MACRO ECONOMIC COMMENTARY – JULY 2020

Author: Ntsekhe Moiloa

Gustav Mahler came to mind when the news flashed across the ticker that the United States had demanded that China close its Houston consulate within 72 hours. While Houston is a large city, at first glance it seems a peculiar location to be targeted. However, back when China and the United States started formalising diplomatic relations, Houston was the first consulate-general established in 1979. The consulate looks after southern states as well as Puerto Rico, but it is also accused of being an important hub for the theft of American intellectual property. Whether this is true is open to conjecture.

The final straw appears to be when local police were alerted to a fire emanating from the consulate, and American politicians alleged that consulate employees appeared to be destroying sensitive documents on a bonfire. And so, Mahler’s remark that “tradition is not the worship of ashes but the preservation of fire” came to mind. On both sides of the trade war, the aggregating habit has become to make the bonfire larger – to preserve it – rather than to allow it to diminish into a pile of ashes.

tradition is not the worship of ashes but the preservation of fire

Gustav Mahler (Composer)

A tradition that we do wish would become a pile of ashes is the tradition of an underwhelming economy in South Africa. The OECD published estimates that it expected South Africa’s economy to contract by about 7.5 percent in 2020 if the country can avoid a second wave of COVID-19 infections. If not, the organisation expects the contraction to be about 8.2 percent. Interestingly, the OECD’s inflation rate outlook bottoms above where current inflation is printing, but the expected recovery in the inflation rate is slow into mid-2021. In the current, slow economic environment, the trajectory sounds about right albeit from a lower level. However, is it possible that the trajectory could be steeper, again from a lower level?

While we are accustomed to thinking of inflation being the result of excess demand driving up prices for limited goods, about half a century ago Milton Friedman famously contended that, “inflation is always and everywhere a monetary phenomenon.” Studies have suggested that M2 growth is the most significant driver of inflation. Issue 4 of the ECB’s Economic Bulletin of 2017, for example, readily points to central bank monetary policy as the key driver of overall inflation over the medium term. This dynamic puts us in a curious position today. At present, economic assets are under-utilised and demand is weak as countries are in various states of coronavirus pandemic management. In other words, there is economic slack. The impact is large. For instance, second quarter Eurozone GDP was down 12.1 percent from the previous quarter after the first quarter had registered a 3.6 percent decline.

Nevertheless, tremendous amounts of liquidity have been injected by monetary authorities; but, not many investors are having sleepless nights about a pending wave of inflation. Are they being naive?

Well, it is not just investors who are unperturbed about inflation risk. In the post-GFC recovery, inflation generally did not pose a problem despite four waves of quantitative easing, so central bankers do not have a reason from recent memory that would caution them against helicopter money. Indeed, institutions like the San Francisco Fed committed considerable digital ink to trying to understand why inflation was so benign.

What is different this time is the additional fiscal liquidity provided, and how it has been provided. Previously, there was relatively little participation from fiscal actors. In the post-GFC period liquidity was provided to the banking system which in aggregate shrunk its lending anyway; this time a meaningful amount is being mailed directly to consumers. The question is, of course, whether they spend or save. The initial indications — from Americans at any rate — is that they are emulating the post-GFC banks and saving at an aggregate level.

A stimulus shot was also administered to South Africa a few months ago, and again, there was a dose for individuals as well. It may be too early to tell but while the South African Reserve Bank has lowered interest rates and temporary, extra social security payments have been made, inflation is not yet an issue. At the end of the month, StatsSA published the June inflation reading, finally catching up after a delayed April number first put the publication schedule out of kilter. After a May reading of 2.1 percent, year-on-year inflation in June was calculated as 2.2 percent. For the months ahead, the inflation rate is expected to rise again as the tailwind of low fuel prices begins to fade. However, in other categories, inflation pressure is expected to remain fairly low.

Although lockdown restrictions have been eased, mobility trends from Apple and Google show the movements of South African residents remaining well below the levels of the beginning of the year. With South Africans moving about relatively little, it is unsurprising that demand for imported goods such as fuel has been moderate. Other import categories which are suffering include machinery and electronics, vehicles and transport equipment, original equipment components, textiles and mineral products. June exports, on the other hand, increased by over 10 percent month-on-month to ZAR 116.3bn while imports dropped by nearly 19 percent month-on-month. Exports of precious metals and stones, vehicles and transport equipment, machinery and electronics and vegetable products increased in June. This culminated in the South African trade balance for June overshooting expectations and registering a surplus of ZAR 46.6bn from an upwardly revised May surplus of ZAR 19.7bn. This was the biggest surplus in 30 years.

We are careful not to ascribe increases in South African exports as an indication that the world is back to trading with enthusiasm. As we scrambled to understand the importance of the demand that the Houston consulate be closed, we discovered that China stands accused by the FBI of harbouring a fugitive from justice in its San Francisco consulate. Tang Juan is accused of committing visa fraud to come to the US as a scientific researcher when she claimed to have no affiliation to the Chinese military. Right at the end of the month she was arrested after leaving the consulate to obtain medical care for her asthma. With an election later this year, there is little to suggest that the Mahlerian fire will not be preserved, fed by revelations such as this California case. In that case, we do not expect an easing in the US-China trade standoff.