South Africa windfall led but still slowing

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By Cees Bruggemans, Chief Economist of FNB.

Newspaper headlines want us believe gold is rising in response to global growth slowdown.

That would hardly be rational. For slowdown-cum-recession pulls very low inflation even lower, indeed into deflation. That’s not something to warrant a higher gold price.

But it is the policy response to the lingering large Western output gaps and slowing growth approaching stall speed that is driving many people to drink and gold.

Central banks have either already taken interest rates to zero or are embarking on a new cycle of interest rate easing. With global inflation having peaked (commodity and VAT-driven) and about to start falling off substantially, with fiscal policies everywhere in retreat, and with output and growth being as lethargic as they are in too many important parts of the world, central banks remain a major last buffer against general collapse.

It is the fear of currency debasement, debt monetisation and a possible currency crisis that’s driving people into marginal safe havens such as precious metals and Swiss francs. Marginal because these are ultimately very small ponds relative to the paper wealth of the world.

As the world pushes gold towards $2000, with talk of $2500 and beyond (personally I still like adding a zero, just to keep things simple), South Africa remains one of the great beneficiaries of this windfall.

It allows mines to mine marginal deposits, prolonging operating lives. On unchanged mining tactics every $500 higher average gold price means $3bn more annually in gold mining proceeds for South Africa.

When adding higher windfall proceeds for platinum group metals, iron ore and coal, it adds up to a sizeable additional gain when bearing in mind that SARB forex intervention added as much as $7bn in a year to the foreign reserves without preventing Rand overvaluation.

The relevance of this mining bonanza comes four ways.

It greatly adds to the household income streams via wage increases, translating into strong spending power.

It strengthens mining company balance sheets, giving them the means and confidence to embark on more new projects (even when other considerations undermine such expansions).

The Minister of Finance will collect more corporate taxes, easing his finances and the way he supports the economy through spending and employment creation.

And the golden tint will draw more liquidity to South Africa, also because its yields still remain attractive.

In the process this mining bonanza boosts income and spending growth while keeping Rand overvalued and inflation suppressed.

These are all short-term gains. There are longer term structural downsides, but that shouldn’t prevent us from appreciating the short term.

Yet despite this supportive external context, South Africa is also experiencing a growth slowdown.

Retail sales volumes and manufacturing output have only made limited gains since late last year. Electricity suffers from a capacity ceiling. Motor trade still boomed in 1Q2011, but thereafter lost momentum and may only be doing mid-single digit growth from here on.

What’s going on?

Real household income growth may be slowing. Not due to any commodity export disappointment or government austerity plans (to the contrary!), but simply because average wage increases have been declining.

Even as the mid-year labour strike season has increased in length and intensity, actual wage settlements have been less outrageous than they were in recent years.

SARB Governor Marcus in her last MPC statement mentioned average wage gains easing from 8.2% to 7.5% according to Andrew Levy surveys. This is at a time when inflation is rising by 2%-3% on account of higher oil, food and electricity prices.

With real household income growth easing, one would expect falloff in retail growth, and by extension in manufacturing production.

This appears to be happening. Also, motor trade pent-up replacement demand may have been largely met these past two years, while many people may have been made more cautious by global crises, local political jabbering and talk earlier this year of higher interest rates looming.

With inflation shortly peaking above 6% but thereafter falling back into the 3%-6% target range, the economy slow as household spending growth moderates even as public and private fixed investment growth remains slow, and the global risk bias shifting to severe risk of slower growth (if not outright recession), making many central banks inclined to return to policy easing mode, our SARB may be sensing similar needs.

Speculation is building up regarding a SARB rate cut, potentially as early as November. Though core inflation will still rise, a large downward change in risk bias towards slower growth may outweigh this, triggering a rate cut ere long, mirroring such actions elsewhere.

With credit growth slow near 5%, asset markets declining in real terms (housing) or selling off in panic fashion (equities), with a large output gap remaining as growth remains inadequate to make a dent in unemployment, the pressure must be building for more rate cuts.

September’s Monetary Policy Committee statement should provide a heavy hint how the wind is blowing, already increasingly discounted in falling capital market rates.

All hands to the national pump. We also need more policy stimulus even as the world showers us with manna.

Source: Cees Bruggemans, FNB, August 22, 2011.

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