February 2022 – ZA Economist

Fiscal perceptions are a different reality for the US and South Africa.

19^th January 2022

Fiscal and monetary policy in the US and SA will command close attention in 2022. The US will be expected to adjust to the success it has had overcoming the Covid threat to its economy. Success has led to excess in the form of much higher rates of inflation. Larger fiscal deficits, that approached 16% of GDP in late 2020 were incurred to supplement incomes with checks drawn on the Treasury has seen the Federal debt to GDP ratio rise to 128% of GDP. Consequently the ratio of money (bank deposits) to incomes (GDP) is now 25% higher than they were before Covid. This huge stock of money will continue to be exchanged for other assets and for goods – and services -when the time is right. The money will not go away – it will merely lose more of its real value as prices – including asset prices – rise further at the inflation rate.

It is a question of how much and how quickly interest rates go higher to restrain spending. Longer term interest rates may rise should inflation be expected to rise permanently to higher levels – which is not yet the case. The problem with higher interest rates is that they have important fiscal implications. Paying higher market determined interest rates to keep the bond market open to issues of more government debt – takes away from other spending – it may demand higher taxes or less government spending – not well suited to make governments popular.

The US, given the currently low cost of raising debt, remains in a favourable fiscal setting. The average yield on all federal debt is below 2%, while the debt service ratio – the ratio of interest paid to the Fed budget – is below 9%. It was about double that rate in 2000 when the debt to GDP ratio was about 50% Every-one per cent increase in the average cost of funding the US debt, means an extra 250 billion dollars of interest to be paid out – on top of the current 500 billion payments. It will require a resolute, politically independent and inflation fighting central bank to tame inflation. (see figure below)

US Fiscal Trends

The comparisons of SA with the US are not alltogether unfavourable. The national debt to GDP ratio is much lower – only about 60% The debt-service ratio is significantly higher equivalent to 13% of the national budget. it was over 20% of the budget in 2000. The average yield on all RSA Treasury debt has gradually fallen to about 6%. It was 10% in 2008. (see figure below)
SA and the US – some fiscal comparisons

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

The SA Reserve Bank did not (wrongly in my view) do quantitative easing. The broader money supply has hardly grown at all since early 2020. The money to GDP ratio has fallen back to where it was before Covid. (see below) There is no excess demand.

South Africa and the US – some money and GDP comparisons

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

Of further relevance is that SA Government Revenues have been growing significantly faster than government expenditure. Thanks to the global inflation reflected in higher metal and mineral prices leading and much improved and taxable mining incomes. Both monetary and fiscal policy settings therefore remain austere. They explain why the economy is growing so slowly.
South Africa Fiscal Trends

Source; South African Reserve Bank, Investec Wealth and Investment

The problem is that our market determined credit ratings have remained unchanged and our cost of raising long term debt very expensive. The RSA pays about 8% more for ten-year money than the US. Even more discouraging is the extra real 4% we offer on long dated inflation protected bonds.

SA Interest rates and risk spreads

Source; Bloomberg, Investec Wealth and Investment

Every-one per cent move in our government borrowing costs- would be worth an extra R37b a year to the Treasury. Lower interest rates would also reduce the returns required by businesses and help revive what is a very depressed rate of capital expenditure. The world of bond investors demands compensation for the danger that SA will sooner or later confront a debt-service trap from which printing money, and the accompanying debt destroying inflation, might be the preferred escape. They are much more generous to the US.
It is fundamentally the failure to grow faster that puts government revenues and Budgets at risk. The best SA can do this year to lower borrowing costs would be to sustain smaller fiscal deficits. And for the Reserve Bank to recognize that growth- not inflation – is the SA problem- and to set short-term interest rates accordingly. To help keep debt service costs down and improve the government revenue line.

Responding to the Zondo Commission

Cadre deployment is to be expected everywhere. Incoming US administrations do it as a matter of course. But why have so many of the most influential of the SA cadres proved so very fallible, as revealed in full gory detail by Zondo.? It is the leaders after all who set the standard. That crime may be expected to pay, given kickbacks to the right places, is part of an explanation. Short-term horizons “ if I don’t take advantage then my insider competitors will do so” may help explain some of the observed behaviour. There has been no lack of competition for the material opportunities offered in the South Africa that have gone well beyond what could be regarded as decent salaries and other employment benefits. Including the generous rewards provided for serving on the boards or management teams of the semi-autonomous government boards responsible for regulating private conduct. Of which many became notorious for providing opportunity for shopping/conference trips abroad and for contrived multiple Board meetings, for which valuable hourly attendance fees are unnecessarily charged.

The key posts in SA government departments and agencies turnover very rapidly with changes in the direction of the political winds – so paranoia of those in office is not irrational. The large financial gains observed coming from BEE – without any obvious relationship between input and benefits realized – may be a further influence. That you become be fabulously rich when lucky in your partnerships –obtained through your political connections rather than your observable efforts or skills – and through doing business with government on highly favourable terms because of these connections – is morally debilitating. And indicates for wide notice that competence or dedication is not necessarily rewarded nor essential to the purpose of getting on in life.

Repeat business is the most valuable source of sales and profits for any business. It helps to keep their owners and workers honest and competitive striving to enhance valuable reputations for fair dealing. Governments departments or agencies however have monopoly power. A trust in their good practice is to be heavily relied upon. It is a trust demanded of those teaching a class, serving in a public hospital or in a police or border post enforcing the law. Yet we need them at more than they seem to need us. We wait in line or on-line patiently and smile obediently. We are not customers but supplicants of the government agencies with great influence over us. Imagine life without a passport, visa, vaccination certificate or a driving license, a good education, or a well-organized casualty ward? We would like to believe that the public servants are trying as hard as they know how, to please us. Because that is the right respectful way.

Unconstrained self-interest cannot fully explain what has gone on in SA. It calls for explanations made better by psychologists. philosophers or historians than economists. Do we understand the derivation of the values that determine the culture of the workplace? Can we explain how a sense of honour, honesty, patriotism or duty is developed to help set the reasonable and realistic expectations of the supplier and user of services of all kinds? Helpful attitudes and good performance are encouraged by a strong sense of vocation- a sense of a job worth doing well. For what are widely recognized as appropriate material rewards that can be well understood and accepted by all parties involved. How are they cultivated? They are part of the implicit employment, or what can be understood more broadly, as a social contract. The best standards do not emerge overnight and should be actively cultivated. Ethics has to be well taught.

When regimes change and the power structures change radically with it, a strong sense of life changing opportunities can become overwhelming and corrupting. The large gains achieved in SA via misgovernment have been highly very damaging to the incomes and prospects of most South Africans. It will take acknowledgement and understanding of it as the path to an agreed much improved moral order and stronger economy. It calls for a new social contract, the hope for a Zondo inspired devotion to doing your duty for fair reward and for obeying and enforcing laws justly made and deservedly respected. A community of those wanting to give service rather than take unfair advantage of their favoured status could become the new morality.

Tighten up in the US – lighten up in SA

It is crunch time for most central banks – but not the SARB. Inflation rates escaped them and recapturing inflation will not be a comfortable or comforting exercise. Rising prices, rising wages and the prices of other inputs, can be very clearly blamed on the usual suspect- more money created than has been willingly held by households, business and banks. Excess money holdings (deposits at banks) have been exchanged for goods, services and other assets enough to raise their scarcity value. And supply has been unusually slow to respond to the unexpected strength of demand.

It will take higher interest rates and a sharp deceleration of the rate of growth of the money supply to reverse inflation trends. It will demand less be spent and borrowed by governments and more tax collected. Paying interest will account for an ever-larger share of government budgets to constrain the much more agreeable benefits that might otherwise be provided by governments.

Their further problem is that higher prices are part of the adjustment economies make to an excess of demand over supply. Higher prices have causes- they also have effects- they help absorb and restrain demands while they encourage additional output. Higher prices reduce the ability of households to spend and less spent may well register as temporarily slower growth – slow enough to make central bankers more hesitant to act. But if they fail to act they may encourage more inflation expected that will show up in higher long term borrowing costs.

A further complication is that there is a great deal of money sitting on the sidelines waiting to enter the markets. The ratio of money relative to income (GDP) in the US has exploded since the Global Financial Crisis and in response to Covid. There is now 80% more money – mostly in the form of bank deposits – per unit of income – than there was in 2008. A ratio of close to one to one between income and money was very much the understandable case before the GFC and before the brave new world of Quantitative Easing (central bank money creation on a vast scale) was discovered. A new money/Income equilibrium will have to be established in the US – a mix of higher prices and less money added will have to bring this about.

The commercial banks play a large role in determining the supply of deposits, through their lending. And they have vast reserves of cash to convert to loans if they choose to do so in response to demands for credit to expand the money supply further. The last time the Fed reversed QE in 2015, to shrink its own balance sheet, the balance sheets of the commercial banks continued to rise as they reduced their cash holdings in exchange for other assets. They may do so again. It might take very much higher short term interest rates to discourage them.

Assets of the US Commercial banks and the Federal Reserve System 2008-2021. Monthly Data Billions

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

We have a clear case of monetary excess in the US and too much monetary constraint in SA, an explosion of the Money/Income ratio in the US and a contraction in SA. Enough to infer that the relationship between money and incomes has undergone a systemic change – in an inflationary direction for the US and contractionary one for SA.

The US and SA – the Money to Income Ratios. (2007.4=1) (Quarterly Data)

Source; Federal Reserve Bank of St.Louis (Fred) South African Reserve Bank and Investec Wealth and Investment

The sense of systemic change in SA is reinforced by a comparison of growth rates in money and income before and after the GFC. Growth rates were much higher and far more variable before 2008. They have declined significantly since. The Fed will have to tighten up to control inflation and the SARB should lighten up to facilitate faster growth for which enough money- not too much and not too little- is essential to the purpose.

South Africa; Growth in Money Supply (M3) GDP and Prices ( Quarterly Data)

Source; Federal Reserve Bank of St.Louis (Fred) South African Reserve Bank and Investec Wealth and Investment

Recent monetary policy: A monetarist perspective

Introduction – monetary developments before and after the GFC and Covid

Reports on the death of the Quantity Theory of Money now (February 2022) appear highly exaggerated. The extraordinary burst of additional money issued by the Fed intended to ameliorate the damage to incomes and economic activity caused by the Covid inspired lockdowns of March 2020 have been followed by a surge in inflation. The increase in the prices facing consumers in the US was running at over 7% p.a. by the end of 2021 The inflation of 2021 appears to have surprised all observers other than the near extinct tribe of monetarists.

Full article here: Recent monetary policy: A monetarist perspective