SA not that insulated against recession
THE RAND’S VALUE cracked last week and weakened to nearly R11 to the US dollar. That sharp decline recalls images of 2001, when it cost more than R13 to buy one dollar. Against the sick British pound (R18,30/R1) and equally sick euro (R14,14/R1) the rand is already trading at unprecedented lows. For the first time ever, the rand will also buy less than 10 Japanese yen.
The fall in the value of the rand is a direct result of the credit tsunami in the United States – now worldwide – that’s shifted from the financial sector to a global recession in economic growth: a recession threatening to become a depression that could be comparable with, or even worse than, that between 1929 and 1932. On Monday last week there was worldwide excitement when the Dow Jones index of select US shares rose by an unprecedented 936 points.
Gordon Brown, British Prime Minister and father of the plan that governments should buy direct shareholder interest in struggling banks rather than just releasing them of their rotten assets, is being hailed as the man who saved the world. Perhaps British banks, but certainly not the world economy: markets began warning loudly from Wednesday last. That day the Dow Jones fell by 733 points, or nearly 8%, and the prosperity of Brown’s plan was wiped out in a single day.
The total chaos on the world’s credit markets clearly spilled over to the real economy of, especially, the US last week. That country’s retail sales fell sharply by 3% in September, sending the first clear warning that the financial crisis wasn’t limited to a few square kilometres around Wall Street.
The great shock for smaller economies, including SA, and also considerably larger ones, such as Australia, is the intensity with which the prices of commodities, from dirty iron ore to glittering platinum, have been put under pressure and have fallen in an almost straight line.
That’s spilled over to the share prices of two of the world’s most sought after resources giants, BHP Billiton and Anglo American. The graphs of their share prices over the past three months show falls of up to 50% and unbelievable destruction of value in the best companies in SA and Australia. The incredible flight from resources and also the shares of resources producers has put pressure on the SA currency. After all, we have a huge deficit on our balance of payments current account. Our deficit in trade and goods – and especially services – with the rest of the world is more than R150bn/year. Because of the more than 50% fall in the price of platinum, our major export product, over the past few months SA’s deficit could rise further.
However, the scarier scenario is that we’re largely dependent on the inflow of portfolio investments to finance the deficit. The sharp fall in the prices of our resources shares is a warning that, especially over the short term, we can no longer depend on that source of financing. The SA Reserve Bank’s foreign exchange reserves, which are luckily on a healthy level of more than US$35bn, will in future have to be used to pay for SA’s almost excessive imports.
One piece of good news for local consumers is that interest rates won’t rise again. Usually, a sharp drop in the value of the rand requires a corresponding increase in interest rates to counter the inflationary pressures that follow such a fall in the exchange rate. That old rule of thumb in SA would have required our prime lending rate to go up by at least one percentage point for every 10% decline in the rand’s value.
The more than 30% fall against the US dollar since the middle of this year, just
before the worst of the credit crisis hit the world, would therefore have required an increase of as much as three percentage points in the prime rate to more than 18%. That would have brought back the ghosts of 1998, when the lending rate soared to 25%/year.
Luckily, that’s not necessary now. The fall in resources prices, with crude oil already costing more than 50% less in US dollars, removes the inflationary dangers from the latest drop in the rand exchange rate.
Worldwide, interest rates are falling sharply, largely due to the unprecedented trillions of dollars being pumped into the financial system by the world’s central banks and also nearly every country’s treasury. SA would be moving entirely against that world trend if our Reserve Bank were to raise interest rates in order to halt inflation, which accompanies a devaluation.
In the US there’s already speculation that the Federal Reserve will also soon have to follow a policy of zero interest rates, as Japan had to for many years since the early Nineties. In fact, Japan’s current bank rate of 0,5% can hardly be called an interest rate.
Such exceptionally low interest rates are needed to try to halt the worldwide destruction of wealth, also called asset deflation. It’s hardly possible for consumers to make merry and spend too much if the fall in the prices of assets – such as ordinary shares, all types of property, cars and even the diamond rings on the fingers and the silver in the cupboard – destroys wealth like never before.
Indeed, the converse is now also possible. The value of the rand is falling because there’s an international credit crisis that refuses to budge, despite the authorities’ best efforts. That crisis has now spilled over into global recessionary fears and a very sharp fall in the prices of commodities.
SA couldn’t escape that. Bankers JPMorgan called SA’s economy “insulated if not isolated” two weeks ago. It didn’t work like that and the dangers of an economic recession are also becoming dangerously apparent in SA.
For pensioners and widows and orphans who depend on interest income that’s bad news. Our interest rates could fall, just like those in the rest of the world, while prices must necessarily rise after the sharp fall in the rand. Prepare for lower incomes and rising prices.
For the rest of the people in this country, the news isn’t that bad. The wealth of the past few years created by rising property prices and a lively share market, especially in the resources sector, has reached its end. Lifestyles will have to be adapted to current income, which isn’t always very pleasant. There may even be the further burden of saving more to make up for the destruction of the value of assets over the past few weeks. ¤
Bankers JPMorgan called SA’s economy “insulated if not isolated” two weeks ago. It didn’t work like that.