The Investor February 2020

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By Richard Cluver                February 2020


Few investors are able to read the big picture because they believe it is too complicated for ordinary folk to understand. But it really is not if you can learn to look behind the clutter of detail.

Thus, for example, few understand why a major share market crash can result in a national economic recession which results in widespread unemployment. Equally they do not understand why a rise in public optimism results in the share market soaring and in turn creates jobs seemingly out of thin air.

Taking that a step closer, few grasp the fact that if everyone suddenly woke up one morning next week to a flood of good news stories from politicians and businessmen, some clergymen and a squad or two of leading sportsmen, the share market might begin to rise and new jobs would begin to happen in a self-stimulating perfect storm.

Image result for business confidence index It is really very simple if you do not let yourself be daunted by too many details. Its all about a convincing story which everyone can believe in. And the reverse is equally true; when everyone begins to doubt the likelihood of a good tomorrow, markets and their linked economies tend to nose-dive and, unless this is speedily checked, we all become victims of a self-fulfilling prophecy of gloom and doom which is exemplified by the graph on the right which tracks how business confidence in this country has plummeted over the past five years. It explains too why we are facing unprecedented levels of emigration which, if they remain unchecked, will seriously damage our long-term prospects of recovery because of the loss of vital skills.

The problem is that we are too focussed upon the negative consequences of State Capture and the lack of progress in putting behind bars those who stole trillions of Rands from the State. Yet one of the most respected global rankings surveys puts South Africa in the top 20 up-and-coming nations and 39th overall in the ranking of the best countries of the world to live in. The Best Countries report is produced from an annual global survey of more than 20,000 people in 36 countries.

To illustrate how the good news/bad news impacts upon society, let us consider the last great JSE share market crash which began on May 22 2008 and cost the average investor 46 percent of his capital. Given that the total market capitilisation of all the shares currently listed on the JSE is R14.87-trillion then it should be obvious that were my prediction of a mega market melt-down this coming October to result in a loss of a similar magnitude, then R6.8-trillion would be lost to the country overnight.


ShareFinder predicts a series of market slides during 2020 culminating in a mega-decline starting in October as depicted in the graph.

The Gross Domestic Product of the country is currently just a tad short of R5-trillion which implies that a catastrophic decline of the JSE would be equivalent to the loss of our entire corporate earnings plus all the profits of every small business and all the salaries and wages of every South African for the equivalent 16 and a half months.

Clearly the impact would be devastating upon the collective psyche of the country extending not just to shareholders, but to every pensioner and to everyone with savings invested in pension schemes. Worse, the psychological effect upon everyone who loses so much money means that most would automatically cut back upon their non-essential spending which would result in a wave of economic pressure rolling onto everyone.

In a worst case scenario, with shop turnovers hit, retailers would be forced to cut back on part-time workers and every conceivable business expense would come under consideration for cutting. So full-time employees could kiss bonuses and salary increases goodbye for the forseeable future. And the the knock-on would immediately result in factories having to cut back on production, cutting overtime and paying off as many workers as they could.

Government too would soon experience a severe cut in the VAT and PAYE revenue they had budgeted for and soon would have to start cutting back on non-essential capital works which would, in turn, mean that construction companies and the like would soon be retrenching workers as the general malaise spread its tentacles throughout the economy.

And, of course, the exact opposite happens when individual investors become optimistic. If just a few investors begin betting that a particular group of companies is likely to make superior profits in the coming year and, as a result, start buying their shares, just a few purchases worth just a few thousand Rands results in the leverage of the entire share value.

For example, Shoprite Checkers has 591-million shares in issue at a current price of R121.62 implying a market capitalisation of R71.9-billion but on an average day only around 1.5-million of these change hands and it only takes a few thousand of these to sell a few cents higher than the previous selling price to trigger an upward movement. If more buyers then react because of some news announcement or because computer analysis has detected the change, it takes only a few thousand Rands more to start an upward trend.

So a few thousand Rands invested by a few speculators can easily move a share like Shoprite upwards by as much as 30 percent. It happened in December 2017 effectively increasing the wealth of Shoprite shareholders by R22-billion: money created as if out of thin air.

Soon the wave of positive sentiment begins to spread to other shares and, inexplicably, the whole market begins rising creating massive wealth for everyone also seemingly out of thin air.

Just as the regularly-occurring share market downward “corrections” bring about a sudden loss of confidence in the whole country, so a daily rise in the portfolios of investors is guaranteed to put a spring in their step and to loosen purse strings. Public spending increases, factories begin employing second shifts and overall industrial productivity rises dramatically as underutilised capital equipment heads for maximum utilisation.

So guess what, if you know where to look you will find just that happening right here in South Africa right now. The twin graphs depicted below represent (at the top) the 2011 Prospects Portfolio which I have run in my Prospects monthly newsletter since 2011 with a green trend line indicating that since August 2019 the portfolio has been gaining in value at a compound annual average rate of 51.6 percent. Below that, with a yellow trend line indicating an annual growth rate of 22.6 percent is the JSE Blue Chip Index.



So readers who follow my newsletter recommendations are making a LOT of money currently and it is not going unnoticed. All it needs now is for some of the promises that have been made by the Ramaphosa administration to show actual results and the country is capable of becoming an overnight sensation.

No act of government can bring about such a change of heart, but it can play a big part in it by ensuring that enabling legislation and an efficient civil service makes doing business a pleasurable and profitable exercise. If our prosecutors could succeed in putting behind bars a few high profile citizens, whose corruption has been widely detailed by the Zondo Commission and by a series of investigative journals, that would also contribute immensely to the belief that crime does not pay in South Africa. It might have a salutory effect upon others who currently believe that their party ranking has given them immunity.

Students of the greatest economic catastrophe of the modern world, the Great Depression recognise that it began with a share market bubble inspired by the then newly-created US Federal Reserve boosting money supply fourfold from the time it was created in 1913. They did so by what we today recognise as a partial ending of the Gold Standard inasmuch as private US banks were thenceforth allowed to hold US Government bonds instead of gold bullion simultaneous with the government needing to find a means of paying for its war debt without unpopularly increasing taxes.

Though many solutions were tried to bring back the boom conditions of the 1920s, of which the final ending of the Gold Standard, the Hoover Dam project and the inspanning of women into the work-force as part of the World War 2 arms-building programme formed significant parts, the world economy really did not properly recover until quite long after World War Two when a new optimism began to return to the world with the realisation that global warfare was probably no longer possible because of the probability that such an event would end in the annihilation of the human race. With it came the second industrial revolution, the conquest of space and the digital revolution.

My graph below tracks the New York Stock Exchange Dow Jones Industrial Index starting in 1913 during the initially slow creation of a growing flood of new money flowing ultimately into the stock exchange and fuelling a bubble that ultimately burst in September 1929. Though the market initially began recovering in July 1932 and peaked in March 1937 as war clouds were gathering over Europe. The next up-phase began in May 1942 coinciding with the decisive victory of US forces around Midway Island which turned the tide of the Pacific War but it was not until the end of 1954 that the Dow finally broke up above the 1929 peak, a whole 25 years later.

 
Here in South Africa, house prices are a reasonably accurate guide to our economic health as the following graph illustrates:

https://housepricesouthafrica.files.wordpress.com/2011/01/comparing-1980-property-boom-to-2004-boom1.png?w=640&h=303

The most significant house price bull markets were between 1977 and 1981 and again between 1999 and 2004.

So it is interesting to compare share market trends. Let’s turn to the 1999 to 2004 period noting that a similar boom began in 1999 subsequent to the second general election which ushered in the Thabo Mbeki era during which the apartheid era national debt was paid down and increasing sums of taxpayer’s money began to flow into infrastructure development ushering in a new era of economic confidence. It continued upward until it was terminated by the May 2008 global share market crash associated with the Wall Street “Sub Prime” property scandal but more particularly here in South Africa with rise of Jacob Zuma as ANC President in December 2007 and the political uncertainty that followed leading up to the recall of Thabo Mbeki in September 2008.


Interestingly, Zuma’s reign of power proved good for the South African economy initially with the JSE rising in quite spectacular fashion from November 2008 until April 2015 and then in more modest fashion until January 2018 shortly following on Cyril Ramaphosa’s election on December 18 2017 as president of the ANC and his subsequent February 15 election as President of South Africa.

Almost immediately the JSE went into continued decline marked out by my descending pair of red trend lines on the JSE All Share Index graph.


Why has the JSE Overall Index been in decline during the so-called Ramaphoria years? Well, the probable truth is that although we sensed that bad things were happening during the Jacob Zuma administration, it was only when the Ramaphosa reforms began to uncover the full horror of what went on, that public confidence began dwindling.

Now we know that the cost of State Capture hovers at around R1.5-trillion over the second term of the Jacob Zuma administration. That’s just short of the R1.8-trillion Budget for 2019. Put differently: State Capture wiped out a third of South Africa’s gross domestic product. Here are the actual numbers that have been reported by The Daily Maverick:

    • R252,5-billion in lost Budget,
    • R67-billion more in debt service costs,
    • R90-billion lost in tax revenue collection.
    • R506 billion lost from the value of South African bonds and listed companies in the March 2017 midnight Cabinet reshuffle,
    • Nenegate wiped out R378-billion from the JSE.
    • R200-billion overspent on Medupi and Kusile coal power stations that are not only over budget but also overdue in completion.
    • The directly State Capture identified costs include R1-billion McKinsey consultancy fee, R659-million Eskom prepayment for coal to the Gupta-owned Tegeta and the R5,3-billion finders fee to a Gupta-linked company in the Transnet locomotive deal.

That’s a devastating sum to have taken out of the hands of ordinary South Africans, but consider for a moment, all it would take to re-create that sum would be a ten percent rise of the JSE. So note well that between November 2008 and January 2018 it rose over 300 percent; simply stated that was 30 percent a year. Just saying!

Here’s optimism!

Noting that Britain’s Prime Minister Boris Johnson has been quick to capitalize upon his new-found dominance of Parliament to launch one of the most ambitious public infrastructure spending programmes that country has seen since the glory days of Queen Victoria, it is time to stop bashing President Ramaphosa and consider what he is contemplating for this country.

This story by the Daily Maverick’s Sasha Planting lifts the lid on an equally imaginative plan for South Africa. I think it is the most uplifting story published so far this year:

Finance institutions have billions to invest in South African infrastructure, but whether they invest or not depends on the development of projects that have a commercial return. And that comes down to the willingness of SOEs and government to package such projects. Our economy hinges on it.

South Africa is peering over the edge of a fiscal cliff with no easy way down. Rating agency Moody’s projects economic growth of 0.7% for 2020, a paltry figure that will inevitably lead to higher levels of unemployment and greater social inequality. Reviving this country’s ailing economy has become the hallmark of the Ramaphosa presidency.

There are many places to start, but tackling the infrastructure backlog as a means to kick-start the economy is one way.

The problem is the state does not have the funds, nor the means to do so.  

So it was that last Tuesday President Cyril Ramaphosa brought together a high powered group that included the heads of SA’s four big banks, the heads of multilateral development banks like the World Bank and International Finance Corporation, and DFIs like the German Development Bank and the African Development Bank Group at Tuynhuys, the Cape Town office of the Presidency. It was an impressive turnout – about 200 people attended.

They were there to talk about infrastructure and, more specifically, how to intensify infrastructure investment in South Africa. This included discussion on the urgent reforms identified by the government as prerequisites for reviving infrastructure investment which has slowed abysmally over the past decade.

The meeting followed Ramaphosa’s restatement in this year’s State of the Nation Address that infrastructure development is front and centre of government’s growth and job creation agenda and follows months of behind the scenes work by the Presidency, National Treasury, the Department of Public Enterprises and the Department of Public Works and Infrastructure.

Of all the places to start, it’s not the worst.

“These multilateral development banks have let it be known that they have R140-billion to invest in infrastructure in South Africa this calendar year, but they need bankable projects,” said Dr Kgosientso Ramokgopa, head of the Investment and Infrastructure Office in the Presidency, following the Tuynhuys gathering.

“This meeting was unprecedented,” he added. “We saw key players in the finance sector coming together under one roof to ensure the government can meet its economic goals.”

Ramaphosa told the assembled gathering that there was considerable work to be done. 

“We have seen a deterioration of some of the most important assets in our country. Where infrastructure is not maintained it has a huge impact on the ordinary lives of people – water is an example.”

There are many reasons for this state of affairs, but the haemorrhaging of technical and financial engineering skills from the public sector has certainly contributed to the dire state of public infrastructure. Further, the lack of planning, asset management and the absence of credible project pipeline has resulted in an erosion of confidence by funders and absence of projects, he said.

South Africa’s legislation governing infrastructure management compounds the problems. It is some of the most elaborate and complex in the world. The unintended consequence of this, Ramaphosa said – and the Public Finance Management Act is just one example – is that terrible delays in decision-making occur. 

“This is a picture I’m determined we should correct immediately,” he said.

The meeting resulted in two critical outcomes.

The private sector organisations present, which, aside from the banks, included the Consulting Engineers of SA and Business Unity SA, have agreed to help government recreate the capacity that has been lost in terms of technical and financial engineering capacity. 

“They will make resources available ahead of the president’s Sustainable Infrastructure Development Symposium, which is scheduled for May,” said Ramokgopa.

“This expertise will be deployed so that when we go into the symposium, we will have shovel-ready projects to show to the financiers.”

There is no limit to the projects that need financing, but for the time being the focus will be on SA’s network industries – water, energy, ports and rail, roads and internet connectivity. Priority will also be given to agri-projects as well as those involving human settlement.

Parallel to all of this, work will begin on revisions to the Infrastructure Bill to ensure that it supports, rather than hinders all of these plans – specifically as it relates to public-private partnerships and the involvement of the private sector.

It is easy to dismiss this as another of Ramaphosa’s infamous talk shops. But Chris Campbell, CEO of Consulting Engineers SA, who presumably would be instrumental in plans going forward, is cautiously optimistic. 

“This is the beginning of a process. It is groundbreaking to have all of these funding agencies and government and ourselves in one room. That has not happened in the longest of times. It inspires confidence. Now we must make this process unfold… not in years to come but now,” he says.

“There is a recognition that infrastructure is a catalyst to grow our economy.”

Maintaining positive momentum is a responsibility that falls on the shoulders of Ramokgopa. It is a big task. BM

The Crash of 2020

By Richard Cluver

I have suggested that the fundamental flaw of the Gold Standard was that it was based upon a pegged value for gold which removed flexibility from the monetary authorities and left them without any weapons to counteract economic cycles like those that occurred in the aftermath of catastrophes like war, acts of God such as earthquakes, hurricanes, epidemic diseases and so forth.

Turning to Wikipedia’s analysis which is a live debate contributed by economists worldwide, the two classical competing theories of the Great Depression are the Keynesian (demand-driven) and the monetarist explanation. There are also various heterodox theories that downplay or reject the explanations of the Keynesians and Monetarists. However, the consensus among demand-driven theories is that a large-scale loss of confidence leads to a sudden reduction in consumption and investment spending. Once panic and deflation sets in, many people believe they can avoid further losses by keeping clear of the markets. Holding money becomes profitable as prices drop lower and a given amount of money buys ever more goods, exacerbating the drop in demand.

Monetarists believe that the Great Depression started as an ordinary recession, but the shrinking of the money supply greatly exacerbated the economic situation, causing a recession to descend into the Great Depression.

Economists and economic historians are almost evenly split as to whether the traditional monetary explanation that monetary forces were the primary cause of the Great Depression is right, or the traditional Keynesian explanation that a fall in autonomous spending, particularly investment, is the primary explanation. Today the controversy is of lesser importance since there is mainstream support for the debt deflation theory and the expectations hypothesis. There is consensus that the Federal Reserve System should have cut short the process of monetary deflation and banking collapse. If they had done this, the economic downturn would have been far less severe and much shorter.

British economist John Maynard Keynes argued in his General Theory of Employment, Interest and Money that lower aggregate expenditures in the economy contributed to a massive decline in income and to employment that was well below the average. In such a situation, the economy reached equilibrium at low levels of economic activity and high unemployment.

Keynes’ basic idea was simple: to keep people fully employed, governments have to run deficits when the economy is slowing, as the private sector will not invest enough to keep production at the normal level and bring the economy out of recession. Keynesian economists called on governments during times of economic crisis to pick up the slack by increasing government spending and/or cutting taxes.

Thus, as the Depression wore on, Franklin D. Roosevelt tried public works, farm subsidies, and other devices to restart the U.S. economy, but never completely gave up trying to balance the budget. According to the Keynesians, this improved the economy, but Roosevelt never spent enough to bring the economy out of recession until the start of World War II.

Monetarists follow the explanation given by Milton Friedman and Anna J. Schwartz in arguing that the Great Depression was caused by the banking crisis that caused one-third of all banks to vanish, a reduction of bank shareholder wealth and more importantly monetary contraction by 35 percent. This caused a price drop by 33 percent (deflation). By not lowering interest rates, by not increasing the monetary base and by not injecting liquidity into the banking system to prevent it from crumbling, the Federal Reserve passively watched the transformation of a normal recession into the Great Depression. Friedman argued that the downward turn in the economy, starting with the stock market crash, would have been an ordinary recession if the Federal Reserve had taken aggressive action.

The Federal Reserve allowed some large public bank failures – particularly that of the New York Bank of United States – which produced panic and widespread runs on local banks, while the Federal Reserve sat idly by as banks collapsed. Friedman claimed that, if the Fed had provided emergency lending to these key banks, or simply bought government bonds on the open market to provide liquidity and increase the quantity of money after the key banks fell, all the rest of the banks would not have fallen after the large ones did, and the money supply would not have fallen as far and as fast as it did.

With significantly less money to go around, businesses could not get new loans and could not even get their old loans renewed, forcing many to stop investing. This interpretation blames the Federal Reserve for inaction.

One reason why the Federal Reserve did not act to limit the decline of the money supply was the gold standard. At that time, the amount of credit the Federal Reserve could issue was limited by the Federal Reserve Act, which required 40% gold backing of issued Federal Reserve Notes.

By the late 1920s, the Federal Reserve had almost hit the limit of allowable credit that could be backed by the gold in its possession. This credit was in the form of Federal Reserve demand notes. A “promise of gold” is not as good as “gold in the hand”, particularly when they only had enough gold to cover 40% of the Federal Reserve Notes outstanding.

During the bank panics, a portion of those demand notes were redeemed for Federal Reserve gold. Since the Federal Reserve had hit its limit on allowable credit, any reduction in gold in its vaults had to be accompanied by a greater reduction in credit. On April 5, 1933, President Roosevelt signed Executive Order 6102 making the private ownership of gold certificates, coins and bullion illegal, reducing the pressure on Federal Reserve gold.

The common position of today’s mainstream schools of economic thought is that governments should strive to keep the interconnected macroeconomic aggregates and money supply and/or aggregate demand on a stable growth path. When threatened by the forecast of a depression central banks should pour liquidity into the banking system and the government should cut taxes and accelerate spending in order to keep the nominal money stock and total nominal demand from collapsing.

During the Crash of 1929 preceding the Great Depression, margin requirements were only 10 percent. Brokerage firms, in other words, would lend $9 for every $1 an investor had deposited. When the market fell, brokers called in these loans, which could not be paid back. Banks began to fail as debtors defaulted on debt and depositors attempted to withdraw their deposits en masse, triggering multiple bank runs. Government guarantees and Federal Reserve banking regulations to prevent such panics were ineffective or not used. Bank failures led to the loss of billions of dollars in assets.

Outstanding debts became heavier, because prices and incomes fell by 20 to 50 percent but the debts remained at the same dollar amount. After the panic of 1929, and during the first 10 months of 1930, 744 US banks failed. (In all, 9 000 banks failed during the 1930s). By April 1933, around $7-billion in deposits had been frozen in failed banks or those left unlicensed after the March Bank Holiday. Bank. Failures snowballed as desperate bankers called in loans which the borrowers did not have time or money to repay.

With future profits looking poor, capital investment and construction slowed or completely ceased. In the face of bad loans and worsening future prospects, the surviving banks became even more conservative in their lending. Banks built up their capital reserves and made fewer loans, which intensified deflationary pressures. A vicious cycle developed and the downward spiral accelerated.

The liquidation of debt could not keep up with the fall of prices that it caused. The mass effect of the stampede to liquidate increased the value of each dollar owed, relative to the value of declining asset holdings. The very effort of individuals to lessen their burden of debt effectively increased it. Paradoxically, the more the debtors paid, the more they owed. This self-aggravating process turned a 1930 recession into a 1933 great depression.

Irving Fisher’s debt-deflation theory initially lacked mainstream influence because of the counter-argument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Pure re-distributions should have no significant macroeconomic effects.

Building on both the monetary hypothesis of Milton Friedman and Anna Schwartz as well as the debt deflation hypothesis of Irving Fisher, Ben Bernanke developed an alternative view in which the financial crisis affected output. It built on Fisher’s argument that dramatic declines in price levels and nominal incomes leads to increasing real debt burdens which in turn leads to debtor insolvency and consequently leads to lowered aggregate demand while a further decline in price levels then results in a debt deflationary spiral.

According to Bernanke, a small decline in price levels simply reallocates wealth from debtors to creditors without doing damage to the economy. But when the deflation is severe, falling asset prices along with debtor bankruptcies leads to a decline in the nominal value of assets on bank balance sheets. Banks then react by tightening their credit conditions which, in turn, leads to a credit crunch which does serious harm to the economy. A credit crunch lowers investment and consumption and results in declining aggregate demand which additionally contributes to the deflationary spiral.

Since the economic mainstream has turned to the new neoclassical synthesis, expectations are a central element of macroeconomic models. According to Peter Temin, Barry Wigmore, Gauti B. Eggertsson and Christina Romer, the key to recovery and to ending the Great Depression was brought about by a successful management of public expectations. The thesis is based on the observation that after years of deflation and a very severe recession, important economic indicators turned positive in March 1933 when Franklin D. Roosevelt took office. Consumer prices turned from deflation to a mild inflation, industrial production bottomed out in March 1933, and investment doubled in 1933 with a turnaround in March 1933.

There were no monetary forces to explain that turn around. Money supply was still falling and short term interest rates remained close to zero. Before March 1933 people expected further deflation and a recession with the result that even interest rates at zero did not stimulate investment. But when Roosevelt announced major regime changes people began to expect inflation and an economic expansion.

With these positive expectations and, just as they were expected to do, interest rates at zero began to stimulate investment.

Roosevelt’s fiscal and monetary policy regime change helped to make his policy objectives credible. The expectation of higher future income and higher future inflation stimulated demand and investments.

The analysis suggests that the elimination of the policy dogmas of the gold standard, a balanced budget in times of crises and small government led endogenously to a large shift in expectation that accounts for about 70 to 80 percent of the recovery of output and prices from 1933 to 1937. If the regime change had not happened and the Hoover policy had continued, the economy would have continued its free fall in 1933 and output would have been 30 percent lower in 1937 than in 1933.

The recession of 1937 to 1938, which slowed down economic recovery from the Great Depression, is explained by fears of the population that the moderate tightening of the monetary and fiscal policy in 1937 would be first steps to a restoration of the pre-March 1933 policy regime.

Theorists of the “Austrian School” who wrote about the Depression include Austrian economist Friedrich Hayek and American economist Murray Rothbard, who wrote America’s Great Depression. In their view, and like the monetarists, the Federal Reserve, which was created in 1913, shoulders much of the blame; but in opposition to the monetarists, they argue that the key cause of the Depression was the expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom.

In the Austrian view it was this inflation of the money supply that led to an unsustainable boom in both asset prices (stocks and bonds) and capital goods. By the time the Fed belatedly tightened in 1928, it was far too late and, in the Austrian view, a significant economic contraction was inevitable. In February 1929 Hayek published a paper predicting the Federal Reserve’s actions would lead to a crisis starting in the stock and credit markets.

According to Rothbard, government support for failed enterprises and keeping wages above their market values actually prolonged the Depression. Hayek, unlike Rothbard, believed since the 1970s, along with the monetarists, that the Federal Reserve further contributed to the problems of the Depression by permitting the money supply to shrink during the earliest years of the Depression. However, in 1932 and 1934 Hayek had criticised the Fed and the Bank of England for not taking a more contractionary stance.

Hans Sennholz argued that most boom and busts that plagued the American economy in 1819–20, 1839–43, 1857–60, 1873–78, 1893–97 were generated by government creating a boom through easy money and credit, which was soon followed by the inevitable bust. The spectacular crash of 1929 followed five years of reckless credit expansion by the Federal Reserve System under the Coolidge Administration. The passing of the Sixteenth Amendment, the passage of The Federal Reserve Act, rising government deficits, the passage of the Smoot-Hawley Tariff Act, and the Revenue Act of 1932, exacerbated the crisis, prolonging it.

Ludwig von Mises wrote in the 1930s: “Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth, i.e. the accumulation of savings made available for productive investment. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand.”

Karl Marx saw recession and depression as unavoidable under free-market capitalism as there are no restrictions on accumulations of capital other than the market itself.

In the Marxist view, capitalism tends to create unbalanced accumulations of wealth, leading to over-accumulations of capital which inevitably lead to a crisis. This especially sharp bust is a regular feature of the boom and bust pattern of what Marxists term “chaotic” capitalist development.

It is a tenet of many Marxist groupings that such crises are inevitable and will be increasingly severe until the contradictions inherent in the mismatch between the mode of production and the development of productive forces reach the final point of failure. At which point, the crisis period encourages intensified class conflict and forces societal change.

Two economists of the 1920s, Waddill Catchings and William Trufant Foster, popularized a theory that influenced many policy makers, including Herbert Hoover, Henry A. Wallace, Paul Douglas, and Marriner Eccles. It held that the economy produced more than it consumed, because the consumers did not have enough income. Thus the unequal distribution of wealth throughout the 1920s caused the Great Depression.

According to this view, the root cause of the Great Depression was a global over-investment in heavy industry capacity compared to wages and earnings from independent businesses, such as farms. The proposed solution was for the government to pump money into the consumers’ pockets. That is, it should redistribute purchasing power, maintaining the industrial base, and re-inflating prices and wages to force as much of the inflationary increase in purchasing power into consumer spending. The economy was overbuilt, and new factories were not needed. Foster and Catchings recommended that federal and state governments start large construction projects; a program that was followed by Hoover and Roosevelt.

The first three decades of the 20th century saw economic output surge with electrification, mass production and motorised farm machinery, and because of the rapid growth in productivity there was a lot of excess production capacity and the work week was being reduced.

The primary reason why the contagion of the US monetary collapse spread around the globe is explained by the then universal application of the Gold Standard. It was the primary transmission mechanism because even countries that did not face bank failures and a monetary contraction first hand were forced to join the deflationary policy since the higher interest rates in countries that performed a deflationary policy led to a gold outflow in countries with lower interest rates. Under the gold standard’s price–specie flow mechanism, countries that lost gold but nevertheless wanted to maintain the gold standard had to permit their money supply to decrease and the domestic price level to decline (deflation).

There is also consensus that international trade protectionist policies such as the Smoot–Hawley Tariff Act helped to worsen the depression while some economic studies have indicated that just as the downturn was spread worldwide by the rigidities of the Gold Standard, it was suspending gold convertibility (or devaluing the currency in gold terms) that did the most to make recovery possible.

Thus it follows that when nations all over the world abandoned the Gold Standard their recovery began. Britain was the first to do so. Facing speculative attacks on the Pound and depleting gold reserves, the Bank of England ceased exchanging pound notes for gold in September 1931 and the pound was floated on foreign exchange markets. Japan, and the Scandinavian countries followed soon after while Italy, South Africa and the U.S., remained on the gold standard into 1933. A few countries in the so-called “gold bloc”, led by France and including Poland, Belgium and Switzerland, stayed on the standard until 1935–36.

And by way of proof of this theory, the earlier a country left the Gold Standard reliably the earlier its economic recovery. Britain and Scandinavia, which left the Gold Standard recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a Silver Standard, almost entirely avoided the depression.

The connection between leaving the gold standard as a strong predictor of that country’s severity of depression and the length of time of its recovery has been shown to be consistent for dozens of countries which partly explains why the experience and length of the depression differed between national economies.

South Africa under General J.B.M. Hertzog briefly maintained its gold standard and farmers were hard hit when the resulting spike in the cost of South African goods devastated exports, especially minerals and wool. Hertzog finally abandoned the gold standard on 27 December 1932 and South Africa’s fortunes almost immediately improved as gold prices increased and sparked a phase of economic expansion. Soon after leaving the Gold Standard in 1932 revenue from the sale of gold increased significantly.

Many economists have argued that the sharp decline in international trade after 1930 helped to worsen the depression, especially for countries significantly dependent on foreign trade. In a 1995 survey of American economic historians, two-thirds agreed that the Smoot–Hawley Tariff Act at least worsened the Great Depression and most historians at least partly blame the Tariff Act for worsening the depression by seriously reducing international trade and causing retaliatory tariffs in other countries.

While foreign trade was a small part of overall economic activity in the US and was concentrated in a few businesses like farming, it was a much larger factor in many other countries. The average ad valorem rate of duties on dutiable imports for 1921–25 was 25.9 percent but under the new tariff it jumped to 50 percent during 1931–35. In dollar terms, American exports declined over the next four years from about $5.2-billion in 1929 to $1.7-billion in 1933; so, not only did the physical volume of exports fall, but prices also fell by about a third. Hardest hit were farm commodities such as wheat, cotton, tobacco, and lumber.

Governments around the world took various steps into spending less money on foreign goods such as: imposing tariffs, import quotas, and exchange controls. These restrictions formed a lot of tension between trade nations, causing a major deduction during the depression.

Not all countries enforced the same measures of protectionism. Some raised tariffs drastically and enforced severe restrictions on foreign exchange transactions while others condensed trade and exchange restrictions only marginally:

Countries that remained on the gold standard, keeping currencies fixed, were more likely to restrict foreign trade. These resorted to protectionist policies to strengthen their balance of payments and limit gold losses in the hope that depletions would halt the economic decline while countries that abandoned the gold standard, allowed their currencies to depreciate which caused their balance of payments to strengthen. It also freed up monetary policy so that central banks could lower interest rates and act as lenders of last resort.

The latter clearly possessed the best policy instruments to fight the Depression and did not need protectionism.

The length and depth of a country’s economic downturn and the timing and vigor of its recovery is related to how long it remained on the gold standard. Countries abandoning the gold standard relatively early experienced relatively mild recessions and early recoveries. In contrast, countries remaining on the gold standard experienced prolonged slumps.”

In Europe the financial crisis escalated out of control in mid-1931, starting with the collapse of the Credit Anstalt in Vienna in May. This put heavy pressure on Germany, which was already in political turmoil with the rise in violence of the Nazi and Communist movements, as well as investor nervousness at harsh government financial policies. 

Investors withdrew their short-term money from Germany as confidence spiraled downward. The Reichsbank lost 150-million marks in the first week of June, 540 million in the second, and 150 million in two days, June 19–20. Collapse was at hand.

US President Herbert Hoover then called for a moratorium on payment of war reparations which angered Paris because France depended on a steady flow of German payments. However, it slowed the crisis and the moratorium was agreed to in July 1931. An international conference in London later in July produced no agreements but on August 19 a standstill agreement froze Germany’s foreign liabilities for six months. Germany received emergency funding from private banks in New York as well as the Bank of International Settlements and the Bank of England but the funding only slowed the process.

Industrial failures began in Germany. A major bank closed in July and a two-day holiday for all German banks was declared. Nevertheless business failures became more frequent in July, and spread to Romania and Hungary while the crisis continued to get worse in Germany, bringing political upheaval that finally led to the coming to power of Hitler’s Nazi regime in January 1933.

The world financial crisis now began to overwhelm Britain; investors across the world started withdrawing their gold from London at the rate of £2.5-million a day. Credits of £25-million each from the Bank of France and the Federal Reserve Bank of New York and an issue of £15-millions fiduciary note slowed, but did not reverse the British crisis. The result was a major political crisis in Britain in August 1931. With deficits mounting, bankers demanded a balanced budget and the divided cabinet of Prime Minister Ramsay MacDonald’s Labour government agreed. It proposed to raise taxes, cut spending and most controversially, to cut unemployment benefits by 20 percent.

To the labour movement, the attack on welfare was totally unacceptable. MacDonald wanted to resign, but King George V insisted he remain and form an all-party coalition government. The Conservative and Liberal parties signed on, along with a small cadre of Labour, but the vast majority of Labour leaders denounced MacDonald as a traitor for leading the new government.

Once Britain went off the gold standard it suffered relatively less than other major countries in the Great Depression. In the 1931 British election the Labour Party was virtually destroyed, leaving MacDonald as Prime Minister of a largely Conservative coalition.

In most countries of the world, recovery from the Great Depression began in 1933. In the US. recovery began in early 1933, but did not return to 1929 GNP levels for over a decade and the unemployment rate was still about 15 percent in 1940, albeit down from the high of 25 percent in 1933. The measurement of the unemployment rate in this time period was, however, unsophisticated and complicated by the presence of massive underemployment in which employers and workers engaged in the rationing of jobs.

A Decade of Living Dangerously

By John Mauldin

Welcome to the 2020s. Some weren’t sure we would make it this far, but we did. Now we face a new decade and new challenges. How we handle them will determine what kind of conversation we have in 2030.

This concern for the future is one of the things that separates humans from animals. Dogs don’t worry about tomorrow, much less next year. They live completely in the present, giving it their all (an ability I sometimes envy).

Being human, I have to think about the future. And being a writer, people want to know what I think. So today I’ll outline what I expect for both the year 2020 and the decade of the 2020s.

Crisis Delayed

In some ways, today’s Decade of Living Dangerously letter is a continuation of my 2019 forecast. I think the 2020s in general will be rough. But to be clear, my view of the decade is not my view of the coming year.

In summary, I expect 2020 will look like a slower version of 2018 and 2019. My base case is for no recession this year, with all the usual caveats, but it’s important to know what we should pay attention to. Some key events began to unfold last year that I think will continue in 2020. Some are hard to grasp, as I said in that letter a year ago.

In a nutshell, I expect to spend this year Living Dangerously. Yes, I’m thinking of the 1982 film starring a very youthful Mel Gibson and Sigourney Weaver, based on an earlier Christopher Koch novel. It has an Asian setting and features corrupt politics, neophyte journalists, international intrigue plus a gender-bending Chinese dwarf. If you aren’t sure how all those fit together, then welcome to 2019. We are all stuck in this craziness and can only make the best of it.

Reviewing old forecasts can be humbling, but I think that mine for 2019 held up well. I outlined several risks, all of which did, in fact, pop up during the year. Fortunately, they didn’t have dire consequences… but they also aren’t over yet.

Risk, by the way, is an often-misunderstood word. It’s the possibility something bad will happen. You take risk every time you get in your car and drive somewhere. Accidents are always possible, no matter how careful you are. The fact that you didn’t crash today doesn’t mean you can throw caution to the wind tomorrow. The risk is still there.

Similarly, the fact we got through the year without Crisis X occurring doesn’t mean the risk is gone. Living dangerously tends to catch up with you.

My top concern for 2019 was a Federal Reserve policy error. The December 2018 rate hike turned out to be that cycle’s last one, though none of us knew it at the time. We saw the Fed both raising rates and shrinking its balance sheet, and markets not liking it one bit. I said they should do one or the other, not both simultaneously. I said it was going to be tough.

We are in a serious pickle. The extraordinary measures central banks took to get us out of the last crisis could make the next one even worse. They seem collectively hell bent on reducing their balance sheets. Avoiding another liquidity crisis will take some seriously active management by the FOMC and central bankers elsewhere, too. I am not confident they can do it.

That liquidity crisis I feared actually happened nine months later. The repo market seized up, causing the Fed to launch a QE-like asset purchase program that is still in progress today. As I explained last month, the Fed’s bad choices have compounded to the point where all the options are bad.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_1_20200103_TFTF.png
Source: Charles Hugh Smith

I see almost zero chance the Fed will end the repo program after the six months it presently plans, because I see zero chance the federal deficit will shrink. (Chances are high it will get even bigger.) Oh, it’s possible they pause for a short time, but then we will see another Taper Tantrum and they’ll reopen the spigots. The Fed’s QE-forever mode is helping stock and other asset prices for now. It may continue into 2020, but not forever.

Market valuations are a little bit stretched, to say the least. Last December we had a 20% correction and the CNN Greed and Fear index went to 1. A year later it was back at 97. In the meantime, the Federal Reserve reversed its balance sheet reductions, cut interest rates and generally accommodated the market’s and Trump’s desires.

If we get anything like the correction we saw a year ago, I think the Fed will respond with another interest rate cut or two, while continuing the current QE and maybe even increasing it. As Milton Friedman famously said, “Nothing is so permanent as a temporary government program.”

Circling the Drain

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_2a_20200103_TFTF.png Another potential 2019 crisis, avoided so far but still with us, lies in the corporate bond market, especially its high-yield segment. Companies continued levering up last year and yield-hungry investors helped them do it. That might be less worrisome if they were using this borrowed money to make capital investments or otherwise generate additional value. Instead, much of it goes to buybacks that prop up share prices but don’t make the company any more valuable. It shifts the capital structure away from equity in favour of debt. It mainly helps option-holding management at the expense of shareholders.

Yet another problem is this debt tends to be short-term and has to be constantly rolled over. This is the same challenge the federal government faces. Congress and the Trump administration are spending more money, forcing the Treasury to sell more paper. This rising demand for liquidity is one factor behind the repo crisis, to which the Fed is responding with QE (or whatever you call it).

Both the Treasury and corporate borrowers compete for the same capital. Each has attractive features it can offer. Treasury has safety but low yields. Corporates have credit risk but higher yields. Low-rated corporates have even more credit risk and even higher yields. But they all have limits.

At some point, junk bond issuers can’t offer high enough yields to compensate for the additional risk they have over Treasury debt. That’s getting harder, not easier, as the federal deficit sucks up more of the available liquidity.

And the quality of the debt just keeps getting worse. BBB bonds now make up more than 50% of investment-grade corporate debt. That is worrying enough. But the spreads over Treasuries are dropping as investors reach for yield with both fists.

This was dangerous last year and it is just as dangerous this year. When (not if) there is a recession this market is going to break badly. Investors and index mutual funds chasing this yield could see losses well over 50%.  

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Source: Bloomberg

I’m fairly conversant with the high-yield/junk bond space, but my go-to guy is really Steve Blumenthal. He thinks investors in some funds could lose as much as 70%+ because so much of the paper is either “covenant light” or has no covenants at all. Literally nothing backs this paper except the issuing company’s goodwill and promises.

You know how exits clog when everybody tries to leave the theatre at the same time. When the bond show ends, there will be nobody on the other side of the trade to buy those bonds in anything like a timely fashion. It will be one of the ugliest and most devastating investment events of our lifetime.

That being said, the bottom of that market will also be the buying opportunity of a lifetime. Patience, grasshopper.

The Fed is trying to manage this and doing a good job so far. Its task could suddenly get way harder if we see any major corporate debt defaults, as is likely if the economy weakens and possible even if it doesn’t. Rates might rise to a point at which already-leveraged companies can’t roll over their existing debts, much less issue more. And then it gets sticky.

And then think about what happens if we have a recession. This chart from the St. Louis Federal Reserve FRED database shows that during the last recession, high-yield rates rose to 21.8%. When that happens next time?

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Source: St. Louis Fed


Let’s look at one fund from Vanguard (I’m not picking on them. This was literally the first chart I found, and dozens of funds would show the same). Notice the cliff-like sheer drop in late 2008. Nowhere to run, nowhere to hide. Your NAV was down well over 30%. Buying somewhere close to the bottom would have brought monster returns in a fairly short time. As they say, timing is everything.

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Source: Yahoo Finance


Where might this start? Your guess is as good as mine. But like a nuclear explosion, you don’t have to be at Ground Zero to get hurt. The shock waves are hard to escape. Debt defaults bring layoffs at both the defaulting company and maybe its suppliers, losses for bondholders, and it gets worse from there. Recession can easily follow.

Or perhaps it will be the other way around, with the recession causing the debt crisis. Either will be bad.

Corporate credit may well be a bigger risk than the federal government’s fiscal woes. The Fed can help the Treasury. Supporting private companies is trickier, both legally and practically. They may find ways to do it, as we saw in 2008 with TARP etc., but that will be tough in the present political environment.

I know many readers will say we should have let nature take its course in the last debt crisis. In a strict free market sense, that is the right choice. “Creative destruction” is what enables long-term growth. People and businesses that make bad decisions need to feel market discipline.

Unfortunately, that is a tough sell when people and communities are hurting. Finding the right balance is a big leadership challenge—and I’m not confident present leaders would handle it well.

Tax and Spend

All this will happen against two important backdrops.

First, whether we like it or not, government and central bank decisions now drive most of what happens in the economy and markets. That’s not ideal but it’s where we are. Yes, over long periods market forces will win. But as Keynes famously said, in the long run we’re all dead. Meanwhile, these outside forces will get what they want.

Second, what they want is increasingly unclear and subject to change. That would be the case even if 2020 weren’t an election year but, with candidates at all levels whipping up emotions, it will be even more so.

On the key economic issues, it doesn’t particularly matter who controls Congress or the White House. They’re going to tax and spend regardless, differing only in the details. But perceptions matter, and we will probably see a lot of volatility as investors grapple with how the perceived winners will manage those details.

Wall Street is putting a lot of hope in the “Phase 1” China trade deal to boost growth. Count me sceptical. Yes, China agreed to some helpful changes. The US dropped some (not all) of its current and planned tariffs. But those aren’t the real problem. The real problem is that businesses still can’t be confident policy will remain stable, and thus are unable to make growth plans. I think we will keep seeing this in capital investment numbers, and there’s really no good solution. The trade war genie is out of the bottle.

Worse, this trade war may be producing the opposite of its intent. Last week Tesla (TSLA) delivered the first vehicles made in its new Shanghai factory, built specifically to avoid trade barriers.

Instead of incentivizing US export production, tariffs are making US companies shift what would have been export production to other countries. We will see more of this. It may be good for those companies but not for American workers.

Profits from overseas operations are one of the primary reasons for sustained and high US stock valuations. The chart below (courtesy of Danielle DiMartino Booth) shows many of the components of said profits are not growing year over year. That needs to change.

If China deal at least changes the mood for international corporations and global trade flows, then we’ll have more reasons for a positive outlook. Continued decline in global trade flows would be a serious headwind. This is something we really have to pay attention to. It is a top risk for my otherwise rather benign view of 2020.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_6_20200103_TFTF.png

Source: Quill Intelligence

Get Ready

While 2020 could bring any of several potential crises to a boil, I think we will more likely have a lot of noise but little real change. I expect more of the same: slow but steady GDP growth in the 1.5% to 2% range, widespread dissatisfaction and polarized opinions on both the economy and politics.

Addressing South Africa’s jobs bloodbath

By Ann Bernstein

At the recent Business Economic Indaba, the president spoke about his commitment to growing the SA economy and the need for more jobs.  In this context he said that he did not understand what problems business had with existing labour legislation and that he had not been presented with a cogent argument from business about what ought to change and why.

If this is literally true and business has not, in fact, spoken to the president about the relationship between existing labour market rules and our horrendous unemployment statistics, one would have to conclude that the leaders of organised business are either not listening to their members or are failing in their duty to articulate their concerns.

CDE has just released a new report on SA’s jobs crisis in which the relationship between our labour laws and unemployment is extensively explored. It concludes that the main cause of joblessness is that economic growth since the 1970s has been too slow to absorb new entrants into the labour market, but that our labour laws have, in fact, played a considerable role, too. SA’s labour laws increase the risks and costs of hiring workers, and this effect is disproportionately strong for young, unskilled workers.

Three areas of policy have pushed employers to employ fewer unskilled workers: industrial policies, the system for setting wages, and the imposition of a variety of non-wage costs on employment.

SA’s industrial policy is biased against employers of unskilled labour, and has been so for decades. The most egregious current manifestation of this bias are the massive direct subsidies received by the vehicle manufacturing industry (which is highly capital-intensive). These subsidies do not result in lower vehicle costs because the industry also enjoys enormous protection against imported vehicles.

Reinforcing the biases of industrial and energy policy, our labour law has discouraged the employment of unskilled workers. It has done this in order to improve the working conditions and living standards of workers in the formal sector, but the result is that employers can afford to create only jobs that generate a higher level of output. The result is that fewer jobs are created.

Legislative constraints on dismissing workers, for example, have expanded job security for those who are employed, but they have increased the costs and complexity of the relationship between employers and employees. Even where concessions exist – such as the somewhat wider latitude employers have to dismiss unsuitable workers while on probation – the rules are onerous and have been drafted on the presumption that employers will act in bad faith if given half a chance.

Policies of this kind increase employers’ reluctance to employ people, and the effect is felt most strongly among young, inexperienced, low-skill work-seekers.

An employer is generally willing to incur more costs for a skilled worker who might make a substantial contribution to the firm’s bottom-line than for an unskilled worker.

These non-wage costs are important, but it is the level of wages paid to unskilled workers, and, critically, the pace at which these have risen, that is the key factor in reducing job creation.

The rise in wages is driven by deliberate policy interventions such as the national minimum wage, ministerial directives which have imposed minimum wages in sectors in which workers are deemed to be vulnerable, and the institutionalisation of a centralised wage-setting system, a core feature of which is the strengthening of organised workers’ bargaining position.

These policies improve employed workers’ lives, but a price is paid in slower job-creation, especially for unskilled workers. Do the benefits exceed the costs?

In support of these policies, two arguments are made. The first is that raising wages is growth-enhancing because it shifts demand towards lower-income households who save less of their income and whose consumption is skewed to local goods and services. The result is an increase in aggregate demand, which facilitates growth.

This argument is deeply flawed. One reason for saying so is that it could be true if and only if higher local wages did not translate into higher prices which would serve to reduce consumption. This is unlikely to be the case. Nor is it clear that poor people devote a larger share of their budgets to local goods and services, since imported food (chickens), transport costs (petrol) and cell phones account for a significant fraction of their household spending. Higher prices would also mean that local goods are less competitive on global markets, reducing exports, which would also slow growth.

Apart from this, the logic of the model implied by proponents of wage-led growth is that growth is accelerated by shifting purchasing power from those who might save (the rich) to those who would spend (the poor).

The problem with this is that an increase in the overall rate of consumption means, by definition, that the savings rate must fall. This is not a good thing: SA already runs a current account deficit, so any decrease in savings must, as a matter of mathematical certainty, be accompanied by either a reduction in investment (to match the decline in savings) or by a widening of the current account deficit as the flip side of the inflow of foreign capital. Thus any move to increase consumption that is not accompanied by a decrease in investment (which is obviously undesirable) implies an increase in imports rather than an increase in local production.

Higher wages, in other words, simply cannot accelerate economic growth.

A more plausible justification for policies that push up workers’ wages is that they reduce poverty and inequality. Here, the core claim is that higher wages reduce poverty by raising household income.

But this would be true if and only if the positive effect on poverty and inequality of higher wages on household income among the poor is not offset by any negative effects.

If higher wages lead to higher prices and/or slower job creation – or, worse, to job destruction – then there is no guarantee that they will translate to lower levels of poverty and inequality overall, even if they do reduce poverty in the households in which wage-earners enjoy higher incomes.

Higher wages’ effect on poverty and inequality makes recipients better off and reduces the gap between their wages and those of people who earn more than them, but potentially leaves more people unemployed.

Ambiguous outcomes exist for all policies, but in a country with over ten million unemployed an approach to development that supports the fastest possible expansion of employment for unskilled workers, even if that is at low wages, should be the preferred option.

Ensuring that existing workers’ living standards are not sacrificed to achieve employment growth must be an important policy goal, but so too must be the expansion of employment for those who will otherwise be left behind.

High levels of unemployment impose monetary and social costs on others and on the communities in which the unemployed live, while employment helps make possible the accumulation of capabilities, skills, dignity and independence that cannot be acquired through other means.

There are convincing arguments about how existing labour laws have helped deepen our crisis of joblessness. If business has not conveyed this argument to the president yet, one hopes someone will soon.

    • Ann Bernstein is head of the Centre for Development and Enterprise. This article is based on new CDE report, Ten Million and Rising: What it would take to address SA’s jobs bloodbath

Growth provides the means to fight crime, protect borders, provide roads, sewers and vaccinations, of equal value to all

By Brian Kantor

A new book by Harvard economists Daron Acemoglu and James A Robinson sheds light on what success looks like for nations. An empowered and critical civil society is crucial.

The achievements of a few highly successful economies are admirable and conspicuous. Consistent growth in incomes and output over many decades has eliminated poverty. The growth has been accompanied by rising tax revenues that are easily collected, without much disturbing the engines of growth.

These are then redistributed in cash and kind to provide a measure of security for all its citizens against the accidents to which individuals and their families are always vulnerable.  Growth provides the means to fight crime, protect borders, provide roads, sewers and vaccinations, of equal value to all.  The caveat is that this historically unprecedented abundance is not as appreciated or as popular as it should be. Continued success can never be taken for granted.
 
Open access to markets for all goods and services and for the resources – labour, capital and natural resources – with which to compete for custom, is a critical ingredient for success. Innovation threatens established interests and must be recognised as a force for good. Rights that protect wealth and persons against fraud, theft or violent assault, supported by predictable laws and transparent regulations, are essential for success.

 
Competent and responsive government agencies are essential. A society that is critical of government action, aware and unafraid of what a powerful government might arbitrarily do to them, makes for good government.

 
Harvard economists Daron Acemoglu and James A Robinson have followed up on their influential book “Why Nations Fail” with the excellent “The Narrow Corridor:  States, Societies and the Fate of Liberty” (Penguin-Viking, 2019). It explains in fascinating detail why it has been so difficult for nations to do what it takes to enter and stay in the narrow corridor that leads to economic success.
 
They explain the advantages of the so-called “shackled Leviathan”. This is when the potential abuse of state power is effectively constrained by an empowered and critical civil society. This is unlike the “despotic Leviathan” that maintains essential order but does so at huge cost to a cowed and vulnerable people. China, old and new, is cited as one such example.

 
Another alternative may well be the “paper Leviathan”. This describes an expensive and incompetent government. South America provides more than a few hapless cases of governments that serve only the people on their payrolls.

“The Narrow Corridor:  States, Societies and the Fate of Liberty” (Penguin-Viking, 2019)

In all the many cases of national failure there is an elite who have a powerful interest in the stagnant status quo – and who resist the obvious reforms that would stimulate and sustain faster growth. Zimbabwe comes to mind as an example.
 
The authors also examine the potentially suffocating role of the “cage of norms” – well-entrenched customs that stultify access to markets and inhibit competitive forces. The caste system in India is still such an inhibitor of economic progress. Traditional land rights are a serious obstruction to producing more in South Africa.
 

 Acemoglu and Robinson regard BEE as helpful to economic success because it broadened the political interest in established enterprises and business practice, enough to help protect them and the economy against destructive expropriation. Cultivating a new elite into business success was necessary for stability and growth.
 
One wonders how Acemoglu and Robinson might now react to the revelations about state capture and corruption; and to the failures of the South African state to deliver satisfactory outcomes for the resources made available to it.
 
The next question is: will the highly transformed South African elite act in the general interest and encourage the invigorating forces of meritocratic competition for resources and customers? Or will they act to protect their gains and privileges?
 
The new elite should be aware that a failing economy will not be politically acceptable and any elite dependent on it will be highly vulnerable. They should be encouraged by our open and critical society to take the steps to get South Africa back into the narrow corridor that leads to economic success.



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