Category: Current

US imposes tariffs on Aluminium and Steel from almost all major producers, and they will suffer the most – why?

President Trump has once again blundered his economic policies, and imposed tariffs on most aluminium and steel products from all major producers. He has done so in the name of “national security”. Assuming that the US would ever go to war against one of its Allies (which is a peculiar thought in the first place), America would not have enough own production capacity to produce aluminium and steel for the production of their own weapons. Not only does show that Trumps policies are stuck in the cold war era, but Trump has also struck a spectacular own goal.

 

Aluminium and steel are input products in a vast array of products, ranging from motor vehicles to Pepsi cans. It is so versatile, that there is hardly any manufacturing industry that could get by without it. Therefore, it is vital for the US to get a steady and competitively priced supply of the materials.

 

It is not certain that imposing tariffs will cause the permanent production of US steel and aluminium to go up, because not many companies will commit the capital to build new production facilities. It is more likely that old inefficient ones, which have been laying idle will start up again (and can again be shut down quickly, should the tariffs be revoked). It is certain however, that the price of steel and aluminium in America will go up. That will hurt all the manufacturers who use steel and aluminium in their products. The higher input prices will have to be passed on to the consumer, and therefore all US produced products will get more expensive.

 

There are predictions that cars produced in the US will be between U$4 000 and U$8 000 more expensive, which would surely cost them market share. In return all those nations that had tariffs forced onto them are retaliating by imposing targeted tariffs on everything from Bourbon to Oranges, Pork and Harley Davidsons. They shouldn’t bother. Many of those products are going to be uncompetitively priced anyways.

So, what should Donald Tump have done to increase their homegrown production of steel and aluminium?  He could have lowered taxes on US aluminium smelters and steel mills or given them special tax breaks. But he has already given a broad tax reduction to corporate America, while the economy is booming. It is never wise to play your trump cards at the beginning, Mr Trump.

The Namibian Government wants to bar foreign and listed companies from bidding for fishing quotas. This is a mistake.

 

One of the greatest natural resource of Namibia are the abundant fishing grounds off the Namibian coast line. It is a treasure, and the government is right in saying that it should benefit Namibians, but they are wrong by insisting that all quotas must be allocated to Namibian citizens, and not foreigners or listed companies. This is a misguided decision on three accounts; firstly the scale and complexities needed to operate in the fishing industry, secondly the scarcity of capital and thirdly the message this policy sends to foreign investors.

 

Start with the complexities. To operate commercially viable fishing companies requires a fleet of ships that can stay at sea for weeks. They must be able to at least partially process the fish, pack them and get them ready to be delivered to the final destination within hours of getting to shore. The logistics are complex and often involve trucks and planes, because if the produce is not fresh, the customer would simply buy fish from another destination that can deliver fresh fish. In addition, these companies have got massively fluctuating overheads, predominantly fuel to run the vessels. Therefore, to be able to bring the product to the market profitably, these companies need volume (ie big quotas) and very deep pockets. Do we have enough local fishing companies that are able to operate in this volatile environment? Or would the recipients of the quotas just sell them on to a company that is able to handle the complexities?

 

Now to the second problem, the scarcity of capital. Put simply, capital is the total available money for investments. By definition, each country only has a specific pool of capital at any time. You can’t print more, because that causes inflation (ask Germany in the 1920’s or more recently Zimbabwe). It grows as investments grow, but that takes time. Thus, the available capital within Namibia can decide to invest a bit more into the fishing industry, but that would also mean that it has less to invest in other sectors, like agriculture. The best way to grow your economy, and thereby creating more jobs and more opportunities for all the citizens, is to attract foreign capital. In that way you can expand the fishing industry as well as agriculture. That is one of the distinguishing characteristics of wealthy countries. All of them were able to grow much faster than they would have otherwise, no matter where they started from. Think of Germany and Japan after the second world war, South Korea and now China, Vietnam and Eastern Europe, just to mention a few.

 

That leads me to my third point: the message the Namibian Government is sending. At a time of low growth and high unemployment, the message being sent to international investors is “we are closed for business”. They could help the economy, but instead, the door is being shut. India did something similar when they became independent. They insisted that they could do everything themselves and would no longer need any foreign help. It caused years of almost no growth, and rising corruption – because everybody was fighting for a piece of the pie, that doesn’t grow. Let’s not repeat the mistakes of others.

 

The rich fishing grounds should benefit all Namibians, and not just a few well connected who are able to get their hands on quotas. The fishing industry should be dominated by Namibians, as investors and employees, but don’t exclude the foreigners.  Foreign investors, who deploy their capital in Namibia  create jobs and opportunities for the locals.

Even more mindboggling than the apparent fraud that was committed by a small group of people within Steinhoff are the current court cases claiming compensation due to the fraudulent activities. It is not only that the amount claimed, north of 60bl Rand is 6 times the current market capitalisation, but that the people suing are the shareholders of the company. In effect the owners of the company (the shareholders) are suing their own company. Obviously, this is too simplistic, and there are various claimants arguing different cases.

The biggest of them all is that of Christo Wiese, who claims that he swapped the ownership of his very successful businesses for shares in Steinhoff under false pretences. This might be true, but then again it is up to everybody in business to do their own homework and do proper due diligence. And since he became the biggest shareholder in Steinhoff, he was also the (very well paid) Chairman of Steinhoff. As the top Director of a company it would be his duty to make sure that everything is above board, and that the shareholders funds are protected. As a Chairman he would also have the ability to immerse himself into the operations of Steinhoff, and would have surely noticed abnormalities like the unrealistic high property valuations. Isn’t that what a Chairman is paid for?

The most recent shareholder who claims a right for compensation is Coronation Fund Managers. That is absurd. They are very highly paid professionals who consistently claim that the exorbitant amount of fees they charge their clients is rightful, because of their in-depth analysis of the companies they invest in. But yet they bought massive amount of Steinhoff shares even though one of the most basic measures of the performance of a company, the “return on capital” has always been poor, between 8% and 14%. One wonders if they have really been doing that much investigative financial analysis, or if they simply followed the lead of Christo Wiese (and ignored early warnings such as the raiding of the Steinhoff offices just after they listed in Germany by a specialised police force).

There are various others, who lost vast amount of money due to the 96% plunge in the share price who are suing Steinhoff. There are two problems though, and one certainty. First the problems with the claims:

A company has got shareholders, directors and various related parties like staff, creditors, the taxman and the society as a whole. For our purposes the first two are the most interesting. The shareholders are the legal owners of the company. The directors are nominated primarily to look after the interest of the shareholders as well as the other related parties. They act as the guardians of the assets of the shareholders. The executive directors are the actual “operators or day-to-day managers” of the company, while the non-executives primary role is to make sure that everything is above board. In this case it seemed that the CEO was the centre of the fraudulent activities, involving a close circle around him. The non-executive directors (two of them were from Coronation) had the power to ask the really tough questions, which they apparently failed to do. The Chairman would have the ability to do something about any allegation of mismanagement, which he failed to do. So shouldn’t the shareholders sue the directors, in particular the CEO?

The second problem is the following: What is a fair compensation? A share price is only the current reflection of the price of the company. It is not a scientifically calculated price, but more driven by sentiments. We know that companies can be very overvalued, in fact it is not uncommon for a share price to half in value at some point in a 10-year time horizon. I thought Steinhoff was very expensive at R47. If investors bought in at R60 should they be compensated for the losses they had measured to their average purchase price, even though, according to some the share price was already very overvalued?

What is for certain though is that with all the lawsuits going on, the likelihood that Steinhoff will need to file for bankruptcy has increased rapidly. No lender would want to give money to a company with such clouds hanging over it. No supplier would want to give credit, and the most talented employees search for better opportunities elsewhere. I assume that most of the lawsuits are aimed at getting to the front of the queue when Steinhoff does face bankruptcy.

Only level-headed judges who look after the interest of all related parties would dismiss these cases. Of those we have too few, because money buys the best lawyers with the most persuasive arguments who drive for a narrow-minded judgement. That is the world we live in.

First and foremost – if you are managing any pension fund money, or other portfolios that don’t have an aggressive mandate, the answer is very simple: No. There is just no information available to make a informed investment decision. But if you have an aggressive mandate, or would like to speculate a bit, Steinhoff International must be on your radar screen.

It is down from its highs of R96 per share to just shy of R3 per share. That is lower than when it listed in the late 90’s. Back then it was a relatively small company, mainly involved in the furniture (in particular beds) manufacturing and sales. These days it is an international conglomerate, with about 12 000 retail outlets worldwide, 26 manufacturing facilities and thousands of employees.

I never held any Steinhoff shares, mostly because I thought that many of the recent acquisitions were overpriced, they did not offer any synergies, I never really understood their accounts and I always had the impression that the ex-CEO, Marcus Jooste would do anything just to bulk up the operations. Infact little was done to create organic growth, and his blessing in the sky came in the form of Christo Wiese, who’s operations were almost the opposite – very cash generative. So Jooste bought even bigger businesses for even higher prices. In short much of the growth was acquired and funded by debt.

But that doesn’t mean that all those businesses are worthless. Some might be worth nothing and should be handed over to business rescue, but some, if not most can be profitable, if not as wildly optimist as stated in there (false) financial statements, and therefore they should be worth something.

Steinhoff International also holds a roughly 70% stake in STAR (Steinhoff Africa Retail), which is a mix of companies from the old JD Group (Incredible Connection, Hi-Fi Coprperation, Unitrans, etc) and Christo Wieses stable (Áckermans, Pep – which are incredibly cash generative). STAR (code SRR) has a market cap of R72bl, making the 70% stake worth R50.4bl. However Steinhoff Internationals market cap is only R11,2bl. Therefore, the market is pricing the rest of Steinhoff a negative R39.2bl. Even with its overpriced properties, and the high debt levels, this is not likely. Add another R10bl of debt due to Steinhoff from STAR, and one gets to a negative valuation of -R49bl – highly unlikely unless the business is hopelessly bankrupt.

One obviously doesn’t know what covenants the Steinhoff debt facilities have, and when they trigger what events. As a fund manager with a long-term view, one would need that know that, or at least that their debt won’t suddenly be called up. But as a short-term speculation, that is the risk one takes for potential high returns.

So, as a speculative buy, Steinhoff looks enticing. Bitcoins vs Steinhoff: definitely Steinhoff.

 

 

Always remember that speculative buys should never be more than 5% of your total portfolio, and one should never gear are speculative buy. There is a chance that the investment will go down to 0.

This is probably one of the most asked questions, and rightly so. For most people, their own home makes up the bulk of their investment assets, in South Africa at least. However buying a home to live in is a very different decision than buying another residential property for investment purposes. A home provides your family a place to make their own, to entertain your friends and to create memories. And you don’t pay rent, but rather pay your bond of. However buying a residential property as an investment is far more sobering. The alternative could have been to buy shares or bonds or Unit Trusts among other. So how does the return of a residential property investment stack up against the others?

 

Firstly, lets start with the basics. If we had no inflation at all, and knew that for the next 20 years, inflation simply doesn’t exist, then the average price of residential properties should at most increase by the growth in GDP/capita. One could argue that as the average population gets richer, they will be able to afford to spend more on property (even though by the classical definition, this would be property price inflation – but lets ignore that for demonstration purposes). The reason is that the cost for shelter (ie property price or rent) can’t continuously increase because then it would demand a continuously higher allocation of the household budget, and in many years would be 100% of the household income. Therefore, it only makes sense that over longer time periods, residential property prices can at most increase by GDP. That would not seem like a good investment at all.

 

The reality is somewhat different. Very few buy properties outright with cash, and most borrow money from the banks to fund their purchase. So now we are talking about a geared investment (and for the technical lot: it only gets marked to market a specific snapshot, when you are taking out the loan. After that, the banks very seldom care what the property price do, they would not suddenly ask you to repay large sums – very different than a geared investment in shares). The advantage of the geared investment can be demonstrated by a very simple calculation: lets say a capital return on an investment is 8%. If you only had R1 million to invest, your return per year would be R80 000. But if the bank lends you another R2 million to buy a property for R3 million, your capital return is R240 000. Obviously you have to pay back the loan, but the government is helping you by allowing you to deduct the Interest from the Income Tax due.

 

Any reasonable property investor would also try and get a decent tenant to live in the property. The rental due would help you pay back the bonds. A general rule of thumb is that if you borrow between 40% and 50% of the purchase price, the rental would cover the bond installments at an interest rate of 10%. So effectively you are buying a property at a 40% to 50% “discount”, and let the tenant pay off the rest. So does that make it a good investment?

 

The answer is still not very clear, because taking out loans, investing into immovable and tenants come with their own risks. However, there is one more factor: inflation. In SA, we have relatively high inflation at 6%. That is not only 4% more than in most of the developed world, but 3 times the rate. So in South Africa the primary investment risk should always be inflation. If the investment does not beat inflation, you get poorer every year. The same reason why residential property prices can’t beat real GDP growth over a long time make sure that it grows with inflation. The rental should increase by inflation, as do the costs, except the repayments of the bond. In short: if you live in a “high” inflationary area, ie anything north of 4%, it does make sense to invest into residential property. In a low inflationary environment, the benefits are not clear.

So who are the winners and losers: The winners are clearly the property owners and the banks, the losers are those bank clients who keep their cash in a current account (or most other bank accounts)

Instead of thinking about how to make the pie bigger, it seems like Namibian politicians are more concerned about how to carve up the pie in new ways. This has expensive consequences.

 

The Namibian government is determined to complete and implement its National Equitable Economic Empowerment Framework, in short NEEEF, by the end of 2018. It requires all white owned businesses to sell 25% of their business to black people, a concept designed to correct the wrongs of the apartheid years, almost 30 years after gaining independence. It is not a new concept, in fact it has failed to make a difference to millions of poor people in South Africa, where a similar concept called BEE (and its successor BBBEE) was implemented shortly after the awakening of the Rainbow Nation. The reason was simple: few could afford to raise funds to pay for the shares. It made wealthy or connected South Africans extremely wealthy but did little to the average South African.

 

In deals further down the line, there was an effort made to make it more accessible to average South Africans. All sort of complex financial structures were put in place, whereby the companies would be able to provide vendor finance, where banks issued preference shares to finance deals and where interest was capitalised and hopefully a rising share price would take care of the fact that borrowed money needs to be serviced. The BEE shareholders were “locked in” for a pre-determined number of years, until the borrowed money was paid back, and afterwards they could benefit from some real wealth creation. But just ask any of the shareholders of MTN, Sasol or Resilient Property Fund about their experience, and one quickly realises what a mess it can create if the share price goes South instead of North.

 

Although it was encouraged that all companies sold some of their shares to black South Africans, it was enforced only at the listed ones. Namibia wants every white business, no matter the size to sell their shares. No matter if it is a big listed company or a small closed corporation. That is insane. There is no liquidity (the ability of in this case black shareholders to find other black investors relatively quickly to sell the shares to at a reasonable price, should you wish to) for small and unlisted companies. I very much doubt that the banks would be prepared to take unlisted shares as security for extending the loans to buy the shares. The only thing certain is that NEEF makes investing in Namibia more expensive, since you now have to generate your return on your investment on 75%, thus requiring a higher return on the investment. Lastly, what ever money is used to buy into the white companies is money that is not available to be deployed elsewhere in the economy. I very much doubt that it would cause more economic growth, the reverse is more likely.

 

It is also astounding that politicians always assume that they can rectify the results of history. Nowhere in the world has it ever worked. Politicians would be more effective if they come up with policies on how to grow the economy. By growing the economy aggressively, i.e. above 5%, they will make sure that everybody will be better off. It will lift poor out of poverty, it will offer opportunities to young entrepreneurs and it will make everybody wealthier. Taking from Peter to give to Joe will not.

When we look back on the period from 2008 to now, we will comment that it was a time when central bankers did too much and politicians did too little to get the economies started again.

The financial banking crisis of 2008, which lead into the sovereign debt crisis was a massive shock to the world economy. The days after Lehman Brothers collapsed could have easily changed the world we know on a permanent basis, were it not for the unprecedented coordinated intervention of Central Bankers around the world. Lehman Brothers, is by far the biggest US bankruptcy with over $691 billion in assets (that is almost twice the size of South Africa’s GDP at the time, measured on a nominal basis), more than ten times bigger than Enron’s bankruptcy. But what was worse was that Lehman Brothers was an integral part of the US financial system, and its collapse could easily have triggered a run on all financial institutions. At the time politicians neither understood the full implications of a bankruptcy, nor did they have the political will to act against the general anti-banks mood and try and save Lehman Brothers.

Banks didn’t trust each other anymore, reflected by the extraordinary spike in the overnight interbank lending rates. If the banks don’t trust their competitors anymore, and if the public doesn’t trust the banking system as a whole, the faith in the US Dollar (and other currencies) would have disappeared, and faith is all that keeps the value in currencies these days. Thanks to the unorthodox response from Ben Bernanke (Fed Chairman), the absolute loss in trust of the financial system has been avoided. The start of the “great recession” could not be avoided however.

To do their bid to restart the economies again, Central Bankers around the world (lead by the Fed) decreased their lending rates to all time low. They did this by buying their own countries bonds, driving those yields un-naturally low and in turn making cash a very expensive asset. Cash fund, most of which are located in the USA began the search for yield and found it in the emerging markets. In South Africa, for example, foreigners bought more bonds in 2010, than they did in the ten previous years out together (on a net basis). In 2011 they bought even more than in 2010, and in 2012 they bought almost as much as 2010 and 2011 put together, thereby financing our current account deficit (and keeping the Rand at very overvalued levels).

All this liquidity from the developed world central bankers didn’t kickstart the economy as they hoped. Companies are sitting on piles of cash, but are not expanding production even though they are operating at record high profit margins. Banks have returned to being profitable, but not by lending out money but by using the cheap finance available for them to buy bonds, thus making a cut of the yield differential. So why is the liquidity not deployed in more productive capital?

While the central bankers went out of their way to revive the economy, politicians did their best impose more rules and regulations and thereby red tape. The American act written in response to the great Depression in the 1930’s was 37 pages long. It set out the rules and regulations regarding the banking industry. It was not perfect, but it could be expected that every senior executive would have read it and thus acted within the rules and regulations. The new act, the Dodd-Frank act is 848 pages long, and it is not finished yet.

Similar overwhelming regulations are imposed all around the world. And while the politicians are at it, they have also tighten up on labor regulations, putting more onus on the employer and thus making it more risky to take on new recruits. Instead of opening up their boarders, politicians opted to increase barriers to international trade. In fact, politicians who were voted into office were more socialist and thus appeared to be anti-business. Take Frances Francois Hollande as an example. His agenda included extraordinary high taxes on the wealthy, supporting trade unions in their fight to force companies to stay open (and at the same time demand higher wages), increasing welfare support and reducing the retirement age. So why am I arguing that politicians did to little? Well, as it turns out the wealthy in France were preparing to leave (some did so rather quickly) and companies like Michelin and Goodyear had to close down some of their manufacturing plants. And mr Hollande recoded the lowest popularity rating of any French president. What most politicians seemed to have forgotten was that an economy can only grow if the private sector grows. Instead of making them as competitive as possible, and making the business environment as accommodative as possible, politicians went the opposite way, at least in most of the developed world, but also in places like South Africa.

The massive support of the Central Bankers however caused huge imbalances, and unwinding the support will cause un-intended consequences, which started last year May (when the Fed hinted at tapering off their asset purchasing programs, and the emerging currencies fell in a heap) and will not end for any time soon.

The South African Reserve Bank (SARB) has once again hiked interest rates, although only slightly, confirming that we are on a definite upward trend. This, even though the economy is weak and seems to get weaker still. The main reason was that inflation seems to be creeping higher, albeit slowly. It is widely accepted that higher interest rates (lending rates) will curb inflation, but at the same time slow the economy. This puts the SARB in a very difficult position. I am not sure that they have made the right decision. This is once again a situation where I think Reserve Bank governors want to do too much, and politicians do too little.

 

Some of the reasons given by the Reserve Bank were that the weakening Rand leads to imports being a lot more expensive, and that food costs are going up. I don’t think that a hike in the rates would achieve any of the desired effects. When it comes to food costs, South Africa is in a very unique position, different than America, Europe and Asia. Theoretically we produce largely enough for our own consumption, however if we fail to do that we need to rely on imports to make up for the shortfall. But in contrast to let say Germany, we can’t rely on our neighboring countries to supply our shortfall. Firstly, they are not big producers of crops themselves, and often have to import to make up for their own shortfall. Secondly, if our crop harvest is down by 10% it is the equivalent of the consumption of the whole of Namibia and Botswana combined. So if we do have a shortfall, we will have to import, and given the geographical position of South Africa, the transport costs will be high. This means that as soon as South Africa doesn’t produce enough crop, we will experience inflation as all crops are then sold at import parity pricing.

 

So would a rate hike curb food inflation in SA? As long as the inflation is supply driven, I doubt it. In fact it might even make it worse. There are many ways to increase the yield of crops, thus making sure that South Africa has the required food security. But these rely on economies of scale, and using modern technology to optimize the planting and harvesting process. These require big capital outlays which are often partly financed by banks. Increasing interest rates make such investments less feasible. The Governments latest comments about farm ownership (see previous article) also deters any such investments.

 

One of the other reasons given was the weak Rand, which would cause imports to be more expensive. Unfortunately the Rand was too strong after the world financial crisis, as investors around the world were searching for yield, since they got nothing at home. Thus a big demand for Rand came from investors, not from sustainable trade requirements. At that point, the SARB should have lowered the interest rate substantially to make the short term investments in South Africa less attractive.

 

In the subsequent years, consumption was one of the main drivers of the economy, as imports became cheaper and South Africans splashed out on new cloths, TV’s, cars, etc. Without any support of the producing side of the economy, the growth was only driven by the stronger Rand (which had nothing to do with the underlying economic factors) and thus unsustainable. Basically we helped countries like South Korea, Vietnam, Mexico, Thailand but also Spain and Italy amongst others achieve sustainable growth by buying all the products they produced.

 

Yet again, the government could do a lot more to foster growth. One of our natural big economic advantages are resources. We have a wealth of natural resources and in theory that should be one of the main drivers of economic growth and thus prosperity. Added to that we had just experienced the biggest commodities bull market since the sixties, but South Africa has not been able to increase production and thus benefit from these extraordinary times. In fact, due to the fast rising labor costs, poor electricity supply and a lack of infrastructure many of the small mines had to close down. Many of the big mines had to turn to their parent company or their shareholders for additional cash injections, just to survive.

 

A hike in interest rate will not make South Africa suddenly more attractive to international investors. A change in politics will though. Thus I am not sure that we are on the right course, however only history will determine the correct outcome.

In a series of short articles, I will write about how to run a government that encourages economic growth with stable policies, something that is much needed here in South Africa.

 

In this article I write about a buzzword that has been making headlines courtesy of the German government over the last few years: Austerity. In the very basic format, austerity is when the government tries to save any unnecessary costs and cuts down on their spending. In general this is seen as a good thing, and thus should be endorsed. Germany is the most prominent country advocator of it. They have managed to present a balanced budget, thus they would not need to incur any new borrowings. Thus they have been trying to force everybody else to follow suite, with mixed results. The Greeks for one, can’t stand the word and are trying to get away with less. Brazil ended up in a recession, partly due to the government’s austerity drive.

 

So is austerity really the medicine everybody need to get their economy on a track for growth? The basic idea is right, the timing if when to do it is almost more important though. It is good to save some costs while the economy is on a sustainable recovery, and the private sector is beginning to boom again. It can have the opposite effect however, if the economy is in tougher times. Just imagine yourself running a business, and just as trading slows down, and you are more reliant on existing customers, the biggest of them all tells you that they are focusing on saving money, thus they will not buy as much anymore. Since most governments contribute between 25% and 35% to the local economy, they are most certainly the country’s biggest “customer”. John Keynes already said that governments should run counter-cyclical budgets, ie save in the good time and spend in the bad times.

 

But what should countries like South Africa, Greece and Brazil do, whilst they are in a situation where it is almost impossible to spend more (because of debt restraints)? Should they spend their way out of their situation or are they better advised to embark on austerity? Well certainly most of the countries facing such difficult economic times have a third option – make the private sector as attractive as possible to investors. That means reduce tariffs, get rid of restrictive policies and red tape, show that the rights of investors are upheld in courts and focus on reducing corruption. Without much fiscal spend, the governments would be able to make their economies more competitive, more lucrative to investors who would be more willing to take a risk and invest in the hope of benefiting through the up-cycle.

The new land reforms set out by the Rural Development and Land Reform Minister Gugile Nkwinti caused a fair amount of up-roar and rightly so. The land reform set out that half of big farms should be handed to the workers on the farm, with the longest serving workers benefiting the most. The farm owner will not be directly compensated, but will receive a share in a fund that funds the small farmers and in return benefits from the returns of the fund (if there are any).

 

The basic idea that everybody should own some land, especially if they work on it is amended from the communist principle that says that everybody should be able to benefit from the land, thus all land should be owned by the government. It sounds fair enough, but as we have witnessed so many times before (it happened in almost every African country) it always has a devastating effect, especially on the poor. And it will be the same for South Africa, where our poor population once again get left further behind because of poor policy choices by the government.

 

To understand why, one needs to understand a bit about the business of farming, the food chain and inflation. Let’s start with the first one:

 

The business of farming:

 

Farming is a highly competitive and, in my mind, volatile business to be in. Essentially you are producing a homogeneous product (since the chickens or maize produced by one farmer is not very different than that produced by another) thus your selling price will be the biggest determining factor of the quantity sold. Added to that, the farmer is often subjected to very unpredictable events that are not within their own control, like the weather and nature (think of locust plagues). Because of this, the income stream is often uncertain and very difficult to predict.

 

If a farmer is a price taker, there are only two ways to increase profits (or in most cases, just survive). The one is to decrease the costs of producing, the other is to increase the yields by increasing the efficiency. The trouble is that most of the innovations done to increase the yields cost money, requiring a cash outlay to buy expensive machinery. The only way to make it feasible somehow, is to be as big as possible, thus reducing the incremental cost per unit (the benefits of economies of scale).

 

The food chain:

 

A lot depends on our maize production. The reason is very simple; maize is one of the main input costs of other foods, like chicken and pork. Thus a lower maize price should reduce the price of chickens (maize cost are about 40% to 50% of the costs of your chicken in the supermarket). We are currently producing about enough maize to supply most of South Africa’s needs. That means that if we loose any more production capacity in South Africa (as we surely will, it has always been the case in previous attempts to distribute land. Farm production of farms that have been redistributed through a the lands claim program before has fallen by more than 90%), we will have to import maize. That doesn’t sound too bad? Well, because of the geographic distance to other major exporting producers (like USA), the imported maize will be substantial more expensive. No local farmer in his right mind would sell his maize at a lower price, thus the local price will adjust to import parity. The effect will be that all foods further down the food chain will become more expensive, just because we have lost the ability to produce enough, which will have a devastating effect on the third topic, inflation.

 

Inflation:

 

Inflation is the percentage at which goods and services get more expensive every year. The official target rate of SARB is 6%. This means that if something costs R100 today, it will cost R106 in a years’ time. With that rate, prices double roughly every 13 years (with an inflation of 2% they would double in about 36 years). The trouble with the inflation figures is that it is a compounded number of the average household. Poor households typically spend more on basic demands (as per Marslow’s hierarchy) such as food and shelter. Thus poor people are more exposed to volatility in food prices (we have recently seen double digit food inflation). A rise in the price of maize will have a devastating effect on the ability of poor families just to get by.

 

I am of the opinion  that the impact  of the land reforms  on the wider economy have not been thought through properly. It is based on sentiments instead of realism, and should it be passed as is, would nudge South Africa one more towards repeating the failed expectations of Argentina in the early 20th century, rather than living up to the potential it could be.