The government debt trap.

Why Pravin Gordhan is concerned about the current state of the markets.

Those who favour aphorisms are likely to be familiar with the “10 cannots”. Despite popular belief that they were written by America’s famous statesman, Abraham Lincoln, they were apparently the work of a religious minister, Henry Boetcker.

They are worth studying and following in all of our affairs, particularly government and public. But at least two will no doubt sound very strange in our modern world:

· “You cannot bring about prosperity by discouraging thrift,” and

· “You cannot establish sound security on borrowed money.”

The world is drowning in debt and funny money and it’s a moot point whether, with all the academic postulates and hypothesis that deluge analyses of the debt of different countries, we would not conclude that they would be either insolvent or close to it if they were individuals – at least from a cash flow perspective. While comfort is often sought in the debt to assets ratio, this is pushing hypothesis to beyond credence. A grand auction of all household and national assets to cover debt is pure fiction. So we see nations trying to revert to a Boetcker like thrift or “austerity” to roll back decades of indulgence and to spark off a heated international debate about whether, in the interests of suffering and stone throwing citizens, there should not be a leaning toward “spending our way out of debt”.

There is no easy answer, particularly because it is difficult to blame the 99% for the pre 2007 financial frenzy that left only 1% better off today. For a large part, the same financial shenanigans are still being practiced and the economic cappuccino machine is still generating much froth. I have a clear empathy for the 99%, but as a product of a generation of thrift and prudence, I am strongly drawn to those qualities being the cornerstone of a solution.

Broadly speaking there are three main forms of country debt:

· personal or household,

· foreign trade and

· Government.

In South Africa all three are cause for concern. Individuals are indebted to the tune of about R1.4trn (or about R50 000 per household), with only a quarter for fixed and appreciating assets such as homes. In foreign trade of both so-called “invisibles” and physical goods, we are constantly earning less than we are spending with our external debt also at about R1.4trn. And our total government debt now stands at about the same.

Global attention, stimulated in no small measure by public unrest, is focused mainly on government or public debt. Which raises the question: how comfortable can South Africa be with its level of government debt close to 40% of GDP (the value of goods and services produced in a year)? And if we are, can it be maintained or even rolled back, or are we heading for a government debt trap?

Not quite…although we could be there soon if one interprets an analysis of government finances by South African economist Christo Luüs. His insightful and coherent treatment of the issue is a must read for anyone interested in our economic destiny and can be found at this link. He sketches five scenarios of which only one can reverse a negative trend, and is highly unlikely; and another which could maintain current comfort, but is also becoming less likely.

In short, there is a strong interaction between three critical components that feed off each other to push government debt either into an exponentially worsening trap, or away from it. They are

· economic growth, or movements in Gross Domestic product;

· the budget deficit; and

· interest payable on that debt.

If one moves in the wrong direction, the others do the same. For example, current capital outflows cause an increase in the interest burden which will force government to go into a deeper deficit to maintain spending on vital services; in turn increasing the deficit as a percentage of GDP; then increasing concern among government bond investors, forcing interest rates up further and so on. You then quickly pass a threshold where, unless some drastic event changes one of the components positively, you are caught in a vortex.

I suggest you look at his scenario 4 which is simply keeping the fiscal ship on course, and then compare that with the latest developments on GDP, inflation, bond yield movements, foreign sentiment, and politically driven expectations to draw your own conclusions.

For me there are more important issues at stake. We are at the mercy of statistics! -- a set of numbers that influences our taxes, inflation, interest rates, jobs and many more.

When that happens my little Human Touch gremlin looks for a spanner. And the first ill-fitting nut it finds is – what if the stats themselves are wrong? In one of the most important statements in years, Economist Mike Schussler wrote that the God of all stats – GDP – could be wrong and understated! Yet, apart from Stats SA’s petulant rebuttal, such an important challenge fails to even remotely rattle the overwhelming obsession with it and receives little attention in mainstream media. On top of that, even if the GDP number is accurate, there is a growing realisation that it is an imperfect measure of progress.

The assessment of the budget deficit itself is arbitrary to say the least. It is based on the “primary deficit”, defined as the deficit before interest payments or debt servicing. It ignores the important distinction between capital expenditure such as infra-structure, and operational expenses such as salaries and wages. There’s a huge difference: like between paying off a home loan, and maxing out on your credit card. The one pays for future assets and is not recurring after a certain time; the other covers exponentially increasing, often inefficient running expenses. Even here, what is capital and what is operational? One could argue that education is similar to infra-structure spending because it develops people rather than structures.

Why the obsession with these questionable “debt benchmarks” – 40% for developing countries and 60% for developed countries? Developing countries need credit to develop and build. Developed countries should be beyond that and their deficits are far more likely to be based on fiscal imprudence.

When South Africa comes close to the 40%, there’s market aversion and censure. But most of the developed nations are way beyond the 60% mark: Japan 134%; Singapore 108%; U.K. 83% and U.S. 108%. Despite these unacceptable debt levels, witness how “risk aversion” caused a huge outflow of capital from emerging markets to developed countries, leaving many national economies vulnerable, their currencies clobbered, their stock markets in tatters, their debt servicing costs increased, their economic growth threatened.

Short term speculative expediency has for decades out-trumped moral legitimacy. Global capital driven by some dubious statistical triggers has become dysfunctional as a stable source of financing growth and entrepreneurship. We and billions of people in emerging economies are still exposed to George Soros’s “wrecking ball”. Of course one can defend it from a paper trader’s point of view – from the global financial institution to the hedge fund to Joe Soap at his computer. No doubt your comments will do this for me.

So be it! If we can’t attract stable capital through questionable statistics, then we have to do so through our behaviour. The pinnacle of maturity according to Abraham Maslow is the point at which “you no longer seek the good opinion of others”. In order to duck the wrecking ball we have to grow up, and fast!

That will require getting the national budget on track, at the very least eliminating that half of the deficit that cannot be attributed to infra-structure. It will mean financing more of the deficit through our own domestic and personal savings. It will mean adopting the wisdom of Boetcker and returning to those “old school” qualities of prudence, thrift and firm and moral leadership. Those are but a few that speak to our national integrity.

We can start by adopting another of Boetcker’s “cannots”, the failure of which is putting increasing pressure on government spending.

“You cannot help men permanently by doing for them what they can and should do for themselves”.