The 2014 Interim Budget for South Africa

The Interim Budget Speech by the new Minister of Finance Nene was as unconvincing as intelligent South Africans have come to expect.  It repeated all the pious hopes uttered by previous Ministers, and by President Jacob Zuma, but it offered no new ideas or glimmers of hope.  And there is good reason why this should be so.

The underlying cause for the numerous problems that beset South Africa is very simple.  The governing Party is using its political power to buy votes.  It concentrates its efforts on ‘improving the lives of the poorest of the poor’, but, unfortunately, economic activity does not grow in that politicised sector.  Growth comes from business, industry and agriculture.  Government has put a large amount of effort into making doing business in South Africa more difficult, with numerous charges, levies, fees and innumerable reports and submissions to a multiplicity of Government bodies, none of which appear to have the capability to make any meaningful use of the data gathered.  The fact that the labour unions represent a large portion of the voter base for the ANC and the SACP has resulted in a very militant labour situation, with demands for high wages that do not reflect the low productivity of the workers, and an apparent inability on the part of Government to moderate such demands to accord with economic realities.  The demands for increased participation by the Black population in the management and ownership of existing businesses represents to huge threats to such businesses.  They result in a much higher cost of doing business.  The average businessman would be delighted to employ a Black worker at an appropriate level, but having to employ an under-qualified person to do a job merely to meet a quota requirement has two important results.  It makes that business uncompetitive, reducing its ability to compete internationally, and it drives up costs locally, becoming an important driver of inflation.  The need to ‘sell’ a substantial shareholding in the business also represents a sizable cost factor.  Regardless of the disingenuous protestations of the ANC politicians and their stooges, the canny investor knows what level of profit can be achieved from the investment.  Any action that reduces the net profit to the investor on his investment must be balanced by an increased level of profit, sufficient to make that investment an acceptable one.  Bear in mind, the ‘investment’ is not necessarily expressed in financial terms – it can also be the value of the business creator in terms of his ideas, skills, ingenuity and experience.  If the return on the investment is not sufficient for any reason, that investment will seek an alternative home.  This is certainly one of the reasons that so few new innovative businesses have been established in South Africa in recent years.  And foreign investors are not the suckers that the ANC seems to believe them to be.  They have followed the discussions regarding the handover of 50% of established farm businesses to the workers.  On the face of it, this is the sort of thing that would appeal to a Marxist Party member.  It makes a large handover to the voter base at no cost to the Government, it gives a wonderful ‘story’ at the next election, where the ANC will use it as a reason to be returned to power, and it provides a wonderful opportunity for the Party faithful, with large bank accounts derived from their Party affiliation, to rake off another substantial bite of the wealth presently owned by the Whites.  However, it ignores the fact that it is no more than institutionalised theft.  To take from a man, or a family, the farm that he has built up over generations, with personal effort, investment and risk, and to hand it to the employees without paying any compensation to the dispossessed owner, is no better than highway robbery.  It will result in farmers taking pre-emptive action to protect his assets and his source of income, as is already happening, and it will result in a catastrophic collapse of agricultural output.  More than two-thirds of farms already handed to Black farmers have failed, and there is no reason to believe that the new idea will work any better.  Already, the number of commercial farmers in South Africa has reduced from 62 000 when the ANC came to power to less than 25 000 today, drained by the continuing threat of farm killings, which the Government still fails to combat in any meaningful way, by the politically-inspired farm labour strikes which have driven up costs to an unaffordable level, and by the continued attack on this bastion of White effectiveness in the re-opening of Land Claims, and the new Zimbabwe-inspired theft of productive farms. 

Canny investors see the new idea, of legislating a requirement to hand over farms to employees without any compensation, as being the first signs of a new wave of dispossession of businesses and assets.  After all, if it is done in relation to farms, why should it not be done in relation to banks, insurance companies, IT firms, security firms and every other productive asset?  The short answer is that the ANC certainly has this in its long-term planning (next year or the year after, but, in any event, before the next general election, when it will be in dire need of another ‘good story to tell’).  Any intelligent investor will see the clouds on the horizon, and either get out while the going is good (consider Anglo American, Billiton, SA Breweries, Old Mutual and many others) or simply not come.  In the Consultancy business of which the writer is part, several reports written to evaluate South Africa, amongst other potential investment destinations, have concluded that it ranks low in practically every meaningful criterion – ease of doing business, honest dealing by Government, corruption, education stand of the workforce, worker productivity, energy cost and security, safety of employees, labour relations, security of repatriation of the investment, time required to get into business, and many other factors.  The result has been that the potential investors have elected to establish their businesses in other destinations.  An increasing number of companies which have already invested in South Africa have requested a similar evaluation of their investments, and an increasing proportion of them are withdrawing from the country.  These are not high-profile decisions.  The companies making them do not generally want to make a political statement, but the number of job losses is mounting, running to many thousands per year, and the unfortunate consequences of these decisions are mounting, as the investors, previously strong proponents of South Africa, have come to realise that this is no longer a place they wish to be, and spare no efforts to inform their colleagues of the reasons for the decisions.

It is time for the politicians running this country to realise that it is no longer possible to make political decisions based on their personal financial benefit.  They must now take the ‘radical’ steps of demanding that any person benefitting unjustly from a Government contract be brought to justice, serve jail time, be banned from any form of business with the Government and its bodies in the future, and be forced to refund any benefit unjustly received.  It is time that the Ministers and the State President accept that they are not kings and queens, but servants of the people, elected to work solely in the interests of the public, and subject to the Constitution and the laws that bind all of us.  It is time for politicians to understand that they represent all of the people, not only the constituents who elected them.  It is also time for the politicians to understand that, if they cannot come up with anything better that populist moves, the sole objective of which is to gain re-election, they must stand aside, to allow people who are competent to manage the economy.

There is not much time left to pull this country back from the brink of African mediocrity.

The Inflation Imperative

 

A factor has arisen that is starting to raise warning signals in the minds of those who understand the theory of economics, and particularly in those minds that experienced the world immediately post World War II.  It seems that the view has come to be accepted that inflation is not only necessary, but also desirable.  There can be no more deadly belief than this.

Inflation is sought by the CEO of the large corporations, whose inflated salaries are padded by the big bonuses based on the (monetary) value per share, and whose welfare, in the short term, depends on the (monetary) earnings of the companies they steer.

Inflation is loved by those who speculate on the Stock Exchange, because it permits the belief of never-ending share price increases.  It is a fundamental of the brokers on the Stock Exchange, who give learned statements on the investment value of companies, while their brokerage fees are based on the monetary value of the shares in those companies.  The recent boom on the Stock Exchanges of the world were partly the result of too much easy money chasing a short-term fixed supply of shares, caused to a large extent by the misguided boost in the supply of cheap money by the central banks, in the belief (hope?) that the funds being created would be channelled to assist cash-starved businesses to keep alive, to grow and to create more employment.  In fact, those funds were diverted to a very great extent into speculative activities on Stock Exchanges, leading to a widespread perception that stock exchange activity could be seen as a proxy for economic activity!  The cause of the boom in share prices is the very definition of inflation:  too much money chasing too few goods.  The sales of the companies being chased were increasing, the costs were being held down, and the profits mushroomed, leading the worldly-unwise mid-twenties traders to buy the shares.  After all, the share price was increasing.  Right?  It is true that the share price was increasing, but was the company’s intrinsic value increasing?  In many cases, the answer would have to be no.  Sales were galloping forward at ten or fifteen per cent per year, in money terms, but the number of loaves of bread being produced, the litres of milk sold, were stagnant.  The number of man-hours expended in production were not increasing, and may even have fallen.  The growth in sales represented nothing more than the increase in prices.  Consider this:  in 1967, a three bedroom house in a good middle class suburb of Sandton sold for R16 000.  In 2012, that same house, now nearly fifty years older, sold for R1 870 000.  A top-of the-range BMW cost R10 831 in 1974.  The top-of-the-range BMW today would cost in excess of R1 800 000.  Admittedly, it has better gadgets, fancier trim, but 16 000% more value?  A two-litre bottle of milk cost R16 two years ago, today R24.  The cost of a driver’s licence renewal rose from R150 five years ago to R224 now.  The financial world is fond of the Government official rate of inflation, which, today, is stated at about 6,5% p.a., but ask the man in the street what his experience of inflation is.  The answer is likely to come back at between 15% and 20%.  The official rate of inflation has very little to do with what the people actually experience in their daily shopping.

What does this mean for investment (not the JSE variant, which is no more than an institutionalised form of slot machine)?  Investment means the purchase of productive assets by the use of saved funds.  The saved funds may be the money presently available, or it may be the funds that will be saved in the future from earnings in order to repay the loans taken today.  Investment happens when businessmen and –women see an opportunity to earn a profit by taking a risk now in the expectation that the investment made today will generate an increase in their earnings in the future.  They will not take that risk unless they are confident that the investment will continue to generate an excess of income over costs in the future.  That will not be the expectation when they believe, usually on the basis of experience, that the costs will gallop ahead faster than the increase in value of the production of the investment.  And that happens, of course, when the cost of staying alive is increasing more rapidly than the earnings of the people doing the buying.  That is what inflation does.  In the short term, people compensate for their shortfall in earnings by maintaining their desired level of expenditure by using credit wherever possible, but the day of reckoning will come, when the credit has to be repaid, and the asset has been consumed.  Credit is an inflation-generator of note.  The banks give out a multiple of the savings flowing into them, and the difference between the two represents an increase in the supply of money.  The classical definition of ‘inflation’ is ‘too much money chasing too few goods’.  The cycle is apparently endless.  The increased sales (or the maintenance of a level of sales not warranted by the earnings of the buyers) goes into the banks, to be re-lent at a multiple of the amount notionally saved, to finance the consumption expenditure.  More money is chasing the same amount of goods.  Unfortunately, the cycle is not endless.  It comes to an end, when manufacturers recognise that the end is in sight, or when the fiscus decides to step in and soak up some of the excess profits generated, or when Janet Yelland decides to warn the ‘investing’ public that stocks are over-valued.  Whatever the reason, the cycle stops, usually abruptly and often catastrophically, and the resultant cutback in consumer spending progresses speedily to retrenchments of bottom-level employees (any management consultant will tell you how management can never believe that the true source of cost increases is the incompetence and surfeit of management staff, usually at the top.  You need only look at the expenditure of Government on salaries and wages to see this!).  That results in an avalanche of spending reductions and job losses – the Negative Multiplier Effect, in which the loss of one job leads to the resultant loss of between eight and twelve other jobs, in a repeating cycle.  It does not require many months for the loss of one hundred jobs to result in the loss of ten thousand jobs, as the unemployed stop buying shoes, going to a restaurant for a pleasant meal or skip a haircut for another month, to stretch the available funds to buy another loaf of bread for the family, instead of the mince they would have bought last year.

Inflation is also dearly beloved by the fiscus.  Ever-increasing prices mean more VAT revenue, increasing wages mean more PAYE revenue, increasing profits mean more company taxation, increasing dividends mean more Company Tax revenue, increasing nominal prices mean more Property Taxes and Estate Duty.  All of this adds fuel to the fires of the Government, who are more than delighted to spend this increased tax revenue on things that buy votes and that add to their Swiss bank accounts.  Remember how smug Pravin Gordhan was when he begged for applause at his announcement that the annual budget was now more than one trillion Rands?  Of course, the increasing revenue flow makes the economy look stronger, particularly when compared with the artificially low stated rate of inflation, and that calls in more trillions of loans, often denominated in US Dollars or Euros, paying a rate of interest double or more of that for US bonds.  When the crash comes, as it surely will, those loans will attract interest at a much higher real rate, because of the crash of the SA Rand, and the repayment will cost fifty per cent more in Rand terms.  Does this scenario start making sense to you in the light of what is happening now?  The Government, unwilling to cut back on its wasteful pork-barrel expenditure, will continue to borrow, at ever-increasing rates in the face of declining security ratings.  The end result will be that our children and grandchildren will be repaying the debt that we allowed our Government to heap up on the hope that the cycle will go on forever.

What inflation does is debase the value of our real investments in the past.  It wipes away the benefits of frugality in our early years, making all of us poorer in later years.  It disincentivises saving, because we all know that R100 put away today will have the spending power of R1 when we reach retirement.  That knowledge says to us ‘Spend today on a high life, because there is no hope that you will be able to afford the little luxuries you forego today when you reach retirement.’  A current Liberty Life ad tells us of how the father of the founder had to live on a pension of R28 per month in 1965.  What it does not say is that the Legal Advisor of a major corporation started work in that year, with two university degrees, at a salary of R130 per month.  If that person were to start the same job today at a salary of R50 000 per month, the pension of Mr Gordon senior, on the same scale, would be R10 769 per month.  Not an exciting pension, but it demonstrates clearly the effect of inflation!  In order to earn that pension, at an assumed rate of earnings (by no means guaranteed!) of 8% p.a., his pension investment fund would have to stand at a current value of R1 615 000, or 103 500% of our young graduate’s annual salary in that year.  And don’t forget, two degrees is somewhat more than the start capital of most 22-year olds!

What inflation does is force us to pay more for the same value, more for our milk, more for our houses.  If you doubt the real meaning of that, look at the price of a Cadbury chocolate bar.  A year ago, a 200 gram slab cost R15, now a slab costs R22, and the mass is only 150 grams.  The cost has increased by 46% for a slab, and the value has decreased by 25% - our inflation rate of ‘6,5%’ has generated an increase of nearly 100% in the cost per unit of value in only one year!

Industrialists recognise the cycle of slowdown, far in advance of the Stock Exchange pundits and the Reserve Bank experts, none of whom seem to understand basic economics.  They understand that things are not likely to continue in the same blind, bling way.  They hold back on buying new productive equipment, believing that it is likely to stand at least semi-idle in the near future, while the cost of the capital invested continues to drain their resources, the reserves that they will need to survive the bleak years after the economic collapse.  They prefer to maximise profits now and hold onto the cash.  That, of course, aggravates the situation, but it is the prudent thing to do.  When the time comes, the cash will be available to acquire assets or even whole companies at knockdown values, while the less prudent, or less-experienced, will be banging on the doors of the banks for the funds they desperately need to keep in business.  The banks, in turn, will be banging on the doors of Government, demanding bail-out money, threatening the collapse of the economy, a situation that they were instrumental in creating, if public funds, in the form of investment are not made available (remember African Bank?) or lower interest rates or quantitative easing (read the inflationary creation of unbacked, fiat money), or preferably all three.  All of that, of course, will come from the wallet of the taxpayer, from you and me.

And the person at the end of the chain is the blue-eyed, rosy spectacle-wearing man in the street, who allowed it all to happen.