Variable pay in gold mining.

Are the risk-sharing proposals in current wage negotiations built on serious fault lines?

At last there is some significant movement towards flexible pay in one of South Africa’s biggest employers – the gold mining industry. As Geoff Candy reported on Mineweb this week, gold producers are looking at some form of pay at risk to counter Union demands for much more than the 5.5% pay hike employers have offered. This could add another 1% based on performance linked to factors such as the gold price, gold revenue, gold produced or cost savings.

It’s doubtful whether this will have a significant impact on reducing the gap between the employers’ offer and the up to 100% demanded by some Unions. In addition, even a superficial glance at the proposal reflects some serious flaws that could be detrimental in the long run to both labour and employers. One can only hope that these flaws do not scuttle the concept itself and delay the inevitability of some form of fortune sharing in the industry.

Fortune sharing in mining has been a desperate need for a long time. It’s a volatile industry, consuming large amounts of high risk capital that has to be ploughed into a depreciating asset, and which simply cannot sustain inflexibility and constantly rising costs.

The graphic below of Harmony Gold mine’s Contribution Account, which I have extrapolated from its latest Integrated Report is an alarming reminder of just how close to the cliff edge most mines have come. The 68% share of wealth to labour is simply over the top. When I consulted to some mines in the 90’s that share was about 50% even in marginal operations. For South Africa as a whole, labour share of GDP is less than 50%.

While some argue that mining is a labour intensive industry, it is far less so than your conventional labour intensive operations such as retail or financial services. It’s a capital hungry industry. The 23% which goes to “savings” or retained income does not have the normal effect of enhancing equity value. It is consumed in capital expenditure such as underground development, shafts, headgear and plant -- most of which have no resalable value. You cannot sell a big hole in the ground – unless someone wants a giant long drop somewhere in the Free State.

In the end, the share of wealth creation should be a fair reflection of the contribution each of the constituents have made in response to the needs of the market – which in gold and most other commodities is an unforgiving place that simply has no interest in your needs and wants, fights and squabbles. In other industries you may get away with imposing such adolescent pettiness on the market through profiteering, collusion, price fixing, bid-rigging and lack of competitiveness. There’s no place for that in mining.

Ultimately, and for any business, real tangible value is created through having served and supplied its customers. That is indeed the common purpose of all of its participants or direct stakeholders.

This is the first serious flaw in the gold producers’ proposals. You can never forge a common purpose through rewards, only through contribution. While that contribution is vague in an industry that is market led rather than customer driven, the production and supply of gold to a world that needs and wants it, is the only common purpose that all involved have. Common purpose based on rewards breaks down when the reward of one is reduced by the reward of another, where higher profits are achieved through reducing the wage bill whether through lay-offs or lower wages; or vice versa.

A well-constructed variable pay system, particularly its ultimate form of fortune sharing, should never be a knee jerk response to wage demands. Flexible pay is not about incentive, but about involvement and engagement, about common purpose and common fate.

Variable pay is about flexibility and viability of the enterprise itself. It should never be a threat to profitability and sustainability. The industry has had an example of this where, some years ago, one marginal mine constructed a bonus scheme based on cubic meters mined underground. Month after month, employees were called in to receive bonuses for their huge and exhausting efforts. At one time, they were all called in to be informed that most of them had to be retrenched. While tons milled had shot up, both the ore grade and gold price had slumped, putting the mine over the edge into bankruptcy.

Virtually all of the proposed “triggers” in the current producers’ proposals can have the same effect. The exception is profit sharing itself, but this carries the danger of rewarding some at the expense of others which breaks a fundamental rule of common fate.

The only common fate metric that exists in any business is cash value added or wealth creation itself. It captures all eventualities and is, after all, the pie that feeds all. Sensible sharing has to be based on two fundamental principles: it has to meet the legitimate expectations of all of the stakeholders and it has to ensure continued contribution. But before you can even get there, the way that pie is currently divided has to reflect some balance. From Harmony’s figures, it would seem the industry is very far from that.

But it can be done. If the employers’ are prepared to let go of their silly, over prudent cap of a 1% increase on current wages to variable pay, they may even convince the Unions to peg current wages and sacrifice say half of their gains from an increase in wealth to restoring the balance. When this balance is restored, or at least comes close to being restored, there is no need for a cap. Indeed given an improved outlook for gold mining from a firmer gold price, cheap rand, containing outside costs, and lifting production through fewer work stoppages one could easily envisage average value-added for the industry lifting by between 10% and 20%. In the current state, retrenchments have to be seen as part of restoring balance but for those left, it would in principle imply at least a 10% increase in pay, albeit at risk. I say in principle because from there one can construct the actual split in a variety of ways to accommodate merit bonuses, safety performance, and specific cost savings.

Then there are many other, perhaps even more serious flaws in the proposal, which I dealt with in a recent article, but will repeat here:

There are four absolute pre-requisites for any form of flexible pay:

· It must be simple and understandable,

· It must have a clear line of sight where employees can see the effect of actions or events on wealth creation and their pay,

· It has to be accompanied by regular and understandable information sharing.

· Pay-outs or feedback must be regular – at least quarterly if not monthly.

Conventional profit sharing schemes can seldom meet these requirements – share option schemes even less so.

While the current proposals are a very far cry from the ideal, they at least represent the beginning of a shift to a more sustainable dispensation.

Revisiting indicators.

Counting what counts, as seen by the initiator of financial indicators in broadcasting in South Africa.

The recent Moneyweb article on “What the indicators are not telling us” sent me on a nostalgic trip to my days in broadcasting.

At that time, until about late 70’s, public broadcasting was a very minor player in economic news. The only dedicated business news broadcasts were 5-minute bulletins at 9.10 pm on the two non-commercial channels. They were to become the springboard for a separate economics news desk feeding news bulletins and talk shows on multiple outlets on Radio and Television and producing two Television shows, of which “Diagonal Street” was one.

I use the term “initiator” perhaps too modestly on the one hand and too conceitedly on the other. Regarding the former, it was more of a pioneering effort in a stubbornly resisting environment, and the latter: the quick growth of the economics department was largely due to a very dedicated team of professionals with whom I had the privilege to work in those formative years.

The indicators were first introduced in short news bulletins, where air time was jealously protected. In convincing the controllers of the validity of regular economic slots, we could not rely solely on examples elsewhere, and intense lobbying and discussions with leaders from various sectors, bankers, economists, brokers, the Treasury and the Reserve Bank clearly isolated the most important to a broad South African audience and how they in turn should interpret them in their daily decision making.

This is not purely a reflection on my past, but rather examining an important issue raised by the Moneyweb article which questioned their relevance today; what should be included and why. At the same time it may help you in applying the information in your own decisions. Our research and given the constraints of air time and target audience led to a number of pre-requisites and disciplines which arguably are still applicable today.

· They have to be brief and concise;

· they should be restricted to a few only and

· they have to be relevant to the country as a whole and not only to a specific sector or interest group.

Instead of the classic distinctions between leading, lagging and coincident indicators, it is more useful to think of them broadly as those that influence economic trends, and those that merely confirm or reflect those trends. It is perhaps a misnomer to call the daily and weekly prices and indices “indicators” because they clearly have to be maintained for a while to influence economic direction. It is also far more important to know what causes movements than to try and extrapolate their future impact. If you know and understand that then you have more than a casual grip on your economic circumstance.

Most economists will rely on monthly or quarterly figures to determine trends, and I’ll deal with those separately in a future article.

Our hunger for immediate information that influences future trends makes an absolute case for daily indicators. Context, reliable commentary, and authoritative interpretations should help even the less aware in assessing their trends and impact. An important rationale for daily indicators in the public media is to enhance a sense of awareness around their importance, and hopefully create a desire for further understanding. At the same time they should offer the informed a quick and concise alert system of developing events.

So what should we include and why?

Interest Rates.

A serious omission in the daily broadcasts today (and surprisingly elsewhere) is the debt markets. Foreign capital movements are our Achilles heel and these will be reflected in the daily movements on both the short term money markets and long term capital markets where debt is actively traded and new paper auctioned. We included both in our original bouquet: the money markets through the B.A. rate, and the capital market through RSA long term bonds. I cannot explain why these have disappeared, but any observer of these rates will have an early detection of the capital flows and trends.

Current movement in all the rates can be found on this page maintained by the Reserve Bank. SABOR on the money markets and the 10 year and longer daily average bond yields are probably the more telling. Despite all of the instruments at its disposal, the Reserve Bank cannot maintain a repo rate that does not reflect the pressures from these markets.

Exchange Rates.

An absolute must! At least we seem to be past the hackneyed and misguided “good for growth” argument for a cheap currency. Most people today have a good understanding of the implications of movements in exchange rates, and when they make news, we have enough professional and amateur commentators to trot out yesterday’s prepared scripts. All I would add is a repetition of what I wrote some time ago “a consistently strong currency reflects economic health and a weak currency the opposite”. But it could be argued that focus on the Dollar, British Pound and the Euro is a bit skewed. Most viewers will not see much beyond the dollar and perhaps a case should be made for the Reserve Bank’s nominal effective exchange rate.

Gold price.

Keep it! If it is assessed purely on gold mining’s contribution to GDP then it has lost considerable weight compared with when it was first included. But the gold price reflects more than export earnings, mining income and mine employment. It is still, albeit informally, an alternative currency to many which explains its place in international business slots.

Also, mining has a far greater multiplier effect on other industries than most other sectors. The viability of mines has a concentrated impact on specific communities, which may be a good reason for also keeping the platinum price as an indicator, where its export income now exceeds that of gold. But I have my doubts. And if we are focussed on export earnings then adding a R/kg price may be more useful for both gold and platinum.

JSE.

Our original argument for its inclusion was based on the logic that share price movements were a reflection of both local and foreign sentiment. This is clearly no longer absolute, given a record breaking All Share index recently, at a time when for the most part the mood was gloomy. The explanation for this is the lack of attractiveness of other investments, continued growth in profits despite lower income growth, and executive rewards linked to share values. But equities still have a dominant impact on public investments such as pension funds, endowment policies and unit trusts, which are more broadly held today than 20 years ago. For a compact bouquet of daily indicators, however, I doubt whether I would want to argue for more than the ALSI.

Oil price.

A significant number of people are often surprised when petrol price adjustments are announced. This casts some doubt on the usefulness of this indicator. The confusion of course, is caused by the Rand conversion. It’s an important price to the economy, but perhaps it could be made more meaningful if it was reflected in Rand terms.

That would be my top five for a daily fare. In time past, I would have championed more, but with the plethora of economic news in various media today, a case can be made for clearing the clutter and focussing only on a handful for routine reflection and your own personal attention. Of course no indicator is insignificant but instead of routinely cluttering these crucial five, it would be better to have fuller treatment, contextualisation and explanation of their movements. An understanding of these indicators, what influences them, and how they impact on the economy, will go a very long way to enhancing economic literacy. I’m left wondering how many of our top leaders in parliament, labour and perhaps even elsewhere have even this very basic awareness.

Of course, you may have more suggestions, and sharing them with us in your comments will enrich this article.

The marvel of an economy is that it is a living, breathing organism where each cell impacts on others and the body as a whole. But what we too often ignore is that at its heart and soul are people; their hopes, fears, aspirations and expectations and the way they behave.

Now, if only we could find a daily indicator that would reflect that!

Bosses with moneybags.

Muting “freedom fighters” at the heart of their “struggle”.

There was a popular caricature in years gone by of the “fat-cat capitalist” boss leaving work with his briefcase stuffed with money that had been gathered from the efforts of exploited workers.

Thys, the mine manager at one of the first sites I consulted at, and I used to have precious moments of levity at his casual safari-suit dress code and absence of a brief case to counter that caricature. Indeed, my presence there was part of that effort, more specifically to set up some form of comprehensible sharing of information that would disabuse the belligerent mobs of their misguided musings.

In all of my work at the time and at many different sites, I could never convince clients of the need to be transparent about pay differences. Even the most belligerent workforces never argued for “equal pay” – only, and then not too convincingly for “equal pay for equal work”. What was even more tragic was that the pay difference cover up was exacerbating misconceptions. Employee suspicions were far worse than the reality. Full and credible disclosure, I argued, would in fact ameliorate the murmurings.

But it all fell on deaf ears, even at one large retail site where we extrapolated an average differential of about 7 to 1 between the top-paid 10% per cent and bottom paid 10%. Of course that was before the introduction of other executive pay magician’s capes such as share options and convoluted bonus schemes. (Latest U.N. statistics puts that calculation for South Africa as a whole at 33 to 1). But at that time, I vehemently championed disclosure, pointing out that it was a differential that even the most radical unions could accept, against the background of a relatively mild prevailing South African Gini co-efficient of less than 5 compared with today’s 6.7.

What I could not achieve in those years was later done by the stroke of a Mervyn King pen. The King III governance requirements has forced executive pay disclosure at a time when the differential has been exponentially burgeoning, not only catapulting the issue into the heart of serious labour ferment, but adding to the frenzy by igniting comparisons and adolescent envy as a motive for increasing executive rewards.

What changed in a span of less than 20 years, that could turn modest, yet covert pay differentials into excessive, now embarrassingly overt gaps? -- certainly not sudden and massive changes in supply and demand for executives. That alone should confirm that the so-called executive market is thoroughly broken, and the price for executives is nothing short of fiction.

It has perhaps been forgotten that the explosion in executive pay has happened in less than 20 years, more specifically as an unintended consequence of American President Bill Clinton’s efforts to curb what was then already becoming obscene levels of executive remuneration. His executive pay tax proposals in the early 1990’s set off a wave of tax avoiding remuneration initiatives that compounded the gap many fold.

South Africa, with its 50-60 times pay differences in a highly emotionally charged environment, simply cannot escape the global soul-searching on executive pay. Switzerland for example is looking at enforcing a 9 times differential cap, on the back of a recent referendum for executive pay reforms.

One of the world’s thought leaders on executive pay, PwC has been challenging executive pay models for a number of years, concluding in its latest Executive Remuneration report that “there are few who would argue that executive pay models have produced better performance over the last decade”. The case against long term incentive plans, it says, may be based on:

• Poor track record of aligning reward with shareholder returns;
• Volatility of performance being rewarded rather than strong sustained performance;
• Impossible to calibrate reliably;
• Perceived as a lottery by participants; and has led to irrational discounting by executives, so valued at a fraction (in many cases only 25%) of their economic cost.

PwC believes that simplification and with it greater certainty will lead to a reduction in executive gross pay, simply by reducing the extent to which executives discount the real value of these incentives. It has proposed a new model to capture

• Financial performance (but with a long-term view on underlying trends),
• Customer,
• People, and
• Risk, compliance, and behaviour.

It says performance assessment criteria should be based on (1) Revenue; (2) EBITDA (earnings before interest, tax, depreciation, and amortisation); (3) Operating free cash flow and (4) Return on capital.

It is beyond the scope of this article to give all the details of the proposed model, let alone a critique of all of its elements. Encouraging as it is simply in challenging the current dysfunction in executive remuneration, my main concern is that it is still deeply rooted in profit maximisation and shareholder value criteria and will do little to effectively counter short-termism and a squeezing out of other social constituents, including labour. The model falls back heavily on elements of the Triple Bottom Line and the Balanced Scorecard, which have been around for decades with no effect on pay disparities or more balanced national economic growth globally.

Ultimately the real value of any business should not only be to one specific group such as the owners, but to all of its constituents, the most important of all being customers or the market that that business serves. Accommodating those constituents as merely co-incidental beneficiaries of the grand purpose of maximising profit is skewed, inappropriate and indeed has led to their neglect.

If, as Bill Kellogg once remarked, the real purpose of a business is to add value to people’s lives and profit is only one consequence (albeit a very important one) of that, then the real issue is to challenge the mother of all measurements, the income statement itself.

The only metric that appropriately captures the very essence of what companies should be about is wealth creation or value added. This is simply income less outside costs. I believe, however, that real wealth creation is more accurately represented as cash Value added, which means that interest, depreciation and amortization should be deducted from the commonly used value-added metric.

If used as the primary incentive criterion, it forges common purpose and common fate within an organisation and will be by far the most powerful tool in countering ever increasing pay disparities. It is the one measurement that will encourage executives to emulate entrepreneurial behaviour while reconciling shareholder and customer interests.

Of course, there are such powerful vested interests cemented in conventional accounting that one cannot expect any serious move towards something else, particularly from the accounting profession.

Indeed, giving credit where it is due, PwC’s challenge to current formulae is a laudable proposal in addressing pay disparities, one of the great distortions of our time. It is such a powerful weapon in the hands of malcontents such as our so-called economic freedom fighters that any hint at its invalidity has to be seriously explored.

PwC’s difficulty will be to reassure a sceptical audience that any tinkering with executive remuneration that implies a reduction in their gross pay, will lead to an exodus of much needed talent.

I used to be an avid poker player. Let’s call their bluff!

The compromise conundrum.

Wage compromises are not a solution in unforgiving markets.

When stances are stubbornly held in adversarial relationships annual compromises in wage negotiations amount to nothing more than temporary patchwork and ultimately simply become untenable.

Management will adjust to the compromise by cutting costs deeper, and workers return to their positions bruised, bloodied, seething with resentment and waiting anxiously to learn whether they will be the next to be turfed out of a job.

The writing has been on the wall for a long time in the mining industry, one of the country’s biggest employers and a hotbed of distrust and violent confrontations, exacerbated in no small measure by union rivalry and by the fact that investors have to seek high returns in a volatile environment with a naturally depreciation asset. In time, a mine simply dies when it runs out of payable reserves. Paradoxically, the only certainty one can establish in such an environment is through flexibility. In turn, flexibility simply cannot accommodate rigidly held demands, assumptions and unrealistic expectations.

It is further severely threatened when extreme if not outrageous positions are taken at the outset of an obscene haggle. This week’s opening gambit by the National Union of Mineworkers was for a 60% pay hike and by its rival AMCU for 100%. It is by far the most extreme demands yet that the industry has had to face and comes on the back of highly costly, violent and disruptive action that has had the industry staggering for months now.

In addition, the relentlessly tightening pincer of a decline in commodity prices on the one hand and rising costs on the other is having devastating effects on global mining with many mine operations facing closure. While some argue that this is a time for compromise on all sides, it could also be argued that it is the time to fully re-examine a wage pricing model that is deeply flawed to begin with.

That model has created the ever widening gulf between employer and employee, between capital and labour, between executives and average worker. On the one hand we have had the industry pleading its cause through some stark reality check figures outlined by Moneyweb Mining Editor, Geoff Candy that put the cost of producing one ounce of gold and replacing that ounce with a new one at between $1,250 and $1,500.

Then we had Labour correspondent Terry Bell earlier defending a double digit pay increase on the basis that “the wage deals struck by most workers over the past five or six years, let alone over a longer period, reveal that these workers have effectively become poorer; that their disposable income has bought less and less as each year went by”.

Mining, like few other industries, has very limited choices. It is not the place where you can bring your needs and wants to the “market”. That market is unforgiving, overwhelming and absolutely dictatorial.

Ultimately it is so with all markets. The ultimate paymasters of profits, wages and all benefits are the end buyers, not management, unions, or the outcome of “negotiations”, belligerent or otherwise, between the beneficiaries.

Wealth distribution has always been secondary to wealth creation. Yet, under the veil of being “market driven” we have made the secondary market the primary one, arguing that collective coercion on the part of labour; kowtowing remuneration committees on the part of executives, shareholder value on the part of capital, and tax decrees on the part of state, represent true value and contribution to the end buyer.

We are being pushed by reward, not being led by contribution. It is in line with the flawed economic construct we have developed over decades that panders primarily to our selfish needs and wants rather than our natural and instinctive desire to do something meaningful for others, the ultimate source of meaning and contentment.

But even that would be tolerable if those markets that should guide wealth distribution were unfettered and functional; where rewards at a general labour level were not determined by panga wielding mobs, unrealistic expectations and rigid legislation; where at executive level they were not the outcome of smoke and mirror board-room lotteries to create 50-60 times pay differences between highest and lowest; where productive capital is not seduced by quick and short-term returns either in flaky financial instruments or by neglecting other constituents; and where taxes were aimed primarily at enablement and not dependence.

Only a truly functional market for skills, qualifications, experience and aptitude can be an appropriate guide to pay differences and how the labour share of wealth creation should be subdivided. The overall strategic pillars of sensible distribution are meeting the legitimate expectations of all of the stakeholders and encouraging continued contribution. But even then, the actual amount has to be aligned to wealth creation itself and each reward ultimately sanctioned by those who pay for it, the end user or customer. If the recognition of value added by the end buyer is volatile according to changes in supply, demand and prices, then rewards themselves have to be flexible and constantly aligned to those changes.

That would be a purist market view – perhaps not attainable for decades to come. But what we now have is broken and unsustainable.

Moods and measurements.

Having our economic destiny driven by manic-depressive markets.

There’s been much talk again recently about what drives what in economics: the immeasurable or the measurable, the way we calculate or the way we behave; the way we think or the way we feel.

It clearly is much more than chicken or egg, and regular readers to The Human Touch will know which side I favour – the title of my column says it all. But then I must concede that I am a product of an age when things were relatively stable, our serenity rattled mostly only by the threat of a nuclear 3^rd world war.

Exchange rates were fixed. Even our money supply was disciplined to how much gold we had in our vaults and changing our exchange rate was a huge political event – “devaluation” implying weakness, mismanagement and instability. At the time a 5% devaluation was “groot skande”; a 15% downward adjustment to the dollar a threat to popularity at the polls. No wonder politicians handed the whole sorry affair over to “the markets” where currency values can move by more than that and both ways within weeks, with only obscure blame on domestic management, but mostly on the pretext that “it is not I that am weak, but he that is strong!”

Remember “Decimal Dan, the Rand/cents man”? At that time you could buy a British pound for R2 and $1½ dollars for R1. It was weird. At home you were poor, but when you travelled you felt like a king among paupers – that’s if you could afford the flight, both physically and financially. My first flight to Holland on a Trek Airways DC-4 took nearly a week – I still remember it as being a lot longer, those propellers no doubt having made a permanent contribution to my chronic tinnitus.

Interest rates were even more tightly controlled. You could not change the bond rate without parliament getting involved. As a young bachelor I remember well the scramble for a fairly abundant supply of “rent-controlled” apartments. We had control boards, which occasionally would challenge Economics 101 by putting up prices because there was a product surplus, but somehow always managed to maintain food supplies at affordable prices. Inflation in the happy hippy 60’s was a term mostly only academics used.

It was a time of oppressive economic controls. Paradoxically it was also a time of great self-control and self-discipline. Many of us compiled budgets with our first pay cheques. An intriguing entry I found under “income” in one of my first monthly budgets was: “Found in pocket = R1”. Of course, detractors from this seemingly idyllic picture can rightfully counter that we had a laager economy, a terribly misguided ideology, and were totally out of step with both what was right and with what was happening in the rest of the world.

So before a warped nostalgia takes me to a point where I lose my conviction born in the 70’s that the markets have a certain magic, that they make better decisions than corrupt governments, that they are better informed than a handful of self-serving bureaucrats and that freedom of choice in all our affairs is worth defending to the death, I need to chant my favourite mantra: “perfect markets perfectly reflect all our imperfections.”

There’s been increasing vindication for the view that moods drive markets and that behaviour drives systems, structures, institutions and ultimately our economic destiny. Our “leading indicators” are no longer restricted to scientific data but include many mood measurements such as opinion surveys and confidence indices. At the same time, there’s been growing scepticism about measurements – not only their veracity but whether we are, as Einstein might have asked: “counting what counts; and ignoring what does not count.”

Without doubt the two are linked, but moods affect the interpretation of measurements, even if they are accurate and valid, and in turn influence the markets to achieve an outcome which comes close to self-fulfilling prophecies. Going back to when most will not remember, and when many of us foolishly believed that economics was an exact science, there were really only two groups who one listened to for market forecasts: the fundamentalists and the chartists. The former, especially economists were great at hedging their forecasts with “on the other hand”. Charting was often viewed as a bit of hocus-pocus. Still, their pretty pictures had sufficient following to influence outcomes.

Today we have the quaint distinction between traders and investors – the former being mood merchants and the latter mostly herd followers trying desperately to maintain the courage of their convictions. When they can’t do that and succumb to the traders’ trumpets they become their fodder, caught in the cappuccino froth.

Traders (we used to call them speculators) need bi-polar markets. They thrive on mood-swings: the sharper and shorter the better with the best players making much more money on panic than tortoise moving confidence. And if they can’t peddle that panic, they are not beyond colluding to rig important triggers like LIBOR. Now driven, as opposed to simply using nano-second electronic trades they are ready to pounce on the slightest differential between trading platforms.

Now all of that would be fine, if speculators were not so many and did not have such an inordinate impact on very important prices and rates that affect the real economy and our economic destiny. Consider McKinsey Global Institute estimates that put the “value” of annual financial speculation at $1.2 quadrillion – 15 times more than the $80trn annual value of Gross World Product.

There’s a first for me! I have never written “quadrillion” in an article before!

Most of that trading centres in bank created I.O.U’s we call money, in the process destroying one of the four essential requirements for money: as a store of value. As a stable measurement of value it is on increasingly shaky ground, but is still holding on to its role as a means of exchange. Regarding the fourth, something you can count in (numeraire) … well you could use sea-shells or poker chips for that.

The predominantly naïve part of my character allows me to reconcile these mind boggling developments with one simple thought. Despite the froth, the underlying coffee remains. The sustainable and for me the most solid part of the economy still rests on life enriching, day to day exchanges that provide us with both means and meaning.

Let the dogs bark….the most effective counter to panic is patience.

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”.

The profit conundrum.

The growing alienation between company profits and other interests in society is a much greater problem than we may think.

At the same time some long held assumptions about profit maximization are being challenged. It has become increasingly evident that the profit motive does not ensure customer care; that being profit driven is not the same as being market driven and the belief that the pursuit of maximum profit is the invisible hand that feeds all is patently wrong.

This is a simple role play that illustrates what happens when companies have a single focus on profits….