Interest Rates

The Retail Boom in SA

I’ve written about the consumer and retail boom in South Africa many times in recent years – most recently in “SA Mining at ‘Breaking Point'”, “South Africa’s Regressing Economy”, and “Impact of Real Interest Rates on Retail and Manufacturing.”

Retail spending is being funded mostly by borrowing from foreigners and locals selling assets to foreigners. We’re selling our capital stock to foreigners and spending the proceeds, not reinvesting it in manufacturing and productive capacity. A low-real interest rate environment means SA is living beyond its means. It’s a highly bearish long-term development for the SA economy.

Continue reading →

Wenzel On Bob Murphy’s Gloating, And My Two Cents

Just for the record, I agree almost completely with Bob Wenzel’s post, where he takes Bob Murphy to task for gloating to his ‘foes’ about the fact that US Treasury yields rose following Ben Bernanke’s statement that he might taper QE.

Bob Murphy is beating his chest because Paul Krugman and Scott Sumner have for a while been saying that the Fed does not impact long-term interest rates. Bob Murphy disagreed and said the Fed does impact long-term interest rates. After the Fed said it will stop buying Treasury bonds last week, the market has taken these long-term yields to the highest level they’ve been in a while, to which Murphy is saying to Krugman and Sumner, “see I told you so.”

Wenzel writes regarding the problem with what Murphy is doing:

As Mises, Hayek and Rothbard taught, the science of economics is a deductive science, not an empirical science. Let’s consider this possible scenario.What happens if Bernanke retracts his statement in the next few days, as he well might do through leaks to favored journalists, and interest rates continue to climb? This could happen.

Would it not be fair for Krugman and Summers to then argue that Murphy doesn’t know what the hell he is talking about, since he argued that Bernanke’s statement caused the run-up in interest rates but now that  Bernanke is hinting that there will not be any “tapering” soon and interest rates are still climbing that Murphy must have the causal factor wrong?

It is also important to note (as Wenzel kind of does) that US Treasury yields were already in a strong uptrend ahead of the Bernanke speech, suggesting something else was already driving the move (or leaked info from the Fed, but I don’t think so, seeing as the market started the move a month and a half before the statement).

Also, to add another scenario to Wenzel’s, I can foresee a situation where the Fed keeps its ‘taper’ talk going, i.e. continues to commit to scaling back QE, but that US Treasury yields start to decline despite that, as growth slows and the stock market corrects, triggering a rotation out of other assets (equities, commodities, junk bonds, EM assets, etc) into the perceived safety of US Treasuries. An economic crisis in Europe, Japan, or China could also trigger a decline of US Treasury yields, despite Bernanke maintaining the ‘taper’ stance. A combination of the two could possibly drive US Treasury yields back to levels where they were a year ago.

Then Sumner and Krugman could also say “see, the Austrians have the causal factor completely wrong!”

Readers who read this post on clb last week, and followed the link to the client report ETM published in March 2013, will note I clearly state I anticipate a rise of US long-term rates in coming months, but that I didn’t mention what the Fed would be doing in coming months as part of this analysis.

In my opinion, the fundamentals moving US Treasury markets today are due to Fed interventions and monetary distortions from months ago. The line of least resistance was already established, and because the market was already bearish, the bearish news out of the FOMC was exaggerated (and bullish news ignored).

ETM’s View on the US Business Cycle, Treasuries, S&P 500

This is an excerpt from the highlights of the ETM US Business Cycle Monitor published on 13 March, when the US 10yr Treasury yield was just below 2.00% and the S&P 500 was at 1,556 points:

Risk to bond market is to downside and for long bond yields to rise above 2% in coming months. Stock market momentum remains higher toward end 2013, although short-term correction should not be ruled out.

The US 10yr Treasury has climbed to the highest since 2011, rising to 2.60% today, while the Zimbabwe-ification of the S&P 500 has continued for the index to rise to 1,687 points before dropping back to 1,592 points today.

For perspective of why the US markets have behaved in the way they did in the past three months, the full March 2013 ETM report can be downloaded here.  For those wanting a forward looking view of the market, the US economic environment is changing rapidly as broad money growth slows.

We will cover this and the implications for tactical asset allocation to Business Cycle Monitor subscribers in the coming week.

Re: China Business Cycle Crash and Interest Rate Spike

This is what me and my colleague, Russell Lamberti, wrote to clients on March 12, 2013 regarding the Chinese business cycle:

The economy now sits with enormous malinvestments in basic infrastructure and real estate. If the monetary environment remains tight, the term structure of interest rates will correct to pre-monetary intervention levels – meaning a big shift higher of particularly short-term rates – and these malinvestments will liquidate, causing major business cycle risks in China that have the potential to become an outright crash.

Two months later, the 7-day interbank repo rate has spiked from below 3% in mid-May to 12% today. That’s the spike we were waiting for and this is about to set in motion a cascade of very negative economic consequences for China and potentially even the global economy.

China business cycle update on its way to ETM Analytics clients‘ inboxes later today.

US Real Interest Rates of 5-10% Gave Birth to Industrial Revolution

In the 1800’s when the US was on the classic gold standard and the economy saw falling prices (deflation) rather than rising prices (inflation), real interest rates were somewhere in the region of 5-10%. The US had a strong currency (gold) and because no central bank existed back then (there were two attempts but both went bankrupt and the Fed as it stands today was created in 1913), the US had positive real interest rates.

It is this high real interest rate environment that brought about the industrial revolution and a rate of savings, capital accumulation and economic progress unmatched in history.

Because the South African Reserve Bank is keeping real interest rates too low (causing rand weakness in turn), it is hampering any chance the manufacturing sector has of growing. Instead, because of low real interest rates and a weak rand, the sector is in terminal decline.

US 10 year constant maturity bond yieldClick on image to enlarge.

Re: Abil and the Unsecured Subprime Market in SA

The share price of African Bank Investments Limited (Abil) is crashing following the announcement that nearly a third of the loans on its loan book are non-performing (meaning people are defaulting on their loans or struggling to repay them). The share price has nearly halved since the start of the year, and is down 21.65% today alone.

Abil

This has been a long time coming. By keeping interest rates lower than they should be – where the supply of real savings match real demand for money capital – the Reserve Bank has created this imbalance of credit supply in the economy.

Coming out of the global financial crisis, the middle- to high income market was saturated with debt, but the low income market was not. As the SARB lowered interest rates by pumping new money into the banking system, it gave banks freshly printed money to lend. Abil (and Capitec) were well placed to aggressively go after the low income unbanked market, which is exactly what they did. The SARB tried to stimulate general economic activity, but instead over-stimulated activity in the unsecured subprime credit market.

More than two years ago in March 2011 I wrote to ETM Analytics clients in a pretty detailed credit market report that [emphasis as in original]:

Within the household credit category, a breakdown shows that “general loans” have risen by just over 50% over the past two years. General loans are mainly personal loans – uncollateralised lending at a premium. The share of general loans as a percent of total household debt has risen from 3.7% in Jan 2009 to 5.4% in Jan 2011.

Under current economic and employment conditions, it is hard to conceive of this increase in personal loans being anything other than household finances being under stress and some expenditures being funded with borrowed money. With the housing market having stalled and home equity withdrawals disappearing as a result, it could mean that households are tapping personal loans to maintain a certain lifestyle and spending habits.

However, the most likely driver here is borrowing by low income earners. A random sample of two established banks and two banks catering more to the lower income segment of the market suggests exactly this.

Absa Bank and Firstrand Group extended personal loans at an average monthly rate of 1.6% and 2% respectively over the six months from July to December 2010. Capitec and African Bank, on the other hand, pushed personal loans to the tune of an average monthly increase of 5.7% and 6.3% over the same period, respectively1. Low income earners are having credit thrown at them, and this is something to bear in mind as it may lead to a category of subprime borrowers in SA that result in a sharp spike in NPLs for these banks in the future.

The original report can be read here. This trend continued until mid-2012, when the credit environment started to change materially, and these short-term loans are now starting to go bad, very bad, judging by Abil’s statement released today.

Although most analysts will say the potential fallout from the unraveling of this unsecured credit market will be small as it is restricted to Abil, I am warning that it could be bigger, and will be likely to ripple through to other banks and then all credit providers serving lower income groups – unless the SARB intervenes.

The SARB will be under a lot of pressure to cut interest rates as this bubble bursts in an attempt to keep the credit structure propped up. A full analysis and insight of the subprime market unraveling, and what this means for the Rand, monetary policy, and various sectors in the economy will be sent to ETM Analytics clients in the Business Cycle Monitor this week.

Price Inflation Accelerates, SARB Keeps Repo Rate Unchanged

The Consumer Price Index increased by 5.9% year-on-year in February 2013, Statistics SA data showed today. Consensus economists expected an increase of 5.6%.

Readers of this blog should have been anticipating the acceleration. I’ve been predicting this for nearly a year now, and my timeline has been pretty accurate even if I say so myself. See this post for the details of those predictions.

Despite that, the Reserve Bank kept the interest rate that it manipulates unchanged at 5%. By doing so, the Reserve Bank continues to fuel major economic imbalances in this economy. That means expect a weaker Rand, rising prices, and ultimately a very painful liquidation of malinvestments in the economy that will express in a business cycle crash.

What Has Caused the Massive SA Trade Deficit

Data released last week showed that the South African trade balance with the rest of the world (the amount exported compared with the amount imported) turned into the biggest deficit on record, of R24.5 billion in January.

This means the SA economy imported R25 billion in goods and services more than was exported. Consensus economists expected the deficit in trade to be R7.6 billion. In graph format, the actual deficit in recent years looks like this:

I’ve been predicting this to be one of the consequences of the Reserve Bank manipulating interest rates too low for the SA economy for some time now. On August 23, 2012 I wrote on clb:

By lowering interest rates below levels they would otherwise be in a sound money, free banking economy (where interest rates are determined by the supply and demand of savings, and not by central bank money printing), the Reserve Bank stimulates consumption spending over savings and investment. This is straight out the Keynesian playbook. This results in credit growth and an economy living beyond its means. The first place this reflects is in the trade balance. When you live beyond your means you consume more than you produce. You borrow the money from abroad to pay for present consumption. You don’t produce the products which you exchange for foreign products. Somewhere down the road, foreigners stop lending you money to buy their goods and you are stuck with no productive base to repay the debt. The consumption based economy collapses, and you must live well within your means for several years to make good on your debts. That’s where Greece is today.

Also, just to say, if the Reserve Bank continues to maintain this loose monetary policy and cuts the interest rate even further, it will simply fuel these imbalances further. The trade deficit could widen much more from here.

Looking through this cycle, the Reserve Bank is setting the economy up for a major business cycle crash. What goes up, must come down. The same counts for the import boom in recent months. It will come down, and that will coincide with a nice big ol’ business cycle crash. The Reserve Bank will blame a crash in China or a crash in Europe for the recession (or whatever is wrong somewhere in the world), but it really will be of their own doing.

Commercial Banks Starting to Hike Interest Rates

Business Day reports the following this morning:

Overdraft rate up 32 basis points

Commercial banks raised their weighted average overdraft rate to 8.95% in December, up 32 basis points from November. From October 2011 to November 2012, banks had cut the rate by 122 basis points, from 9.85% to 8.63%, even though the South African Reserve Bank cut its repo rate by only 50 basis points to 5.0% over the same period.
Banks are starting to hike interest rates despite the Reserve Bank’s 50bps rate cut in July 2012. This is the market starting to correct for the imbalances that the Reserve Bank’s interest rate distortions have caused. At 5%, the Reserve Bank’s interest rate is set too low and has caused major distortions in the economy’s capital structure. If the market continues to push interest rates higher, the economy will crash, which means the Reserve Bank may very well respond with more rate cuts to keep the phony money manipulated economic mini-boom propped up.