I chose that headline deliberately because I know it is provocative and eye-catching. But it is true and there is a rumour doing the rounds now that another crash is imminent….and that too has a strong basis in fact. But I personally do not think it will happen in the short term and those who act on that belief might miss out on some spectacular market gains in the interim.
Cutting to the chase, the concern in some investment quarters is based upon previous experience of what was nicknamed “The Taper Tantrum.” Referring to that event, Investopedia explains it as “…the 2013 collective reactionary panic that triggered a spike in U.S. Treasury yields, after investors learned that the Federal Reserve was slowly putting the brakes on its quantitative easing (QE) program.” And of course, as I have for some time been warning readers, there is growing evidence that runaway inflation could result from the Covid stimulation package recently introduced by the Biden Democrats which expanded the total US money supply by an unprecedented one third – following on the excessive money-printing that both the US Federal Reserve and many leading nation central banks have indulged in ever since the October 2007 “Sub Prime” market collapse.
Just a year ago, the total amount of money in the world was growing at a rate of six per cent year on year; it is now growing at almost 19 per cent year on year. This is the highest growth in world money supply since the late 1980s when OECD inflation was close to 10 per cent.
The graph on the right might not seem to be so scary but the reality of that up-tick on the right is that the total amount of US dollars in circulation in the world last year increased by a third: the greatest ever increase in the history of the US!
The graphic directly below tells it a little better. The US Fed’s balance sheet pre 2008 is represented by the 12 black blocks on the left. From then, it added 37 new blocks until 2020 and, in the last 12 months added 21 more.
And if you think the American picture is a little troubling, the global picture of what went on before while most of us were barely paying attention, is pictured below:
Global money supply from 1960 to 2018:
What happens when you increase the supply of any commodity beyond what the market can comfortably utilize is that its value diminishes proportionally or, to phrase that in words housewives best understand, the cost of everyday goods from groceries to house prices to share market values rises in direct proportion. It’s called “inflation” which folk going on pension in the 1970s and 80s well understood as so many became totally impoverished in that era.
In the language of economists, “When the cost of money has already decreased to close to 0%, further increasing the supply of money can’t force people to demand more. This is reflected in the velocity of money decreasing as the supply has increased (the rate at which money circulates through the economy). The significantly reduced velocity of money was seen during the last decade. However, the shift from increased saving during the pandemic to wanting to get out and spend is likely to result in an increase in the velocity of money during Q2 2021, this combined with the higher levels of money supply is likely to have a direct impact on prices for physical goods. However, with the spread of Delta, this is likely to dampen some of that increased propensity to spend during Q3 2021.
So, consider my next graph which tells the recent leading nation inflation story: It’s on the rise everywhere!
Meanwhile, as investors, most readers of this newsletter are naturally most interested in the growth in value of share prices, so one needs to turn to the world’s most representative share market index to properly reflect how share values have responded to the global money supply increase.
So above I have reproduced the New York Stock Exchange’s most representative S&P500 Index which, as you can see relative to the light green trend line, was growing at compound 15.5 percent annually from March 2009 until the Covid crash of February last year. Then central banks everywhere reacted by printing money in quantities the world has never before experienced and the S&P500 responded by rising from then on at compound 66.5 percent annually as delineated by my dark green line.
So look what happened to inflation rates. The surprise is that despite central bank “Quantative Easing” both the US and global rates were falling from 2008 to 2015. The reason, of course, was that the world was being flooded with cheap consumer goods pouring out of the sweat shops of China. But even that was eventually insufficient to curb the ever-increasing rates of money supply and inflation began rising six years ago……………… and now the genie is out of the bottle!
Right now we are living in a kind of Cloud Cuckoo Land, a dreamworld in which central banks have tried to reassure the world that inflation was temporary and that they will not be forced to intervene to claw back some of the currency oversupply. But growing numbers of investors understand that this is sheer bravado. That is why they have been piling into cryptocurrencies which are seen as a safer form of money. In my graph below, the extent of the almost panic-stricken flight into Bitcoin is illustrated by the compound annual average growth rate of 403 percent between March 2020 and April 2021: from $8.53 to $47. 11.
Recently this best-known iteration of crypto coinage suffered a reversal when headline-making South African Elon Musk announced his company would no longer accept payment in crypto coins for his revolutionary Tesla electric vehicles.
Once, however, he explained that this view had been motivated by environmental concerns about the amount of coal-generated electricity needed to facilitate Bitcoin mining and in recognition that other cryptocoinage – like the new ShareFinder coin whose value is assured via a linkage to the issued shares of ShareFinder International rather than a power-hungry computer algorithm – the coins have taken off once more at an incomprehensible compound annual average rate of 219 900 percent as the trend line on the right of the graph above illustrates.
So why the fear that another crash is imminent? Well the US Federal Reserve has recently been moderating its language indicating that it is no longer as firmly wedded to the ultra-low interest rates which underpin the payments the US Government is forced to pay lenders who invest in their Treasury Bonds. Initially, investors were entirely disbelieving with the result that the yield on 30-year T Bonds was rising at compound 234 percent between August last year and mid-March from a yield of 1.18 percent to a peak of 2.48 percent as my graph below illustrates.
Students of global debt well understand that if this rate were maintained, the US government might be driven into effective bankruptcy. Though this issue is a technicality for the US as the sole prime currency issuer, it has posed intolerable pressure upon the central banks of lesser nations that do not enjoy the “Bretton Woods privilege” and I imagine that Fed Chairman Jay Powell would have come under considerable pressure to adopt a more reassuring tone lately. But do note that of late US long bond rates have again begun rising at compound 483 percent (green trend line) from 1.18 percent to 2.41 percent.
Furthermore, note the graph on the right, the far more sensitive 90-day borrowing rate appears to reinforce the view that investors might have cause for concern. My red line in this graph is rising at a compound annualized average rate of – brace yourselves – 47 511 percent. From a yield of 0.01 percent in May, it is now standing at 6 percent. Though short-term movements in the 90-day debt market are not so indicative of trends, this move is too great to ignore. And if the Fed is forced to become more defensive against the rising US inflation threat, the share markets of the world will inevitably be forced to act in a similar way.
My next graph on the left, courtesy of the Wall Street Journal, illustrates the absolute relationship that has always existed between inflation and NYSE share prices as represented by the oldest index of them all, the Dow Jones Industrial. What it tells you is that as inflation rises so do share prices and when central banks are forced to rein in inflation the Dow has always fallen.
So, back to the Taper Tantrum, what some investors fear is that sooner rather than later the pressure upon the US Federal Reserve to act against the rise of inflation in the US – which, as the 90-day bond yield graph illustrates, appears to have temporarily stalled at a very high 5.4 percent – must force Fed action. That is why this month’s inflation figures could be so critical for Wall Street share prices. Should August inflation be higher than 5.4 percent, share prices must surely react negatively. But the jury is obviously out on the long-term market outlook.
So I leave you with ShareFinder’s outlook for the Dow. There is a better than 90 percent probability that ShareFinder’s AI-generated market projection for the S&P500 will be accurate in predicting it will CONTINUE rising for the foreseeable future. But now you do, I hope, fully understand the odds!
But I cannot, however, leave the issue there because I believe that no single Fed chairman since Marriner S Eccles – who helped steer the Bretton Woods talks which gave the US almost feudal power over global currencies – has had to navigate one of the most challenging periods in modern monetary history. It lies in the hands of the current incumbent, Jay Powell to either renew or destroy the world monetary system.
Just as an aside, Eccles is famously remembered for the quote that, “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth … to provide men with buying power. … Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. … The other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”
Read that quote carefully because it resonates with the current era in which wealth disparities are again growing rapidly and social tensions are becoming intolerable. That completely explains the rise of political popularism and in South Africa, which unenviably has the world’s greatest know levels of wealth disparity, it has manifested itself in rioting and looting.
Eccles and the Bretton Woods agreement gave the US arguably its most prosperous era in history. If Powell missteps, he could go down in history as the one person most to blame for bringing on the ‘Greatest Depression.’
The cryptocurrency phenomenon has amply demonstrated that the world is rapidly running out of trust in the global monetary system and the graphic on the right, courtesy of Wikipedia, totally explains why. At a time when the patience of ordinary folk everywhere in the political class is at its lowest ebb, the US is headed for technical bankruptcy with its debt headed for 200 percent of Gross Domestic Product.
At a time when fake news is dominating the public belief system as amply demonstrated by the growth of socially lethal vaccine denialism, when dominant news channels like Fox and CNBC are at such pains to exaggerate their polar opposing views that average citizens no longer have credible news sources, the world is arguably ripe for social revolution!
Much has accordingly been written about the “Great Reset” which a growing number of economic commentators believe is inevitable; an event which is expected to cataclysmically replace the world order of government, replace currently accepted monetary and economic systems and eventually usher in a new consensus which is only dimly imagined at present.
The only questions, authorities believe, is whether it will come with a whimper or a bang…and when it will come? Who would be Chairman Jay Powell and his colleagues in the leading nations? Steady hands are needed on the tiller and, I fear, they are mere mortals!
We are demonstrably on the brink of dramatic change. When such things happen in a slowly-controlled fashion, they are labeled as “Progress.” But when things get out of control and move too fast, it is labeled “Revolution.” That is why so much of our future welfare rests upon Jay Powell and his fellow central bankers!
Last week, the US Centre for Disease Control and Prevention announced that it is extending the eviction moratorium. No more rent! How many branches of government are we up to now?
Then, the Department of Education announced that it is extending student loan forbearance for the fourth time. The new extension will last until January 31, 2022. But this will be the last one, they’ve assured us. No more student loan payments!
No more work! No more school! Society is coming apart before our eyes. What does this all mean?
We have heard echoes of this before: in the 1960s, during the counterculture movement, and in the 1920s, with the reaction to alcohol prohibition. The late 1960s saw rising inflation and the peak of a long bull market that lasted the entire decade. Though the 1920s wasn’t characterized by inflation, it was also a peak of a long bull market.
Are there any parallels to today? I don’t know. I am just making things up. But when other countries experience episodes of rising inflation, stuff gets weird. This was well-documented with Weimar Germany, where great social upheaval coincided with a period of hyperinflation.
Inflation rips society apart; deflation bands people together. Japan, despite decades of deflation, is a peaceful and prosperous society with its values intact. Inflation creates political instability, which can lead to democracy… disappearing.
Which would you prefer?
This is not an anti-Fed newsletter, but this is what the Fed gets wrong. The dangers of high inflation are not strictly economic—they’re cultural and political.
This country won’t survive 30% inflation.
We’ll end up with an autocracy. And we’re already trending in that direction, as attitudes have shifted ever-so-slightly away from democracy and toward “strong leaders.” The shift is even more noticeable among young people. A large number of them say that democracy might not necessarily be the best political system. So, if you’re a Fed governor, you are either ignorant of all this political and monetary history, or you just like to poke the bear, shoot for a little inflation, and try not to get too much. A little bit of inflation is fun, after all.
I am reminded of a quote from Doc Holliday in the 1993 movie Tombstone, “I have yet begun to defile myself.” We’re in the process of passing a joke infrastructure Bill in a bipartisan fashion, with a spending bill coming down the pike that is five times larger than that. It is possible that we could end up with a $7 trillion deficit this year, or about 30% of GDP.
I haven’t looked it up, but I think this is the biggest deficit in the developed world—in history. In peacetime, of course. Early indications are that most, but not all Republicans, want to restrain Biden’s spending—or simply redirect it to their own pet causes.
We’re losing our minds. But we’re not done yet—not even close.
I am a trader, and as a trader, I am fond of saying that it doesn’t matter until it matters. For the time being, the bond market (along with the Fed) seems to be absorbing all of this supply. If it doesn’t, the Fed will simply be used as a political utility to keep rates low.
There is that old line from Greenspan’s essay: “The law of supply and demand is not to be conned.” The next sentence in that essay reads: “As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise.”
This behaviour will continue until there are serious economic consequences. What would constitute a serious economic consequence? Double-digit inflation for starters. Four percent interest rates. Persistently high unemployment. Skyrocketing food and energy prices.
Until one or more of these things comes to pass, we’ll continue spending and printing. And who is arguing against that? Nobody in government. Nobody, except for a few Austrians on Twitter.
All of this happened in the span of 20 years. If you want to go back a little further, you could point to 1971.
Our experiment with a flexible monetary standard is relatively short in economic terms. Fifty years is a small sample size. What if we’ve just experienced the first half of one long, economic super-cycle, and we haven’t gotten to the down half yet? What if this results in 50 years of recession?
People are a little nuts about vaccines and the virus. This has been true for a while, but it is still true. Anytime I mention vaccines my inbox fills up with hate mail, and I am not some anti-science ogre. I was one of the first people to get the jab last February. But people are touchy about this stuff. Y’all need to relax.
Anyway, you cannot talk about the stock market without talking about vaccines and the virus. The value/inflation/re-opening trade remains a never-ending ass-ache. I am even hearing chatter about new lockdowns on Twitter.
The doomsday scenario is that the delta variant turns into the epsilon variant, which turns into the omicron variant, and then the xi variant, and we’ll have rolling lockdowns for the next ten years. If that happened, what would the stock market do?
Well, in the first iteration of the coronavirus, the Fed poured liquidity into the economy, and the government handed out free cash, which resulted in stocks climbing 100% from the lows last March.
If you continue that train of thought a little bit, you might conclude that the virus is not bad for business. In the short term it is, but in the long term, it’s not. Extreme fiscal and monetary policy measures tend to be good for stocks, not bad.
So here is my thesis, which we will discuss in a little more detail. Once we get past the delta variant, whatever that looks like, it will result in a stock market boom perhaps half as large as the one we had last year. That might seem unlikely right now, as the indices are treading water. But if you look at a short-term chart of the SPX, it looks like a chart that is waiting to explode higher.
Of course, we’re not really interested in what the index does because the index is dominated by humongous tech companies. I’m not interested in the S&P 500. I’m interested in the S&P 490. Remember last year, when, if you didn’t own the big tech companies, you were massively underperforming the index? That is about to change. I am uncertain of the timing.
These were the last few bear markets in stocks:
I am leaving out the LTCM crisis of 1998, which, basically, only lasted a day.
Now, the conventional wisdom around bear markets is that we cannot conceive of what would cause a bear market in advance. It is a black swan? Is that true? The only true black swans on our list—2020 and 1987—resulted in very brief, short-lasting bear markets. The other stuff, like the financial crisis, well, we could see that coming a mile off.
Now that I’m not doing the radio show and I have more time, I sit around and think of what might trigger the next bear market. I am not coming up with anything! And I’ve never been accused of lacking imagination.
Meanwhile, the Fed and the government are dumping cash into the economy, and everyone has so much money there is no place to put it. So, I have a tough time believing people who say this is somehow going to result in… deflation. I am not an economist, and this does not constitute economic analysis. I’m just the dumb newsletter writer. The simplest ideas are always the best.
If future variants of the virus cause more cash to be dumped into the economy, I have a tough time seeing the stock market going down? What will cause the next bear market? Probably a withdrawal of liquidity when the Fed tightens monetary policy. It will make the taper tantrum of 2013 look like child’s play.
Ten years from now, when you’re making a list of big bear markets, and you look at the causes, this will be fairly obvious. If the Fed hikes rates and the government tries to reduce the deficit, we are in for one hell of a crash.
But that’s nowhere on the horizon. This is how markets work: it will matter when it matters, and not a moment sooner. There is no use thinking about it now.
In the meantime, I think the stock market could rally 30% over the next 12 months. That might be a little ambitious, but not by much.
The Fed has a million reasons not to tighten monetary policy. Two big ones are unemployment and the virus. The Fed only has one reason to tighten: inflation. And the Fed is just doing what it said it would do—making sure that inflation averages two percent over time.
Despite the major political transformation that the country has undergone since the end of apartheid, and the government’s overriding policy goal of making growth more inclusive, there has been a stark divergence between the incomes of the rich and poor.
Between 1993 and 2019, the real average pretax income of the top 10% of earners grew by 30%, while that of the bottom half dropped by 30%, according to preliminary estimates by Aroop Chatterjee of the Southern Centre for Inequality Studies at Wits University, Léo Czajka of the Université Catholique de Louvain in Belgium, and Amory Gethin of the World Inequality Lab.
The top 1% have done the best of all, experiencing average income growth of 50% over this period.
The divergence became even more acute after the global financial crisis of 2008, according to a separate paper, “Exclusive Growth? Rapidly Increasing Top Incomes amid Low National Growth in SA”, by Ihsaan Bassier, a researcher at the Southern Africa Labour & Development Research Unit at the University of Cape Town, and Woolard.
The researchers find that between 2003 and 2017, the top 1% experienced real compound average income growth of 4%-5% a year, with their real income nearly doubling over this period. By contrast, the incomes of the rest of the population mostly stagnated.
The upshot has been increased income inequality — something Bassier and Woolard describe as “an alarming trend in one of the most unequal countries in the world”. It is also starkly at odds with SA’s aim of fostering inclusive growth.
In short, what little growth the country has seen since the global financial crisis seems to reflect higher growth in top incomes, rather than inclusive growth. In other words, they say, “growth in SA has almost never been pro-poor”. This is despite the fact that the government has put in place an extensive social transfer system, including grants, to uplift the poor.
Previous studies have shown that SA’s tax-and-transfer system is highly redistributive, reducing SA’s Gini coefficient from 0.74, to 0.63 once taxes and transfers are taken into account. (A Gini score of 1 represents absolute inequality; 0 is absolute equality.) As Woolard explains: “SA does more to redistribute than any other country … but inequality after taxes and transfers is still higher than in any other country.”
Importantly, Chatterjee and his colleagues show in their soon-to-be released paper, “Inequality, Redistribution and Growth: Evidence from SA (1993-2019)”, that the income losses of the poor have been almost fully compensated for by government social spending.
For instance, in 2019, the average pretax income of the bottom 50% of SA earners was just $1,400 a year (in real 2019 US dollar purchasing power parity, or PPP, terms), but this rises to $2,500 once social grants are factored in. This number climbs even further to $3,500 once the impact of government health expenditure is included, and to $4,500 once education expenditure is added. In other words, the state’s tax-and-transfer system boosts the earnings of the poor threefold.
However, this increased social spending by the government is only possible thanks to a large increase in tax revenue. Total tax revenue rose from 29% to 37% of net national income (NNI) between 1993 and 2019, allowing government spending to rise from 32% to 41% of NNI over the same time.
Over the past 15 years, the state welfare system has increased its coverage from 13% to 31% of individuals (or 44% of all households).
What is hard to believe, however, is that the increase in social spending has been paid for not only by higher taxes on the rich, but also by higher taxes on the bottom 50% themselves, mostly in the form of VAT, excise duties and trade tariffs, according to the Chatterjee paper.
Or, put more bluntly: the poor pay out in tax almost exactly as much as they receive back in state transfers.
For example, Chatterjee and his co-authors show that, in 1993, those in the second-lowest decile spent 27% of their pretax income (including social grants) on indirect taxes. By 2019, that figure had grown to about 37%. The proportion of income spent on VAT climbed from 15% to 21% over this period.
The researchers also consider it likely that the levels of indebtedness among the poor are so high that many are borrowing to finance consumption — losing significant disposable income to interest payments in the process. (The total interest paid by SA households is equivalent to an astonishing 5% of NNI.)
The researchers acknowledge that these consumption trends may be overstated due to possible measurement errors, yet these findings also seem to be borne out by the fact that SA’s aggregate household savings rate is negative: 75% of South Africans declare in some surveys that they have “no savings in case of emergency”.
The upshot is that despite all government’s efforts at redress, the after-tax disposable income of the bottom 50% of earners still averaged about $1,400 in real PPP terms in 2019 — 30% below where it was in 1993.
In short, even though the government’s social transfer system provides a huge boost to the earnings of the poor, their real disposable income has been rendered so low (by debt, taxes and the high cost of living) that the poorest 50% are worse off now in terms of their take-home pay than they were at the dawn of democracy.
Still, it would be wrong to conclude that this means income inequality between black and white South Africans must have worsened or at least stayed the same since the end of apartheid.
While the top 1%-10% of South Africans seem to have been the main beneficiaries of economic growth, the racial composition of this group has completely changed.
Consider that in the early 1970s, all of the top 10% and top 1% of earners were white. But by 2019, 37% of the top 1% were black (and 50% white), and there were slightly more blacks than whites in the top 10%.
Chatterjee and his co-authors find that where the average white person earned seven times more than the average black person in 1994 (a ratio of 7:1), this had dropped to 4:1 by 2019. In other words, SA has almost halved racial income inequality over the life span of the new democracy.
This is quite an achievement — or it would be, if these gains had been broad-based.
However, the researchers’ findings suggest the reduction in racial income inequality has been driven by the rise in incomes of the richest 5% of black people. The rest of the black population group has been left behind.
This suggests that the big income inequality gap in SA is not only between blacks and whites (a ratio of 4:1 means there is still a vast gap), but even more so between those with marketable skills and decent jobs and those without.
Globally, the steep increase in top income percentile shares over the 20th and early 21st centuries, particularly in English-speaking countries, has been well documented by French economist Thomas Piketty, among others.
Piketty argues that if capital returns are greater than economic growth rates, then the incomes of those in possession of capital (typically the most affluent) will grow at a faster pace.
That phenomenon seems to have played out in SA: income from capital (shares, profit, capital gains) grew at a compound annual rate of 10%-20% from 2011 to 2014, while labour market income averaged just 2%-3% over the same period.
Bassier and Woolard conclude that in SA the divergence in incomes has been partly driven by high returns to capital enjoyed by the big earners, since a greater share of their income comes from investments (see graph).
And yet this does not explain the rapid income growth enjoyed by individuals in the 95th to 99th percentiles, who still derive 80% of their income from salaries and bonuses. This suggests that in SA, wage growth — and the type of jobs performed by high-income earners and their marketable skills — has also played a decisive role in driving income inequality.
In Bassier and Woolard’s study, the top 1% begins with those earning about R800,000 a year, and includes occupations ranging from university professors and general medical practitioners to the CEOs of large firms. Most of the people in the 75th to 90th percentiles (who were employed but experienced little real income growth) worked in elementary occupations, had skilled jobs in agriculture or fisheries, or were machine operators.
Their study suggests that higher-income South Africans may have been able to capture more of the gains from economic growth by virtue of having higher bargaining power — which is something that continuing skills-biased technological change may have steadily increased.
And, in another fascinating observation, Bassier and Woolard also suggest that trends in public-sector employment may have helped to widen income inequality in SA over the past decade.
They point out that the big increase in the number of public servants, and the upward shift in the distribution of their salaries, meant that by 2008, 37% of all top-five percentile individuals worked for the government (roughly 50% of all public-sector employees).
R350 a month won’t buy stability
The finding that wage growth has driven income inequality in SA — and that the tax-and-transfer system has been unable to alter this — has profound policy implications.
Says Woolard: “Fiscal policy can only do so much; further reductions in inequality will need to come primarily from changing the distribution of labour market incomes. We need more jobs and less wage inequality.”
This is not to say that Woolard thinks cash transfers are unimportant. On the contrary, she regards SA’s social welfare grants as “a big success story”.
For one thing, cash transfers are essential for short-term poverty relief, and help break intergenerational poverty by ensuring that children are better nourished, better able to access health care and better able to stay in school.
“But this doesn’t mean we can let our government leaders off scot-free by suggesting that cash transfers are enough,” says Woolard. “They also need to improve the schooling system, provide quality universal health care and build infrastructure. There are really tough fiscal choices to be made.”
These are the difficult choices that the finance minister will face as he reprioritises spending to help finance the relief package — especially as it will be hard to cut the usual soft targets of state security and infrastructure in the wake of the unrest.
Yet it seems the toughest choice of all — to reject demands for a universal BIG that would have doubled the state’s welfare bill — has already been made. For, while the budget numbers have been rearranged by the latest unrest, the underlying fiscal approach has not been abandoned.
SA’s fiscal stance is that the best way to support the economic recovery and avoid a sovereign debt crisis is not by increasing government spending through higher taxes and borrowing, but by doing the complete opposite: working to stabilise debt, and implementing structural reforms to accelerate growth and job creation. It is an attempt to reverse the disastrous course of the past decade, during which inefficient, consumption-led government spending led to an unsustainable build-up of debt in exchange for very little growth.
Private-sector economic activity also fell, as the excessive debt put upward pressure on real borrowing costs.
The government’s new approach was reinforced when it terminated the special Covid relief grant at the end of April. It was a harsh decision, given the deep scarring wrought by the pandemic, especially on lower-income groups — but it was consistent with the state’s vow to rein in spending.
Yet since the unrest, the consensus in SA seems to be shifting to the view that raising welfare spending is akin to taking out an insurance policy to prevent hunger and anger from boiling over and being exploited by political opportunists.
This argument is that it’s no longer about whether SA can afford to provide income support to unemployed adults, but whether it can afford not to.
In the post-unrest context, reinstating the Covid grant may well be the right course of action — at least in the short term, while buffers exist. This is true not only from a political, humanitarian and constitutional perspective, but because the evidence suggests that high inequality is bad for growth and for social stability.
Greater inequality implies higher inequality of opportunity, which leads to the waste of human potential and discourages innovation and effort, says Woolard. It also erodes people’s social mobility which, in turn, erodes their aspirations and perceptions about fairness and trust in society.
“When taken to the extreme, the cycle of low perceived mobility and low aspirations creates social instability,” she adds. This implies that “we will need to address the inequality challenge if we are serious about spurring long-term, sustainable growth”.
Institute for Economic Justice co-director Gilad Isaacs argues that fiscal sustainability, economic growth and the provision of social welfare are mutually reinforcing — not opposing — imperatives.
Addressing inequality is the key to securing social stability, but the only sustainable way to do so is by creating more jobs
“You cannot stabilise public debt without economic growth,” he says. “And you cannot grow on the back of falling demand from a starving population unable to even secure their health and educational needs.”
This is a sentiment that Ramaphosa seemed to endorse in his speech, when he said: “No country can expect its economy to grow or people to live in peace and harmony while many of its citizens remain marginalised, hungry and excluded.”
But, clearly, a grant of R350 a month isn’t going to buy SA peace and harmony. For that SA needs to create jobs — and lots of them.
“Even though a grant puts a bit of food in your stomach, it does not give you hope that the future will look better than today,” says University of the Free State economics professor Philippe Burger. To have that hope, people require options, and agency, and the resources to improve their lives.
“To help the poor we need to create jobs, and for that we need investment,” he says.
In recent years, private investment has averaged a mere 12% of GDP. But Burger points out that, given the strong correlation between private investment and growth, if it could be lifted to 15% or even 18% it would add an extra one or two percentage points to the nation’s GDP.
This would raise the rate of job creation by the same amount, given the 1:1 relationship between growth and employment.
But for this to happen, the government will have to see the private sector as a true partner, he says, one whose expertise and capital can be used to further leverage the state’s plans.
“We therefore need to seriously reconsider our policies, speed up much-needed change and start building a believable message of hope — hope stemming from real concern for the plight of the poor and serious implementation of [reforms].”
Ramaphosa conceded this when he said that the recent events had made the implementation of the economic recovery programme “even more urgent”.
Still, his bland assurance that the government would “accelerate the implementation of reforms, drive inclusive growth and create jobs” rang hollow, since it was accompanied by no practical road map to achieve this.
It was surely the right moment to have declared that the government would repeal 100 pieces of red tape in 100 days; or that a new growth-friendly scarce skills policy would be published this week; or that the backlog of 5,000 mining licences, which is holding back about R30bn in investment, would be cleared by the end of the year. Yet he didn’t announce any of this.
Some economists fear that the government, having delayed and bungled structural reform for so long, has too little credibility to ignite an investment revival. Certainly, the government’s inept response to the looting has severely damaged SA’s investment case — possibly beyond repair.
Organised business remains constructive, and many affected firms have been quick to restock and rebuild. But it’s impossible not to sense the fear bubbling under the surface, or ignore the feeling that business’s heart is no longer in it.
“Fundamentally, the willingness of businesses to take on risk by financing rebuilding will depend on the confidence they have in the future,” says Business Leadership SA’s Busi Mavuso.
Before the violence, that confidence was returning, thanks to vital structural reforms the government had announced, she says. Now — in addition to the stated priorities of addressing chronic energy insecurity, spectrum allocation and visa reform — restoring confidence in the security services has become paramount.
“That, plus structural reforms … are now key to whether businesses will have the confidence to rebuild,” Mavuso adds. “We need to redouble our efforts to get the economy moving.”
SA is skating on very thin ice. There can be no more mistakes.
Change happens quickly and, often, unpredictably. And as we will see, the unpredictable part is actually a mathematical principle. Not just bankruptcy but change also happens slowly and then, seemingly, all at once. It’s time passing without change that causes the worst problems, including some historic economic catastrophes. It turns out we shouldn’t just accept change; we actually need it.
Last time, I said we would skip this letter since I’m fishing with friends at Camp Kotok. But over the weekend, I realized it would be a perfect opportunity to repeat part of a letter I originally wrote in 2006 and have referred to several times. It is the single most-read letter I have written and the most commented-on, too. I consider it, in some ways, my most important letter. You should read it again if you’ve read it before. I have updated it a little bit, but the principles are timeless.
I’ll be quoting from a very important book by Mark Buchanan called Ubiquity, Why Catastrophes Happen. I HIGHLY recommend it if you, like me, are trying to understand the complexity of the markets. The book isn’t directly about investing—although he touches on it—it’s about chaos theory, complexity theory, and critical states. It is written so any layman can understand—no equations, just easy-to-grasp, well-written stories and analogies.
Here’s that story with some new comments and thoughts afterward.
As kids, we all had the fun of going to the beach and playing in the sand. Remember taking your plastic bucket and making sandpiles? Slowly pouring the sand into ever bigger piles until one side of the pile starts to collapse?
Imagine, Buchanan says, dropping one grain of sand after another onto a table. A pile soon develops. Eventually, just one grain starts an avalanche. Most of the time, it’s a small one. But sometimes, it builds up, and it seems like one whole side of the pile slides down to the bottom.
Well, in 1987, three physicists named Per Bak, Chao Tang, and Kurt Wiesenfeld began to play the sandpile game in their lab at Brookhaven National Laboratory in New York. Actually, piling up one grain of sand at a time is a slow process, so they wrote a computer program to do it. Not as much fun, but a whole lot faster. Not that they really cared about sandpiles; they were more interested in what are called “nonequilibrium systems.”
They learned some interesting things. What is the typical size of an avalanche? After a huge number of tests with millions of grains of sand, they found out there is no typical number:
Some involved a single grain; others, ten, a hundred, or a thousand. Still others were pile-wide cataclysms involving millions that brought nearly the whole mountain down. At any time, literally anything, it seemed, might be just about to occur.
The pile was indeed completely chaotic in its unpredictability. Now, let’s read this next paragraph slowly. It is important as it creates a mental image that helps clarify the organization of the financial markets and the world economy.
To find out why [such unpredictability] should show up in their sandpile game, Bak and colleagues next played a trick with their computer. Imagine peering down on the pile from above and coloring it in according to its steepness. Where it is relatively flat and stable, color it green; where steep and, in avalanche terms, “ready to go,” color it red. What do you see? They found that at the outset, the pile looked mostly green, but that, as the pile grew, the green became infiltrated with ever more red. With more grains, the scattering of red danger spots grew until a dense skeleton of instability ran through the pile. Here then was a clue to its peculiar behavior: a grain falling on a red spot can, by domino-like action, cause sliding at other nearby red spots.
If the red network was sparse, and all trouble spots were well isolated one from the other, then a single grain could have only limited repercussions. But when the red spots come to riddle the pile, the consequences of the next grain become fiendishly unpredictable. It might trigger only a few tumblings, or it might instead set off a cataclysmic chain reaction involving millions. The sandpile seemed to have configured itself into a hypersensitive and peculiarly unstable condition in which the next falling grain could trigger a response of any size whatsoever. (Emphasis mine.)
Something only a math nerd could love? Scientists refer to this as a critical state. The term critical state can mean the point at which liquid water would change to ice or steam or the moment that critical mass induces a nuclear reaction, etc. It is the point at which something triggers a change in the basic nature or character of the object or group. Thus (and very casually, for all you physicists), we refer to something being in a critical state (or use the term critical mass) when there are the conditions for significant change.
But to physicists, [the critical state] has always been seen as a kind of theoretical freak and sideshow, a devilishly unstable and unusual condition that arises only under the most exceptional circumstances [in highly controlled experiments]… . In the sandpile game, however, a critical state seemed to arise naturally through the mindless sprinkling of grains.
Thus, they asked themselves, could this phenomenon show up elsewhere? In the earth’s crust, triggering earthquakes, in wholesale changes in an ecosystem, or in a stock market crash? “Could the special organization of the critical state explain why the world at large seems so susceptible to unpredictable upheavals?” Buchanan asks.
Buchanan concludes in his opening chapter:
There are many subtleties and twists in the story… but the basic message, roughly speaking, is simple: The peculiar and exceptionally unstable organization of the critical state does indeed seem to be ubiquitous in our world. Researchers in the past few years have found its mathematical fingerprints in the workings of all the upheavals I’ve mentioned so far [earthquakes, eco-disasters, market crashes], as well as in the spreading of epidemics, the flaring of traffic jams, the patterns by which instructions trickle down from managers to workers in the office, and in many other things.
At the heart of our story, then, lies the discovery that networks of things of all kinds—atoms, molecules, species, people, and even ideas—have a marked tendency to organize themselves along similar lines. On the basis of this insight, scientists are finally beginning to fathom what lies behind tumultuous events of all sorts, and to see patterns at work where they have never seen them before.
So, what happens in our game?
After the pile evolves into a critical state, many grains rest just on the verge of tumbling, and these grains link up into “fingers of instability” of all possible lengths. While many are short, others slice through the pile from one end to the other. So, the chain reaction triggered by a single grain might lead to an avalanche of any size whatsoever, depending on whether that grain fell on a short, intermediate, or long finger of instability.
Now we come to a critical point in our discussion of the critical state. Read this next excerpt with the markets in mind (and this is critical to our understanding of markets and change. Maybe you should read it two or three times.):
In this simplified setting of the sandpile, the power law also points to something else: the surprising conclusion that even the greatest of events have no special or exceptional causes. After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point.
What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size. (Emphasis mine.)
Now, let’s couple this idea with a few other concepts. First, economist Dr. Hyman Minsky showed how stability leads to instability. The more comfortable we get with a given condition or trend, the longer it will persist, and then the more dramatic the correction when the trend fails.
The problem with long-term macroeconomic stability is that it tends to produce unstable financial arrangements. If we believe that tomorrow and next year will be the same as last week and last year, we are more willing to add debt or postpone savings in favor of current consumption. Thus, says Minsky, the longer the period of stability, the higher the potential risk for even greater instability when market participants must change their behavior.
Relating this to our sandpile, the longer a critical state builds up in an economy—or in other words, the more fingers of instability that are allowed to develop a connection to other fingers of instability—the greater the potential for a serious avalanche.
A second related concept is from game theory. The Nash equilibrium (named after John Nash, subject of the Oscar-winning movie A Beautiful Mind) is a kind of optimal strategy for games involving two or more players, whereby the players reach an outcome to mutual advantage. If a game has a set of strategies with the property that no player can benefit by changing his strategy while the other players keep their strategies unchanged, then that set of strategies and the corresponding payoffs constitute a Nash equilibrium.
So, we end up in a critical state of what Paul McCulley calls a “stable disequilibrium.” We have players all over the world tied inextricably together in a vast dance through equities, debt, derivatives, trade, globalization, international business, and finance. Each player works hard to maximize their personal outcome and reduce their exposure to fingers of instability.
But the longer the game runs, says Minsky, the more likely it is to end in a violent avalanche, as the fingers of instability have more time to build, and, eventually, the state of stable disequilibrium goes critical.
Go back to 1997. Thailand began to experience trouble. The debt explosion in Asia began to unravel. Russia was defaulting on its bonds. (Astounding. Was it less than 25 years ago? Now Russia is awash in capital. Who could have anticipated such a dramatic turn of events?) Things on the periphery, small fingers of instability, began to impinge on fault lines in the major world economies.
Something that had not been seen before happened. The historically sound and mathematically logical relationship between 29-year and 30-year bonds broke down. Then country after country suddenly and inexplicably saw that relationship in their bonds begin to correlate, an unheard-of event. A diversified pool of debt was suddenly no longer diversified. The fingers of instability reached into Long Term Capital Management and nearly brought the financial world to its knees.
And now, different fingers of instability are creating an even worse crisis in the credit markets.
All right, back to the present. When I originally wrote that letter, it was 2006, and the fingers of instability hadn’t yet created the Great Recession. You could certainly see red dots in the sandpile, most notably subprime debt, but there were literally hundreds of dots scattered throughout the world economy, most of them innocuous until they weren’t. And then the scramble for liquidity began, except the liquidity wasn’t there, and, well, you know the rest of the story.
This should be even more concerning if you think about my recent series on what I think is a major policy mistake being made by the Federal Reserve and central banks worldwide. We are adding sand to not just one inevitably collapsing sandpile, but dozens and maybe hundreds of them. They won’t keep growing forever.
Which particular sandpile will fall first? It could be many, but it will likely be debt-oriented. And the fingers of instability tell us that it doesn’t matter which grain of sand is the trigger, just that there will be one. Millions of investors think they can continue acting as if today will just be like yesterday, which will be like tomorrow, and then be able to sell when trouble appears.
They’re partly right. They will be able to sell… but well below the prices they expect.
I write often about the connectedness of so many global markets and how the debt crisis, unfunded pension liabilities, and government promises all over the world seemingly keep mounting, yet markets go up more.
I think the mother of all Minsky moments is building. It will not be an instant sandpile collapse but instead, take years because we have $500 trillion of debt to work through. Remember, that debt just can’t be swept away. It is both money somebody owes and an asset on somebody else’s balance sheet. If you are retired, your pension and healthcare benefits are part of your net worth. They are assets on your balance sheet that you count on to cover future spending. We can’t just take that away without huge consequences to culture and society.
But the fingers of instability, the total credit system, are seemingly growing with more red sand dots every month. All are inextricably linked. One day, another Thailand or Russia or something else (it makes no difference which) will start a cascade.
Remember, very astute people saw the subprime crisis and made a lot of money shorting that market. I saw it coming but didn’t know how to trade it. I guarantee you, I’m paying attention now to who can profit from the next credit crisis. Maybe I’ll succeed, and maybe I won’t, but just once, I would like to be on the right side of a crisis.
One last comment that I picked up over the years. My friend Peter Boockvar actually crystallized this thought, but I think I’m going to make it part of my own liturgy: We no longer have business cycles; we have credit cycles. Central banks and governments, not to mention investment banks and investors, are all using credit in formerly unbelievable ways, and I am here to shout that the world is becoming one massive finger of instability.
Let’s go back to that 1987 mathematical experiment. The simple fact is there are green sand dots all over the world. They represent stability in the global system, which is allowing the fingers of instability to build up in a potentially deadlier way than we have ever seen before.
While we have had to deal with a virus-triggered recession, we are thankfully watching the economy begin to grow again. It is happening in ways that will make the world look different in 2022 than it did in 2019.
We take comfort from the stability we see around us. Corporate profits are up. We are greeted every day with some amazing new technological innovation that changes everything in some industry. Living standards keep rising.
And yet, Minsky tells us stability breeds instability. That sandpile experiment, as simple as it seems now, shows that the longer the stability lasts, with the fingers of instability connecting in hidden and unknown ways, the greater the avalanche will be.
I suggest you read at least the first half of Nassim Nicholas Taleb’s book, Antifragile. Here are three lessons that will show you what it means to be antifragile:
This is a great way to explain the sandpile game in economic terms. Economic sandpiles that have many small avalanches never have large fingers of stability and massive avalanches. The more small, economically unpleasant events you allow, the fewer large and, eventually, massive fingers of instability will build up.
Efforts by regulators and central bankers to prevent small losses actually create the large fingers of instability that bring down whole systems and spark global recessions. And, increasingly, the unfunded liability of government promises will be the most massively unstable finger.
In that crisis, things that should be totally unrelated will suddenly become intertwined. The correlations of formerly unrelated asset classes will all go to one at the absolute worst time. Panic and losses will follow. Governments will try to stem the tide, perhaps appropriately so, but, eventually, the markets have to clear.
There is a surprising but critically powerful thought in that computer model from 35 years ago: We cannot accurately predict when the avalanche will happen. You can miss out on all sorts of opportunities because you see lots of fingers of instability and ignore the base of stability. And then you can lose it all at once because you ignored the fingers of instability.
You need your portfolios to both participate and protect. Don’t blindly buy index funds and assume they will recover as they did in the past. This next avalanche is going to change the nature of recoveries as other market forces and new technologies change what makes an investment succeed.
I cannot stress that enough. Don’t get caught in a buy-and-hold, traditional 60/40 portfolio. Don’t walk away from it. Run away.
Cautious optimism is always the long-term winner. Always. But a buy-and-hold portfolio in today’s world is neither cautious nor optimistic. Hope is not a strategy. That’s precisely what a buy-and-hold portfolio is.
South African savers, dependent on their pension and retirement plans, will have become aware that the actions of the Chinese Communist Party are sometimes more important than the actions or non-actions of the ANC. This is because of their likely large stake in a Chinese Internet giant, Tencent, held through their shares they own in JSE listed Naspers, (NPN) and via its controlling stake in Amsterdam and JSE secondarily listed, Prosus. (PRX)
Because of the much greater uncertainty about the policies the Chinese will apply to the Tencents, the Alibabas and Baidus and their like, a share in NPN or PRX has become much more risky to hold and therefore less valuable. Shareholders taking on more risk require compensation in the form of higher expected returns, this almost always means a lower entry price, a lower current share price.
The risk to any asset holder is simply the risk that the price of the asset they hold may rise or fall from its current level, should they have to or be forced to cash in their investment at some perhaps unknown point in time. The chances of a rise or fall from the current market determined price, assuming a well-informed active market in them, will be about the same 50% on any one day. Market prices follow a random walk, rising and falling in an irregular sequence. Hopefully these random movements come with an upward drift to bring actual returns in line with the higher expected returns, that make holding risky assets a rational choice for the long-term investor.
In riskier times the daily or hourly moves in both directions, up and down, become significantly wider, while the average move over any extended period will still stay close to zero. When the sense of the future becomes less certain, volatility of share prices increase, the standard deviation of daily moves about the average of almost zero widens, and the cost of insuring against such changes in market prices in the form of an option to buy or sell an option on the share or Index inevitably increases. As it has done in the case of Naspers.
The recent increase in the daily volatility of NPN has been of extraordinary dimensions. Daily share price declines of 7% and then increases of 10% on August 10th are truly exceptional and reveal how difficult it has been for well informed investors to make up their minds about what the future will hold for Tencent, NPN and PRX. The standard deviation of daily moves in the NPN share price (30 day moving average) has almost trebled since June 2021.
Volatility compared; S&P 500 (VIX) JSE Top 40 SAVI and NPN Standard Deviation of Daily price Moves (30 day moving average of the daily SD) to August 9 2021
The rewards for holding on to your NPN or PRX shares remain to be seen. The China risks may decline to help add value. NPN management also hopes that the value of an NPN or PRX will be enhanced by the shares trading more closely to the market value of their Tencent Holdings. They are re-jigging the allocation of its Tencent holding between Johannesburg and Amsterdam to attract stronger investor interest to reduce this discount to the sum of its parts, mostly Tencent.
My theory is that the value lost by shareholders is mostly because of scepticism about the value of the acquisitions and investments made by NPN/PRX. They are expected to return much less that the investors could earn for themselves taking on similar risks and so investors and analysts write down the value of this expensive investment programme when they estimate the value of NPN or PRX. The more invested, the more value destruction expected, the lower the value of an NPN or PRX share and the larger the discount. With the completion of the latest restructuring in sight we will see the alternative theories of the discount put to the market test.
The one possible for shareholders – if my theory holds – though it would be a bitter consolation, is that the lower the Tencent share price and the weaker the NPN and PRX balance sheets, the more disciplined and constrained will be their investment and borrowing programmes…. And the lower the discount.