M2 is a broader classification than M1 because it includes assets which are still highly liquid but that are not exclusively cash. Money is also present in the form of investments and derivatives. The total market capitalization of just the New York Stock Exchange and Nasdaq is over $48-trillion as of December 2022, according to Statista. The total market cap of cryptocurrency, as reported by CoinMarketCap, adds another $1.07 trillion to that figure.

So enormous sums need still to be mopped up before the threat of rising global inflation can be consigned to the back-burner. However, as the second graph suggests, by weighing all the available data, international advisory group Statista is able to predict the likely trajectory of global inflation through to 2027 and, as you can see, offers the optimistic view that global inflation actually peaked last year and is now in steep decline to a projected 3.3 percent by 2027 matched by a general economic slow-down.

 The problem, however, is that while wealthy Western Nations are winning the war against what is in fact an insidious tax which hurts the poor most of all, developing nations like South Africa are not. Worst of all, since developing nations in general earn their keep by exporting raw materials to the developed world, any economic slow-down radically affects the export earnings of countries like South Africa.

Furthermore, when developing nations fall under the control of socialist-thinking governments who simply cannot grasp the inevitable in-built inefficiencies of make-work policies when, as in South Africa, they also control many of the means of production such as the power utility and its badly-maintained electricity distribution systems as well as dysfunctional railway systems and pot-holed highways which collectively make it impossible to get those raw materials to the harbour, you have a formula for disaster.

Add in the Post Office that has just gone into liquidation and a disconnect between the people you purport to represent as legislators together with ever-increasing personal greed epitomized in “our time to eat” policies which favour corruption and, you have a perfect formula to destroy any economy. Finally, once you have borrowed to the hilt on the international markets, there is nothing left to eat but the imaginary wealth of the few entrepreneurs who have not yet fled your shores.

While inflation has fallen significantly in the major advanced economies since 2022, for heavily-indebted countries like South Africa, the journey is just beginning as the Financial Times second graph illustrates. Like most developing nations, South Africa has a bigger fight on its hands since its economy is afloat in an international sea dictated by imported inflation in respect of energy prices and most of the manufactured commodities it needs to keep its internal industry turning over. But in this latter case, second round events of a far stickier nature are now coming into play because restless labour, epitomized by its civil service unions, have begun flexing their muscles. The latter have, furthermore, got a reasonable case because they have endured several years of enforced austerity.

With an election year looming, the SA Government has some extremely difficult decisions to make, particularly since the ANC is in an alliance with the Communist Party and the Trades Unions which are now threatening to abandon them if workers are not suitably rewarded for their patience. However, South Africa’s problem, like many other socialist-leaning nations which used the public service as a ‘make-work’ to win the favour of labour because it had inherited a good international credit rating, was thus able to subsidise the wage bill using international borrowings at a time when the country’s borrowing record was still good.

Back in 2013 when the Zuma administration was trying to meet a jobs crisis that was threatening national stability, the government could borrow at 5.88 percent compared to a current 9.885 percent as the graph below illustrates. So it began to recklessly take on a million additional employees.

But since then, the cost of borrowing has been creeping up steadily. Now, as a share of GDP, South Africa enjoys the dubious honour of having the world’s third most expensive public service as this OECD graph illustrates.

 Yet, notwithstanding the efforts of the Zuma administration – or more probably because of it – South Africa now has the world’s highest unemployment rate at 32,7 percent in the fourth quarter of 2022 while the expanded definition of unemployment, which includes those discouraged from seeking work, was 42.6 percent almost precisely double the 2008 rate of 22.4 percent as the graph below illustrates.

In such unemployment circumstances one would expect employers, both in Government and the private sector, would easily be able to resist strike action. But, of course, as I have already mentioned, there will be a general election next year and a major portion of the ANC’s support base resides among State employees.

Already, South African strike action has turned violent, with critically ill patients being denied access to hospitals as an illustration of the callous disregard that strikers have for the general public. Furthermore, the relatively easy availability of “scab workers” has angered workers who expect employers will undermine their actions while failing to appreciate their perceived plight as workers’ families struggle to put food on the table in the face of rapidly-rising food prices.

It is an explosive cocktail. Furthermore, few investors have forgotten the 2021 July riots which caused massive loss of life and destruction of private property. From a foreign investor’s perspective then, there are many less risky places to invest in. Thus, while Wall Street is pricing in a likely recovery later this year and has in fact been in recovery mode since last October as illustrated by ShareFinder’s projection graph of the SP500 index below, South Africa is not looking nearly as good.

 That green trend line dating from mid-October last year suggests that Wall Street’s broadest measure of share market activity will continue gaining at a compound annual average rate of 18.3 percent. And while in the orange trace of ShareFinder’s artificial intelligence-powered projection of the likely future trend, weakness is sensed between the end of June and early September, most investors will likely see this as nothing more than a buying opportunity.

Sadly, ShareFinder is far less optimistic about South Africa. Pushing its artificial intelligence resource far into the future is always a risky business, but for what it is worth, here is the picture: That yellow trend line suggests an annual average decline of the JSE All Share Index at compound 4.6 percent from now until March 2025……in other words, ShareFinder is not optimistic about the post-election period either….and we have all been witness lately to the chaos of political party coalitions in our municipalities.

In my weekly column of Friday, April 14 I compared South Africa’s current situation to that of Venezuela, once on a per-capita basis the fourth wealthiest nation on earth where in recent years inflation has skyrocketed, shortages of food and other basic necessities abound, and its citizens are increasingly fleeing the country. Venezuela, home to the world’s largest oil reserves, is a case study in the perils of political mismanagement as tracked in the graph below by its annual GDP performance; proof that even the richest nations can collapse if they are not properly managed. Clearly we are headed down the same path if we do not use the 2024 elections to make a radical change.

 In Venezuela’s case, annual inflation skyrocketed to just over 130,000 percent in 2018, and though it has slowed in recent years, it remained at 234 percent in 2022. It is a salutary story of particular importance because here in South Africa, political pundits fear we are headed in the same direction. While it is abundantly clear that the ruling African National Congress long ago ran out of ideas about how to create economic growth, it is far from clear that they will lose the coming 2024 general election.

Though poll results make it clear the ANC will probably find it impossible to achieve an outright majority – it seems they could get 40 percent – there appears to be an increasing probability that an alliance with Julius Malema’s EFF will allow them to hold onto the reins of power. But at what cost for wherever Malema’s men have joined in municipal coalitions, the price has normally been control of municipal finances? And since the EFF stands for the nationalization of the Reserve Bank and all privately-owned property, the International Monetary Fund graph tracking Venezuela’s recent economic history makes obligatory consideration.

This is what we are likely to get if Julius gains control!

Over the last decade, Venezuelan President Nicolas Maduro and his allies have violated basic tenets of democracy to maintain power. This includes restricting internet access and arbitrarily prosecuting and detaining political opponents and critics: does this sound like Zimbabwe? These, coupled with international sanctions and the COVID-19 pandemic fuelled a devastating humanitarian crisis, with severe shortages of basic goods such as food, drinking water, fuel, and medical supplies. As a consequence, a November 2022 survey showed that 50 percent of Venezuela’s 28 million residents live in poverty (though that is down from 65 percent the year before) and more than seven million Venezuelan refugees have fled to neighbouring countries and beyond since 2014.

Recently South Africa’s government debt had begun to decline following a wave of austerity measures conducted by the Ramaphosa administration. That might sound admirable but the reality is that Treasury has run out of international lenders. The graph below, courtesy of the SA Reserve Bank tracks government borrowing since 2004. Inevitably, however, that austerity has led to the recent wave of strikes which all but guarantee that borrowing will be on the rise once more……not to mention the massive R254-billion Eskom bailout and the ominous moves to exonerate the power utility from reporting corruption and mismanaged spending for the next three years.

 Is the latter in an effort to create what former CEO Ander de Ruyter named a “feeding trough for the ANC” to fund its next year election campaign…just asking? According to Business Tech, the African National Congress (ANC) spent more than R1-billion on campaigning for the 2021 municipal elections. Just to fund his own 2017 election campaign, Cyril Ramaphosa has admitted that it cost R300-million. Given that it is very likely make or break for the ANC, a billion Rands will likely be chicken feed this time around. But the party is broke. It cannot even pay its own staff salaries. So one can only guess at what corruption lies in store for the immediate future as the party seeks to fund next year’s election!

That is why our investment markets are so uncertain these days. It’s nearly impossible to predict an economy run by idiots. It is even worse when the idiots think it is OK to plunder state assets to fund their retention of power.

Inflation Will Bounce

By Jared Dillian

The latest US CPI report showed that inflation continues to slow to 5% on an annualized basis. That is a lot better than it was last year. We should be happy about this.

The bad news? Inflation won’t go down much more before it finds support.

There is a website called Truflation that computes inflation on a mostly real-time basis. Go to their website and check out the chart: Truflation currently measures inflation as 4.34%, and you can see from the chart that it is bouncing and heading higher.

I always thought it would be difficult to get inflation below 4%. It’s a matter of psychology—people expect price increases, so they act in such a way as to perpetuate price increases. So how do you eliminate inflationary psychology? You raise interest rates to the point where you cause a very serious recession.

Volcker gets credit for ending the inflation of the 1970s, but not many people remember how difficult things were when inflation was at its peak. GDP was down 6% in that recession. It was one of the worst recessions in history. It was relatively short-lived, though, and set us up for an expansion that would last almost 20 years. But we had to take a lot of pain in the short term.

Have we taken enough pain yet? Well, contrary to what New York Fed President John Williams says, the Fed hiked interest rates enough that banks began to fail. Was that enough pain? Did we kill the inflationary psychology? I don’t think we did—they are going to have to hit it harder.

But I don’t spend a great deal of time thinking about what the Fed should do; I think about what the Fed will do. And the Silicon Valley Bank incident looms large in the minds of the Fed. Could the Fed destabilize the financial system through further rate hikes? Absolutely.

And while financial stability is not one of the Fed’s official mandates, it is one of its unspoken mandates. If the Fed nukes 500 banks, there won’t be much left to save from inflation.

The Path of Least Embarrassment

Long-time readers know that I frequently say that the Fed follows the path of least embarrassment. The Fed doesn’t try to make money—it is incidental to what it does—but it does care about politics, optics, and public opinion.

The Fed was slow to act when inflation began to ramp. Why? There were two scenarios: The Fed hikes rates and fights inflation, bringing it down earlier than expected. Or it hikes rates erroneously and causes a recession when it isn’t absolutely necessary. Which path would have caused the Fed the most embarrassment? Clearly, the latter.

Today, the Fed has two possibilities: keep hiking rates and fight inflation or pause and watch inflation go higher. Which of those possibilities will cause the most embarrassment for the Fed? The latter.

Public opinion has shifted. People care about inflation to the exclusion of everything else. This Fed will be humiliated if it pauses interest rate hikes and watches helplessly as CPI climbs over 10%. It would have failed in its mission. Financial historians will be comparing Powell to Arthur Burns. So, the Fed will wait until it is absolutely clear that inflation has returned to normal.

What is normal? The Fed’s official inflation target remains at 2%. Will it wait for inflation to get back to 2%? Maybe. But one thing that the Fed has said all along is that it wants to see progress on inflation, and after the latest CPI report, it is obvious that we are making substantial progress on inflation.

People are very focused on what the Fed will do at the next meeting. It seems as though it will raise another 25 basis points. But there are rate cuts priced in toward the end of the year, which will probably only happen if it becomes clear that the economy is entering a recession.

Predicting the Stock Market

It is true that you can forecast the direction of the stock market if you can forecast the direction of the Fed. I have done pretty well doing this over the years. The next meeting of the FOMC is on May 3. I expect the Fed to hike 25 basis points and pause while still performing quantitative tightening. That will place the lower bound on Fed funds at 5%—a nice round number.

I have always said that the Fed needs visibility as to the end of rate hikes. If we get that visibility at the May meeting, stocks could rally significantly. We have been seeing some reports that short positions in S&P 500 futures are the highest since 2011. You have been duly warned.

Electricity distribution

By JP Landman

A glimpse of what the future could be.

My sense is that South Africans are utterly exhausted. So, to give readers a break, this month I am sharing something very different.

A real-life story from the ground up. A former Eskom engineer, his wife and two engineering sons (the Bosch family) have developed a practical example of how electricity distribution in South Africa will change over the next few years.

The engineer-father started working on the maintenance and administration of electricity distribution systems 30 years ago when Eskom embarked on its mass electrification programme of 350 000 houses a year. Eskom made losses on these programmes and then outsourced the management of these to private companies. The father began a family business, contracting his services to Eskom in Hammanskraal, north of Pretoria. The losses were turned around and the services became profitable. What was the secret of their success?

1   Firstly, they involved local communities. No, not local politicians. The real local community, the shebeen and funeral parlour owners, the taxi bosses and spaza shop owners. Block by block, those who were leaders in that area – a chief or a chief’s son, a church leader or a community organiser – anyone of stature or credibility. These community members received nothing and all they were asked to do was to support the delivery of electricity services in their area.

2   Secondly, they rendered the service. If the power went out, they got there and fixed it, no matter the time of day. One night in the early 90s, the couple’s eldest son, who was a mere baby, was sleeping in the bakkie; Ma was holding a search light for Dad who was up on a pole in Hammanskraal to attend to an electricity outage. Four men walked up with AK47s. Remember, it was still quasi-civil war back then. Ma dropped the light, introduced herself to the four men, shook their hands and explained they were busy fixing the power. The four men laughed, wished them well and went on their way. The power was restored.

The result of community buy-in and service delivery was that households paid for their power, theft of equipment was minimal and company vehicles weren’t stolen or hijacked. Well, no, not quite true. A brand-new Nissan bakkie was stolen before it had company signage on. Word went out and the bakkie was recovered.

One door closed, another one opened.

 When demands for ‘a cut’ emerged in 1998, the family didn’t renew their Eskom contract and moved on to private sector work. They managed the distribution of electricity for a bank across all its retail properties. Later, the same for a large property company (it was before the days of REITs). It proved to be a very successful enterprise, saving the bank and the landlords many millions.

It proved there was legitimate money to be made in the administration and management of electricity distribution. That is the opportunity the family saw and exploited. So much so that the company was sold for a tidy sum of money. The family then had the option to emigrate to Australia or New Zealand. Or they could put the money into electricity distribution infrastructure in the Free State. They chose the latter.

Helping local government.

They made a very promising start in the Free State in Mafube, a municipality covering Frankfort, Cornelia, Villiers and Tweeling in the north-eastern Free State. Mafube municipality had to pay an average R5 million a month to Eskom and had an average income of only R1,7 million a month. Meters were not installed or repaired (and in numerous cases, simply bypassed or just partially billed), there was no money for petrol or diesel to go out and attend to problems, and there was no capital for replacement parts or equipment. So, Mafube municipality contracted the family business to take over electricity distribution in the four small towns.

About R100 million was invested in infrastructure, staff were trained and re-trained to the desired standards (YouTube helped a lot), and custom-made technology was deployed. Long story short: there are 12 000 clients (households and businesses) and only 65 have been cut off over 12 years for non-payment and the subsequent debt written off. I will write that again: out of 12 000 clients, only 65 were cut off over 12 years. If people receive effective services and are treated decently, they pay for the service.

Take a step back and think about the basics: who will handle the distribution of electricity better? A local government busy with politics, conflicting priorities and patronage, or a specialist company focused on distribution only? Keeping customers happy with prompt and proper service, maintaining infrastructure, managing debtors, and training personnel properly – in theory local governments can do this, in practice most don’t.

For the Mafube municipality, electricity distribution went from a huge cash outflow and liability to positive cash flow and better service delivery. The municipality is now receiving a royalty from the distribution of electricity. Load-shedding is reduced by about 17% from what Eskom requires, thanks to solar power. Water and sanitation works are excluded from load-shedding. As a result, a large agricultural co-op decided to expand its business in town, creating 120 new jobs. Small businesses are flourishing again. Property prices have risen. Plans are afoot to build two bigger solar plants and entice businesses from other towns to relocate to Mafube.

As a late departed friend would have said, what is not to like?!

Corruption trips more progress.

The success of Mafube led to a second project, this time in Harrismith in the eastern Free State. The second project was literally 10 times bigger than the Mafube system. Again, there was a turnaround. Again, requests for ‘a cut’ emerged. Again, the family withdrew. That municipality is one of Eskom’s biggest debtors today.

In Harrismith the ANC lost control of the town council in the 2021 elections. In Mafube it retained a comfortable majority. There is political advantage in successful service delivery.

From consumers to owners.

A next chapter in the Mafube story involves plans to build two large solar farms and then sell ownership of them to electricity consumers. This can be done via voluntary extra payments on monthly electricity bills. The principle is the same – involve the local community, but now extend it to ownership.

The family is now looking for a specialist company that can do the management and administration of many shareholders slowly buying their shares through small monthly contributions. (If any readers can help, please let me know.)

So what?

• Electricity distribution does not have to be a drain on the fiscus.
• With proper management and using available new technology, even the smallest and poorest municipality can run distribution and generate a surplus. There is no reason for any municipality to run up huge electricity debts.
• A proven alternative is a decentralised and localised operation free from political control and corruption that provides proper services and involves the community.
• Citizens want electricity, will pay for it, and will help to protect the infrastructure.
• The benefit of using a private company is that the cost of infrastructure does not have to come from public funds – it comes from private capital.
• All our electricity attention is currently focused on load-shedding. But distribution is the next area of crisis in electricity, as it has already become in some municipalities.
• Just like electricity generation, the distribution model will also change – by choice or by default, it will change. Better to do it by choice and design. Mafube points the way.

We’re going to have a crisis

by John Mauldin

Recent banking events give me disturbing thoughts. As I try to analyze where this is going, I see a plausible, and indeed probable outcome: an even more concentrated banking industry with less personal banking and even more models.

That’s not great, for a variety of reasons we will discuss today, but even worse is what will happen on the way there. We could be heading toward a truly unthinkable series of crises.To understand why, we need to put several pieces together.

Something Odd

We’ll begin by noting something odd at Silicon Valley Bank: At the time it failed, some 96% of SVB’s deposits were in excess of the FDIC limit ($250,000 in most cases) and therefore uninsured.

More accurately, they would have been uninsured except that the FDIC, in consultation with the Federal Reserve Board and Treasury Secretary Janet Yellen, invoked a “systemic risk” clause to extend unlimited coverage to all SVB deposits. This decision wasn’t cost-free. The FDIC announced it had, after liquidating SVB’s assets, paid out an additional $20 billion to make depositors whole. This was charged to the FDIC’s Deposit Insurance Fund, which is funded by assessments on all banks and must now be replenished. Also keep in mind, the FDIC is backstopped by the US Treasury if its own funds are insufficient. “Taxpayers” didn’t pay anything this time but are potentially at risk.

That makes it harder to deny SVB depositors received a “bailout.” I know it’s a loaded word, but facts are facts. As I understand it today, the FDIC essentially unloaded SVB’s easily tradeable assets, sold the rest to another bank, and still had to draw from its own reserves to make good on the expanded deposit insurance guarantee. Those who received the benefit had been clearly warned not to expect any such thing, yet they got it anyway. “Bailout” seems to fit. SVB wasn’t systemic until it was.

(That $20 billion isn’t spare change, either. The FDIC’s reserves were $128.2 billion as of last year-end. SVB alone consumed over 15% of this balance. A few more such incidents—or even a single large one—could easily deplete this fund. The FDIC is going to levy a special assessment on other banks to replenish their funds. Who pays? The banks? No, ultimately their customers. They must keep shareholders happy, just like the consumer products makers who (blaming inflation and the Fed), raise prices to meet forecasts.

 There’s no obvious reason why these large and presumably sophisticated SVB customers would keep such large amounts of uninsured cash in bank accounts. A bank account is a loan to the bank. FDIC assumes the credit risk for balances below the well-known limits. Above that, any losses are on the depositor.

Moreover, many alternatives are available—sweep programs and such. SVB itself had one, though few customers seem to have used it. Why? I simply can’t believe the CFOs of large companies like Roku—which had almost $500 million of uninsured cash at SVB—did this unwittingly. All I can imagine is SVB offered some other benefit they thought justified the higher risk and lower yield. What that benefit was, I don’t know.

Giant Assumptions

And whatever is going on here, it’s clearly not just SVB. Here again is a chart from Ed Yardeni I showed two weeks ago. Observe not just the amounts, but how uninsured deposit growth accelerated in 2020 while insured deposit growth stayed close to its trend. Here’s a longer-term chart of the uninsured deposits. Source: Reuters

For whatever reasons, large depositors feel increasingly confident with the risk of holding uninsured balances. Maybe they think the banks won’t fail. Maybe they feel sure the FDIC will save them even if the bank does fail—which was a winning bet in the SVB case. But these are giant assumptions which affect both depositors and banks.

My friend Woody Brock had a brilliant analysis of the banking situation (which he kindly allowed me to share here). He makes this important point about “moral hazard:”

“A moral hazard occurs when the provision of insurance changes the incentives and thus the likely behaviour of those insured. For example, if I can obtain $750,000 insurance against my house burning down, when I (unlike the insurer) know that the true cost of rebuilding is $500,000, then I have an incentive to burn the house down to obtain both a new house and a cash bonus of $250,000. This incentive in turn increases the probability of a house fire because I am now motivated to burn down my house. The insurance company understands this possibility which is why it will not insure a house at a value higher than its market value…

“In the case of banking, what insurer in his right mind would insure the owners of a bank against bankruptcy when (i) the true risks involved cannot be measured, and when (ii) the risk of moral hazards are ever present – especially if bank managers know that depositors will never lose money and as a result are emboldened to take risks they should not have taken.”

To use Woody’s metaphor, we are now in a situation where many presume the insurer (FDIC) will cover far more damages than it should under its current rules. This incentivizes both depositors and banks to take more risks on the assumption they will be bailed out if necessary.

But they may be betting on the impossible. The FDIC’s insurance reserves come from risk-based assessments on bank deposits. Do they really reflect the risks? Colour me skeptical. But regardless, the FDIC’s stated goal for its insurance fund is a 2% ratio to insured deposits. As far as I can tell, that has never happened. This table shows the ratio’s high since 2002 was 1.41% in 2019. At the end of 2022 it was 1.27%. And note well, that’s 1.27% of insured deposits, which are roughly half of total deposits.

Is that enough? Probably, maybe, hopefully, and then the Treasury would fill any shortfall. But it’s all cloudy and uncertain, and the uncertainty is itself a problem. Are the nominally “uninsured” bank deposits safe or not?

People keep asking Janet Yellen and Jerome Powell, and both send mixed signals. They swing between vague statements of confidence and rote recitations of current law—which says no, the FDIC limits are firm absent a “systemic risk” determination.

Nature abhors a vacuum but, in this case, the only honest answer is “Maybe.” Having had a near-death experience in the last month, some large bank depositors don’t like that answer. And they’re starting to take matters into their own hands.

My thoughts on FDIC insurance? They should raise the limits to $500,000 or $1 million and somehow cover specialty accounts like payroll which must have larger amounts. Offer a way for larger depositors to buy additional FDIC insurance.

The key point is to avoid privatizing profits and socializing losses. If you want guarantees, someone (customers or banks) needs to pay for them. I see that hand: “John, won’t that mean customers change their banking habits?” (chuckling). Yes, that’s precisely the point. When large banks get implicit guarantees small banks don’t have, it changes the competitive balance. That MUST change.

“We’re Going to Have a Crisis”

When you see your life flash before your eyes, the natural reaction is to become more cautious. The owners of about $10 trillion in uninsured bank deposits, now realizing it is at risk, are looking for new arrangements.

This comes as some of those depositors were beginning to notice they could get significantly higher yields in non-bank instruments like Treasury bills and money market funds. Bank rates have always been lower but the spread matters. Moving money out of your bank for an additional 1% yield might not be worth the trouble. Triple that difference and it becomes more tempting.

So, we have two different but complementary forces at work: safety and yield. Both are pulling money out of banks, particularly small banks. If yield is your priority, your best bet is to move out of banks into Treasury securities, money market funds, and other short-term debt instruments. If you absolutely want safety, then Treasury bills are probably still your best bet.

But there’s a third force: convenience. Or maybe “inertia” is a better word. Many folks, even some wealthy ones, just default to keeping their money in a bank. The fact you read an investment newsletter says you probably aren’t in that category but it does exist. Combine it with the businesses who need to keep their working capital quickly accessible, and a lot of cash is firmly attached to banks. Again, larger businesses need to maintain payroll accounts, which is why they should be a separate category.

This cash can choose which bank gets it, though, and recent events are sending a loud and clear message. To adapt that famous Animal Farm quote, “All banks are safe, but some banks are safer than others.” That’s not a fallacy. It is very clearly correct, and the safer banks are the ones whose failure would be a “systemic risk” that allows for expanded FDIC coverage.

This isn’t an accident. This is the system Congress established in the Dodd-Frank Act after our last banking crisis. It put some additional requirements on the “SIFI” (Systemically Important Financial Institution) banks. Are they really any safer? It’s hard to know. But they are being perceived as safer in terms of getting the FDIC to cover your over-the-limit balance, so they are where money is flowing.

Four years ago I wrote what in hindsight may be one of my most important letters: Capitalism Without Competition. I talked about how the Fed’s interest rate manipulation was increasing concentration in industries like airlines, retail, health insurance, food, and more. The result is always the same: higher prices and/or lower quality. And it happens because government policy protects politically powerful oligopolies from smaller competitors.

The same is true in banking. A handful of megabanks already hold most of the deposits and they are getting even more, at the expense of community and regional banks whom customers perceive (not wrongly) as less likely to be bailed out. This reduces the competition that leads to better service and lower prices for everyone.

Again, this isn’t happening by accident. It is a policy choice. It’s not the only choice but it’s the one our leaders have made.

In fairness, let’s assume they meant well in Dodd-Frank. Maybe it was the right response in 2010 but that was more than a decade ago. It’s clearly due for a rethink. We need to safeguard the banking system without giving advantages to some banks over others.

This rule that lets regulators subjectively decide to insure what would otherwise be uninsured deposits is a problem. Better to have a base benefit with no exceptions and let large depositors buy additional coverage. If they choose not to and their bank fails, it will be their own responsibility.

I am not optimistic for that or any other solution, though. Our political system is sadly not up to the task. The current structure is all we have, and it won’t improve until a crisis forces change.

And the situation demands changes. Which means—and I don’t say this lightly—we’re going to have a crisis which will give us that change.

Which brings to mind the old line: “Change, why change? Aren’t things bad enough already?” These words were (apparently) spoken by the then-Prime Minister Lord Salisbury in the late 19^th Century. Renowned for his cynicism, he certainly lets his feelings be known about the benefits of changing the status quo in the situation he found himself in.

Most larger players don’t really want change. The status quo is working for them. Not until a crisis will they bend and then demand change although they will still want it to benefit them (don’t we all?).

I can’t claim to know exactly what will happen, or when. I foresee big problems in commercial real estate, where small banks have a critical role and losing them may haunt us. Look at this chart:

Source: Dror Poleg

 Breaking that down by components, we find some banks seem to specialise in various types of commercial real estate: from residential to construction to commercial. Which makes sense as each of these areas has its own nuances. I know one bank quite well which has one group focused on online sports gambling companies. Others focus on energy, etc.

Source: Dror Poleg

Office buildings in some large urban areas are a real problem. The work-from-home trend is reducing demand for office space. Landlords are beginning to default. Dror Poleg writes:

“This leaves the bank in a bind. What seemed to banks like conservative investments in 2021 is now a ticking time bomb that threatens to destabilize their business. The valuations of many office buildings have dropped or will likely drop considerably. And government bonds are much cheaper now than they were two years ago.

“Most office buildings will be ok, and some will do better than ever. But that doesn’t solve the problem. To maximize their value, owners must introduce new services and amenities and embrace flexibility. This costs money. And more importantly, it changes the nature of the asset. Offices are no longer a ‘monopoly’ asset with stable, bond-like returns. Instead, they are more like a retail or hospitality business—with more volatile income and shorter-term commitments from customers.

“The challenge for banks is not that offices are worthless but that they are riskier than they assumed.” 

And customers are demanding more services and amenities for longer-term leases. Some areas will see reduced rents. There’s a slow train a-coming pulling change behind it.

Now look at what else we know. The Fed is forcibly deleveraging a highly leveraged economy. The government is in debt up to its ears. The political system is both divided and paralyzed. Demographic trends are colliding with new technologies like artificial intelligence. Our biggest trading partner, China, is rapidly becoming an adversary with its own shaky economy. Europe and European banks are much worse.

In short, we have a lot of moving parts right now. Some of them are going to clash.

Longtime readers know I’ve been predicting a “Great Reset” in the 2030s that resolves our massive unpayable debts. I’ve also said things would get bumpy before we get there. We have taken an off ramp to a different kind of road. The nice smooth highway is behind us. From here on, it’s going to get uncomfortable. We will all need to think the unthinkable.

Something is happening with gold, and it isn’t just against the dollar as it is all strong and muscly in multi-currency terms. Yes, you could make the case for the “banking crisis” being the reason why gold has popped up over the last month. However, gold has been etching higher over the last six months in dollar terms and longer in other currencies.

Gold in SGD, AUD, EUR, CNH, JPY indexed to 100 – year-to-date

 And it seems to have been working off an overbought condition over the last couple of years. If this was a flash in the pan thing for gold, it should have given back all its gains of 2020 on the back of Covid (as the Nasdaq has). Also note gold was already moving higher in 2019 way before Covid.

So it would seem to us that the COVID scam and the recent banking crisis/circus is just “fleas on a dog’s back” for gold — there is something “systemic” going on. The lack of trust on a global scale is revealing itself in gold. We have a strong conviction that this is the tip of the iceberg (i.e. the upside of gold in multi-currency terms is a long way from being done). Long term it would seem that the odds are in favour of gold outperforming the world stock market.

I know there is a lot to take in, and I’m going to show you yet another chart, but this is truly revealing.

Gold in SGD, AUD, EUR, CNH, JPY indexed to 100 – last 20 years

This takes us back to 2000 — 20-odd years ago. Multi currencies against the yellow metal indexed to zero. Is this not monetary debasement in a simple picture?

Obviously, it depends on where you take your time period from, but from 1990 the world stock market is up some 380% whereas gold is up 450%. So it could be argued that all the gains in the world stock market have been on the back of monetary debasement.

There is one key thing we left out in the chart above — the effect of compounding dividends. If we include dividends and assume they are reinvested, then the return of the world stock market goes to 710%, but around half of those returns are accounted for by monetary debasement.

Our thinking is that, longer-term (a 10-year view), holding a “whack” of your money in gold (physical or an ETF) in preference to the general equity market (or other growth orientated ETFs) isn’t a stupid idea and is actually a no brainer.

Are we on the verge of massive outperformance of gold relative to the S&P? Like the 1970s or even from 2000 to 2013? Well, stranger things have happened. Note that when gold gets going, the trends tend not to last for just a couple of years but rather 10 years at least. Here is where things are far from being a no-brainer… What is going to outperform over the next 10 years or so? Gold or gold miners?

From 1983 to 2008, gold and gold miners tracked each other reasonably well. Then, from mid-2008 (the onset of the GFC), something happened and gold has outperformed miners dramatically. Sorry, but 1983 is as far back as the XAU (Philadelphia Gold Miners Index) goes.

Gold miners (XAU) and gold spot indexed to 1 as of 1983

Zooming into the period from mid-2008 until present, we can see in the chart below that gold miners haveunderperformed gold by some 70%, although they have moved in lockstep since the start of 2015 (eight years).

What is the reason for this underperformance?

Some say it is because of the increase in costs from energy. Yet, from 2008 until present, crude (a good proxy for diesel prices) has gone down relative to gold.

The contrarian in us suggests that we are approaching a time for gold miners to outperform gold. But we are lacking a fundamental reason for that genius idea.

Stacking up relative to the S&P 500 we can see in the chart below that the gold miners have performed more or less in line with the S&P 500 since the start of 2015.

And gold miners are as out of favour as they were during the height of the TMT/dot-com bubble of 2000.

In a nutshell:

• We don’t think it is going to be difficult to outperform the S&P 500 with a basket of gold miners over the next 10 years
• Whether or not you would be better off investing in gold miners or gold, toss a coin… or go 50/50 GDX and GLD — Newmont and Krugerrand or whatever tickles your fancy.

What else?

Is gold foretelling us of an impending monetary crisis?

Well, we do know one’s coming so…

Parsing the increase in the Repo- and questioning its wisdom

Professor Brian Kantor

There was no good reason for the Reserve Bank to have surprised with a 50 basis point increase in its repo rate. There is in fact no good reason at all to subject the beleaguered SA economy to any further increases in interest rates.

Given the bank’s own assessment of the state of the economy. To quote the statement of the Monetary Policy Committee of the 30^th March. “Turning to inflation prospects, our current growth forecasts leaves the output gap around zero, implying little positive or negative pressures on inflation from expected growth”. The output gap is the estimated difference between potential growth in the economy (the supply side) and the growth in demand expected. The expectations for both growth in demand and supply are depressingly slow- no more than 1% p.a. over the next two years.. But clearly there are no demand side pressures on the price level.

The Bank’s forecasting model indicates that every 1 per cent shock to the repo rate will reduce GDP growth by 0.17% on an annual basis with the peak impact two or three quarters after the interest rate shock. While inflation is predicted to decline by 0.12% two years after the shock. While these are the estimated impact of higher or lower interest rates, other things equal, other things are very likely to change in highly unpredictable ways. For example exchange rates, or food prices or electricity tariffs or export prices- supply side shocks – over which the Reserve Bank has no control, nor any superior ability to predict. And which are as likely to move higher or lower over the forecast period and therefore should be ignored when setting interest rates. The strong focus of policy attention should be on the demand side of the economy- on the potential output gap over which the Bank does exercise influence. And without excess demand price increases cannot continue in an ever-higher direction- irrespective of recent inflation. Why the Bank would risk even slower growth by imposing still higher short term interest rates is hard to appreciate.

Since its January meeting the Bank, by no means alone, has been surprised by global inflation, by food prices, by rand weakness etc, enough to have taken recent headline inflation rates above what was predicted at earlier meetings. Though the longer term expected trend in headline inflation remains as it was – pointing distinctly lower below the targeted band. Incidentally the core inflation rate that excludes energy and food prices – large supply side shocks – has behaved almost exactly as expected. All further reason to have stood pat.

SA Headline Inflation. Actual and forecast by the Reserve Bank

Source; SA Reserve Bank and Investec Wealth and Investment

SA Core Inflation. Actual and forecast by the Reserve Bank

Source; SA Reserve Bank and Investec Wealth and Investment

There is perhaps more to the decision to raise interest rates than the usual focus on prices. The MPC statement and the Q&A session after the meeting cast unusual concern about the foreign financing needs of the SA economy. To quote the MPC statement again – “South Africa’s external financing needs are expected to rise. With a sharply lower export commodity price index, stable oil prices and somewhat weaker growth in export volumes, the current account balance is forecast to deteriorate to a deficit of 2.7% of GDP for the next three years. Weaker commodity prices and higher sate-owned enterprise financing needs will put pressure on financing conditions for rand-denominated bonds. Ten-year bond yields currently trade at about 11.2%, despite the expected moderation of inflation over the forecast period”

It therefore appears to me that higher interest rates to attract foreign capital interest rates may have played a decisive role in the MPC decision. The rand and the long end of the bond market did benefit from a wider interest rate spread in a modest way.  But such experiments in exchange rate management are surely not to be recommended, given all else that can happen to exchange rates.  I thought we have learned (expensively) to leave exchange rates and long-term interest rates to sort out balance of payments flows – and yet still to learn to set interest rates with the domestic economy front of mind.

RSA 10 year bond yields and the USDZAR – before and after the decision to raise the repo rate by 50 b.p.