Budget 2015 overview – courtesy of Stanlib News Insights and Opinions

Budget 2015 overview

The national budget for 2015 and the subsequent three fiscal years (referred to as the medium term), delivered by Minister of Finance, Nhlanhla Nene, in parliament today, held no surprises or fireworks. Our economy is constrained by various factors, such as the state of the world economy, our electricity supply disruptions, high unemployment, a struggling manufacturing sector and more. These constraints have cumulatively translated into low growth and therefore lower tax revenue collections and thus a shortfall in the country’s budget. The government is spending more than it collects. None of this is news.

To deal with the shortfall, the Minister’s proposal includes a mix of reducing government spending and increasing of taxes. The appropriateness of each of the measures detailed could be debated, but overall it was a fine juggling act to balance out the needs of a developing nation with a shortage in finances.

Money will be channelled to education, health, social grants and security, while there is a planned “consolidation of government personnel numbers” and cuts in government spending on goods, catering, entertainment and venues as well as travel costs. There is some support for business through various development grants, but it certainly does not amount to a business landscape overhaul.

There are the usual and expected tax hikes – you can expect to pay more for your guilty pleasures (alcohol and cigarettes) as well as more at the petrol pump, due to the increase in the fuel levy. It also seems that e-tolls are here to stay, although the monthly ceilings will be revised. No further detail was provided, but it there seems to be firm commitment to us paying for roads.

You will pay more income tax if you earn over R450 000 per annum, but the lower earners are catching a bit of a tax break.

While the Road Accident Fund levy will need to be increased, as this fund is in deficit, the Unemployment Insurance Fund has accumulated enough excess funds to allow it to take a temporary contribution holiday from employees and employers. This will effectively translate to “tax breaks” of R15 billion, back into the taxpayers’ pockets.

The National Development Plan was mentioned often in various contexts, but the speech was thin on detail on how it would actually be implemented to reach its ambitious targets.

There was a brief mention about how the African Bank bailout is progressing – and it seems that the R7 billion pledged by the Treasury to prop up this institution may not be needed, as the bank is now generating positive cash flows.

Whereas the new tax free savings account is set to commence on 1 March 2015, the broader retirement reforms are still being negotiated.

From next year, the Minister proposed an increase to the electricity levy and will be introducing a carbon tax, to manage the demand side of our strained electricity system. This is still under discussion. The financial industry can expect to see more onerous regulation of insurers, derivatives and hedge funds but no further detail was supplied.

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Money Marketing Newsletter with Patricia Hoburn: Pressing need to deleverage raises threat of deflation

Today we share an article on deflation – inflation is always an economic, budget and investment issue. Globally inflation seems under control – but individually – some economies are worrying about deflation – some stagflation – some inflation. What are the deflation concerns? 

Pressing need to deleverage raises spectre of deflation
By Fabian de Beer, chief investment officer, Mergence Investment Managers

The monetary stimulus and quantitative easing programmes launched by major central banks in recent years are unprecedented since the 1930s. Central banks have been doing all in their power to resuscitate growth in the face of over-indebtedness and prevent the prospect of a deflationary recession – or at worst a deflationary depression. The ultimate outcome of this grand monetary experiment remains unknown. Is it possible that the world will ultimately face the full consequences of over-leveraged global economies despite all the initiatives and efforts to prevent any dire outcome?

The US Federal Reserve led the way in 2008, cutting interest rates toward the zero-bound and then introducing massive quantitative easing (QE). Facing similar problems or the need to provide economic stimulus, the Bank of England, the European Central Bank, the People’s Bank of China, and recently the Bank of Japan joined the battle with their blend of QE measures.

Can markets be in the comforting arms of limitless “liquidity” from generous central banks until global economic growth is self-sustaining and an acceptable level of inflation and unemployment is achieved? On the contrary, despite unparalleled monetary stimulus globally and the lowest interest rates in living memory, two things are evident: below-trend or subpar economic growth (the so-called “new normal”); and an inflation scenario that remains subdued. Self-sustaining economic growth has largely been elusive while all the liquidity provided, essentially via central bank balance sheet expansion, has yet to result in the inflation spectre so much anticipated and feared. Rather, financial asset prices have inflated while global economic growth remains fragile.

What is of concern is that the only confidence game seems to be central bank stimulus, especially that of the US Fed. The recent nervousness displayed by markets about possible scaling back or tapering of stimulus measures reflects the sheer dependence of markets on these programmes. The fact is that over-indebtedness, especially of developed economies, is the primary malady plaguing the global economy. Many believe that attempts to address the debt problems with even more debt, as in QE, will ultimately end in tears as the inevitable has merely been postponed.

In order to deleverage, over-leveraged economies have to confront their debt problems in one way or another, be this by payment, debt reduction (“haircuts”), bailout, default, debt forgiveness, debt restructuring, or inflation. Normally economic growth, and thus income, is essential to servicing and reducing debts. Whatever course is adopted, there will be economic sacrifices and trade-offs. With so much debt in the system, the implications of reducing this debt – especially after a severe financial crisis – are a slowdown in economic growth and potential for a deflationary environment.

The signs are there. Note the ongoing recession in Europe, high unemployment, the volatility and softness in commodity and metal prices, debt downgrades, and lately the decline in bond prices in the absence of inflationary pressures. The many summits, bailouts and stimulus packages of recent years have all failed to lift European Union economies, even though EU financial authorities have predicted otherwise. Observe the many times economic growth forecasts by authorities such as the IMF and World Bank have been revised lower. Credit growth has generally been weak in developed economies given the compelling and pressing need to deleverage. Moreover, Japan has been in the grip of deflation for years despite the government’s many efforts to combat it. They have recently implemented desperate renewed and aggressive attempts to extricate the economy from its weak economic growth and deflationary trap. Yet, while markets got excited about the stimulus package, some signs such as higher bond yields are not encouraging.

Few can remember much about the 1930s, the last time deflation reigned.  Furthermore, we all tend to have an inflation “bias” as inflation ruled for many decades in our life experience. People are so used to it that they cannot imagine the opposite monetary environment.

Deflation is characterised by a contraction in credit on the back of a pressing need to deleverage. It should be noted that most deflationary environments emerge from periods of high indebtedness. Furthermore, rising interest rates deflate debt and are therefore deflationary.

The chart below reflects the enormous debt build-up in the US. The debt during the Great Depression (1929) seems like a molehill compared to the current mountain of debt. The last number of years has seen growth in credit instruments and vehicles and also shown that the crisis of indebtedness stretches beyond the US to involve other major economies.  This period of credit growth has become known as the “Debt Super Cycle”. It is likely that the events since the start of the financial crisis in 2008 have signalled the end of this exceptional credit (debt) growth era. After central banks managed to “manipulate” yields and interest rates lower, the now rising interest rates – as recently seen in bond yields – have negative implications for borrowing / leverage and asset prices, especially if they continue upward.











Robert R Prechter, a foremost proponent of a deflationary depression and author of Conquer the Crash, defines deflation as a contraction in the overall supply of money and credit. He contends that deflation is unavoidable as there is too much debt in the world that cannot be paid back. The great need to deleverage would ultimately overwhelm QE measures.

It is worth recalling economist Irving Fisher, one of the earliest American neoclassical economists, and his later work on debt deflation. Once the Great Depression was in full force, Fisher warned that ongoing drastic deflation was the cause of the disastrous cascading insolvencies then plaguing the American economy because deflation increased the real value of debts fixed in dollar terms. Fisher was so discredited by his 1929 pronouncements and by the failure of a firm he had started that few people took notice of his “debt-deflation” analysis of the Great Depression.

Yet there are lessons to be gleaned from Fisher’s work. Today, almost everyone agrees that the root of the 2007-2009 global financial crisis was a surfeit of debt. After chronicling the influence of various “disequilibriums” common to economic contractions – factors such as over-production, low savings and overconfidence – Fisher identified the monetary pressures behind every prolonged depression:

“In the great booms and depression, [other] factors … played a subordinate role as compared with two dominant forces, namely over-indebtedness to start with and deflation following soon after…”

Assuming Fisher is correct, and knowing that the world is attempting to solve prevailing debt crises and related problems by shifting and magnifying the debt problem (typically though central bank balance sheet expansion and the concomitant liquidity injections causing the monetary base to inflate as a result), then any additional or increasing indebtedness would induce further weakness and reduce policy options into the future. Further, Fisher is saying that the insufficiency of aggregate demand is a symptom of excessive indebtedness and that the only way to contain a major debt depression event — such as the aftermaths of 1873, 1929 and 2008 — is to prevent the build-up of debt ahead of time.

If we accept what Fisher said about debt controlling all other economic variables in a debt deflation, then the excessive levels of indebtedness in the US, Europe and elsewhere are constraining and deterring economic growth. This is borne out by the experience of major global economies over the last number of years, and the drag it has exerted on other economies.

The end of a long debt super cycle is different to the end of a normal business cycle. Once an economy becomes extremely over-indebted, the normal business cycle model that everybody believes in really becomes ineffective over time as the strong secular forces of excessive indebtedness dominate. Deleveraging, and with it the potential for deflation, thus becomes a thematic feature of economic life. As investors, we need to be aware of the possibilities that could play out and prudently consider their likelihood and consequences. The spectre of deflation and its potential ramifications is such a possibility. We do not need another Black Swan.

The opinion and comment in this newsletter is opinion and comment only.

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Money Marketing Newsletter with Patricia Holburn: Current investment climate – forecasting the next ten years

How would you describe the current investment climate – is it hot, cold, tepid, treacherous? Today we share some thoughts on what is shaping our current investment  views, debates and thoughts – and what should the long term investor be looking at.

 We wish you a wonderful day on Friday 9 August –  National Women’s Day

An investment climate with many temperatures
A well known contrarian investor argument states that you should avoid the herd – be fearful when others are greedy and greedy when there is fear. Consensus is often an investor dilemma as this may point to a narrow view and/or sometimes a bubble. Our current investment climate offers many views and perspectives for the investor. It is a difficult time to invest – but it is also starting to look quite interesting – on some issues there is broad consensus, on others not.

Tepid – the economic picture
We don’t invest in a vacuum and our investments often perform as a result of what happens in the economy. If there is economic growth and employment consumers are willing to spend, and save. If times are tough – unemployment is low – confidence sags and economic growth falls.

The current economic picture is tepid. Growth is present – but it is below par. Speaking at last week’s Old Mutual Investment Group’s media briefing, economist Johann Els said that global growth is expected to be 3% this year – and a good figure for global growth is 4%. Within this figure is a wide range of individual country performances – but of the major economies – growth sits in the sub-par classification. US, Europe, China, and here in SA.

Growth is good, slow growth is not a disaster, but it is a more difficult environment in which to find profit and earnings.

South African growth remains a problem – we had that dreadful just below 1% figure for  quarter 1 GDP  – quarter 2 is expected to be better – but as Els said last week – we need to look at it in conjunction with quarter 1 and average.

We’ve got growth – but not nearly enough. The problems and issues are well documented. It’s not yet a treacherous picture – but it could go there if the very low growth numbers continue. Again from Els – SA growth should  ideally be in the 4 – 6% range.

Mild – inflation scenarios
Inflation also has a big effect on country and personal finances.  Globally inflation is not an issue, locally it remains in – or just outside the official target range of 3 – 6%.  Personal inflation is proving to be a problem and if you are looking to grow wealth and use it for an income that will include purchasing high inflation items like medical expenses, electricity and possibly food (because although food inflation is down food prices are not) you need to take this into account and look for an inflation plus plus return. (and save for longer)

Speaking earlier in the year at the FPI Convention, Investment Solutions’ Chris Hart said we must take everything into account when we invest – and one of the things we must consider is how different assets perform in different kinds of inflation environments.

A look back in history provides an excellent example.

In the 1970s inflation was high and interest rates were high. Sanlam Private Investments’ Alwyn van der Merwe showed on Tuesday that US equity returns for the 1970s were negative 1.6%. Local equities delivered 6.5% after returning 11.9% in the 60s (these are real returns – above inflation). Local bonds returned real negative 4.8% in the 70s.

In the 1990s – when interest rates in SA were high – SA equities had a 5.8% above inflation real return.

The question must be asked – how will my portfolio perform in various inflation scenarios.

Right now you may not think this is a valid question – interest rates are so low that even a rate of 10% seems unrealistic. But as investing sits in the future unknown area – what ifs must always be asked. If you are a long term investor and inflation could be a problem in the long term can your portfolio weather this?

As inflation destroys an investment never forget that it too has a treacherous side.

Hot, warm and cold  – very volatile markets
We have had very volatile markets in the short term – 7% corrections as an example (of which we have had two this year) – and this looks set to stay.  “Across the world there is an enormous amount of uncertainty,” said Alwyn van der Merwe.

Over the long term – how will assets perform? Where should an investor be positioned for growth?

“The environment is tough for a number of asset classes,” said Old Mutual Investment Group’s Peter Brooke last week. With low interest rates cash remains a no growth area, bonds are problematic and we are coming off a 30 year bond bull market. This leaves equities as “the only game in town,” said Brooke. Van der Merwe referred to them as “the best of a bad bunch.”

Investing is about weighing the alternatives and scenarios and implementing the strategy that meets an individual’s objectives with what is available – if you need growth you have to include assets that will grow.

Speaking at the Sanlam Private Investments media briefing this week, Van der Merwe shared some research on the returns of various asset classes over time. Below we share these ten year returns of select asset classes – they are real, per annum – after inflation numbers


Van der Merwe noted that each decade has a winner and particular type of economic environment.  Often that winner is the next decade’s loser  – Gold in the 70s for example, the Nikkei in the 80s, the Nasdaq in the 90s.
To forecast what might happen in the future – Van der Merwe looked at a known – the starting price – and found that there is clear correlation between price and performance. A low starting price leads to higher performance in the future. If the price is high “the risk is that you won’t get a decent return over the next ten years.”

Using this – he came up with the following forecast returns for the next ten years: (again these are real per annum returns – after inflation)

SA Cash: 0
SA Bonds: 2.1%
SA Property: 3.2%
SA Equity:  3.8%
US Equity: 3.1%

Does this favour local equity over offshore equity? Van der Merwe was asked this question. While offshore may not look like a fantastic buying opportunity as an entire market – it is much easier to find cheaper shares offshore than it is in SA.

Within the SA Equity market Van der Merwe looked at Industrials, Financials and Resources.

Over ten years he expects SA Industrials to deliver 0.41%, Financials 6.93% and resources 6.2%. But Resources he noted, is the “wild card,” the price might be low – but is it a low for a reason or low that will go higher in the future?

Van der Merwe’s conclusion is that there is not “a single asset class that promises exciting prospective investment performance.” Investors will have to “recalibrate investment return expectations.”
In the words of Peter Brooke – you have to save more.

And you have to select a strategy and plan, and stick to it.

Treacherous – investor behaviour
The returns the market gives are often different from investor to investor – and this is often due to investor behaviour.

Investors are often swayed by short term news and views and short term – the market moves look very volatile.
Van der Merwe said that one of the reasons he believes leads to volatility is the expectation of investors – when we invest we expect returns of xx and want smooth returns: when that doesn’t happen we often react “quite aggressively.”

We also anchor our views in the current reality, Van der Merwe said. This is the ‘JSE is always going to deliver fantastic returns’ danger.

A long term investor needs to take a long term view – and for the active manager and investor – volatility and uncertainty create opportunity.

“Volatility and uncertainty are the friend of the informed investor,” Van der Merwe observed.

A brief word on forecasts
Forecasting is very treacherous – so many unknowns are involved. Van der Merwe shared a study of earnings forecasts in the US that showed an optimism bias – analysts forecasting earnings were generally over-optimistic – only on two occasion in 25 years were analysts pessimistic and returns were above forecasts. This also showed – that our current expectations are anchored in current reality. Reality changes day to day, year to year, decade to decade.

Speaking at the beginning of June, Richard Carter of Allan Gray said that in investments if you are right two thirds of the time you are a top manager. This is why diversification remains important.

Forecasting also involves a number of assumptions and if you are going to look at forecasts and use them you have to know what the assumptions are. Van der Merwe used real earnings growth of 3% and a dividend yield of 3.7% in his forecasting for SA Equities.

The comment and opinion in this newsletter is comment and opinion only and does not constitute personal financial advice. Personal financial advice must be based on each individual’s circumstances, and not general comment and opinion. For all investment and financial decisions please consult a professional financial planner.

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Money Marketing Newsletter with Patricia Holburn: Investment platforms – present and future

In all the talk of financial and retirement reform and the fees and costs of an investment – attention will turn to investment platforms. In South Africa they changed the investment industry, offered investors and retirees more options and created opportunities for new investors. Today we share an article that looks at investment platforms – the challenges they face and the opportunities they present.

Investment platforms, present and future
By Anton Raath, chief executive: Glacier by Sanlam

The benefits offered by an investment platform are well-known.  They include:  wide investment choice, ease of switching between the investments, transparent and consolidated reporting (including tax reporting), and online access to your portfolio.

But an ever-changing investment and regulatory environment provides platforms with the opportunity to offer clients and their financial advisers so much more.  The environment is an extremely competitive one, where new products are quickly copied.  The future belongs to those who can fulfil their clients’ needs – quickly and cost-effectively.

Above all else, platforms need to make it easy for clients to invest and interact with them.

Where we find ourselves at present
The regulatory environment is becoming more intrusive for platforms and intermediaries alike.  Currently, we’re facing the upcoming implementation of the first phase of Treating Customers Fairly (TCF) in 2014 and the proposed retirement reform legislation from 2015 onwards.  Both of these provide opportunities to further improve the investment choice, and to better ensure that clients only invest in products that meet their needs, as well as to build increased trust in the industry.

TCF will see a move towards greater transparency and accountability in serving clients.  Investment platforms are already better placed than many other service providers to meet these requirements.  This is because they currently show clients the fees that their financial advisers are earning as well as the fees earned by the platform that supports the adviser.  This is to ensure that clients are fully aware of what they are paying for, and why.

To date, a series of discussion papers around retirement reform has been released, and much consultation between government and industry has taken place.  Increasing life expectancy worldwide has resulted in the need to save more, and to save for a longer period of time.

In a bid to encourage additional savings over and above retirement fund savings, government plans to introduce tax-friendly discretionary savings vehicles in 2015.  These vehicles will not attract capital gains tax or income tax on income and dividends.  However, there will be an annual contribution limit of R30 000 and a lifetime limit of R500 000. Platforms have traditionally led the way with products that address the needs of the client and the new regulations could be the catalyst for some innovative solutions.

Product development will, to a large degree, be driven and dictated by legislation and technology.  One of the objectives of the retirement reform is to ensure that investors have a sustainable income for life after retirement.  This provides further opportunity for platforms to expand the range of retirement income options for clients, including partial or full income guarantees.

In this environment, corporate governance is more important than ever before and clients can be assured that the investment options provided via the platform are sound.  Clients’ money is deposited into a trust account or the retirement fund’s account.  Units in the collective investment schemes are held on behalf of clients in the name of the nominee company.  In addition, separate boards of trustees that include external representation govern all the retirement funds on the platform.  In the case of Glacier, all investment linked living annuity investments are invested into a Sanlam life policy that forms part of the Sanlam balance sheet.  This means that investors are assured of the backing of the larger group at all times.

Role in investment strategy
Platforms offer tools and solutions which, together with the expertise and advice of a qualified financial adviser, play a valuable role in guiding the clients’ investment strategies.

Firstly, a wide investment choice across different asset classes allows clients to construct a portfolio that will serve their long term needs, across changing life-stages and risk-profiles.  In future, we could even see platforms offering direct access to the full set of financial instruments, including exchange traded funds, index funds and other alternative investments – and allowing investors to switch seamlessly between them.

Secondly, platforms provide access to various tools to help intermediaries in constructing an optimal portfolio.

Thirdly, platforms develop and provide solutions to help clients create and preserve wealth over the long term.

Some platforms also offer the opportunity to diversify across other financial solutions by offering fiduciary services (estate planning, wills and trusts), personal cover and business assurance, as well as short-term insurance.  Once again, the client benefits from consolidated reporting across all solutions.

Estate planning is especially important to an affluent investor, to ensure that succession planning and tax objectives are achieved.

The role of technology
That more sophisticated investors require service excellence is beyond question.  Ease of placing business, problem-solving and on-going, relevant communication are among the top requirements.

The way consumers interact with technology will shape the way platforms evolve in future.

Cloud technology and office integration tools could enable platforms to further enhance their service offerings to intermediaries.  This could, for example, eliminate duplication between the offices of the intermediary and the platform by allowing sharing of certain information.

The role of technology will essentially be to simplify the way we do business.

Into the future
The platform of the future will need to serve a larger and more diverse set of client needs.  The primary goal of the emerging affluent market is to grow their wealth and this group has specific product needs when it comes to medical insurance and education, for example.  Higher-net worth or more established investors tend to have a higher allocation to shares and property within their portfolios.  Making these investments directly available on the platform would meet the needs of the more sophisticated investor.

The platform of the future will also look very different from a resourcing point of view. The distribution structure will constantly evolve to fit the changing needs of the intermediary.  IT will serve to simplify and support processes, making it easier to do business with the platform.  Technology will be used as an enabler to make it faster and more efficient for clients and advisers to interact.

As the platform becomes less admin-intensive, we’ll see a shift in resource requirements from administrative skills to insight, coupled with analytical ability.

From a structural point of view, we could see consolidation of some of the platforms locally.  This is already happening in the US and Australia where a few large platforms lease out their operational and IT capacity to the smaller platforms.  Locally, this is still blue-sky thinking but opportunities abound.

The most successful platform of the future will be the one that offers solutions that best meet the needs of the client;  offers value for money;  facilitates the best advice to clients by ensuring that clients and their advisers have access to online tools and information;  and provides good governance on product and investment options.

The opinion and comment in this newsletter is opinion and comment only. For all financial decisions please consult a registered financial adviser.

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Money Marketing Newsletter with Patricia Holburn: To be or not to be offshore

To be or not to be remains one of the most quoted Shakespeare lines and speeches. If you are an investor this question is often asked – to be or not to be in equity markets, in a particular asset class – and offshore. Our local market has not had the year (so far) it had in 2012 – and it doesn’t look like it will have the decade it has recently had – but if it is now the time for an offshore investment how can you fail to be influenced by the tumbling rand? Geoff Blount looks at how we should approach the offshore decision and highlights what our decision should be based on.

To be or not to be offshore: how do you decide?

Geoff Blount, CEO of Cannon Asset Managers, looks at past trends and provides some useful pointers in making the decision to take assets offshore.

Given the rand’s recent wobble, the question most investors are asking again is whether to invest offshore or not and, if so, how much of their portfolio should be invested in other countries.  Unfortunately for those who want a simple answer, there isn’t one: much will depend on the investor’s specific circumstances.  However, take a look at the following graphs which are instructional in providing some guidelines for making decisions about investing abroad.

In chart 1, we have plotted the average annual returns in dollars for the South African equity market (FTSE JSE All Share Index) and global equities (S&P 500 and MSCI Developed Markets) versus dollar inflation over 10 year rolling periods, and in chart 2, we show the same but in rands versus rand inflation.

Chart 1:  10-year (annualised) rolling returns – US dollars













Chart 2:  10-year (annualised) rolling returns – SA rand













What these graphs demonstrate is that there are some very long term cycles at play.

•         From the mid-1990s until the early 2000s SA equities were characterised by poor returns while global equities experienced great returns.  We see this divergence in terms of performance in both the dollar and the rand returns.

•         During the 2000s, these roles were reversed:  we experienced a decade of excellent returns for SA equities and dismal returns for global equities.  Again these trends held true in both rand and dollar terms.

While the 1990s were a period of rand weakness and the 2000s a period of rand strength, the greater influence on performance was the actual equity market movements rather than the currency movements.

Implications for making the “offshore” decision:

There are some very powerful observations to be made from these graphs that can guide investors with regard to their offshore decision:

1.       Over time, the performance of equity markets moves around long-run averages (the equity risk premium).  Extended periods of superior returns are likely to be followed by extended periods of subpar returns: nothing outperforms forever.  The 1990s ended on very high valuations for offshore markets, and attractive valuations for South Africa, which informed much of the following 10 years of returns.  It is therefore unsurprising that SA equities performed well in the 2000s, after a decade of relatively poor performance, while global equities did the opposite.

What is the likely path forward given the above observation?  Mean reversion implies that the great returns of SA equities of the last decade are unlikely to repeat themselves, and the poor returns of global equities are unlikely to repeat themselves.

2.       And what about valuations?  The price that is paid for an investment (its valuation) is also critical to longer term returns.  At the moment, South African equities are on a Cyclically Adjusted PE of 16.1 times, global equities on 16 times and US equities on 18.2 times, approximately at their long term average.  So while our market is marginally more expensive than global equities and cheaper than the US, the valuation differences are not compelling enough to motivate a wholesale switch to another market.  We do, however, believe that pockets of our market are very expensive (such as large cap industrials and cash retailers) and represent high investment risk.

3.       Don’t base your decision on a view of where the currency is going.  Firstly, movements in the rand are likely to defy logic and one’s forecast will be incorrect.  And secondly, as the graphs indicate, the performance of the asset you own is far more important than getting the currency right.  In other words, it’s your asset selection and not currency selection that matters.  Short term investment decisions on currency moves are nothing more than speculation.  Try and avoid these and rather look at your long term asset allocation.

4.       Hence, base your decision on the advantages of diversification rather than on expected currency moves.  This can be explained by the fact that there are shares and other investments overseas that are simply not available in South Africa; assets that are useful in diversifying risk given their different business markets and earnings drivers.  For example, in South Africa, you simply can’t buy exposure to businesses like BMW or Samsung.

5.       So even if mean reversion and diversification points your portfolio overseas, don’t rush to invest all your assets in overseas equities.  Investors that live in South Africa, have their liabilities or living expenses mostly in rands.  Putting all their assets overseas means they get poorer in periods of rand strength.  Ask investors that had most of their portfolio overseas in the early 2000s how that decade felt for them.  Also note that over extended periods, South African equities have always beaten South African inflation, unlike global equities.  Perhaps the old adage of “Don’t put all your eggs in one basket” applies here.

6.       Interest rates and yields have historically been higher in South Africa than overseas and this is likely to continue.  For people such as retirees, who are living off the yield of a portfolio, the offshore income will be pretty meagre when compared to local income levels.

Considering all of these observations and the guidelines flowing from them, we suggest that while long term trends and valuations indicate that global equities are likely to do better than domestic equities, investors shouldn’t rush for the door, or take a view on the rand’s current weakness to inform their view.

Rather, investors should look to allocate assets to global investments, or increase their current global equity allocation, while being cognisant of their own risk profile, their need for income and their South African liability status.

The opinion and comment in this newsletter is general opinion and comment only. It is not personal financial advice and is not intended to be personal financial advice. For a financial investment decision that matches an individuals’ circumstances personal financial advice from a professional financial planner must be sought.

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Money Marketing Newsletter with Patricia Holburn: The global trust deficit

As global growth relies ever more heavily on emerging and growing economies – do these economies have fair and adequate representation in global forums, and are the rules applicable to developed economies relevant for growing economies? Today we share an article on this issue – that may be critical for Africa. As the continent grows and investors seek to benefit from that growth – why is Africa so under-represented on the global stage when it comes to setting global policy?

The global trust deficit
By Peter Blair Henry, Dean of New York University’s Stern School of Business and author of Turnaround: Third World Lessons for First World Growth

NEW YORK – In their preoccupation with fiscal deficits, developed-country policymakers continue to neglect a different, yet equally critical, shortfall: the trust deficit between advanced and emerging economies when it comes to global governance.

For decades, developed-country shareholders at the International Monetary Fund and the World Bank used loan conditionality to spur economic reforms – often including contentious fiscal-austerity measures – in the so-called Third World. Through pragmatic, sustained reform efforts, countries like Brazil, China, and India turned their economies around to achieve stunning increases in GDP growth – from an average annual rate of 3.5% in 1980-1994 to 5.5% since then.

But, although developing countries now account for more than half of global GDP growth, advanced countries have yet to admit them to leadership roles that reflect their growing influence in the world economy.

The failure so far of the US Congress to ratify the IMF reform package agreed to by G-20 finance ministers and central-bank governors in 2010 is the latest breach of trust – one that makes the promise of adequate representation for emerging economies seem like a shell game. America’s unwillingness or inability to ratify the package – which includes doubling the IMF’s funding quota and shifting 6% of the new total, together with two directorships, to developing countries – undoubtedly contributed to the decision by the BRICS (Brazil, Russia, India, China, and South Africa) to establish their own development bank.

In fact, a backlash against Western hegemony in global governance has been brewing for years, with developing countries increasingly turning away from the IMF in favor of creating alternative, regional sources of funding. The Association of Southeast Asian Nations (ASEAN), together with China, Japan, and South Korea, established the Chiang Mai Initiative in 2000, and Latin American countries launched negotiations on the Banco del Sur in 2006.

The accelerating erosion of emerging economies’ trust in the Bretton Woods institutions is particularly problematic now, given slow growth and continued economic weakness in advanced countries. While the world economy is expected to grow by 3.3% this year, average annual growth in the advanced countries is projected to be just 1.2%.

Developed and developing countries alike would benefit from greater economic-policy coordination. While regional groups may obtain some short-run benefits by pursuing narrower interests outside of multilateral channels, neither emerging nor advanced economies can fulfill their long-run potential in an environment characterized by isolationism and a zero-sum mentality in areas like trade and exchange-rate policy.

Policy coordination, however, depends on trust, and building trust requires advanced-country leaders to keep their promises and offer their developing-country counterparts opportunities for leadership. Instead, developed countries have been taking actions that compromise their legitimacy.

For example, after spending decades encouraging developing countries to integrate their economies into the global market, advanced countries now balk at trade openness. Indeed, despite pledges not to erect trade barriers after the global economic crisis, more than 800 new protectionist measures were introduced from late 2008 through 2010. G-8 countries, the supposed champions of the global free-trade agenda that dominates the World Trade Organization, accounted for the lion’s share of these measures.

Some question the leadership ability of the BRICS. But many emerging markets are already leading by example on important issues like the need to shift global financial flows from debt toward equity. Mexico, for example, recently adopted – ahead of schedule – the changes in capital requirements for banks recommended by the Third Basel Accord (Basel III), in order to reduce leverage and increase stability.

For too long, developed countries have clung to their outsize influence in the international financial institutions, even as their fiscal fitness has dwindled. By ignoring the advice that they so vehemently dispensed to the developing world, they brought the world economy to its knees. Now, they refuse to fulfill their promises of global cooperation.

Leaders in developed and developing countries alike must deepen their commitment to economic reform and integration. But only by giving emerging economies a real voice in global governance – thereby reducing the trust deficit and restoring legitimacy to multilateral institutions – can the global economy reach its potential.

Copyright: Project Syndicate, 2013

The comment and opinion in this newsletter is
comment and opinion only and does not in any way constitute personal financial
advice. Please seek advice from a professional financial adviser for all
investment and financial decisions.


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Money Marketing Newsletter with Patricia Holburn: Some Tips for National Savings Month, Dividends – 9th wonder of the world?

 The current news of the day is starting to centre around some quite complicated financial issues – fiscal and monetary policy, currency movements and the reasons for these, regulation. In the midst of this it is important to remember that to be financially well, responsible and hopefully one day a financially independent retiree the basics can never be forgotten. Last month saw the start of National Savings Month – and in this month we must not get so tied up in the big issues of the day that we forget the basics of good financial health. Today we feature two articles – one that looks at the basics and another at the very important topic of dividends – a source of much growth and income for many investors.


The basics of financial wellness

What does it mean to be financially well?

Spending less than we are earning? Not being dependent for basic necessities? Being able to afford some luxuries? Having a growing pot of wealth? Being happy with what our current income can buy? Making sure our future financial income is secure?

Financial wellness is many things – but to many of us it is making sure we are comfortable today and tomorrow, and that we can provide for what we need to provide for and a few of the ‘want’ items.

In our journey to financial wellness it pays to keep a few basics in mind.

1. Save early and save a lot
Nothing – nothing will compensate for not having saved enough.

Saving early and saving a lot gives a really good start. This also allows for the maximum gains from compounding – as there is more to compound and more time to allow the full benefits of compounding to set in.

Writing in this year’s Sanlam Benchmark Survey Research Insights Report, Jaco-Chris Koorts and Jayesh Kassen of Glacier by Sanlam note that the advice pensioners would give includes saving and investing for retirement from an earlier age.

2. Identify what assets you have and how you will protect them
Whether they be tangible – household items – or intangible like income earning potential. If you lose one of these assets what are the financial implications and can you prepare for them.

3. Don’t get too carried away by what markets are doing, what the neighbours are doing, and the hot topics of the day
What matters most is what your money is doing.  And be wary of believing what Finance Minister Pravin Gordhan calls the “Narrative of the day” – in any financial context.

4. Pass on money tips and money responsibility
SASI – Savings Institute of South Africa has long had a Teach a Child to Save campaign. Learning financial responsibility is not something that rests solely with parents or schools or institutions – it rests with everybody if we want a better financial future for our country. Often the example we set financially shows itself in the next generation. If we don’t want this generation burdened by debt, we need to set it an example and engage in honest financial discussions.

5. Seek professional advice
To ask the awkward questions, spot the inconsistencies, keep you and your  money on the straight and narrow. This was also another piece of advice pensioners surveyed in the Sanlam Benchmark Survey gave – “members should seek professional financial  advice.”

Dividends: the 9th wonder of the world
By Paulo Senatore and Franco Barnard, Ashburton Investments

Albert Einstein once said “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pays it.”

While dividends may not be the ninth wonder of the world, dividend returns within equity investments are often under-rated. Dividends have a significant impact on investment returns and should therefore play an important role when making investment decisions.

In general, companies list on a stock exchange in order to raise capital. This capital is used by companies so that they can expand and grow their businesses.  Investors purchase shares in companies primarily for inflation-beating returns over time. In selecting a specific company, consideration is given, amongst other factors, to the quality of management, industry exposure, geographical spread and the business model. In the final analysis, superior returns are achieved by choosing to invest in companies with superior profits and the ability to grow these profits over time.  These profits are usually either distributed to shareholders via a dividend, share purchases, or retained by the company to grow the business. In most cases, a portion of the earnings are paid out as dividends whilst retaining the balance for growth. The ratio of dividend payments to retained earnings depends on the business cycle and the maturity of the company.

When a company is newly listed and in its growth phase, or in a cyclical industry, the dividend pay-out ratio is usually low. Good examples are Aspen, Discovery and Naspers which are companies that retain most of their profits to invest in growth opportunities. In contrast, certain companies have high-dividend pay-out ratios either because growth opportunities are limited or the company is in a mature phase. Companies that come to mind here are Vodacom (in 2013 they paid out 90% of profits in dividends) and Coronation (in 2013 the paid out 100% of profits in dividends).

The true benefit for investors really lies in reinvesting dividends received back into the companies that paid the dividends. This creates an “Einstein-like” compounding effect. The chart below illustrates the positive effect of reinvesting dividends in the FTSE\JSE All Share Index. One hundred rand invested in 1995 would be worth R1 400 today, if dividends were reinvested. Where dividends were drawn and not reinvested, the same R100 would only be worth R855.










A company’s dividend policy and dividend history is an important consideration when making investment decisions. To illustrate this concept the share price movement and dividend distribution of Standard Bank over the last 20 years is discussed:









The first observation is that there is a strong correlation between the share price (red line) and the dividend per share (blue line). When profits grow, dividends increase which underpins the share price.

The Standard Bank share price at the beginning of 1993 was R7.70 and the company paid a dividend of 19c per share. Standard Bank increased their dividend every year between 1993 and 2008 when the United States sub-prime financial crises impacted the world. What is remarkable is that even during the financial crises which prompted a selloff in global equity markets, Standard Bank managed to maintain the dividend pay-out. If R10 000 was invested in Standard Bank in 1993 one could have purchased 1 300 shares. The value of that investment, 20 years later, would be worth R156 000. That’s a 1 456% increase in the share price alone. What’s more, the value of your dividend in 1993 would have been R247 (1300 x R0.19) but by the end of 2012 the dividend would have risen to R5 915 (1300 x R4.55), an increase of 2 300%.

While dividends remain an important income source for many investors as they usually increase as profits increase, the after-tax returns provide further attractiveness. Until recently, dividends were tax free. However, since April 2012, tax legislation changed and investors are required to pay a 15% dividends withholding tax (certain entities are exempt).  Nevertheless, even after dividends withholding tax, the dividend yields for some shares remain very attractive with respect to cash yields. For example, the after-tax dividend yield for Vodacom is currently just below 6%, whereas one-year cash yields are 5.57% (pre-tax).

In summary, dividend distributions increase as companies expand and profits grow. These dividends, when reinvested, can generate significant compounded returns over the long term. Are dividends the 9th wonder of the world? No they aren’t, but it is clear from the examples presented that dividends are a significant contributor to investment returns and should not be ignored when making investment decisions.

The opinion and comment in this newsletter is opinion and comment only and does not in any way constitute personal financial advice. For all financial and investment decisions seek professional advice from a registered financial adviser.

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Money Marketing Newsletter with Patricia Holburn: A closer look at market cycles

 In today’s newsletter we take a look at market cycles – how to identify them, what happens in a market cycle, how do investors behave and what is the history of market cycles.

Market cycles

“You know, people talk about this being an uncertain time. You know, all time is uncertain. I mean, it was uncertain back in – in 2007, we just didn’t know it was uncertain. It was – uncertain on September 10th, 2001. It was uncertain on October 18th, 1987, you just didn’t know it.” Warren Buffett

Over the last few years we have seen investors across the world face the same dilemma regarding the global market. We wait in anticipation for some certainty to return to the markets, for the seemingly unrealistic surging market rally to end and for a sense of normality to return. Ever since the atomic bomb of the 2008 financial crisis hit, individual investors and global market economies as a whole have been trying to reconstruct their financial lives again…but just like the after effects of an atomic bomb that seem to linger for decades later, the after effects and consequences of piecemeal attempts to pull ourselves back continue to haunt us.

For the last four years we have been witness to classic investor behaviour. Some savvy investors have managed to take advantage of the ‘accumulation’ or trough phase in the market cycle, buying in when markets crashed and managing to acquire quality shares at discount prices. For many, the initial resurgence after the 2008 crash was looked upon with mistrust and an understandably healthy amount of fear. In general most investors remained cautious, waiting for the next ‘bubble’ to pop.

Although market cycles are theoretically easy to identify, in reality, it is extremely difficult to accurately identify exactly where we are in the cycle. For the most part, emotions tend to get the better of the general investor – either stopping them from investing, or causing them to greedily jump in.

The problem that most of us face is that we hold back too long and when we jump in, the market is either beginning to normalise or is turning toward an upward swing in the cycle. As the tide turns, market conditions stabilise and remain so for a while. Market sentiment shifts from negative to more neutral territory. At this point one would see early investors start foraying into the market – their confidence boosted by improved technicals.

As commodity prices start to slowly creep up and overall equity prices start to rise, the early phase of the bull market begins. As the rally gets well underway, investors who were previously burned when markets fell, quickly forget and driven by greed and the fear of missing out, plough into the market. We see equities start to outperform and valuations rise well above historical averages. Sound judgement and reason are forgotten as greed takes over. At this point we see smart investors start to sell out and slowly we see equity prices start to moderate. Certain investors who are looking to time the market may see this as an opportunity to buy and as they delve into the market it causes the market to make one last jump, technically known as a selling climax.








If we look at our equity market over the last decade, one will note that since 2000 the All Share Index has made gains in every year, except 2002 and 2008 when the financial crisis hit. In 2001 the market rose 40% and then crashed spectacularly in 2002 due to the ‘dot.com’ bubble. It recovered in the year after and between 2003 and 2007 produced an average 30%.

The South African equity market was down about 30% in 2008, but up about 40% in 2009. Since that time investors have been waiting for the penny to drop, patiently waiting for markets to re-rate and for a correction to occur. In 2010 markets returned a respectable 19%, but relative to 2009 this was still much lower, adding to the uncertainty felt by investors. The relatively dismal performance from the equity markets in 2011 (2.6%) caused many investors to feel justified that the doom and gloom predicted had finally come to pass. Then during the course of last year equity markets surprised on the upside, rising to all-time highs in December and ended the year gaining 27%.

Being able to identify in which phase of the market cycle we are in and in what way one can best take advantage of this, would be tantamount to holding a crystal ball. No person can accurately and with 100% certainty do this. With the exception of a few investors, since 2008, the majority of the market has been caught between fear and hope – being equally swayed by positive and negative economic and industry information.

Dominated by a general level of uncertainty and a prevailing sense that the tide is soon going to turn, it is surprising to see the picture that emerges when one looks at the South African equity market from a historical perspective. The graph below depicts the South African market from 1961 to 2013. The South African economy has over the last six decades experienced various ups and downs from both a political, socio-economic and growth perspective.








The oil crisis in the 1970s, the distorted government policies in the 1980s, the Asian crisis in the late 1990s, the blow up of the ‘dot.com’ bubble in 2000 and most recently the global financial crisis of 2008, have all impacted our economy. Looking at it on a monthly basis, what is evident is that although the market and economy were hit hard by these events, the duration of downward trends is significantly less than the up-swings or market rallies that follow.









From an economic point of view there are a few clear indicators that may point to which phase in the cycle we may be.  In the trough phase one would normally see a surge in unemployment, central banks will normally reduce interest rates as inflation tends to recede and consumers are under pressure. There is often also a general feeling of pessimism and negativity regarding the economy and market. Usually at this stage value investors step in and as they start buying into the market, one may see markets start to normalise.

The next phase is seen as the recovery or upswing. The economy starts to stabilise, unemployment starts to gradually decline, consumer balance sheets start to look healthier and demand for credit starts to increase. As consumer demand and sentiment starts to look positive, sales and productivity start to rise and companies start increasing their inventory.

As soon as the market gains momentum we see consumer spending starting to rise much faster, its pace is soon followed by growth in production and sales. Employment starts to improve as companies start investing and hiring more people. Soon shortages emerge in goods, services and skills. This in turn causes prices to be pushed up and central banks begin to increase interest rates in order to combat inflation. As the market starts to peak there is normally an overwhelming sense of optimism about the future.

The fourth and final stage in the cycle (downswing) is marked with uncertainty.  Once again households fall under pressure resulting from high levels of debt, high interest rates and rising inflation. Credit demand starts to fall and will soon be followed by a decline in production and sales. Unemployment levels start to rise as companies start cutting costs and reducing their workforces. During this time certain sectors may still be performing well and as a result investors are not clear which direction the market will take.

In each decade markets have been positive for an average of 60% of the time. So even though the graph of the equity markets and table above attempts to depict a downward or upward trajectory – over that time period there could be intermittent positive or negative months. Looking at it from this point of view each investor could have a very different experience depending on when they decided to get into the market and when they decide to exit.

We know that timing the market cycle is a feat that is near impossible, therefore looking at market fundamentals and not just being swayed by sentiment is extremely important. Investors need to set a firm foundation – clearly defining their level of risk, their time horizon and ultimately and most importantly, be clear on their financial goals.  By doing this, whether we are in the head rush of a bull stampede or being pulled under by the undercurrent of a grumpy bear, while others are trying to shine up their crystal ball, you can sit back and be secure in the decisions that you have made.

This article was prepared for Glacier Research by Samantha Matthew in April 2013.

The comment and opinion in this newsletter is
comment and opinion only and does not in any way constitute personal financial
advice. Please seek advice from a professional financial adviser for all
investment and financial decisions.

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Money Marketing Newsletter with Patricia Holburn: Three new lessons of the Euro crisis

In today’s newsletter we share an article that looks at the ongoing crisis in the Euro-zone. What would make a single currency region successful, what could harm it and what are the implications for the many different countries and economies in that region?

Three new lessons of the Euro crisis
By Arvind Subramanian

WASHINGTON, DC – While some observers argue that the key lesson of the eurozone’s baptism by fire is that greater fiscal and banking integration are needed to sustain the currency union, many economists pointed this out even before the euro’s introduction in 1999. The real lessons of the euro crisis lie elsewhere – and they are genuinely new and surprising.

The received wisdom about currency unions was that their optimality could be assessed on two grounds. First, were the regions to be united similar or dissimilar in terms of their economies’ vulnerability to external shocks? The more similar the regions, the more optimal the resulting currency area, because policy responses could be applied uniformly across its entire territory.

If economic structures were dissimilar, then the second criterion became critical: Were arrangements in place to adjust to asymmetric shocks? The two key arrangements that most economists emphasized were fiscal transfers, which could cushion shocks in badly affected regions, and labor mobility, which would allow workers from such regions to move to less affected ones.

The irony here is that the impetus toward currency union was partly a result of the recognition of asymmetries. Thus, in the aftermath of the sterling and lira devaluations of the early 1990’s, with their resulting adverse trade shocks to France and Germany, the lesson that was drawn was that a single currency was needed to prevent such disparate shocks from recurring.

But this overlooked a crucial feature of monetary unions: free capital mobility and elimination of currency risk – indispensable attributes of a currency area – could be (and were) the source of asymmetric shocks. Currency unions, in other words, must worry about endogenous as much as exogenous shocks.

Free capital mobility allowed surpluses from large savers such as Germany to flow to capital importers such as Spain, while the perceived elimination of currency risk served to aggravate such flows. To investors, Spanish housing assets seemed a great investment, because the forces of economic convergence unleashed by the euro would surely push up their prices – and because there was no peseta that could lose value.

These capital flows created a boom – and a loss of long-term competitiveness – in some regions, which was followed by an all-too-predictable bust. To the extent that monetary and fiscal arrangements fail to reduce or eliminate moral hazard, the risk that capital flows create these endogenous asymmetric shocks will remain commensurately high.

A second insight from the case of the eurozone, advanced by the economist Paul de Grauwe, is that currency unions can be prone to self-reinforcing liquidity crises, because some vulnerable parts (Greece, Spain, Portugal, and Italy at various points) lack their own currencies. Until the European Central Bank stepped in last August to become the central bank not just of Germany and France, but also of the distressed peripheral countries, the latter were like emerging-market economies that had borrowed in foreign currency and faced abrupt capital outflows. These “sudden stops,” as the economists Guillermo Calvo and Carmen Reinhart call them, raised risk premiums and weakened the affected countries’ fiscal positions, which in turn increased risk, and so on, creating the vicious downward spiral that characterizes self-reinforcing crises.

The most appropriate analogy is with a country like South Korea. In the aftermath of the Lehman Brothers collapse in 2008, South Korea needed dollars, because its firms had borrowed in dollars that domestic savers could not fully supply. Thus, it entered into a swap arrangement with the Federal Reserve to guarantee that South Korea’s demand for foreign currency would be met.

Of course, the euro crisis was not just a liquidity crisis. Several countries in the periphery (Greece, Spain, and Portugal) were responsible for the circumstances that led to and precipitated the crisis, and there may be fundamental solvency issues that need to be addressed even if the liquidity shortfall is addressed.

Finally, a less well-recognized insight from the euro-crisis concerns the role and impact of a currency union’s dominant members. It is often argued that the United States, as the major reserve-currency issuer, enjoys what then French Finance Minister Valéry Giscard d’Estaing famously called in the 1960’s an “exorbitant privilege,” in the form of lower borrowing costs (a benefit estimated to be worth as much as 80 basis points).

There was always a downside – previously ignored but now highly salient in our mercantilist era – to this supposed privilege. If investors flock to “safe” US financial assets, these capital flows must keep the dollar significantly stronger that it would be otherwise, which is an unambiguous cost, especially at a time of idle resources and unutilized capacity.

But, in the case of Germany, exorbitant privilege has come without this cost, owing solely to the currency union. Weakness in the periphery has led to capital flowing back to Germany as a regional safe haven, lowering German borrowing costs. But, yoked to weak economies such as Greece, Spain, and Portugal, the euro has also been much weaker than the Deutschemark would have been. In effect, Germany has had the double exorbitant privilege of lower borrowing costs and a weaker currency – a feat that a non-monetary-union currency like the US dollar cannot accomplish.

The future of the eurozone will be determined, above all, by politics. But its development so far has forever changed and improved our understanding of currency unions. And that will be true regardless of whether the eurozone achieves the closer fiscal and banking arrangements that remain necessary to sustain it.

Arvind Subramanian is a senior fellow jointly at the Peterson Institute for International Economics and the Center for Global Development.

Copyright: Project Syndicate, 2013

The comment and opinion in this newsletter is
comment and opinion only and does not in any way constitute personal financial
advice. Please seek advice from a professional financial adviser for all
investment and financial decisions.


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Money Marketing Newsletter with Patricia Holburn: Currency war and peace

In today’s newsletter we share an article on global financial issues – what fears are currently prevailing and are they justified, how do they affect economic policy and monetary policy.


Currency War and Peace
By Otaviano Canuto

WASHINGTON, DC – Much of the hype surrounding last month’s meeting in Moscow of G-20 finance ministers and central bankers was dedicated to so-called “currency wars,” which some developing-country officials have accused advanced countries of waging by pursuing unconventional monetary policies. But another crucial issue – that of long-term investment financing – was largely neglected, even though the endgame for unconventional monetary policy will require the revitalization or creation of new long-term assets and liabilities in the global economy.

The collapse of Lehman Brothers in 2008 drove up risk premia and triggered panic in financial markets, weakening assets in the United States and elsewhere, and threatening to provoke a credit crunch. In order to avoid asset fire-sales – which would have led to the disorderly unraveling of private-sector balance sheets, possibly triggering a new “Great Depression” or even bringing down the eurozone – advanced countries’ central banks began to purchase risky assets and increase lending to financial institutions, thus expanding the money supply.

While fears of meltdown have dissipated, these policies have been maintained or extended, with policymakers citing the fragility of the ongoing economic recovery and the absence of other, equally strong policy levers – such as fiscal policy or structural reforms – that could replace monetary policy quickly enough.

But several years of ultra-loose monetary policy in the advanced countries has led to significant liquidity spillover abroad, putting excessive upward pressure on higher-yielding developing countries’ currencies. With developing countries finding it difficult to deter massive capital inflows or mitigate the effects – owing to economic constraints, like high inflation, or to domestic politics – the “currency wars” metaphor, coined in 2010 by Brazil’s finance minister, Guido Mantega, has resonated widely.

Moreover, only a small portion of the liquidity created by unconventional monetary policy has been channeled toward households and the small and medium-size enterprises that generate most new jobs. Instead, crisis-affected global financial entities have used it to support their efforts to deleverage and to rebuild their capital, while large corporations have been building large cash reserves and refinancing their debt under favorable conditions. As a result, economic growth and job creation remain lackluster, with the availability of investment finance for long-term productive assets – essential to sustainable growth – severely limited.

Some believe that the elimination of macro-financial tail risks, the gradual strengthening of global economic recovery, and the increase in existing asset prices will eventually convince cash hoarders to increase their exposure to new ventures in advanced economies. But such optimism may not be warranted. In fact, at the recent G-20 meeting, the World Bank presented an Umbrella Report on Long-Term Investment Financing for Growth and Development. The report, based on analysis from various international organizations, highlights several areas of concern.

For starters, banks’ current retrenchment of long-term investment financing is likely to persist. After all, many of the advanced-country banks, especially in Europe, that dominated such investment – for example, financing large-scale infrastructure projects – are undergoing deep deleveraging and rebuilding their capital buffers. So far, other banks have been unable to fill the gap.

Furthermore, the effect of internationally agreed regulatory reforms – most of which have yet to be implemented – will be to increase banks’ capital requirements while shrinking the scale of maturity transformation risks that they can carry on their balance sheets. The “new normal” that results will likely include scarcer, more expensive long-term bank lending.

The World Bank report also points out that, as a consequence of banking retrenchment, institutional investors with long-term liabilities – such as pension funds, insurers, and sovereign wealth funds – may be called upon to assume a greater role in funding long-term assets. But, to facilitate this shift, appropriate financing vehicles must be developed; investment and risk-management expertise will have to be acquired; regulatory frameworks will have to be improved; and adequate data and investment benchmarks will be needed. These investors must focus on the small and medium-size enterprises that banks often neglect.

Finally, local-currency bond markets – and, more generally, domestic capital markets – in emerging economies must be explored further, in order to lengthen the tenure of financial flows. Local-currency government-debt markets have performed fairly well during the crisis, while local-currency corporate-debt markets have played a more modest role as a vehicle for longer-term finance. This suggests that domestic reforms aimed at reducing issuance costs, improving disclosure requirements, enhancing creditors’ rights frameworks, and tackling other inhibiting factors could bring high returns.

Anxiety over unconventional monetary policies and “currency wars” must not continue to dominate global policy discussions, especially given last month’s pledge by G-20 leaders not to engage in competitive currency devaluations. Instead, global leaders should work to maximize the liquidity that unconventional policy measures have generated, and to use it to support investment in long-term productive assets. Such an approach is the only way to place the global economy’s recovery on a sustainable footing.

Otaviano Canuto is Vice President for Poverty Reduction and Economic Management at the World Bank.
Copyright: Project Syndicate, 2013.

The comment and opinion in this newsletter is
comment and opinion only and does not in any way constitute personal financial
advice. Please seek advice from a professional financial adviser for all
investment and financial decisions.


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