By Cees Bruggemans, Chief Economist FNB Cees@fnb.co.za

2 October 2011


It is interesting to note how the great turbulent events of 2011 are working out and how South Africa is maintaining a steady, if uninspiring, course through such choppy seas.
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The Arab Spring came and went, leaving upended regimes in Tunisia, Egypt and Libya, with Syria and Yemen also seriously worried by reform. Not quite finished yet, but then genuine democracy is never finished demolishing strictures, as we could also daily witness at home.

The immediate consequence was a worrying run-up in oil prices, carrying global inflation consequences. But the fading of the Spring and slowing global growth helped to ease Brent oil back nearer $100/b despite disruptive supply constraints.
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Japan was deeply shaken by its March tsunami and earthquake, the industrial disruption going global in 2Q2011, but its rebound was mostly completed by 3Q2011.

Even so, the country remains mired in its decades-long stagnation dating from the late 1980s.
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The US economy has lost two important long-term growth engines, namely housing (one-in-five home mortgages remain underwater) and easy household access to credit.

While it is struggling to come to terms with these realities, trying to reinvent itself, the country apparently is also going through a fundamental political rethink, with long-term social choices up for grabs, and seemingly no price too high to achieve desired outcomes.

Such brinkmanship has mostly neutralised US fiscal policy as an instrument of stability control at a time that loss of confidence is palatable, endangering growth.

Yet despite corrosive fiscal austerity and shaken confidence we find American business in ruddy health with strong balance sheets and earnings performances (at record levels relative to GDP).

Despite household deleveraging and the broken property market, with banks frugal with credit, the US economy continues to generate income and output.

Its gains, however, aren't vigorous enough to dent the large lingering output gap (29 million Americans unemployed or underemployed, some 20% of the labour force), with cyclical expansion more akin to stagnation (feeling more like creeping along the bottom of the barrel and only now and then coming up for air).

The US suffers from a lack of leadership, as hinted at by Fed chairman Bernanke at Jackson Hole, only nibbling at recasting its old market framework with a left-leaning President while Republican interlocutors are apparently only intend on unseating him and making a clean sweep of Congress so that they may regain control of policy.

Still, the Fed remains generously supportive with zero interest rates for as long as it takes (something that could turn out to be very long indeed), where needed supplemented with non-conventional supports such as various forms of QE and market 'guidance'.

This monetary liquidity cushion keeps the markets in play, and the broader economy supported, so far preventing a more fundamental breakdown from gaining real traction.

And thus the US keeps limping forward, benefiting from a weak Dollar and still good growth elsewhere in the world, with its ample Dollar liquidity remaining supportive for commodity prices and yield-seeking EM capital inflows on days when risk is switched on.
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China has been determined this past year to address rising inflation (not easy, for it is mostly food based) and its bubbly bank credit and property scenes.

With inflation peaking and starting to recede, and property prices pulling back while weaker developers are exiting as they are subjected to a funding pinch, some air is being let out of China's Great post-2008 Bubble.

Though many in the outside world fear a more fundamental shakeout, China appears to be welcoming the property moderation underway, with policy likely to become supportive once again shortly as the shakeout will have progressed enough while next year's political leadership transition looms.

Still, the lingering rigid communist control over China's internal markets causes problems. The proud showcasing of large-scale industrial achievements reminds of old Soviet-style and Chinese output quotas being achieved at the expense of quality, frugality and precision.

For now Chinese authorities have to explain high-speed trains colliding due to faulty signaling systems and subway trains colliding due to faulty lighting.

Outraged youth have taken to the streets and authority clearly fears another Tiananmen Square. The country's land policy is under attack from all sides and food inflation remains a major bugbear, feared by large parts of the population earning low incomes.

China needs to make more progress with human rights and its old export-led growth model needs updating as global conditions change and become rapidly less accommodating.
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The European saga has steadily worsened this year as markets have increasingly insisted on immediate and far reaching structural reforms while European politicians like to do things one-step-at-a-time, tinkering with a market framework marked by rigid bureaucracy and growing nationalism.

So far, fearful discipline has been imposed on peripheral countries who previously had not kept to the letter of EU agreements, disapproving electorates everywhere have been kept on board through various means and nervous markets have been sidestepped through ECB intervention by way of supportive bank liquidity injections and purchases of distressed sovereign debts.

Lifeboats have been launched, upgraded and re-engineered and this process remains ongoing while seeking democratic parliamentary mandates.

Next on the agenda are further intensification and refinement of peripheral discipline, the agreeing of new EU fiscal rules, more thorough bank recapitalisation and this probably accompanied by select, orderly peripheral debt restructuring (Greece and others?).

The real challenge is to achieve structural reforms engendering faster internal growth throughout Europe instead of exports being the ultimate fallback option (relying on global, especially Asian, growth to keep Europe moving forward despite its internal drag anchors).

This remains an intimidating agenda but it isn't as if there has been no progress.

Meanwhile, the many Euro skeptics worldwide keep the idea alive that a market-driven collapse of banks and peripheral countries will presage the end of the Euro and the beginning of renewed European fragmentation.
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With global growth having slowed a notch in the East, and a few notches throughout most of the West, with the Fed remarkably constrained in its QE exercises (compared to what could have been ...... and may yet be......) commodity-driven inflation surges have been arrested and could be subsiding soon, also assisted by substantial Western output gaps suppressing inflation.

It is not a world without danger, as the IMF so usefully tells us whenever markets nervously heave while EU and US politicians grapple with their enormous complexities, seeking their way through seemingly insolvable conflicts.

It is also not a world where progress proves elusive, as the various afflicted gradually munch through their seemingly indigestible problems, crafting temporary solutions which time will test, and no doubt will demand to be revisited.
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South Africa is under the circumstances not doing too badly (relative to what most Westerners are going through) though it could have been doing so much better (when compared to what some Easterners and other commodity producers are still harvesting).

There are a few too many supply-side 'own goals' being scored with great regularity in South Africa, such as electricity rationing, limited export rail capacity, overvalued Rand, public sector technical manpower shortages, disruptive regulatory interventions.

This is keeping the growth 'modest'.

It manifests via constrained output, limited fixed investment expansion and few private employment gains.

Households surprised for a while with strong income growth and spending revival leveraged off commodity windfalls, public sector patronage, aggressive union demands, skill scarcity premiums, low inflation and new leverage through unsecured borrowing (a limited option).

But this year the nominal wage and salary growth has fallen off somewhat, while average inflation is gaining about 2%, thus eroding real income growth.

The consequent slowing in real spending was further reinforced with a loss of confidence, as much locally sourced (political talk about new social burdens, nationalisation of commanding heights, new paths and many populists) as overseas (fearful evening news daily about US and EU problems overwhelming the world).

Though a lack of confidence also weighs down business mindsets, preventing more vigorous fixed investment resurgence, there remains evidence of some defensive investment appetite, especially driven by IT-productivity and high-cost labour-substitution opportunities.

It is a configuration that makes for disappointingly slow GDP growth of 3%-3.5% (maintaining a modest output gap as not all available resources are being reabsorbed into productive deployment), inflation of 5%-6% that's mostly target bound (warranting only a watching brief for now), a Rand that remains mostly overvalued in 6.50-8.50:$ territory, with fiscal policy fully supportive (and only gradually regaining its 3% of GDP deficit) and monetary policy remaining fully supportive with 35-year low interest rates possibly for years to come (in imitation of the Fed's America, if on a less ambitious scale).

So the Americans, Europeans and Japanese aren't the only ones making haste slowly. We, too, have refined this to a fine art as we debate greater state intervention via NGP and other stuff as compared to more market-friendly supply side reforms, in the meantime settling for good old-fashioned paralysis as a compromise.

South Africa wants to experiment with developmental state dynamics, with as excuse that we need to escape our historic resource 'curse' that distorted 'everything' (energy, transport, finance, industry, urban structures and income, education and health distributions).

But the really important things supporting our own market framework don't get the attention they deserve and critically need if we are to outperform (infrastructure maintenance, replacement and expansion, labour market distortions, education shortcomings).

All around the world everyone may be looking for new paradigms, but these seem to be only slowly arriving. We are all busy repairing broken reeds, learning along the way repair requires new structures. The main global lesson may well be the need for new model structures within a market framework.

Perhaps the ultimate irony is that all these global challenges make our own problems look relatively digestible, not (as yet) as systemically critical as elsewhere the case.

Be that as it may, we could be doing so much better with relatively limited additional inputs. This makes us rather a positive global exception. Yet to date we have not risen to the occasion, a remarkable opportunity loss, one for future generations to digest more fully.

Meanwhile the East looks like it will keep going hell for leather, with relative global positions shifting at a remarkable pace, as the world keeps reinventing itself.

Keeping our bearings in all that will need some doing.

Cees Bruggemans
Chief Economist FNB
Twitter sound bites @ 'ceesbruggemans'

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