Times like these remind us all of the importance of a rainy day fund, whilst governments are desperate to encourage their populations to increase their spending to boost economies, most have cut back spending considerably either because of retrenchment, unemployment or uncertainty about the future. No one knows how long the ecomonic downturn will take to recover, as governments have to increase their incomes through increased taxation to begin paying back the record injections of cash they made into the banking sector and large corporations through 2008 and 2009. Some of this money is finding its way back into public coffers: General Motors in the United States which is now 61% government owned, announced on 18 August that they are planning an Initial Public Offering (IPO) to raise as much as $16 Billion to help repay the US Government’s $50 Billion stake in the company and reduce government control and oversight.

Of the $351 Billion that the United States Government originally expected to inject into financial institutions to save a collapse triggered by the 2008 financial crisis, $291 Billion was spent and only an estimated $89 Billion still has to be repaid, with the last creditors on track to meet their obligations.

The United Kingdom similarly created a  £50 Billion Bank Recapitalisation Fund, from which UK banks could seek an injection of capital to see them through the crisis in exchange for a shareholding given to the UK Government. The UK Government now controls 60% of the shares in the Royal Bank of Scotland (RBS) Group as a result of a £20 Billion from the fund.

Paying It Back

As the world works hard on recovering from the global recession, the burden of increased government debt and a smaller tax base from which to repay it will dog growth for years to come. With less people employed and businesses under strain with lower profits, tax revenues have been hit hard. The South African Revenue Services received R26 Billion or 4.3% less tax revenue in 2009/10 compared with the year before, in the UK tax revenue for 2009/10 is down 5.6% year-on-year. Governments therefore have to increase taxes and slash costs in order to repay the debt; a move which will hit their citizens whilst the banks whose actions led to the financial crisis in the first place are already sitting on healthy profits two years after the crisis hit, RBS Group in the UK posted a very healthy £1.4 Billion profit in the second quarter of 2010.

The Ordinary Man

Where this leaves the ordinary man is at the back of the queue; whilst banks and corporates will begin reaping profits and relieve themselves of government control it will be the man in the street who is still without a job, or still battling to repay his debt whilst servicing higher taxes. Governments keep talking about a special tax on the financial sector to recoup losses directly from those that created the problem, but the counter lobby of stifling their growth and economic recover is strong. The lesson is to never let oneself get over-indebted and always have that key rainy day fund (3-6 months salary) stashed away for when things change.

The past week has been dominated by Greece’s debt crisis and attempts by the EU to help them out of it. Greece switched its currency, the drachma, to the Euro in 2001 and gained a seat at at the big boys table in the financial markets. Overnight investors saw stability (Euro, Germany, France) where yesterday they saw risk (Greece, drachma). Greece found it easy to borrow money at low interest compared to rates they were afforded as a standalone country with a weak currency. After all they are now backed by some of the world’s strongest economies in the Euro.

As it was with individuals finding it hard to resist mounting piles of cheap debt before the 2008 financial crisis, so it was with Greece. Cheap debt and willing investors fuelled a spending spree in government: salaries in the public sector doubled between 2001 and 2009. Together with wide spread tax evasion (it is estimated that half of Greece’s economy operates out of the taxman’s reach), this steadily meant an increasing budget deficit which has peaked 12.1% of their GDP at February 2010 and has triggered crisis talks in the European Parliament. Most alarming is that the European Union has only come to know of the extend of Greece’s debt burden in recent months, it seems that transparency isn’t just an issue among the Greek population – the government has been cooking its books to hide from trouble.

Exposed and in trouble, Greece’s finance minister George Papaconstantinou has to slash spending and stabilise his budgets before convincing investors to refinance $25 Billion in debt in the next few months or face defaulting on debt payments. The European Union standard for budget deficit is no more than 3%, Greece has a long and painful road ahead to get there.

South Africa

President Jacob Zuma’s State of the Nation speech was the focus of economic news in SA this week. The key notes of the speech were:

• The economic recession seems to have ended, although it is too soon to tell how fast the economy will grow in the immediate future
• Therefore the government will continue its support measures, such has loans to small businesses in distress and retraining programmes for retrenched workers
• New plans to increase literacy in schools, access to housing and foster independent electricity suppliers to the national grid
• Plans to spend R846 Billion on infrastructure in the next three years

So… what does Dubai World own besides the Islands projects? You’d be surprised:

• Nakheel: which oversees the Islands and similar development projects
• Dubai Drydocks
• Dubai Maritime Facility (due for completion in 2012)
• Istithmar World: specializes in global diversified equity and alternative investments
• Leisurecorp: Which owns a variety of golf and leisure locations globally
• Dubai World Africa: Which owns the Cape Town V&A Waterfront
• And many many more…

Dubai World shocked markets in November stating that it will have to delay debt repayments until at least May 30, and talks are still ongoing with its major creditors. Abu Dhabi stepped in during December with a $10 Billion loan that prevented Dubai World from defaulting on a $4.1 Billion bond repayment and keep it afloat until the restructuring talks have concluded in an agreement.

How much is $59 Billion? Only 63 countries in the world have a GDP more than $59 Billion, and it represents 36% of the United Arab Emirates’ GDP. Dubai World is an aggressive effort on the part of the United Arab Emirates to distance its reliance on oil as an economic driver, Abu Dhabi’s $10 Billion rescue in December shows that it can still rely on its friends for capital but things won’t be easy to manage in their boardroom until the global recession has been forgotten and people around the world have an appetite for buying into their property and tourist portfolio.

The story is interesting not only because of the huge sums involved but also because it shows that no matter how big or small your purse and ambition, the fundamentals of living within one’s means apply.

Local

The Johannesburg Securities Exchange (JSE) ended higher today thanks to a continuing weak US Dollar boosting resources, the gold price has risen to $1,108 per ounce.

Indices (at close of trade)

Currencies (at close of trade)

International

Indices (at close of trade)

United States

The S&P 500 Index in the US rise to a 13 month high today, boosted by good news in China that its production has grown significantly. In addition, 80% of US companies in the S&P 500 Index that have released third quarter results beat analyst expectations, meaning that overall the real economy is recovering well.

Bank of England May Continue Stimulus

Despite his mood last week hinting that the Bank of England (BoE) may stop financial assistance to troubled banks and companies, Governor Mervyn King said he is leaving the door open to more stimulus packages as the two year inflation forecast remains below 2% in the UK. The consequence of pumping money into an economy as the BoE and other central banks have done in recent past is that the increase in money supply leads to inflation, clearly the 2% inflation potential generated thus far isn’t enough to discourage more aid to boost the financial economy.

Local

The Johannesburg Securities Exchange (JSE), having ended down most of last week, started with a decent rise today. Resources (gold, mining and related) and financial stocks led the way rising by over 2% at the close of trade.

It looks like the recovery is due to two things:

1.       The markets looking to recover from the losses of last week
2.       Positive news from the United States boosting global markets and the gold price, which has reached $1,100 an  ounce!

Indices (at close of trade)

Currencies (at close of trade)

International

Indices (at close of trade)

Group of 20 Extend Handouts

The “Group of 20” leading industrialized nations agreed today to extend stimulus packages that are helping to bail out banks and companies suffering from the global recession. This was behind the market rises in developed markets, particularly financial stocks.

What is interesting is that this news contrasts with noises made by the Bank of England and European Central Bank last Thursday (see Thursday’s Market Report), clearly the other Group of 20 members overruled their sentiments.

Prime Buyers are Bank in the US

Numbers from the US housing sector today also showed that things in the “real” economy continue to improve step by step. The number of “prime” mortgages issued is up, that is mortgages to solid creditworthy people and although banks are still not swamped with people buying property, there are more people coming back into buying houses.

Banks Don’t Seem Very Sorry

Hector Sants, Head of the UK Financial Services Authority (FSA), said in an interview with Bloomberg today that the FSA is looking into imposing bans and fines on banks which haven’t taken efforts at introducing measures to curb a repeat of the 2008 financial crisis. In his view, banks haven’t taken collective responsibility for the financial crisis and the FSA is determined to be an intrusive regulator that “judges the judgements” of senior banking executives, and interviews banking executives on their expertise, skills and ethics.

The thing with stimulating an economy…

It is easy to understand why resources have risen today and the Dollar has dropped, with a record gold price it is boom time for mining companies. In my next commentary article I will explore the concept of “printing money”, that is increasing the supply of paper money in the economy and how this devalues a currency and as a result makes people want to buy something more stable (gold). On Thursday, the comments that the money presses would stop from the Governor of the Bank of England, Mervyn King, and Jean-Claude Trichet, President of the European Central Bank strengthened the Dollar but weakened resources such as gold. For the same reason today the opposite news is causing the opposite effect in markets.

Overview
The Johannesburg Stock Exchange closed a little higher in the end today, after spending the afternoon in negative  territory after the United States released its highest unemployment rate numbers for 26 years. It’s been a tale of ups and downs on the real economic data front, US markets were celebrating good productivity numbers only yesterday, but started today lower on the news of higher unemployment. As at 1.45pm Eastern Standard Time however the Down Jones Industrial Average was up 0.12%.

Indices (at close of trade):

Exchange Rates:
1 Dollar buys R7.53
1 Euro buys R11.17
1 British Pound buys R12.50

United States: Fannie Mae seeks $15.8 Billion from Bankrupt Lehman

In my commentary yesterday I discussed the financial economy and how derivatives called mortgage backed securities set the scene for the financial crisis in 2008. Fannie Mae, one of the largest home loan companies in the United States is trying to recover the funds it lost when Lehman Brothers went bankrupt. Fannie Mae specialized in buying mortgages from banks and guaranteeing mortgage backed securities, and owns 20% of the US housing market. Fannie Mae partnered with Lehman Brothers, who underwrote much of its activity but then created a $15.8 Billion hole in Fannie Mae’s finances when it went under in September 2008. Fannie Mae’s prospects of recovering their funds aren’t good, at best they will receive a partial payout.

The September 2008 market crisis was one of financial economy in the first instance, not real economy. The spiral of bank collapse precipitated by Lehman Brothers was almost unreal, the financial economy had become unreal and prone to collapse. Banks had lost their way in the heady world of complicated financial trade, where the market swapped things far divorced from the real economy. We all know that there is no free lunch, you cannot make something from nothing, and yet this is precisely how many of the investment banks operated. A bank is supposed to oil the wheels of the real economy, make it possible for someone who has a bright idea but no money to loan it from a bank who has a depositor with no idea and money to spare. Both sides of the equation benefit as the idea bears fruit, the loan-holder can make his dreams reality and the depositor earns interest.

A new breed of bank emerged over time, the investment bank, whose ambition was less to oil the real economy but to oil a financial economy. Rather invest money themselves and earn, don’t wait for depositors to pony up savings. In time they became fiercely competitive, creating a dog eat dog world where to be second was to be last and innovating means of making money from a financial economy was their sole purpose.

Investment banks saw their dreams come true with the boom of complicated “assets”, called derivatives. A derivative is what it says on the tin: a derived thing based on some underlying real thing. Take for example a futures contract. Here the buyer promises to buy something from the seller at a future date, but for a price that is agreed now. An example would be a futures contract between wheat farmers and a wholesaler, where the wholesaler guarantees that he will buy the farmer’s crop at harvest for an agreed price, before the farmer sows his fields. The farmer then knows how much to sow: as much plus some margin to ensure he delivers what the wholesaler wants. The wholesaler is happy because he knows he will definitely be in for a quantity of wheat at a set price, and he can negotiate with the market or store upfront as well.

The problem is that investment banks have become very creative with derivatives in recent history. The 2008 financial crisis was caused by a collapse in the US housing market. Why? Well some very clever fellow creative a derivative called the mortgage backed security or MBS. Here a bank loans out money to anyone it can, then buckets 1,000 loans into a single derivative and sells that bucket of debt to another investment bank (who in turn sells it on and on and on).  Now you can imagine how things might and did go wrong:

i)                    The bank who originally loaned the money isn’t that concerned with the prospect of repayment, because it will have sold the debt on before long;

ii)                   The investment bank trading MBS cannot with all the computers in the world figure out how much an MBS is worth. How will a crack team of bankers in New York know whether 1,000 homeowners in Florida will pay their mortgages this month?

iii)                 The big assumption was that house prices will increase tomorrow so it doesn’t really matter because underneath the MBS derivative somewhere is a house worth more than it was bought for.

The collapse was set up by all three of the points above, (i) meant that banks were lending 120% of the mortgage value to new buyers, (ii) meant the hot potato was spreading all over the place and it didn’t take long for (iii) to stop occurring. At some point even 120% didn’t buy many new homeowners a house, and suddenly everyone saw how far removed the financial economy of MBS had departed from the real economy of bricks and mortar. Everything that has happened since is the popping of a big balloon so that the financial economy drops to the real economy of what a house is worth, which is as it always was: what someone is willing and can pay for it.

The real and financial economies are still trying to find one another. The financial economy was nuked in September 2008 and radiated its poison to the real economy. Good businesses went bust just because their banks clenched up, not because they were in any way inefficient or unprofitable. McDonald’s almost missed payroll because its bank suddenly decided that it wasn’t credit worthy! Small businesses have closed in their thousands because they cannot get a $1,000 overdraft to see them through a slow week. Instead of oil the financial economy became glue, as each small business went under, its suppliers lost another payment and also collapsed. The housing sector simply buckled after the first deck of cards was down, the real economy now in dire straits with people losing work just because their employer cannot find $1,000 more to keep going.

The solution by world governments lay in melting the financial glue, to do this meant shoveling as much money as it took to fill the bomb site at the banks until they had stopped the cycle of shock and horror. In today’s market update, for the first time in over a year, it looks like governments might at last be done filling the hole but the jury is definitely not out yet.

My advice is to stick with the “real” economy news; this is where the jobs and the road to recovery lie. If data from the US, Europe and South Africa is anything to go by, we appear to be recovering, albeit slowly.

Overview
It has been interesting this week, it appears that gold traders have cashed in on their profits today causing the top three indices in my table to dip slightly. If you recall in yesterday’s update the gold price hit a record high, clearly those in the know had bought beforehand and are taking some profits.

Otherwise the South African market was fairly quiet today, currencies didn’t really do much and the Rand weakened around half a percent to each of the three major global currencies.

Indices (at close of trade):

Exchange Rates:
1 Dollar buys R7.60 (Rand is 0.65% weaker than yesterday)
1 Euro buys R11.31 (Rand is 0.42% weaker than yesterday)
1 British Pound buys R12.60 (Rand is 0.60% weaker than yesterday)

Good News Continues out of the United States

More good news on the “real” economy in the United States today is driving up the Dow Jones Industrial Average Index by 1.47% as at 10.30 am Eastern Standard Time. In the second set of numbers released about productivity, the US manufacturing sector has grown at its fastest pace in six years by increasing efficiency of staff. Data shows that output per staff grew by 9.5%, meaning people are working harder or more efficiently to produce more.

The increased efficiently is due in part to companies in the US being very cost conscious, and as new orders and sales come in they are reluctant to hire new staff but continue to slash their payroll and eek out as much per staff as possible.

European Central Banks Signal End to Spending Spree

The Governor of the Bank of England (BoE), Mervyn King, and Jean-Claude Trichet, President of the European Central Bank (ECB) made the first decision toward stopping bailouts of banks and companies in Europe which have been ongoing since the September 2008 financial crisis.

Both the BoE and ECB maintain that European economies are “fragile” but there are signs that, as in the US, the “real” economies in Europe are starting to recover. Good signs are a 1.7% increase in UK manufacturing output and signs that the housing market is recovering.

See more about what this, and the signs of improvement mean to South Africa and the World in my analysis blog.

SA Air Force Cancels R40 Billion Airbus Order

Sensibility seems to have returned to our military’s procurement division. A contract for eight Airbus A400M aircraft which was originally priced at R17 Billion but has escalated to R40 Billion was cancelled today by the Cabinet. The R2.9 Billion deposit paid will be refunded in full, due to missed delivery deadlines by Airbus.

The Air Force is now back to drawing board to replace its ageing fleet of transport aircraft.

Overview
The Johannesburg Securities Exchange closed marginally higher today thanks to a record high gold price of $1 090.47 an ounce. As discussed in yesterday’s market update, South Africa is a key commodities exporter including the world’s second largest gold producer after China so good prices for commodities such as gold drive our markets upwards.

The American Dollar continued to weaken, which dampened some of the positive effect of the high gold price. Recall yesterday that I discussed a weak dollar means our commodities are relatively expensive for foreign buyers, but today thankfully the positive effect of the high gold price outweighed the dollar effect.

Indices (prices quoted at close of trade):

Exchange Rates:
1 Dollar buys R7.40 (Rand is 4.01% weaker than yesterday)
1 Euro buys R11.32 (Rand is 2.43% weaker than yesterday)
1 British Pound buys R12.61 (Rand is 2.85% weaker than yesterday)

In the United States, the positive production numbers announced yesterday had the expected positive effect on markets, the Dow Jones Industrial Average (DJIA) posting a 1.27% improvement as at 3.30pm US. Other positive news helping the US market is the Federal Reserve (the US equivalent of our Reserve Bank) keeping interest rates down for an extended period, relieving pressure on US citizens under pressure to repay debts amid job losses.

Ramos Appointed to Barclays Group Executive

Barclays today announced the appointment of Maria Ramos, husband of Trevor Manuel and ex-CEO of SARS and more recently Transnet, to its Group Executive Board. The announcement has caused some concern among investors, citing the move may distract Ramos from attending to problems in ABSA’s senior ranks. ABSA has seen a number of high profile departures since Ramos’ appointment as CEO in late 2008.

Finance Minister Doubles Foreign Investment Allowance

South African Finance Minster, Pravin Gordon, announced changes last week to the foreign exchange rules permitting South African individuals an allowance of R4 million as opposed to the previous limit of R2 million for foreign investment per single person. In addition, the annual discretionary allowance for foreign spending by South African individuals has been increased from R500,000 to R750,000 for adults over 16; under 16’s can still take out R160,000 per financial year.

As an example, a family of 5 can now emigrate with R9.98 million made up as follows:

R4 million capital allowance for each parent

R750,000 discretionary allowance for each parent

R160,000 discretionary allowance for each under 16 child

Individuals are still required to request clearance from the Reserve Bank before exercising the above allowances.

Overview
The JSE closed lower today thanks to negative sentiment in the United States and other First World Markets. The negative sentiment caused investors in the United States to be risk-averse, meaning that they preferred selling their shares and holding on to cash or other safer instruments. This in turn weakened the dollar, in which most commodities are priced, notably gold, coal and other key South African exports. As such the negative sentiment caused a weak dollar, which devalued commodities and as South Africa is a key commodities exporter this led our markets downward.

Indices:

Exchange Rates:
1 Dollar buys R7.83 (Rand is 0.16% weaker than yesterday)
1 Euro buys R11.51 (Rand is 1.01% weaker than yesterday)
1 British Pound buys R12.86 (Rand is 0.01% weaker than yesterday)

Other factors which caused negative sentiment globally were:
UBS Bank saw the withdrawal of 26.6 billion Swiss Francs (205 million Rand) by its wealthiest private clients (individuals) in the past six months, that news saw its stock drop 9.2% today.

Royal Bank of Scotland (RBS) and Lloyds banks in the United Kingdom asked the UK Government for an additional 31.3 Billion Pounds between them to see tough times through. Both have already received extensive funding, meaning this latest bailout is a sign that the UK banking sector is still in trouble.

US “Real” Economy showing signs of improvement
The United States manufacturing sector had its fifth straight month of increased orders for goods, showing good signs that the economy is on its way up. Don’t count chickens however, the banks caused the 2008 financial crisis, and they still look to be mostly in trouble or bottoming out.

South Africa Car Sales Down
Car sales are down 12.5% compared to October 2008 according to the National Association of Automobile Manufacturers. ABSA Asset & Vehicle Finance Managing Executive Marcel De Klerk was quoted as saying that used car sales are showing signs of recovery but it will probably be March 2010 before we see things picking up again on the new car sales side.