-route to India and to Asia beyond and Cabral’s ‘accidental’ landing at Monte Pascoal had added South America to Europe’s world view.
Such was the volume of trade that grew out of Europe’s Age of Discovery that it helped redefine capitalism itself: within a century the first multinational company, the British East India, was formed, as was the first joint stock company, the Dutch East India. By 1602, the first stock exchange was established in Amsterdam.
Whilst it would still take some 350 years for a European economy, the United Kingdom, to eclipse that of China in size, the swing from East to West had invariably begun.
Of the many reasons cited as being behind Europe’s greatest ever coming out party, the urgent need for sea-born access to the riches of the Indies – most especially to a steady flow of spice that was not taxed multiple times on its overland passage to Europe – was arguably the most important. Post 1450, Europe was finding it increasingly difficult to store enough food for winter to feed its fast expanding population. Spice was the magic dust that could preserve food or at least disguise the smell of food that was off but still edible!
Running out of the capacity to support itself from home-grown sources was also the driving force behind China’s post-2000 coming out party, though China calls their Age of Discovery ‘zou chuqu zhan lue’ or ‘going out strategy’. And, of course, in the post industrial era, China’s resource needs now include both hard and soft commodities.
China in 2000 was broadly the equivalent of Europe in 1500: an economic imperative drove both abroad to seek out their resource-rich New Worlds. If Europe’s New World then was Africa, the Americas and Asia, China’s New World today is effectively the same only the now also resource-short United States would be replaced by now ‘on-the-map’ Australia and New Zealand.
The massive consequences for China’s growing appetite for imported resources are only now starting to be glimpsed. Commodity prices are rising, albeit following a saw-tooth pattern as the tug-of-war of demand elasticities, East versus West, sees the Western hold periodically slipping and causing prices to fall-back to a level where the battle can again resume. Overtime, the East’s appetite is inexorably gaining ground on the West’s as the relatively stronger economic health of the savings-rich and younger Orient gradually contains demand in the economically weaker, debt-ridden and aging Occident.
Price patterns are becoming confused: when determining their price of oil, the US look to the West Texas Intermediate benchmark whereas Asia looks at, increasingly, Malaysia’s Tapis: a $20/barrel differential has opened up between the two with, unsurprisingly, Asia willing to pay the higher price. The same pattern is evident in the price of tin. The positive Asian differential is now resulting in London Metal Exchange stocks being physically transferred to the Shanghai Metal Exchange.
The dynamics behind the copper trade in Shanghai are similarly far more bullish than they are in London. Such two-tier price structures are rarely sustained for long but they do illustrate the origin of the world’s most important ‘giant sucking sound’ when it comes to commodities: it is coming out of Asia and especially China.
Meanwhile a new order of corporate giants is emerging as a consequence of China’s New World: BHP-Billiton or more precisely China’s Minmetals and India’s Vedanta are the East India Companies of our age. (Since 2004, Chinese listed mining companies have increased from 8 to 33; their combined enterprise value has risen from $19bn to $320bn.)
A new national order is also emerging in this New World. Following Churchill’s advice and again looking back at 1900 when the United States and Europe were mid-industrialization, the richest countries on the planet (in GDP per capita terms) were half a world away from the centre of this industrial action: New Zealand led 1900’s ranking and Australia was 2nd; Argentina was 7th. In 2011, the accolade of the world’s richest country in GDP capita terms belongs to gas-rich Qatar, a country which has also led the GDP growth stakes since 2000.
Indeed of the 27 countries to have achieved a compound annual growth rate of GDP in excess of 6% since 2000, 21 were resource-rich; of the top 15, only China and India were not resource-rich. This year’s top 5, according to The Economist, are all likely to be resource-rich: Qatar, Ghana, Mongolia, Eritrea and Ethiopia.
The period of 1865 to 1914 – when the United States and Europe industrialised – also suggests the economic rise of China and its Asian hinterland will not happen without periodic hiccoughs. The United States experienced seven recessions in its 1865-1914 heyday, some of which, like the Panic of 1893, were severe. But with hindsight, they proved to be short-lived suggesting that young economies, as with young human beings, tend to recover quickly from knock downs whereas older economies, like aging Japan and now the US and Europe, do not. Youthful East Asia’s swift rebound from their 1997 crisis adds further weight to this thesis.
Since 2000, the world has echoed the era following 1488 and started to change rapidly only this time with the East in the ascendance not the West. By 2050 “the world as we know it” could be almost unrecognizable: Citibank even sees India as the world’s largest economy, not China, with the latter’s reign at the top lasting only 30 years, beginning with its surpassing of the US around 2020.
Given that not one but two Asian Leviathans will come out over the next 40 years, resource producing nations are indeed the Indies of our age. And, notwithstanding growing pains in the form of periodic commodity price pull-backs, the coming era could well represent the best years of the economic lives of those ‘Spice Islands’ that constitute the New ‘New World’.
Reflecting on current market conditions, the Arab proverb reminds us that “The dogs bark, but the caravan moves on”. Keep going, Australia: your Golden Age is yet to come.

Posted by: michaeldavidpower | November 1, 2011

Adding more fuel does not mend a flooded engine!

Adding further fuel to the tank when the economic engine is flooded does not solve today’s problem in the West. Policy makers have left the choke of stimulus out for so long, the engine is drowning in liquidity and so misfiring badly. In Japan’s case, it has hardly fired in two lost decades. Welcome to the “New Normal”. As impotent as this might make policy makers feel, more of the same, more fiscal and monetary accommodation, would not be the right solution given this diagnosis.
Traditional Keynesians might not acknowledge this but there is not enough scarcity in the West today for Western capital to engage profitably in investment – cash-flush US Inc is testament to that.
I am drawn to an “off-centre” debate Piero Sraffa tried to have with Keynes in 1932, one which was brushed aside in the dark days of the Great Depression but which – as none other than Joan Robinson feared might happen – has now come back to haunt the West. Sraffa was grappling not with the idea of insufficient demand but excess supply. As Robinson wrote to Keynes:
I think that, like the rest of us, you have had your faith in supply curves shaken by Piero. But what he attacks are just the one-by-one supply curves that he regards as legitimate. His objections do not apply to the supply curve of output as a whole – but heaven help us when he starts thinking out objections that do apply to it!
Sraffa never concluded his line of thinking but perhaps the “supply curve of output as a whole” has finally caught up with – and overwhelmed – today’s West. Perhaps using fiscal and monetary stimulus to goose demand has reached the limits of its effectiveness leaving Western economies trapped in the vice between their bond market’s growing reluctance to finance the accumulated detritus of decades of near-permanent pump priming and worsening Western demographics, where those obliged to pay for those accumulated debts are noticeably declining in number.
Current fiscal and monetary stimulus generates increasingly unprofitable demand in that it yields a price for goods and services lower than the level required to cover the costs incurred in making those goods and services including, critically, the non-cash cost of capital charge. Exhibit A: the US Auto sector; exhibit B: the US Airline sector. This means huge swathes of the Western economic landscape are commoditizing because of oversupplied product that cannot be sold at a true profit.
Sraffa’s ghost would today likely be pointing at the abundance generated by aggregate supply, not insufficient aggregate demand, being the root cause of the West’s current problems. Abundance? It was Keynes’s insight too, for he too noted that the root cause of the 1930s was a supply one: “We should have it at the back of our heads that this is not a crisis of poverty, but a crisis of abundance.”
Perhaps Keynes’s 1930s solution – to goose aggregate demand by using the fiscal choke to jump-start the engine of growth again – was indeed the right “just-do-something” approach then. But the West and Japan have been running that engine full throttle and with the choke out ever since. And now their economic engines are flooded and vast sectors of their industrial landscape commoditized.
With today’s much higher accumulated levels of national debt, much higher levels of government expenditure as a share of GDP and far worse demographics, more fiscal and monetary spending in today’s context rewrites Einstein’s definition of insanity: doing the same thing again and again and expecting the same result… even when the background conditions are materially different.

Posted by: michaeldavidpower | October 3, 2010

Martin Wolf: Fallen Hero

Until the Global Financial Crisis (which events have shown it to be “merely” a Western Financial crisis), I was an avid fan of the FT’s Martin Wolf. His balanced but essentially capitalist perspective matched my own views, global in perspective, sceptical of quick fixes, practical, thoughtful and undoctrinaire when it came to making policy recommendations.

But since the GFC (as the Australians who were not part of it still persist in calling it!), the FT Economics Correspondent has, in my opinion, lost the plot. He has become a born-again Keynesian, narrowly pro-Western in his viewpoint and often visibly impatient with those who disagree with him, especially if they have reservations about pouring more fiscal and monetary fuel onto the embers of the conflagration that recently swept through the over-indebted West.

Martin Wolf – in one of his latest editorials – repeated the dominant narrative peddled by most (but not all) of the Western establishment that, echoing the 1930s view of Keynes, the Western World is suffering from deficient demand. Saying the opposite is apparently verboten: that it is labouring under the weight of oversupply induced by lax credit and now perpetuated by QE.

To those of us outside this narrative, especially if we live in Emerging Markets, having been lesser actors in and in some cases simply onlookers on the tragedy of 2008, we now find it galling that, flooded by the liquidity of QE, we are now expected to pay the heavy price of unwanted currency appreciation – even when we already run current account deficits! – in the wake of the desperate efforts of the US to inflate its way out of its problems at almost any cost.

QE in particular can now be seen as the monetary equivalent of an oil spill and QE II as a form of enhanced recovery technique that must be turned to when the well of QE I runs dry.

When Japan dared to cry “enough” and intervened to try and stem the Yen’s strength, it was only joining a long list of countries from Russia to Brazil, South Africa to Taiwan and Turkey to Peru who have – with varying degrees of success – been doing in their currency markets the monetary equivalent of what Florida did in its coastal waters in the wake of the Makondo oil spill in the Gulf of Mexico: erecting a boom in an attempt to prevent their financial shores from being polluted by fiat dollars.

Isn’t it about time we named the main (though by no means only) villain in the developing currency wars? BP now stands fiscally for Barack’s Profligacy and monetarily for Ben’s Pump-priming. May we ask when this spill will be staunched or is the rest of the world expected to pay the price of what happens when a democracy becomes overripe, exhibits a very low threshold of pain, cannot come to terms with Schumpeter’s destructive yang as the price to be paid for also experiencing the creative yin and in an attempt to continue living beyond its means borrow billions – nay trillions – from its grandchildren by funding those borrowings, in the interim, with the savings of surplus nations who are unwise enough to park their monies in US T-bills?

I fully accept that this argument has two sides to it, but currency manipulation can also come from – and perhaps more so – those who print fiat money irresponsibly as it does from those who grapple with the adverse consequences of such monetary incontinence. QE is quite simply a form of currency intervention.

Posted by: michaeldavidpower | October 3, 2010

Keynes’s Lament of the Long Term Investor

Finally it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks. For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

John Maynard Keynes
The General Theory of Employment, Interest and Money
Posted by: michaeldavidpower | October 3, 2010

Kenya – two years on, after the disputed election of 2008

I wrote the following article over two years ago, in the immediate aftermath of the Kenyan General Elections when sadly there was a spate of post-election violence and predictably a bout of Western hand-wringing as “Africa’s Great Black Hope” seemed to be (in Western eyes) “doing a Zimbabwe”. I felt the events, sad as they were, were actually “good news” for Kenya, constituting as they did a necessary rite of passage which Kenya had to endure and which many African nations would still have to face. So subsequent events have proved – a new constitution has been written and approved by the electorate. The country seems to be making genuine political progress though it is far from moving up a level to the next stage of democracy. Even its economy has rebounded strongly. The East African Community has been reformed and the region as a whole will likely grow over 6% in 2010, with kenya falling only a littlre short of that number.

Life goes on. Kenya is muddling through. More good is happening than bad. By far. Africa as a whole is making progress, politically and economically – with the latter helping secure the former, and vice versa.

I HAVE LEFT THE ARTICLE UNTOUCHED SO IF THERE ARE REFERENCES THAT A TAD BIT STALE, PLEASE UNDERSTAND WHY! I WANTED MY THOUGHTS OF THEN TO BE PUBLISHED NOW IF ONLY SO AS TO REMIND THE AFRO-PESSIMISTS HOW LITTLE THEY UNDERSTAND TODAY’s EMERGING AFRICA.

The World’s Press – mainly the Western World’s press – has made Kenya front page news in 2008. And, let there be no mistake, given the atrocities that have occurred in the aftermath of Kenya’s parliamentary and presidential elections, there is absolute justification for this spotlight. Sometimes, just sometimes, the glare of publicity can shame the seemingly shameless into thinking twice about repeating their atrocities.

But sadly and predictably, Western reportage has focussed more on the ‘what has happened’ than the ‘why’. Perhaps this is the pre-ordained format of ambulance chasing journalism.

Except for isolated smatterings of true insight, the resulting coverage has been that, whilst the gruesome detail is new, the story’s form is depressingly old. Most Western commentators have discovered – Eureka! – another snake in this African Garden of Eden, a venomous species called “Tribalism”. Profiling this primeval reptile provides slam-dunk headlines and easy analysis. Perhaps when your paper or TV has helicoptered you into hell, why try to get to the bottom of a story when a shallowly researched pop story will get your name in the by-line anyway?

Deciding how to approach today’s Kenyan tragedy deserves a far more sober and sombre analysis than the ambulance chasers – predictably now including a host of foreign diplomats – appear willing to contemplate. Within the tortured evolution of the Kenyan body politic and as hard and callous as it is to say, ‘why what happened’ is far more important than ‘what happened’.

There are two main reasons for this. The first is immediately relevant: any ‘solution’ emerging in coming days and weeks must address that ‘why’ to stand any chance of sticking. A rapprochement that merely papers over the cracks – cracks which, within the increasingly fluid socio-economic miasma of modern Kenya, are so much more complex than the merely tribal – will not only not last but ultimately may end up doing more harm than good.

The second is that the ‘why’ of Kenya is echoed across much of modern Africa. A not dissimilar chorus was heard at the African National Congress gathering in Polokwane just before Christmas. Consequently addressing the deeper issues underlying the Kenyan crisis might yet become a test case for other African countries. As painful and as tragic as some of the consequences already are and still yet might be, there are boils suppurating in parts of post-colonial Africa that must eventually be lanced. The hardest choice facing all those now asking the Kenyan Question is whether now is the time and Nairobi the place to start this painful exorcism.

My greatest fear is that the all-too-predictable approach of most well-meaning foreign mediators, from Archbishop Tutu to Jendayi Fraser, appears to be evolving into some sort of restoration of the status quo ante after which liberal amounts of soothing balm will be applied to the now open wounds: the current favourite ‘solution’ appears to be to form a Government of National Unity. Maybe, just maybe, on this occasion, this type of approach is the one that will no longer stick.

So what is the ‘why’ behind what has happened in Kenya? This easy answer is that there is no easy answer. But let me try. New winds of change are blowing across much of the African Continent, a region which is grappling with not just the post ‘post-colonial’ stage of its socio-economic development but which, like many now industrialized nations before it, is trying to cope with the myriad pressures of rampant urbanization.

To many Kenyans, this has necessarily meant the loosening of ties – tribal and even family – that accompany this rural uprooting and urban migration. Meanwhile a newer combination of disparate factors – the advent of cheap and easy communications, the liberalization of markets, the ravages of AIDS and malaria, the shifting of the economic centre of gravity from West to East… in short all the modern manifestations of ‘globalization’ – are eroding older, cosier, more predictable practices and replacing them with the unfamiliar and constantly changing. Whilst the visual wrapping may remain exotic, the deeper substance of modern Africa is actually becoming far more mainstream.

The uncomfortable result for the ambulance chasers is that accurate analysis precludes using the hackneyed metaphors. The reality of modern day Kenya – indeed much of modern day urban Africa – is far closer to the back-street grittiness of the Kibera slum as portrayed by Brazilian Fernando Meirelles in his film the Constant Gardner than the stale lyricism of the Ngong-facing verandah as imagined in Pollack’s Out of Africa.

This means that the real and urgent story of Kenyan politics is far less about stubborn tribalism and far more about how a more educated, younger if still poor urban majority is chafing at the bit still being pulled by a richer, aging, less technocratic, frequently corrupt minority. And when apologists for the status quo retort with a “be that as it may, we must oppose those favouring change because they are socialist in their policies”, increasingly such apologists are precisely wrong. Most Kenyan reformers are far more market-minded than their kleptocratic leaders. And most oppose the very visible and very dead hand of corruption far preferring to try their luck with the invisible hand of the market.

That a good part of Kenya’s ruling elite is largely composed of Kikuyus, the centrally located, most populous ethnic group best positioned to take up the reins of power when the British left in 1963, is largely an accident of history. To Kenya’s poor and numerous, virtually whoever might be in their petrified political elite and from whatever group they might come would classify them as a “them”. This fact was made vividly clear in the recent parliamentary election results where many regional leaders who had been co-opted into the Nairobi establishment were roundly beaten on their home turf by political nobodies. Even in an election that the incumbent regime tried hard to rig, those favouring the promotion of a morally as well as a materially better life expelled Kibaki’s Vice President and over 20 of his ministers from Parliament.

As Kibaki’s now exiled anti-corruption czar, John Githongo (incidentally a Kikuyu), put it: “There are truly only two tribes in Kenya – the very small tribe of rich people and the giant tribe of poor people. When things get difficult, the small tribe gets together in board meetings, nyama choma (a Kenyan meat-braai) and at golf clubs, to agree on how to sustain the oppression of the poor.”

Recent events in Kenya are not uniquely Kenyan. Much of Africa faces similar hurdles though a number of countries – think Tanzania, Ghana, Zambia – may have already navigated this rite of passage thereby taming their – to use Patrick Marnham’s phrase – “vampire elites”. (Why, other than land-locked-by-Kenya Uganda, has no other African state endorsed Kibaki’s win? Because New Africa is an increasingly democratic Africa and is appalled by the Kenyan incumbent’s anti-democratic behaviour.)

As seemingly bizarre as it might seem, especially amidst Kenya’s rarely-seen-before refugee camps and the charred remains of its shanty town shacks, one can be optimistic about events in Kenya. If the independence era of the 1960s was that of the African Magna Carta – when the colonial ‘king’ was contained by Africa’s Bwana Mkubwas, its Big Men – perhaps we now witnessing a Second Uhuru where the people at large will taste a wider and more liberating freedom. If the modern Philippines began with ‘People Power’ in 1986, perhaps modern Kenya will be dated from ‘Wananchi Power’ in 2008.

As a Kenyan friend told me: “Rites of passage are nearly always painful and good education is hardly ever free”. Thus one must ask of those well-meaning peace-makers jetting into Nairobi: please think twice before you try to rebuild the humpty dumpty that was old Kenya. Maybe this egg was so rotten, it should stay scrambled; perhaps your time would be better spent trying to help incubate a new one. For surely Kenya’s ultimate tragedy would be that if, at the end of this terrible ordeal, nothing really changed.

Posted by: michaeldavidpower | October 3, 2010

Home thoughts from Abroad – Reflections on Britain’s Predicament“

What comfort can the UK extract from what is happening in the Eurozone?

  • The Eurozone is not a united place, not in circumstances, causes, consequences, policy options and likely solutions. So one cannot generalize about where it is and where it is going. “One size does not fit all” (and never did) which again underlines the wisdom of the UK staying out of the Eurozone thus far and for the foreseeable future.
  • Fiscally, policy is decided by each country separately and virtually everyone is tightening their belts, the Club Med countries because they absolutely have to, most other countries because they need to (France falls into this category) and Germany and the Netherlands because they have decided that it would be prudent if they did. The UK is in the category that ‘has to’ (the current account deficit is a strong conditioning factor here – see below) and, notwithstanding the monetary independence still afforded by keeping sterling, the current government has chosen not to fudge fiscal reform as it would have been so easy to do and – judging on past performance – a Labour Government would have almost certainly done were they still in power, which thankfully they are not.
  • Monetarily, Eurozone policy is centrally determined by the ECB. Policy is currently very loose with rates very low (indeed negative in real terms) and the ECB accepting almost any collateral the banks might offer in return for ready cash. It is no secret that it is too loose for Trichet and most in the Bundesbank but thus far the policy cracks between the Southern Doves and the Northern Hawks have been papered over, mostly by compromising in the South’s favour.
  • The simple truth is that – notwithstanding high fiscal deficits and low interest rates – without decent (2.5%+) GDP growth, the situation will at best improve at a snail’s pace. Furthermore GDP growth (such as it is) will most likely be jobless. In other words, fudging – as much of especially Southern Europe is currently being allowed to do – is unlikely to be a permanent solution. The North is for now being patient but if the South does not show early signs of coming right, that Northern patience will run out. If it does, the very premise upon which the Eurozone was built – the core economies will help out the peripheral ones in return for expanding the size of a one-currency market – may crumble. But when ‘help out’ becomes permanent ‘bail out’, the core’s subsidy to the periphery will grow too large and that may threaten the Eurozone itself. For now and in the meantime, the Northern countries are using the intervening period to repair and strengthen the balance sheets of their big banks in case the Eurozone does indeed eventually fragment.
  • The question now is not so much what more fiscal and monetary policy can do to help but overwhelmingly what can be done to reinvigorate growth that does not rely solely on these fiscal and monetary drugs, “uppers” whose effectiveness now seems to be subject to a form of diminishing returns. The challenge now must be, to paraphrase JFK, to “Ask not what your Government can do for your economy using fiscal and monetary policy; ask what you and your government can do to help stimulate genuine rather than artificial growth.”
  • One area of potential Government action is to follow through on the central intent of the Lisbon Accord and liberalise and deregulate the EU economy to a far greater degree than has heretofore been done. Isn’t it ironic that Greece has only begun to do this over the past year in the wake of a near melt-down in its public finances? And doubly ironic that Portugal has thus far paid little heed to the Lisbon directives?
  • CRITICAL POINT RARELY NOTED BECAUSE IT IS SEEMINGLY NOT “Economically Correct” TO DO SO. It is no coincidence that the strongest countries of Europe lie in the northern part which almost without exception all run current account surpluses and nearly all border Germany or are in Scandinavia – Germany and its neighbours, Austria, Netherlands, Switzerland, Luxembourg, Hungary plus Scandinavia i.e.  Norway, Sweden, Denmark, Finland, and recently even the erstwhile wayward Baltic States of  Estonia, Latvia and Lithuania. Some (like the Baltics) have only recently experienced economic problems but have started to address them; others (the rest of Scandinavia) remember the fall-out from the Swedish Banking Crisis of the early 1990s. What distinguishes them from the Club Med countries is that their fiscal belt-tightening is more likely being done out of prudence than immediate necessity though these Northerners also a face medium term demographic crunch. The moral of this story is that, in hard times, countries running current account deficits face harder choices than do current account surpluses.
  • On the face of it, in this regard, Britain is more Southern European than Northern European having run a structural current account deficit for decades (as with the US and most other ‘Anglo Saxon’ economies save Canada.) Were Britain part of the Euro Zone, adjusting to the new realities of austerity would be much more painful than it has been thus far and still will be in the future. Part of the adjustment and so pain can and will be borne by Sterling. The Club Med countries by being in the Eurozone are denied this privilege.
  • LESSONS FOR BRITAIN:

o   Sterling has been a saving grace – given the unavoidable pain that must be endured, an independent currency allows a nation to spread that pain more evenly and THINLY across the whole nation.

o   Current account deficits reduce the options of the choices that must be made taken and make them tougher. If Britain reduces its dependence on foreign inflows to balance its external account, it will increase its options and reduce the degree of pain that must be endured as part of the unavoidable adjustment that must be made. This means a more competitive currency might not be a bad thing for Britain.

Posted by: michaeldavidpower | October 3, 2010

Is Keynesianism a one trick pony or a clapped out nag? Or both?

My problem with the modern Keynesians – unlike their mentor – is that they are never ever as passionate about dieting in good economic times as they are about fiscal feasting in the bad. This bias towards profligacy leads me to think they only ever feast and never fast.

If so, as economists, they are in danger of being one-trick ponies. Worse still, I fear their reflex profligacy eventually suffers from a form of diminishing returns: if all they ever do is feast and never fast, does the economic sustainability of their fiscal fiesta eventually wear a little thin? Perhaps I am being too biblical here, but I thought the whole idea behind fat years was to store up grain for the lean ones that will surely follow. Yet modern Keynesians seem to inhabit a Nirvana where their grain silos are perennially full. (I think Mr Bernanke calls his grain silo a “printing press”.)

I also wonder whether fiscal incontinence in a nation whose demographic life-cycle is approaching maturity is not the height of intergenerational irresponsibility. If Maynard were alive, would he be writing an essay entitled “The Economic Consequences for Our Grandchildren”?

Finally just how effective is the all-important multiplier in a modern developed economy? Even leaving aside the not-unimportant aspect of the West’s broken down financial sector (which surely is the transmission mechanism by which the multiplier effect works), given the level of openness to trade of most modern economies, is not fiscal spending today the equivalent of turning on the air-conditioner whilst leaving the windows and doors wide open? (Keynes himself warned that the more open an economy, the more ineffective fiscal policy would be.)

If this is so, them fiscal spending is at best of little use in the short term but of even greater concern in the long – somewhat akin to a diabetic eating a chocolate bar: the sugar rush quickly gives way to a crash. (Is this what we economists would call a “double-dip recession”?)

Today’s Keynesians must not simply try to say that fiscal spending has worked before (and not all economists agree here either) so by definition it will work today. They need to argue convincingly that, in today’s West with today’s demographics and today’s open economies, it will work in the here and now. So far, no economist I have read has come remotely close to doing so. I fear this is because yesterday’s one trick pony has aged to become today’s clapped out nag.

The South African Economy has, over much of the past decade, exhibited many outward signs of good health belying the inner deterioration of those fundamentals that must necessarily drive our longer term economic growth forward. First and foremost amongst those fundamentals has been the singular lack of success in creating new private sector jobs which are both long term in nature and structurally secure in character.

Much of the appearance of good health has been the result of cyclical much more than secular factors. Internally, a robust credit cycle supported the growth of consumer spending leading to rosy metrics such as strong retail and car sales as well as rapid house price appreciation. Indeed, fuelled by abundant credit, it was not unusual to see retail and car sales growing at rates that were over twice nominal GDP growth, clearly an unsustainable trend over time. Not surprisingly savings rates fell, debt to disposable income ratios rose, investment was diverted into consumption and, as the macro aggregator of all these factors, the current account deficit grew materially.

For those economists who might have believed in the now spectacularly disproved Cheneyism of “deficits don’t matter”, the South African economy was, and in many respects still remains, a microcosm of its UK and US counterparts. It has put the consumptive cart before the productive horse and relied on the kindness of strangers – in the form of foreign capital inflows into the bond and stock markets – to balance our national books. Extraordinarily, there was a time not so long ago when many mainstream economists believed this model to be sustainable.

No longer. Even as I write, realization is rapidly dawning on governments worldwide – but especially amongst the deficit-prone, demographically-challenged nations of the West – that this model’s shelf-life is reaching its life-cycle limits. If nothing else, the kindness of strangers is being replaced by what one European finance minister has called the cold-bloodedness of the wolf-pack.

Where South Africa has been different from the US and the UK is that, in addition to mainly consumer and not producer-led growth driving our economy forward, a bad dose of Dutch Disease has addled our residual industrial base, not merely preventing it from growing but actually compressing it. This in particular has weighed on South Africa’s capacity to generate jobs in urban areas for our rapidly-growing but still insufficiently skilled work-force.

Dutch Disease – the affliction that hits a resource-rich nation in the wake of a bonanza in natural resource prices by causing an uncompetitive appreciation in its currency – has, as it always does, manifested itself as a blessing disguising a curse. Short term, it helped create an illusion of South African prosperity; longer term, it has hollowed out South Africa’s industrial base and made material employment growth, except perhaps temporarily in non-tradable consumption-oriented areas like retail and banking, all but impossible to achieve.

As if this were not enough, Dutch Disease has even harmed sectors that are supposed to prosper in such circumstances. The overvalued Rand has hastened the decline of productivity in South Africa’s gold and diamond industries and capped growth in our platinum sector; it has also weighed on growth in our agricultural and tourism sectors.

During the period since 1994, the South African Treasury has on balance run an excellent fiscal policy, mostly cutting its expenditure suit to match its revenue cloth whilst still providing finance for many of the pent up social objectives the country so urgently needed to address. However, as the recent recession has illustrated, much of its income was ‘pumped up’ in the sense that it was derived from the credit-fuelled consumption that has characterised much of the past decade’s economic growth. With the drastic reduction of this revenue source – VAT receipts, duties on imported cars and other consumer durables – the budget’s basic underlying imbalances have been exposed. Even so, Treasury appears to be taking remedial action to address South Africa’s medium term budgetary pressures.

Besides, where Dutch Disease threatens, Government’s response must be most concentrated on the conduct of an appropriate monetary policy and not fiscal policy as the latter is not so much a cause of the malaise but usually harnessed to ameliorate its adverse consequences. When dealing with Dutch Disease, absolutely critical to the proper conduct of monetary policy is a true understanding of the effect that an overvalued currency can have on a nation’s macro competitiveness and in particular its capacity to compete in a job’s market that is increasingly determined by a global wage rate (i.e. for the sake of easy cross-country comparison, with wages priced in US Dollars and not merely in Rands).

In today’s world, to adopt a policy of benign neglect towards an appreciating currency because of an overarching commitment to a policy of inflation targeting is quite simply economically naive. Indeed as HSBC’s Chief Economist, Stephen King, notes in his latest book “Losing Control”, inflation targeting reflects a parochial focus on price stability in a world where, because of the rise of a goods-producing, resource-consuming and so for South Africa a Dutch Disease-generating Asia, consumer price inflation is no longer a proper reflection of domestic monetary conditions. King goes even further, heading one chapter “Price Stability brings Economic Instability”.

In today’s world, for a South African in search of a job, his or her wage inflation rate is our South African wage inflation rate adjusted for any movement in the Rand: a 6% local wage inflation rate accompanied by a 15% appreciation in the Rand versus the US Dollar means that the South African annual wage inflation rate (measured in US Dollars as a unit of account) would be over 20%. Even if inflation should be targeted, in today’s world one can quite legitimately argue that inflation adjusted for currency movements and not merely domestic inflation is actually the more appropriate measure to target.

Whilst addressing the overvaluation of the Rand is by no means a cure-all silver bullet for South Africa’s economic ills – and especially for our chronic unemployment rate – ignoring it, given today’s very different and very competitive global economic environment, is arguably a case of not so much benign but malign neglect.

South Africa must seriously reconsider the continued practice of macroeconomic policies made in the West and designed for the economic challenges of the West. And given that those very same macroeconomic policies have now proved themselves so spectacularly inappropriate for the West anyway, why on this earth should we continue practicing them in South Africa?

The Joint Letter from South Africa’s Manufacturers and Trade Unions is a plea for policy makers and certain private sector commentators to wake up and address the deeper realities of today’s moving-from-West-to-East global economy. If nothing else, we owe it to ourselves to have a serious debate on what set of macroeconomic policies we as South Africa need to practice. Exchange rate management is only but a part, albeit an important part, of that debate.

A brand new day, profoundly different as to where the global economic centre of gravity will be, is dawning. South Africa urgently needs to adopt a set of economic policies that matches our own very pressing needs to the coming of that new world. And in doing this, we must not hang on to the policies of yesterday, policies made in and for the world of yesterday.

Posted by: michaeldavidpower | October 3, 2010

Catching up…

I have been remiss in keeping my blog up to date recently but my travel schedule – and speaking commitments as a part of that – have overwhelmed my previous dedication. Mea culpa! As such this series of posts amounts to a “catch up” adding a series of comments and thoughts I have written down over recent months. In no particular order, they are as follows:

“Of locomotives, oil tankers and coal trucks”

Although the term ‘decoupling’ lost favour as stock indices even in emerging markets tumbled in the wake of the 2008 Credit Crunch, if one looks merely at the macroeconomic performance of the global economy, decoupling is indeed a fair description of what has happened. The world has divided itself broadly into two economic tracks: the fast one led by the locomotives of China and, to a lesser extent, India versus the slow one headed by the Puffing Billies of the US, Europe and Japan.

In 2009, the rest of the world attached themselves to whichever train most dominated their export profile. Nearly every other country could be classified as one of three types of rolling stock: coal trucks (exporting coal, metals and other resources) or oil tankers (oil alone) or passenger cars (net resource importers).

It would be neat but incorrect to conclude that the first two resource-rich categories hitched themselves to the growth engines of Asia in 2009 whilst the passenger cars – epitomised by Mexico and Eastern Europe – had little alternative but to trundle along behind their adjacent locomotives. Yes, the coal trucks went largely with Asia and the passenger cars went mostly with Europe and the US but the latter were – in 2009 at least – joined by the oil tankers too as the West’s energy needs remain more oil-intensive; by contrast, the East’s energy needs were still more coal-based. Since then, as China’s appetite for oil has continued to grow apace, the oil tankers have started to ‘jump tracks’ and hitch themselves more to the Asian locomotive, though they have yet to make the transition completely.

If the New Normal does grasp most of the big Western markets in its icy grip – though less so Germany, it seems, again because of its strong export profile of capital goods to China – then the Western train is set for a long journey at low speed. By contrast, countries that have resources to export to both the hungry Chinese Dragon and the now tap-dancing Indian Elephant have, by coupling themselves to the fast train, already shielded themselves from the so-called “global” slowdown. (Note that Western commentators – and too many of their ilk in South Africa – frequently mislabel what has essentially been a Western phenomenon as a “global” one.)

As China’s resource-intensive growth phase still has a good decade to run and the Indian equivalent has at least three decades to go (not to mention the roles being played by the supporting cast of their smaller but often still heavily populated Asian neighbours like Indonesia at 235m, Vietnam at 86m, and Bangladesh at 165m), the commodity super-cycle still has very long secular legs. This can only be good for the future prospects of resource-rich nations, be they coal trucks or oil tankers, whether they are in emerging or developed markets.

South Africa has, up till now, for the most part chosen to ride the wrong train despite our resource-rich export profile. Partly because there are vested interests defending established traditions – usually practitioners of the dark science of Sandtonomics and its associate school, Constantianomics – who still see us more as South Tuscany than South Africa, our economic orientation has been not been what it should have become: towards the Orient and not the Occident. The sooner we abandon the Old World train and hitch ourselves to the New One – in other words see ourselves for what we in South Africa are and for what we can become rather than some faux-European outpost adrift in the Southern Hemisphere – the better it will be for our collective future.

As the people of the aptly named Mpumalanga (“the place of the dawn”) can surely testify, the sun rises in the East and sets in the West.

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