SA not that in­su­lated against re­ces­sion

Finweek English Edition - - Cover -

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.

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