China's stranglehold

BRICS - the acronym originally coined by Goldman Sachs, isn't exactly food for the imagination. Even so the moniker stuck and as the laws of gravity dictate and as the epithet suggests, like a stone has settled nicely at the bottom of the economic quagmire.

The original BRIC, for those of you who don't know, defined the broad association of the four major emerging economies; Brazil, Russia, India and China. In 2010 the plural was added with the addition of South Africa and since those heady days and the euphoria of that headline we haven't come up for air even once.

In 2007 the China-owned ICBC bought 20% of Standard Bank, South Africa's largest bank by assets & earnings. At that time it was the ICBC's largest investment outside of China. By inference it was also the perfect window into Africa; where local knowledge & expertise was acquired for not much more than 30 pieces of silver... Oh captain, my captain.

Simultaneously China continued to accumulate Africa's primary resources / commodities by all means legal.. - either by entreaty, trade-treaty or by IOU and we loved them for it. So enthralled were we that we filled boatloads of Africa's future at prices-past whilst the puppet-master piped the economic tune. Elsewhere EMEA and other 1st-world professionals / experts plied the Chinese with intellectual capital as fast as Switzerland could absorb the short-term Judas-change. China's only contribution was artificially-cheap labour & an enforced / exploitative work-ethic. Made in Italy was really Slapped-up in China and for a while consumers noted a disparity in quality. As a consequence China upped the ante. Quality became the focal point. Soon goods usually made by hand, with scrupulous attention to detail and by processes handed-down from craftsmen to craftsmen, were no better than China's / [Germany-sold]  mass-produced-machine-product. Craftsmen all around the globe perished on China's ambition to own the shelves & her propensity to exploit her own people. Mainstream media fobbed off these inevitable consequences as a spin-off of GLOBALISATION and derided the craftsmen for their tardiness and inefficiencies.

Back in South Africa China's easterly vacuum accounted for both our intellectual property & our hard-commodities. Trees were felled to make Chinese-built, Chinese-staffed & Chinese-supplied thoroughfares usually into the hinterland where more trees were shelled and more holes dug. That the infrastructure has subsequently begun to disintegrate is a discussion for another time. Shipping lanes were gridlocked with the outflow. Around about then ships, hitherto empty, started returning to South Africa fully laden with Made in China. 

Made in China carried a State-subsidised price tag & almost always significantly lower than the prices of similar goods Made in South Africa. Local product competed for a while, usually on loyalty, but in time-honoured fashion, consumers eventually felt compelled to take advantage of the foreign boon. Domestic industry suffered; the Textile-Sector first to mothball their looms. Ordinary, hard-working generations of South Africans were subsequently made redundant and became integral to the burgeoning unemployment statistic. Breadwinners became welfare-dependents and their own school-going dependents, expelled by circumstance to earn a crust. Perversely domestic commodities were ruthlessly wrenched from African soil and shipped unrelentingly East.

Next to go was the domestic white-goods industry. Tariff-free goods Made in China and subsequently dumped in the retail outlets, confounded strategic rationale. Inevitably there were more redundancies; more unemployment - more desperation; more crime. Consumers, bloated on cheap fridges & kettles, pointed accusatory fingers at the Executive for doing less than their crime-mandates had promised. The domestic currency slipped against the basket - and the unraveling began in earnest. Other domestic sectors, drowning in this sea of Chinese goods, adapted as best they could and by the only means open to them - redundancies. Staff-cuts, across the board,was a humanitarian tsunami that struck the core of South Africa's psyche. The rand deteriorated further. Goods became more expensive to import & in the absence of a domestic industry, we had no other choice. As a consequence we started to import inflation and around about then growth began to deflate. Our interest rates remained low - inflation targets notwithstanding. Lacking the economic backbone of a strong domestic industry and an employed workforce, South Africa's ability to stave off the inevitable became academic at best. Ratings agencies sat up and noticed. The rand deteriorated further. The financial-garrote pulled tighter.

In recent times the once-prosperous mining sector, wholly premised on Chinese-demand, has finally succumbed to fear-induced staff-cuts, the severity of which few people truly comprehend. China's structural over-capacity negates demand, even temporarily and South Africa's reliance on a single basket for all her eggs is a childhood lesson long unlearnt. More redundancies, less consumer-spending; more lay-offs, more bad-debt; bank failure - collapsed rand and so on. Perversely South Africa's recent cap-in-hand visit to Beijing is a suicidal injustice bloated by systemic incompetence. Who knew we could be this pathetic?

At last we find ourselves at the crossroads of desperation and yet the solution is as obvious as the day burns hottest in Africa. Reinstate national pride by protecting local industry; impose multiple import-tariffs on foreign-manufactured goods and negate China's exploitative reliance on her poverty-controlled people. Let's make knives & forks; stop the export of raw product and value-add our commodities in local industry.  Get our people back to work and back in school! Education is an investment for the future. We are a proud nation; a skilled nation and I don't see why we've allowed ourselves to become the economic slaves of a country which less than a century ago lived a rural life, largely uninterrupted by aspiration and an ambition to rule the world. Who's laughing at whom, exactly?

It's an economic force majeuere..

Where to from here?

For one thing we need to appreciate the burgeoning economic ‘disconnect’ from one region to another. Economic disparities, regional and global, are real and here to stay. Here’s how I see it.

1. The so-called BRICS are all but dead in the water. Aside from China (modest growth) the rest of the team are looking at zero to marginal growth at best. Even Brazil, which raised rates last week in a declining growth environment (historical hyper-inflation jitters), has little chance of beating the average even though they, along with Mexico, are seemingly viewed more positively than all the other economies in that region. 
2. Europe is struggling – period. It’s a self-imposed period of self-loathing rather than a function of external threats.
3. Asian growth is moderate comparable with their immediate past but moderate nevertheless.
4. Japan is ‘in trouble’, by ‘Western economic measurements’; has been for decades and yet enjoys a standard of living seemingly at odds with their GDP-growth. It’s an economic conundrum that might possibly be a function of culture ie: non-spending /savings, rather than anything else. Even so, both Japan and Europe have the financial / structural means to artificially boost their respective economies. 
5. The US is coming up for air at last even if the debt-ceiling is expected to limit their festivities in the next few months. 

The problem in Russia is exactly the same as the one we face in South Africa. Infrastructural-spend / maintenance has been neglected. Commodity prices have plummeted on a scale unprecedented. It’s rumoured that both the oil and iron-ore markets are being manipulated and from the activity on the respective markets that could quite possibly be true. What we don’t appreciate is the following – lower energy prices are stimulatory; significantly more so than giving money to banks to gamble (ie: invest) in the derivative markets. The benefits of lower energy prices is money in the peoples’ pocket; across the board (On the assumption the benefits are not absorbed into the political ether).

The other issue both Russia and SA face is cronyism and the long-term prognosis is much more concerning. Infrastructural neglect from non-compliance, apathy or incompetence has the same end-result. It helps very little to bemoan managerial ineptitude, at state-owned / run enterprises (parastatals), if basic-compliance, compelled by the laws of the day, is effectively / serially circumvented or was ignored in times past. On this point the Zimbabwe-lesson is first-hand experience of the long-term catastrophe caused by misplaced loyalties and or cronyism. Incidentally if Putin was caught ‘flat-footed’ by a collapse in oil markets then, quite frankly, he is more of a threat to the Russian people, in the immediate short-term, than he has already been given the credit for. For what it’s worth that’s been on the cards ever since the US shale-reserve came online, so to speak. In SA the nepotism is less subtle and has the same negative consequences for the country as a whole. The underlying difference, however, between SA and Russia lies largely in the extent of their respective ‘cash-in-the-bank’ reserves. Russia has sufficient for the immediate future; SA does not.

BTW – in my last note to you I said the derivatives market was approximately $600 trillion. I was wrong. It is, in fact, $710 trillion and significantly higher now than it was prior the financial crisis. The risk ‘to the system’ is an obvious code red and the US appreciates the fact. Don’t forget it’s the US banking industry which has the most to lose if the system fails. Hypothetically (ie: for fun) if Putin could /would engineer a black-swan event on global markets or even threaten the US with something along those lines the derivatives market could /would implode. You might be forgiven for guessing that if anything of that sort came to light commodities would recover (remarkably); oil included and sanctions against Russia lifted or lightened.

On the flipside if Russia had to comply with the dictates of sanity only Putin's pride would suffer. Putin likes to box. As an individual he must appreciate the fact that he’s deep in the twelfth looking for a knock-out just to survive. Why they don’t give Ukraine back to the Ukrainians is beyond all comprehension. Access to the Black Sea via Donets’k is in the bag anyway.

Here’s my solution to the economic woes of the world and I will use the financial carrot as a catch-all. Homo sapiens is, after all, a creature of logic premised on material comfort –

• Europe is a ‘welfare-state’ paying good money after bad to protect a lifestyle that is simply obsolete. Siesta time is over. If we are to take Europe seriously then productivity /price efficiency needs redress. Wages must reflect that fact. Protecting intellectual capital is the promise of salvation! The French will revolt..
• Close the tax loop-holes for multi-nationals /transnationals eg: Google, eBay, Intel etc which pay as little as 3% in some countries. Spend this tax-revenue on removing the draconian regulations under which legitimate corporate-Europe currently labours.
• The US political system is defunct. Urgent redress required! Meddling in international affairs is / should be a UN-sanctioned solution. Save the money spent on international peace-keeping efforts and on which moral-legitimacy is worn as a mask for cheaper oil, and reinvest the savings on domestic infrastructure, the manufacturing sector and on national productivity / skills-enhancement programs. 
• Expel China from Africa with immediate effect. Mine the resources and value-add / up-skill the raw material ie: sell the finished goods at a valued premium. China competes in a lob-sided market, premised on skills bought or otherwise and I’m not sure why that has to be. China has the financial resources to absorb the short-term wrist-slap for the ‘good of all’
• If Japan isn’t the perfect example of a nation fed-up with incompetence and mediocrity what is? What Japan has achieved, post WW2, largely hindered by the US btw. is astounding. It’s an example to all that solutions lie in value-add rather than raw product and perhaps, in a more modern context, solutions-driven in technology rather than on human capital alone. Europe’s threat or her obsolescence, if you like, is the forfeiture of technology and other intellectual capital to the East for short-term import-pricing gains at the expense of their own industry.
• As for South Africa if the infrastructural decay continues at the current rate and corruption / incompetence / apathy is not addressed, the best is in the past and that's the truth. Paradoxically, South Africa's issues are, however, possibly the easiest to address if the authorities apply themselves honestly and with some urgency. By way of example the first step [also the easiest] is to declare force majeure at Eskom and cancel the 'electricity at half-price / below cost' contract signed with a private-sector multinational more than 20-years ago. This same multinational uses approximately as much electricity as the rest of the country combined... On this basis Eskom's solvency is assured. Nepotism / cronyism next and an emphasis on adding value to our own raw materials and so on.. 

Emerging markets - NEUTRAL?

It's quite clear that Europe's economy is currently non-sustaining ie: more liquidity is required, especially in the short to medium term. With the systematic transfer of private-sector debt to the public sector there's not too much doubt that the ECB will inject liquidity into the system. That being the case Europe's impact on the global market should be fairly muted in the second half of this year.

More interesting is the debate on China's economy and the commensurate market reaction on the price of commodities. BHP Billiton projects a rosy outlook for commodities, generally and iron-ore specifically. Even so, housing data released this morning suggests that China may be headed for a 'less-soft' landing than initially expected. In addition, one or two developing political nuances in South America and Southern Africa adds fuel to the emerging-market-neutral debate.

Given the global- market aberration and the historically low equity-ratings in the US, it's no surprise that recent global equity-investment flows are US positive. Even so, the currency of the land of the free is only for the brave.