By Cees Bruggemans
• Building plans falling off steeply since 4Q2007
It has been an unbelievable few months, with systemic failings and cyclical turnings left and right.
We now know that buildings plans started plunging as long ago as September 2007. One always suspects affordability first. Interest rates increasing by 40% in 18 months, on top of the 50% increase in the ratio of household indebtedness to disposable income in four years, with the coup de grace administered by the new national credit act implemented as of July last year, couldn’t have remained without effect on housing demand.
But don’t rule out absolutes. Municipalities functionally unable to provide bulk services to new housing developments are like approaching a concrete wall at great speed. It is your car that will crumble on impact, not the wall. By December 2007, new building plans were 19% down on a year ago on an abruptly declining trend.
And that was before that decisive moment in late January 2008 when 6000mw worth of Eskom electricity capacity tripped. With over 15% of capacity shutting down unplanned and having to re-establish an operational safety margin of at least 15%, Eskom required an immediate permanent 10% reduction in electricity demand. And it got its way. Nothing was ever more effective in killing off the fun so abruptly on such a scale, and leaving us all fuming in the dark, too.
The growth outlook deteriorated on impact, and is still sliding, as we remain saddled with load shedding rather than letting us decide for ourselves when and how to shut off the juice. But 60% electricity tariff increases are apparently on the way, a killjoy in more efficient garb.
However big Eskom loomed in our daily affairs so far this year, it is the oceanic tides internationally that are truly slapping us around.
On Women’s Day in mid-August 2007, of all days, a public holiday on which most of us were relaxing, I had been invited to address 160 women on the joys of a promising future steadily unfolding. Yet blissfully unbeknown to all of us, the global banking system picked that moment to go walkabout. It was a climax of epic proportions, as the death knell was sounded on innovative banking practices of decades.
In the 1930s a largely unregulated US banking system had imploded, with US policymakers unprepared and without the necessary tools or understanding to address the rapidly unfolding disaster.
Once the debris of the 1930s had been cleared, banks were tightly regulated for decades. But banks’ self-interest in regaining their freedom to make unrestrained profits induced them subsequently to wriggle free once again in stages. US banks then proceeded to create an off-balance sheet, mostly unregulated, parallel banking universe, yielding great profits anew.
In the process, however, practices were indulged that ultimately would serve to destroy trust in the system once again in our time.
The shaky foundations were already starting to tremble from 2006 as the latest US housing boom turned to dust under the steady mounting pressure of increasing US interest rates, uncovering shady mortgage lending practices that increasingly posed difficult questions to which answers went begging.
The boil was finally lanced only last August, pushing the global financial system into a state of shock which has only progressively deepened since then, despite heroic counteraction by the leading central banks, by way of liquidity provisioning, interest rate cutting and facilitating banking bailouts and mergers.
So far there have been three major waves to the global banking turmoil, going by spreads on bank funding paper, in August 2007, January 2008 and again this month.
At every one of these stages, the size of potential losses and the ultimate problem seemed to mushroom to yet greater heights. We are currently talking ballpark losses of some $1 trillion globally and toxic assets of at least $2 trillion needing drastic addressing, yet there are even scarier scenarios a few multiples bigger yet.
Commodity prices had been on a roll ever since 2002, when a previous US financial emergency had drastically lowered interest rates and leaned on the Dollar, even as emerging Asia led aggressively by China and India deepened its industrialization and urbanization momentum and its call on commodities.
But instead of commodity prices being intimidated by the cyclically slowing US economy these past three years, nothing of the sort happened as dynamic Asia continued to steam on, fundamentally underwriting commodity demand even as global supply was kept tight for a variety of sector-specific reasons.
As of mid-2007, however, the US financial troubles started to intervene. Instead of suppressing commodity prices on expectations of slower growth ahead, just the opposite happened. The spreading financial anxiety encouraged a search for safe havens, and the falling US interest rates and consequently weaker Dollar favoured commodities above all else. Commodity prices rose yet further, often explosively to new highs, such as oil, agricultural commodities and precious metals, but also steel, copper and other industrial commodity prices.
This in turn has these past two years injected turbo power into rising inflation in many countries. Especially poorer countries with food and oil consumption carrying a large share of national spending, and consequently higher weightings in their inflation baskets compared to far richer countries, have suffered most.
In the case of South Africa, CPIX inflation has exploded from 3.5% in 2005 to an expected 9.4% this week, with PPI inflation already for some months over 10%. At least three-quarters of these inflation increases can be traced back to oil and food, and a weaker Rand.
If these global tendencies were to continue, fed by the as yet unresolved US financial situation and even lower US interest rates and Dollar still looming, also putting further downward pressure on the Rand, as well as this year also having to absorb the direct and indirect fallout from Eskom’s electricity doings, our CPIX inflation could average early double digits for a while before eventually gradually subsiding.
However, the world isn’t standing still. The full enormity of what has transpired in the US financial system in recent years is only now fully sinking in, as is the realization that the Fed may not perhaps be entirely capable of easily or fully addressing these issues in timely fashion.
Fear has been stalking the world, none more so last week when blinkered eyes had one more layer of denial about the underlying realities removed.
In the process, however, we may finally get to a critical tipping point in global expectations regarding slowing growth and its fundamental impact on commodities.
It isn’t as if Asia’s long-term growth story is in doubt, or that the Fed will still cut interest rates further from the already low 2.25% achieved only last week, or that the Dollar will still weaken further beyond 1.60:Euro. But despite all these attractive supports for yet higher commodity prices on the back of increased speculative demand, two other factors are now gaining critical mass.
Fundamental demand and supply is changing, starting in oil, but likely spreading wider ere long. US consumers are now already consuming 3% less petrol than a year ago. Slowing economic growth and higher oil prices are undermining demand, to the point where oil inventories are now steadily rising. Traditionally this is the stage when oil prices can be expected to start falling.
One important prop has to be blown away first, however. Speculative financial demand needs to lose its faith in price momentum, and become intimidated by deteriorating growth prospects undermining physical demand, classically the signal to take profits and take money off the table.
In the week preceding Easter 2008 US financial market convulsions reached the kind of pitch most easily compared with a speculative climax. Is this it? If so, the abrupt price pullbacks observed since then have further to go across the board as capital withdraws faster than what it ever was injected.
For South Africa as much as the world this would be a crucial development for both inflation and central bank actions. For if the commodity price bubble could be deflated at least partially, an awful lot of countries would see their inflation trends reversing, opening the way for central bank interest rate cutting in support of arresting their slowing GDP growth performances.
So far only the US Federal Reserve has thrown caution to the wind, although the size of its economy, its advanced slowing, the limited importance of food and energy in deciding things, and the overwhelming importance of arresting the financial rot make its actions plausibly less irresponsible than what many outsiders loudly like to claim.
But if the commodity inflation turbo could be switched off, at least temporarily, and inflation expectations stabilized even as growth is slowing, many countries would take this as the signal to safeguard their economies by also easing nominal interest rates (though not necessarily real rates).
For South Africa, the situation may perhaps be slightly more complex.
We have a very large current account deficit at 7.5% of GDP, which is considered a major black mark against our name. Our reputation has been tarnished by the Eskom electricity interruption, giving the impression that we after all can’t be trusted to manage our affairs wisely. The political noises in recent years about future policy agendas are also a turnoff for too many foreign observers. And we are succeeding in corroding our attractiveness by letting our growth rate slip and letting the old-age wrinkles shine through. These are all own goals, for which the world has only one reward. Sell them till it hurts.
When the world is financially convulsing as it has been in recent weeks, risk aversion goes into high gear and perceived risk is sold off, the Rand gets pressured.
We get little acknowledgement for the fact that our precious metals have been a natural hedge against rising oil prices, protecting our economy, unless we must accept that the Rand would already have been an awful lot weaker than it is, if it wasn’t for that natural hedge.
Meanwhile, it is a tossup whether the prospect of lower interest rates would sink the Rand further as well towards 9:$ or worse, preventing as much of an inflation improvement; or whether the interest rate cuts would promise better growth ahead, and in any case similar parallel moves internationally reinforcing global equity values, in the process making us a buy as well. That could rub off on the Rand, firming it towards 7:$ or better once again, accelerating CPIX inflation decline.
Clearly, there is much scope here for surprise. Don’t expect the SARB to be eager to overreact. Rather expect standby mode, weighing the risks, and only pouncing once some certainty has been obtained.
We won’t be the last ones into the water globally, but don’t expect us to be the first one either. Instead, expect a lot of toe-tipping, soul-searching, hand-wrenching and spirited debate, no doubt all behind closed doors as is only proper, before the ultimate will ultimately be revealed.
And the winner is …………? No announcement will have been awaited with greater expectation, except perhaps Nelson Mandela’s Cape Town Parade speech on being released in 1990, the preceding opening of parliament speech by De Klerk unbanning everything that previously had been banned, Botha’s finger-wagging Rubicon speech in 1985, Harold Macmillan’s Winds-of-Change speech in 1960 or Oom Paul Kruger’s ultimatum to the British Empire in 1899. Historic stuff indeed.
Meanwhile, our GDP growth is probably still sliding, from over 5% last year to 3% this year, and that is after taking into account the agricultural windfall, but also electricity induced losses, dysfunctional institutions eroding fixed investment momentum, the effect of higher interest rates and loss of purchasing power due to higher inflation, and the confidence sapping quality of recent events generally.
We need a weakish Rand and lower nominal interest rates (but not necessarily lower real ones) to restore our growth momentum nearer a sustainable 4%. One hopes that events may now indeed oblige us rather than sink us yet deeper into the mire.
Source: Cees Bruggemans, Chief Economist, FNB, March 25, 2008.
More on this topic (What's this?)
Senate Committee Looking At Commodities Investment Limits (Money Rx, 5/21/08)
Bolton Bolting Commodities (CONTROLLED GREED.com, 5/29/08)
Stephen Briese: 200-days Oil Supply Held Long by Speculators (Audio Interview) (Green Light Advisor, 6/24/08)
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