June 2021 – ZA Economist

The steps taken in the US to counter the destruction of incomes and output caused by the lockdowns of economic activity can be regarded as a resounding success. Real US output is now ahead of pre-covid levels. By the end of 2021, GDP could well surpass the GDP that might have been expected absent the lock downs. It took a great deal of income relief in the form of cheques in the post from Uncle Sam, supplemented by generous unemployment benefits and relief for businesses.

The extra income means an increase in deposits, in other words money placed with the US banks, to be spent later or exchanged for other financial assets.

Deposits held by banks with the Federal Reserve System have increased by 85%, and deposits at the commercial banks have grown by 26% since March 2020. The source of the extra cash, the deposits at the commercial banks and the Fed, has been additional purchases of government bonds and mortgage-backed securities in the debt markets from the banks and their clients, which are being maintained at the rate of US$120bn a month.

The assets and the liabilities of the Fed have increased by 36% over that period. This is money creation on an awe-inspiring scale and it has worked, as intended, to promote demand for goods and services. Providers of goods and services are struggling to keep up with demand, while also struggling to add to payrolls, leading to upward pressure on prices. The US CPI was up by 5% in May – a rate of inflation not seen since 2008 and before then only in the 1990s.

Inflation in the US – annual percentage changes in CPI

Source: Federal Reserve Bank of St Louis and Investec Wealth & Investment, 15/06/2021

However, the outlook for inflation in the US is less obvious than usual. The Fed has been surprised by the pick-up in the inflation rate, as was indicated by the Federal Open Market Committee and Fed chief Jerome Powell’s press conference on 16 June. Powell remains confident that the increase in inflation is transitory and the Fed does not intend raising interest rates any time soon, at least not until the economy has returned to full employment, which is judged to be some way off.

(It should be noted that full employment may mean a lower number than previously estimated, given that two million potential workers have withdrawn from the labour market since the lockdowns. They may however wish to return to employment should the opportunities to do so present themselves; this is one of the uncertainties the Fed is trying to deal with as it looks to understand the post-Covid world.)

A number of Fed officials however have brought forward the time when they think the Fed will first raise its key interest rates, to the first quarter of 2023, a revision that surprised the market and moved long-term interest rates higher. The bond market nonetheless remains of the view that inflation in the US over the next 10 years will remain no higher than the 2% average rate targeted by the Fed. The Fed will be alert to the prospect that more inflation than this will arise.

A tale of two central banks

The contrast of the actions of the Fed with those of the South African Reserve Bank (SARB) is striking. The SARB balance sheet contracted by R115bn, 10.8%, between March 2020 and May 2021. Since January 2020, the sum of notes issued plus deposits of the banks with the SARB (the money base) has declined by 6%, the supply of bank deposits (M3) has grown by a paltry 4% and bank credit by 2%. These are shocking figures for an economy struggling to escape a deep recession.

The SARB may be of the view that money and credit are less important for the economy, and that changes in interest rates are the only instrument they have to influence the economy.

Monetary comparisons between SA and the US (March 2020 = 100)

Source: SA Reserve Bank, Federal Reserve Bank of St Louis and Investec Wealth & Investment, 15/06/2021

The SARB seems to believe their lower interest rate settings have been accommodative and helpful to the economy. Higher interest rates would, of course, have been unhelpful and lower rates were certainly called for. However, the money and credit numbers indicate deeply depressing influences on the economy, influences that the SARB could and should have done much more to relieve, following the US example. There is more to monetary policy and its influence on the economy than movements in interest rates.

GDP in the US and SA (March 2000 = 100)

Source: SA Reserve Bank, Federal Reserve Bank of St Louis and Investec Wealth & Investment, 15/06/2021

It would be easy to despair of the prospects for the SA economy given the current, discouraging trends in the supply of money and credit. However, we can draw hope from the possibility that the US cavalry (with some Chinese assistance) will rescue us, in the form of rising prices for metals and minerals that are very much part of the inflation process currently under way in the US.

Metal prices have always led the SA business cycle, in both directions. They may well lead us out of the current morass, after which the supply of money and credit will then pick up momentum to reinforce the recovery, as they have always done in a pro-cyclical way. The responses to the lockdowns have made it clear how our monetary policy reacts to the real economy. A favourable wind from offshore may lift the money supply and bank credit, without which faster growth is not possible.

A monetary tale of two economies

The steps taken in the US to counter the destruction of incomes and output caused by the lockdowns of economic activity must be regarded as a resounding success. Real US output is now ahead of pre-covid levels. By the end of 2021 GDP may well have surpassed the GDP that might have been expected absent the lock downs. It took lots of income relief, checks in the post from Uncle Sam, supplemented by generous unemployment benefits and relief for businesses. The extra income means extra deposits, that is money with the US banks, to be spent later or exchanged for other financial assets or real estate or bitcoins or precious metals.

It has also taken lots of extra money, money in the form of deposits held by Banks with the Federal Reserve System have increased by 85%, and deposits at the commercial banks have grown by 26% since March 2020. The source of the extra cash and the deposits at the commercial banks and the Fed, has been additional purchases of government bonds and mortgage-backed securities in the debt markets from the banks and their clients – insurance companies and the like, that are being maintained at the rate of 120 billion dollars a month. The Assets and the Liabilities of the Fed have increased by 36%. It has been money creation on an awe-inspiring scale and it has worked as intended to promote demand for goods and services as excess holdings of money are exchanged for goods and services, that businesses are stimulated to supply and to employ more workers to help do so. The fact that they are struggling to keep up with demand, also struggling to add to payrolls, has meant significant upward pressure on prices. The US CPI was up by 5% in May – a rate of inflation not seen since 2008 and before then only in the nineteen nineties.

Inflation in the US – Annual percentage changes in the CPI (Monthly Data)

Source; Federal Reserve Bank of St.Louis and Investec Wealth and Investment

The outlook for inflation in the US is much less obvious than usual. The Fed has been surprised by the pick-up in the inflation rate as was indicated by its Open Market Committee and Governor Powell’s press conference held yesterday 16^th June. But Powell remains confident that the increase in inflation is transitory and the Fed does not intend raising interest rates anytime soon, and not until the economy has returned to full employment which is judged to be some way off. Though full employment may mean fewer workers employed given that two million potential workers have withdrawn from the labour market since the lockdowns. They may however wish to return to employment should the opportunities to do so present themselves and is one of the uncertainties the Fed is trying to cope with post Covid for which there are no precedents as the Fed points out. A number of Fed officials however have brought forward the time when they think the Fed will first raise its key interest rates to Q1 2023, a revision that surprised the market and moved long term interest rates higher. Though the bond market remains of the view that inflation in the US over the next ten years will remain no higher than the 2% p.a. average rate targeted by the Fed. The fed as the market will be highly alert to the prospect that more inflation than this will come to be expected.

The contrast of the actions of the Fed with that of the South African Reserve Bank is striking. The SARB balance sheet contracted between March 2020 and May 2021 by R115b or by 10.8%. The sum of notes issued plus deposits of the banks with the SARB (the money base) has declined by 6% since January 2020 and the supply of bank deposits M3 has grown by a paltry 4% and bank credit by 2% since. Truly shocking figures for an economy struggling to escape a deep recession of the government’s making. The Reserve Bank must be of the view that money and credit do not matter for the economy, that changes in interest rates are the only instrument they have with which to influence the economy and that they have declined far enough. These are serious errors of judgment that have punished the economy unnecessarily severely.

South Africa and the USA Monetary Comparisons; March 2020=100

Source; Reserve Bank of South Africa, Federal Reserve Bank of St Louis and Investec Wealth and Investment

The Reserve Bank likes to believe their lower interest rate settings have been accommodative, that is helpful to the economy. Higher interest rates would have been very unhelpful and lower rates were called for. The money and credit numbers indicate only deeply depressing influences on the economy that the SARB could and should have done much more to relieve, following the US example. There is more to monetary policy and its influence on the economy than movements in interest rates.

GDP in the USA and South Africa. March 2000=100. Quarterly Data

Source; Reserve Bank of South Africa, Federal Reserve Bank of St Louis and Investec Wealth and Investment

It would be easy to despair of the prospects for the SA economy given the current trends in the supply of money and credit that are highly discouraging. But for the possibility that the US cavalry with some Chinese assistance may well rescue us in the form of rising prices for metals and minerals that are very much part of the inflation under way in the US. Metal prices have always led the SA business cycle in both directions. They may well lead us out of the current morass- and the supply of money and credit will then pick up momentum to reinforce the recovery- as they have always done in a highly pro-cyclical way. The responses to the lockdowns have made it very clear how our monetary policy leads with not against the winds blowing from the real economy. A favourable wind from offshore may lift the money supply and bank credit without which faster growth is not possible.

Pursuing a public interest in the wrong way

The Competition Commission has prohibited Grand Parade (GP), a JSE listed company, from selling its assets and obligations in the Burger King franchise to a private equity company. The reason why the transaction was prohibited was, to quote the media release, “ …the Commission is concerned that the proposed merger will have a substantial negative effect on the promotion of greater spread of ownership, in particular to increase the levels of ownership by historically disadvantaged persons in firms in the market as contemplated in section 12A(3)(e) of the Competition Act. Thus, the proposed merger cannot be justified on substantial public interest grounds” Grand Parade has a large 68% historically disadvantaged body of shareholders (HDP’s) , ECP Africa Fund IV has none.

The qualification substantial public interest grounds, not just prohibited on an unqualified and damaged public interest is revealing. The problem with public interest arguments is that the public is inevitably made up of a variety of private interests some of whom will benefit from a particular agreement and others who may be harmed. For examples common to the modus operandi of the competition authorities in SA, one can refer to cases of M&A activity that are only approved, subject to the acquirer not reducing the numbers employed in the merged operations. Clearly a restriction in the limited private interest of those who would not lose their jobs that they might otherwise have done. But one that makes the merged operation less efficient and competitive than it would otherwise have been, given the cost saving synergies of a merger, which would be its essential justification in the broad public interest.

Any lack of efficiency is clearly not in the interest of many consumers who may have benefitted from lower prices or better quality or more convenient locations that a more competitive business might have offered its many customers. Suppliers of goods services or credit to the less efficient operation and their employees would also have been compromised by a less capable business to engage with. And restrictions on cost savings would be obviously unhelpful to its shareholders who may be many and include historically disadvantaged persons (HDP’s) who are quite likely to be members of collective investment schemes with widely spread ownership claims increasingly exercised by HDP’s through retirement plans. Does the competition commission look through to the members of pension and other collective investment schemes to establish their racial composition? Or are the only empowerment interests recognised by them and the government more widely, are those held directly? Which is to conveniently understate the numbers of beneficial owners of SA businesses of all races and open-up the opportunity to do more deals to empowerment entrepreneurs, who are small in number, influential and politically important, but hardly representative of the public at large.

The winners and losers in this deal prohibited by the commission are obvious enough. The losers are the owners of GP, heavily and genuinely empowered, who are prohibited from realising part of their risky investment in GP. Their shares lost 60 cents on the news and with 430 million shares in issue this was a damaging loss to them of the order R300m. Surely not a sacrifice they would willingly make in some vague public interest. Another case of expropriation without compensation through regulation. The chances of their realising the same value with another deal, with a company similarly broadly enough empowered to satisfy the commission, is surely remote.

As indicated by the commission there are very few if any such broadly constituted and empowered groups of shareholders around. The shareholders and managers of GP are in effect compelled to do nothing but hold on to their investment in Burger King which may well end up destroying all of their investment.

But are such sacrifices forced on the shareholders of GP likely to promote similar such widely owned enterprise in the public interest? Denying risk taking investors the fruits of their risk taking, or the ability to mitigate their losses, which is the case with this transaction, is surely setting a very discouraging precedent for further broad-based empowerment. It suggests that HDP’s can take the risk of investing their savings in a broadly based and empowered venture but you are prohibited from cashing in on its success or from reducing your potential losses. Hardly an enticing prospect.

Because you will only be allowed to sell assets or the company to a very restricted number of buyers- presumably then at a knockdown price. Surely not a restriction any business with current or prospective empowerment credentials would welcome.

The logic of the competition commission therefore defies me. Even if such interventions in agreements willingly reached, by parties fully capable of recognising their own self-interests that have no implications for competition, can ever be against the public interest – which I seriously doubt. The commission should protect competition and efficiency and the genuine public interest in well-functioning markets they are set up to protect. The public interest in competitive markets is not the same as a political interest interfering in them. One that is usually narrowly defined to supporters and sponsors of a party and best left to the politicians and the voters to pursue.

More and better public private partnerships please

The value of your home only partly depends on is location, size and the quality of all its fittings and fixtures. It also depends crucially on the quality of the services provided by your local municipality. By how much they charge for services they deliver or fail to deliver and how much of a wealth tax they impose for your right to own. The better the services provided the more valuable will be your home. And the more you are charged the less the home will be worth to others for any services provided. Negative feedback effects on home values are painfully apparent to home-owners in most parts of the country. The real value of homes of all kinds and types are falling because of the growing in-balance between what is being extracted by municipal governments compared to what they deliver.

But not in Cape Town. Where service delivery is holding up well, as are home values. The difference between what you get for a home or apartment owned or rented in Cape Town and in the other major urban centres is strikingly wide. Despite the charges levied by the City that have been rising well ahead of inflation. In 2010 Rates collected by the city were R3.84b. By 2020 these had grown to R10.08b, that is at an average compound rate of growth of 8.8% p.a. Well ahead of inflation that averaged about 5% over the period. Evidence surely of more valuable real estate. Revenue from electricity water etc compounded from R8.7b to R19.8 at an average rate of 7.5% p.a. over this period. They took a knock from Covid, declining by R329m in 2020. Which begs a question – what is the present value of a predictable income stream of R10b growing at a real 3% p.a? Perhaps twenty times current revenues or possibly R200b. It is this potential value that secures any borrowing the City or any city might want to do to support its growth with well-designed and honestly executed capex.

The City of Cape Town does however have a spending problem. It has spent far too little on its infrastructure over many years now. Capex (PP&E) was R4.7b in 2010 and only R6b in 2020. Capex in Cape Town has been declining in real terms by about 2.5% per annum on average. Surely not nearly good enough to support and encourage a growing metropole and its property values.

The result is a very strong City balance sheet. The financial assets on the 2019 CTC balance sheet, cash, other financial assets less debts meant net financial reserves of a positive R10.1b. The equivalent amount on the 2015 balance sheet was a mere R2.3b. Debts have remained constant at about R6b since 2015 while cash reserves grew from R3.2 to R8.4b. It is a build-up in financial strength that should be hard to justify to property owners and residents. Perhaps it is the self-evident hopelessness of the potential competition to run the City that explains such parsimony. The reserves did come in useful in 2020. The City had budgeted to raise an extra 2.5b in debt in 2020. It did not have to do so. It drew down its cash reserves by R2.6b still leaving it a large cash pile of R5.8b.

The City is now realistically budgeting for a significant increase in its capex. It plans to increase its capex to over R11b in three years. To be funded in part by an extra R7b of debt that will cost the City a very manageable net financial charge of 573m in 2023-4. Cash reserves nevertheless are planned to increase to R9b by the end of the three-year planning horizon. I would suggest that the City urgently needs help with its capital expenditure problem. It should partner closely and usefully with the businesses that could help plan and undertake the spending programmes.

Voters at the next municipal elections should choose their mayors and councillors on local not national issues. Essentially by what they can be expected to do to protect, perhaps even enhance, the value of their highly vulnerable homes.