Thursday, December 30, 2010

Goodbye 2010, Hello 2011!

I have been reading lots of forecasts about 2011 – some in the local South African Sunday papers just say that the emerging economies are the place to put your money, and others, such as the Economist warn that the emerging economies will become more risky as some of them become dangerously overheated and recommend reconsidering the US given the new stimulus from the Tax bill recently passed through the US Congress. The general consensus in terms of investment in stocks is that emerging markets will continue to be the preferred location for stocks, but if US economic policy signals a change towards greater growth in the developed world then this will trigger large capital flows from emerging to developed markets.

In this posting I want to review 2010 in terms of the financial markets and consider the various (geographic) alternatives for a good portfolio strategy for 2011. From an economics perspective, economic growth refers to growth in the size of the economy which should therefore increase the profits of companies in dollar terms as quantities of goods produced increase. Stockmarket prices should be an indication of future profits, so one might expect stock prices and economic growth to be correlated, but interestingly their correlation is not that high. Nevertheless this is more likely due to a variable lag relationship between the two which would not show up in a simple correlation. Common sense tells us that there must be some kind of relationship there, otherwise it would imply complete irrationality on the part of the markets.

There is general consensus now that the US economy is now beginning to recover from the economic downturn, as are the European and Japanese economies. Obviously the continuing US economic recovery is key to a general global recovery given that the US tends to drive global economic growth and therefore the stockmarkets, but there are other considerations for 2011. As of December 15th US economic growth was forecast to be 2.8% for 2010 with stockmarket appreciation of 10%. Growth is likely to accelerate next year, so stockmarket gains should continue into next year, but probably not at an accelerating pace.

The big question marks in terms of where to put your money are Japan and Europe. I do not agree with the cynics on continental Europe and the future of the euro, but stockmarkets are probably not the best place gamble when probabilities are uncertain, as sometimes markets themselves can precipitate crises. In the UK the prospect of cuts and political uncertainties do not make both Southern and middle Europe an attractive proposition in 2011, but northern Europe and in particular the Nordic countries still look very attractive going into 2011, with Sweden the leader of the pack in 2010 ( - growth of 4.6% and stockmarket appreciation of 27%).

Japan, I believe, might be the big surprise of 2011. Japan is still in the throws of deflation with current year over year inflation running at around -2.5%, but growth is now picking up, with the Japanese economy growing at a projected 3.2% in 2010, far ahead of most of Europe, and prices are actually now rising on a month to month basis. Japanese stockmarkets have advanced around 8.3% this year, ahead of all European stockmarkets with the exception of Germany’s DAX index. If this trend continues then Japan may outperform most of Europe, and with a resumption of healthy growth, the Japanese stockmarket could incorporate a sharp upward correction in 2011.

Now to the emerging markets. Although China has been a hot market in 2010 with estimated 10.2% economic growth and its stockmarket up by nearly 22% in dollar terms, I believe that China is now a risky prospect for 2011, with possible strikes, an unfortunate (lack of a coherent) foreign policy, and a rapidly increasing inflation rate. We do not really know what the economic growth rate in China is, as state factories always have an incentive to meet or surpass their targets, so in fact growth may not be as fast as reported. The main point is that a continuing “cultural clash” between the communist run political state and a free market economy could quite possibly lead to greater unrest, human strife and uncertainty in 2011.

Apart from the other smaller South East Asian economies (like Thailand, Malaysia and Indonesia – countries that all experienced double digit stockmarket gains and) which all grew at phenomenal rates in 2010, India with an 8.8% growth rate and a 15.3% (in dollar terms) stockmarket rise, is, in my opinion, a much better long term bet than China. Larger Indian companies are now making their mark in many other emerging markets ( - I’ve seen a surprising number of Tata vehicles on the road in South Africa, for example), and their emphasis on technology and software development all bodes well for the future.

What about the rest of the world? South America continues to surprise, with Argentina, Chile and Columbia leading the pack, and here I would say Brazil is likely the country to watch, as their stockmarket has really not gained this year partly because of fears of overheating, but clearly there is still a lot of potential here. Africa, Eastern Europe and Russia are the wild cards. Africa probably has the greatest growth potential but political instability (as so vividly shown in the Ivory Coast and soon to be seen again in Zimbabwe) is the big problem here. Eastern Europe and Russia also have a lot of potential, but once again politics also plays a big hand, although some countries in Eastern Europe, particularly those that sank fastest and most dramatically in the economic downturn (the Baltic states), are likely to be good places to invest in 2011.

Last, the commodity and bond markets. The commodity markets (and particularly gold) make me nervous right now. There is no real reason for gold to be at the level it is ( - and incidentally that is a good reason not to put money into Australian or South African mining stocks right now), and the fundamentals really do not support further increases in the price of crude oil either. In terms of the bond markets, stay away from developed economy markets as the timing of when interest rates will start to rise are very uncertain, but emerging market bond markets likely will continue to offer good yields, particularly at the long end.

Wednesday, December 22, 2010

South Africa's New Growth Plan - A (non-Nobel) Outsider's Evaluation

Recently the South African ANC government headed by President Jacob Zuma published a New Growth Plan which is to guide policymakers and businesses in terms of the future growth path of the economy. The Economic Development Minister, Ebrahim Patel, got nobel Laureate Joseph Stiglitz to write a review which was widely published in South Africa endorsing the government’s New Growth Plan. Of course getting an endorsement from a Nobel Laureate is always a good strategy to build credibility for what is clearly a new and somewhat controversial direction for South Africa, but Nobel approvals aside, in my humble opinion there are some clear pluses to the plan and some definite minuses and problems with it as well. I deal with the pluses and minuses as I see them below, but where I was most disappointed was with the macroeconomic policy proposals. A copy of the plan is available at

The major pluses as I see them are: i) clearly expressing the government’s strategy in one coherent document with justifications for the choice of “growth-drivers” so that everything is there in detail for all to see – hopefully that will lead to some consensus on certain parts of the Plan and maybe other parts being dropped or re-worked; ii) the acknowledgement that it is the private sector that is the major job creator in the economy, although recognizing the state’s role as a “growth enabler”; iii) the combining of macro and micro policies into one policy document; iv) the inclusion of “stakeholders” in the process for implementing the Plan; v) the concern for rural development, particularly in the previously self-governing “Bantustans”; vi) the emphasis on environmentally sustainable growth; and vii) the idea of establishing a sovereign wealth fund in the mining sector. The first plus is self evident, as is the second, the third is just the economic approach, but perhaps a couple of the latter points require some elucidation.

One of the hallmarks of Germany’s success as an economy is rooted in their “corporatist” approach to economic management – this involves inviting all stakeholders in a business or industry to partake in important decisions, whether it is wage increases (obviously done at the industry level when Unions have significant bargaining power), shift work hours, expansion of operations or product line. Business, unions, state governments or federal government often met to make sure that everyone was “on the same page”, so to speak. This is important as it allowed proper flow of information and led to an avoidance of strikes and better management shop floor relations. If what the government has in mind is more of a “stakeholder” decision-making process in industrial development then it is clearly to be welcomed. After the strikes that hit South African industry in the middle of 2010 and the threat of lower investment from major multinational sources of FDI, if this represents a move to a more “corporatist” economic structure then it is to be welcomed.

The concern for development of the rural areas in South Africa is clearly also stressed in the plan. With the proper policies in place, in fact these areas have the most catching up to do and therefore the greatest potential for economic growth. Allowing private businesses to flourish in these areas requires the agrarian economy to become more streamlined but also the infrastructure needs to be in place to allow non-agrarian businesses to take off. In this day and age this requires good and reliable energy supplies as well as broadband internet connection. This is where competition with government specifying what is required might yield the best results. Financing is also usually a major constraint on the private sector in rural areas so the idea of a state owned bank to stimulate lending in rural communities is interesting and I believe worthwhile considering. But I hope that the government also looks at the idea of what in the US is called a “credit union” or in the UK a “building society”. These are non-state-owned and not-for-profit financial institution models, and might work better in some rural communities than a state-owned bank.

So what about the problems that I see with the report? The biggest problem that I can see here is the lack of analysis of exchange rate regime options. The report clearly advocates managing the exchange rate, but I don’t see any evaluation of what would work best for the country, nor a clear rationale for the “soft peg” option of keeping the currency undervalued in the report. I am guessing that the Chinese model of a managed low and competitive currency is the major inspiration for the new formulation of macro policy, and it is clear that many other elements of the report are subservient to this – in other words lower interest rates are achieved through a more lax monetary policy, and a stricter fiscal policy compensates for this, but to prevent inflation there has to be wage and/or price controls in place (which includes “collective bargaining” and caps on executive pay inflation). But would a policy that works well for China work well in the South African context? And what of the severe criticism that China is facing for its foreign exchange policy? Would South Africa really want to play “currency wars” with other countries? [See for a South African article reviewing this issue].

Let’s take a step back from this issue for a moment and look at another aspect of the current “problem” with the high value of the rand. As a reasonably frequent visitor to South Africa, I recognize that the exchange rate has appreciated in real terms, but this is nearly all due to capital inflows into the “emerging markets” because of the more rapid recovery from the economic downturn here, combined with the flow of capital into the mining and minerals sector of the economy as commodity prices recover. This will not continue forever, and in fact many economic commentators are expecting these flows to slow and maybe reverse in 2011 ( - see the latest edition of The Economist). In this case the currency may depreciate quite rapidly. So if the exchange rate is perceived to be a problem right now, it may cease to a problem in a year’s time. What is more important though is deciding on what the most appropriate exchange rate regime is for South Africa in the longer term ( - and I am available for a much cheaper rate than a Nobel economist would charge to analyze this!) The main point is that if the exchange rate is to be the anchor for macroeconomic policy, there needs to be a discussion on what the policy should be and how the policy is to be implemented. If you are going to use an anchor, you should make sure you’re using the right anchor, and in the right way!

What about other problems in the plan? The emphasis on “labour-based production methods” is rather strange in this day and age. We live in a world where capital enhances labour productivity and therefore leads to higher wages. Why would a country want to encourage methods that specifically use labour-based methods? I understand the need to reduce unemployment rates, but this is best done by having a booming economy with major injections of capital as China and many other countries in South East Asia have discovered, rather than “labour-based production methods”.

Another problem is that the manufacturing sector strategy is not well-thought out in my view – phrases such as “supporting activities that can generate employment on a large scale and meet basic needs at lower cost in the short to medium term, while sustaining development of more knowledge-intensive industries for long-run growth” when referring to manufacturing industries, do not make a lot of sense to me. The manufacturing sector’s objective is not to create jobs – it is to create products that consumers and other businesses want so as to make a profit. Jobs are the welcome by-product of this objective.

Lastly, I would like to make two suggestions that I hope might help in the micro part of the report. In terms of industrial product development, the establishment and fostering of University-industry linkages has been shown to be very advantageous in many countries (UK, US and Canada, for example). If South Africa is serious about its future then it needs to attract research talent from around the world and make sure that industry can benefit from the research that Universities do. Lastly, I believe that reducing the high cost of access to broadband in South Africa really needs to be an absolute priority if the country’s citizens and businesses are to be able to take advantage of global technological opportunities, and not get left behind, as many African countries will be.

Monday, December 20, 2010

China and Africa – not a win-win situation?

Every time I visit South Africa at some point I end up in a store called Woolworths.  Now for people in the US Woolworths is synonymous with a failed chain of stores that catered mainly to the working classes and might be thought of as the Walmart of the 1960s.  There was also a Woolworths in the UK which went out of business but the Woolworths in South Africa used to be owned by the venerable UK chain store of Marks and Spencers known for its quality merchandise and good value for money.  In the 1980s Marks and Spencers decided to go global opening chains in Canada, South Africa and even France – in South Africa it decided to use the Woolworths brand name. When Marks and Spencers downsized in the 1990s it sold off its Woolworths chain in South Africa but the store still has the reputation of supplying quality merchandise.

On my latest trip to Woolworths I was surprised by certain changes.  For example, on previous visits there were always clothes and other items made in South Africa, Lesotho, Swaziland and Mozambique ( - all Southern African countries) – but this time I struggled to find anything that wasn’t made in China.  I eventually found some linen shirts made in Bangladesh, but absolutely nothing that was made in Southern Africa.  Now to me this is extremely disconcerting.  It means that African manufacturing companies are struggling to compete with Chinese manufacturers.  In fact the latest manufacturing output statistics for South Africa show a decline in output which continues a worrying trend for a country that relies on commodities and should be the manufacturing engine for most of the rest of Africa.  Recent statistics on capacity utilization at also underscore this.  

So why is this?  Unskilled wage rates are hardly high in Africa so this must be mostly to do with the Chinese exchange rate.  Now there has been plenty written about China’s undervalued exchange rate on the US and Europe, but not a lot has been made of the effects of China’s undervalued exchange rate on the rest of the world.  But China’s exchange rate policy has impacted developing countries as well, with Mexico’s maquilladoras struggling to compete and Indian companies also struggling with competing with China’s rapidly expanding industrial complexes. But although the US and Europe have criticized China, not much has been forthcoming on the issue from African politicians.  One of the most important reasons why Africa is not as anxious to criticize China as the developing world is that huge amounts of money have been flowing into Africa to buy up land and upgrade infrastructure – money that probably wouldn’t have flowed to Africa otherwise. 

The trade off with China in Africa (and indeed in other parts of the world) is a different one from that in the developed world.  In Africa the influx of money from China is not in the form of loans to fund the trade deficits run with China by the US and European countries, but instead is in the form of foreign direct investment in mining and mineral companies and land.  Either way the trade off is not a good one – it is a matter of short to medium term convenience to allow China to buy US and European bonds to keep interest rates low in the developed world, but the purchase of land and foreign direct investment in Africa, although supporting factor prices, is not easily reversed and comes with a major decline in the industrial base and also a sizeable loss of manufacturing jobs. Of course this differs by country with some of the extremely poor agrarian African economies benefitting from the inflow but not losing any industrial base ( - as they never had one to begin with), but the losses for other more industrialized countries (like South Africa and Nigeria) are likely to be much more serious in the long term.

In my mind there is another really important question here which is largely ignored by economists.  Is it in the rest of the world’s interest to have so many products made solely in China and hardly anywhere else?  What happens if there is major political unrest in China or striking workers limit output?  With virtually only one (monopoly) producer of certain articles this means that prices for these articles would skyrocket around the world until manufacturing capacity could be expanded elsewhere.  It would then be in the rest of the world’s interest to allow the Communist authorities to suppress any unrest on economic grounds, while on political grounds there would unlikely be much support for what the authorities end up doing ( - given their record on human rights). 

Thursday, December 16, 2010

Thoughts on South Africa's Day of Reconciliation

I am currently in South Africa and today (16th December) is a public holiday to celebrate the 1994 Truth and Reconciliation Commission which was chaired by Bishop Desmond Tutu. The Commission brought together victims of the apartheid regime ( - apartheid literally means “apartness” in Dutch) and some of the implementers of the previous oppressive regimes (particularly the regime under Botha) to tell the truth about what happened during the dark times in South Africa. The Commission is now held up as a model around the world as a way of moving a country forward from vicious divisive regimes towards more egalitarian humanistic and tolerant regimes. Bishop Tutu had to chart a difficult course, not apportioning blame but at the same time allowing reconciliation between oppressor and victim, which usually meant bringing together a white oppressor with a black victim. The world watched in rapt attention as stories of torture, arson, murder and worse were brought in front of a national audience and usually the victims or relatives of the victims.

In my view, Bishop Tutu deserves to be as celebrated a character as Mandela (or “Madiba” as they call him around here) as the Commission itself was an essential part of the bloodless transition from an apartheid government to a multi-racial government, and this public holiday is really a testament to how well Bishop Tutu managed the Commission, allowing the birth of essentially a new nation. And what a country it has become. After successfully hosting the World Cup this year, South Africa is now not only the biggest economy in Africa, but is clearly the most dynamic on the continent. Growth is strong, inflation is under control, migrants flock here from troubled adjacent nations, and the economy is generally still extremely vibrant. Under apartheid, South Africa was once isolated by the rest of the world, but the contrast now couldn’t be greater, with South Africa now incredibly plugged into the rest of the world, with South African leaders such as Thabo Mbeki acting as chief representative to the African Union on the Ivory Coast issue, South Africa being very active in many international organizations, taking a leading role in the World Trade Organization and the United Nations.

But of course progress is always relative. 16 years after the transition from apartheid to a truly democratic society there are still plenty of issues to be addressed. Although there has been a significant transfer of wealth to a newly emerged black middle class here, the vast majority of black South Africans remain uneducated and mired in poverty. In business the Black Empowerment Act requires that a minimum percentage of black South Africans have to be hired in companies with more than 15 employees – and this has certainly helped to transfer this wealth – but in education there is still a divide between the races. Most neighbourhood schools end up serving specific racial communities because apartheid still exists in terms of neighborhoods. Also violent robberies are becoming more widespread, with some shockingly open attacks in very public places – and this doesn’t seem to be a matter of race, but more the lack of effective policing in certain areas.

Unfortunately as well, racism is still alive in South Africa. Much of it is now covert in public, but it is still quite apparent when you speak to older anglos and Afrikaaners in private. For someone usually used to a reasonably multicultural environment, there are certain very obvious signs. First, I haven’t seen any multi-racial couples – I’m sure there are some, but they are definitely not common – and I haven’t seen one in the Port Elizabeth area. Second, despite the transfer of wealth to the new black middle class, the whites still hold the majority of the wealth, certainly in terms of their average per capita income. Third, most places I have been to, either to eat or drink or shop, clearly serve one specific racial community ( - the clear exception being gas/petrol stations). Fourth, land ownership is extremely important in terms of transfer of wealth, and although no one would wish a Mugabe-style forced transfer of farms to black farmers, many land claims by black farmers are still stuck in limbo years after the original claim. So nearly all agricultural means of production clearly still lies in white ( - mostly Afrikaaner) hands.

Like the Civil Rights movement in the US, though, letting the effects of de-segregation filter through to the roots of society will take time, and will probably only take visible effect one generation after the actual initial change. I am positive though that if South Africa can retain its democratic principles, its commitment to good business practices and keep a lid on corruption, it will prosper. South Africa is a country that has a lot for the rest of the world to admire – the weather, the scenery and the incredible cultural diversity here, but I think perhaps the transition to a better, more egalitarian politics is one of the most important things for the future of this country.

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