Some thoughts on South Africa's exchange rate

The weaker rand exchange rate raises alarms in the monetary policy sphere. The rand depreciated by 23% against the US$ from January 2012 to December 2013. This has implications for people wanting to take a holiday in the US or purchase anything that has a $ tag assigned to it. Apart from the worrying tourist, the central bank has to keep an eye on the exchange rate as it could lead to higher inflation. A final issue related to the rand is the trade deficit narrowed – and why it has not narrowed.

In essence three economic questions arise: (i) Is the rand permanently weaker (i.e. what has happened to the equilibrium exchange rate), (ii) what is the effect of the weaker rand on inflation (i.e. what is the exchange rate pass-through) and finally (iii) how do imports and exports respond to the rand.

I will summarise the results here in case you don’t have time to read the entire section.

·    The rand’s equilibrium value to the US$ is R8.50. The rand is thus undervalued and should start appreciating (given that SA or the rest of the world don’t undergo some massive structural change).

·    Rand appreciations are shorter lived than depreciations. Depreciations are usually more persistent over time.

·    The exchange rate pass-through to inflation is time varying; i.e. it changes over time and across different policy decisions. The current exchange rate pass-through is low, however, depends on low and stable inflation.

·    The trade deficit did not narrow since the rand depreciation. Both export and import volumes increased. Imports simply increased more than exports. Some researchers argue that this is due to a J-curve effect. I, however, argue that the response of certain imports is inelastic to the exchange rate. This means that if SA imported exchange rate inelastic imports, then any rand depreciation would have a very small effect on decreasing imports.

11.    Some (important) preliminary statistics of the exchange rate

Figure 1: The rand is not alone – Other developing countries’ exchange rates have also depreciated

Source: Bloomberg

South Africa’s rand is not the only developing country exchange rate that depreciated; The Indian rupee along with the Brazilian real depreciated by similar margins. The Chinese yuan remained at similar levels only because of its massive reserves – the Chinese actively intervene to maintain a stable currency. 

The top row of Figure 2 illustrates the distribution of depreciations vs. appreciations. Notice that large depreciations occur quite frequently. This is supported by the fact that depreciations are more persistent. Appreciations are small the majority of time. There are, however, periods of massive appreciations. These occur at low frequencies as appreciations are abrupt. Row two of Figure 2 shows that the r/$ exchange rate is much weaker than it historical averages (comparing the average of 1990 until 2013 vs. the average since inflation targeting). We also see that the rand is weaker than an HP-filtered exchange rate (a measure of the long-run exchange rate).

Figure 2: Appreciations are abrupt while depreciations are persistent

Source: South African reserve bank and own calculations

It can be argued that the rand fluctuates around its steady state (equilibrium) if one can identify the factors that determine it. The figure above illustrates that the rand does not deviate too much from such a steady state (assuming that this steady state is represented by the smoothed line).

This paper shows that interest rate differentials, productivity differentials, openness and the government’s budget balance determine the equilibrium value of the rand. Thus any deviation from the rand away from equilibrium will tend towards equilibrium later. The author finds that it takes just under a year for the rand to move back to equilibrium.

  

The paper above shows that:

·        * If SA interest rates increase by 100 basis points relative to US interest rates then the exchange rate will appreciate by 0.8 percentage points.

·        * If SA GDP growth increases by 1 percentage point relative to its trading partners then the exchange rate will appreciate by 1.3 percentage points.

·         *A 1 per cent increase in the government deficit will appreciate the currency by 1.5 percentage points.

Figure 3: The equilibrium exchange rate in 2011Q4 was R8.15 to the US$

Source: de Jager

22.      On exchange rate pass-through to consumer prices

How will the SARB react to the weaker exchange rate? This depends on what they believe will be the impact on inflation. If the exchange rate depreciation translates into higher consumer price inflation then the probability of an interest rate hike increases. So not only are consumers concerned about higher prices due to the exchange rate, but also higher interest rates from the SARB to curb inflation.

Econometric analysis that measures the exchange rate pass-through to inflation over time shows that it has decreased since implementing inflation targeting (see Figure 4). The highest pass-through occurred in 2002 and 2003 at a time when inflation was very high and volatile and the exchange rate very weak. Currently the pass-through is close to zero. This means that the weaker exchange rate hardly translated into higher consumer prices. In Figure 4 the exchange rate pass-through is highest over four quarters. Exchange rate shocks almost dissipate completely over three years.

  

Figure 4: Pass-through has been lower since inflation targeting

Is it reasonable to assume that low pass-through will persist? If this can be assumed then we need worry very little about the possibility on an increase in interest rates due to exchange rate pass-through. But to make this assertion we need to know what causes high vs. low pass-through.

We use the pass-through coefficients in Figure 4 as a dependent variable and analyse likely factors that influence it. The most important determinants of exchange rate pass-through is the extent of mark-ups and inflation (see Table 1). A 1 per cent increase in mark-ups reduces exchange rate pass-through by 2.71 per cent on average. This seems counterintuitive at first but makes sense given that monopolies are able to absorb price shocks. Perfectly competitive firms that operate at the margin have no choice but to pass-on higher prices when a shock occurs. High and volatile inflation increases exchange rate pass-through by large margins. This highlights the importance of a credible monetary policy: If firms expect inflation to be contained by the monetary authority it knows very well that high inflation will be reduced by an increase in interest rates. These firms trust the SARB to do its job and they are thus not that much concerned about the exchange rate shock and could absorb it. This story is however dependent that depreciations do not occur for much longer periods than one would normally anticipate.

Table 1: Low pass-through depends on low and stable inflation

Variable	Mean	Standard deviation
Market concentration (PCM)	-2.71	0.43
Neer	-0.01	0.04
Neer-squared	0.00	0.01
Inflation	1.00	0.77
Inflation-squared	0.02	0.04
Output gap	-1.23	0.99
Government debt (gov)	0.06	0.14
Variance inflation	5.39	1.53
Variance Neer	-0.74	0.23

33.      Some imports do not respond that strongly to an exchange rate depreciation

Imports have grown by 24.8%, 2.71 and 14.3% during the first three quarters of 2013 while exports grew by 11.3%, 5.1% and 13.5% over the same period. The consequence is that the trade deficit worsened and payments to SACU countries increased.

So by how much do imports respond to exchange rate depreciations? To control for income effects we used G7 growth as a proxy and to control for long-run vs. short-run effects we estimate these elasticities in a dynamic panel setup (we use Pesaran’s (1999) PMG methodology). Aggregate imports decrease by 0.8 per cent given a 1 per cent exchange rate depreciation. But we are only interested in import components. We see that building equipment, petrol, metals and transport equipment have a less than one per cent decline when the exchange rate depreciates. Coincidentally minerals, vehicle equipment, machinery and appliances contributed the largest shares of import in 2013. This analysis helps explain why imports have not decreased in line with the exchange rate depreciation.

Figure 5: Recently SA has imported more inelastic goods

44.      So what do we make of all this?

The concerns about the devalued rand are probably overstated in the media. Exchange rate pass-through to inflation is still low (partly thanks to credible monetary policy and firms absorbing the exchange rate shocks); the rand has deviated from its equilibrium – it is expected to return to its equilibrium (i.e. close to R8 against the dollar). As a negative, the exchange rate has not reduced the current account deficit. Imports have increased in response to the rand depreciation despite muted household consumption growth. While it is difficult to say whether this is a permanent trend (it could reflect fixed contracts that were signed over a specified period), the likely future appreciation will deter import growth – probably causing the current account deficit to persist.

55.      Appendix: The probability of an appreciation is not too low

In one of the previous sections we were interested in whether the exchange rate will depreciate indefinitely. We mentioned that an indefinite depreciation is not realistic if the structural fundamentals of our economy are maintained. These structural fundamentals, as mentioned above, are informed by the interest rate differential, GDP growth and the government’s budget balance. We estimate the probability of an oncoming appreciation by using a probit model. Our dependent variable is a binary variable that equals 1 in case of a rand depreciation and zero when the rand appreciates. Unfortunately some of the data is only in quarterly frequency with the latest update in 2013Q3. We can use this as a gauge on how useful the model is in picking up the likelihood of an appreciation. Figure 6 shows that the probability of an appreciation from 2013Q3 was less than 20%; the rand has not appreciated since then. On the right hand side of Figure 6 we examine how probable a depreciation is on a scale of interest rate differentials (assuming that all the other variables are evaluated at its mean except for growth). 

Figure 6: The probability of an appreciation vs. depreciation?

In pursuit of the real

It seems like I have forgotten what is real. All I see are infomercials, adds, cars, computers, mobile phones and other types of electronic gadgets. In addition to tangible things, I also see how we race through time being occupied by making money, visiting friends or experiencing thrills that let the heart pulsate. Before we know it we have become part of a rat race, engulfed by desires, pleasures and "easy way outs". And this makes me wonder if I am really myself or am I just simulating what is required for an artificial world system to work?

To make the point clearer; when I was young I made an effort to keep myself busy with activities outside home walls, I was forced to spend many hours by myself and as a consequence had a lot to think about. I was also very concerned about the well-being of others and would make genuine attempts to improve the lives of others. My mind was not yet programmed, or rather deceived by things that have absolutely no substance. I find myself now doing the opposite. I care for myself more than others and am consumed by noise that adds little life substance.

To fill the void and to keep ourselves occupied (we have other people and machinery that simplify our lives thus making more time available) we turn to entertainment. Our main goal is being happy right? This is the greatest illusion ever! We revel in drunkenness, desires of the flesh, money and status while there are real struggles across the world. We call ourselves human, but what we are is something very far from it. Most likely these words will just fall on deaf ears since we already believe the lies around us.

It becomes close to impossible to distinguish the real from the fake. Even if we realise that we are living a lie we find it very hard to escape too. It is a struggle for our lives and our souls. This I believe is the biggest challenge that humanity has ever had to face. In true adversary we realise what it is to live. In struggling we appreciate life for what it really is - this is but a glimpse in time, so important, yet so fragile. This is all we have. If we don't struggle, if we don't experience pain we become disillusioned and mindless. I would much rather know myself in pain and struggle than lose myself in endless pleasures.

Sometime fighting to become oneself again becomes disheartening. Especially when you see yourself succumb frequently to the very thing that you wish to escape. Often we want to be part of the thing that we wish to escape. But knowing this truth and trying to deceive yourself will only lead to despair.

Despair, purposeless and deceit; these words describe our reality when we purchase from the world. From experience, the only true escape from these lies is faith in God. This is simultaneously an easy way out but also the hardest to accomplish. It requires a total dilution of the ego - pride. Fortunately it is God, not us that does all the work. I personally struggle to distinguish between reality and that which poses to be real. I know that only God is real. I do not have to visibly see Him (the world deals in appearances), my heart knows Him and my soul thirsts for Him. Even if I have everything that the world has to offer and not have God, I would be but a speck of dust, a simulation that follows worldly rules. Yet, I experience the pain of betraying myself to a world that is not real and all I can hope for is God's endless mercy. I can only hope to escape all of this if He is completely in charge. I have experienced too frequently how my strength fails me. There is no hope, but there is only God.

Morality, judgment and love

We hold ourselves to certain moral standards. The obvious one is do to unto others as you want others to do to you. Yet I observe how "moral" people are swift in passing judgment based on ambiguous evidence. From experience I have learned that those who claim to be proponents of morality are indeed very far from being moral. In fact they are just as immoral as I am when I judge them. The difference is that I do not claim to be a moralist and I also do not attack morality but rather pursue it. In a world filled with injustices and heinous crimes one might almost be justified to ignore strangers who look "different" to what society dictates. But what in the end drives the decision process to ignore or befriend a stranger. And, based on logical inference, and if we dare call ourselves moralists, shouldn't we first examine the person before making inference about his existence by mere hints of clothing, race, sex etc.? And where does this lead us in terms of helping the needy (not necessarily the poor)?

If the answer evades you we may look at the actions of the great moralist in history. While there are many to choose from, I choose Jesus as an example. He regularly met with society's outcasts. He protected the life of a prostitute, made friends with tax collectors, had meals and drank with society's rejected and healed the sick. On the other hand he judged Israel's religious leaders of following man-made rules at the cost of loving one's neighbour, he exposed their insincere motives and showed that pride lay behind the veil of "righteousness". A few things happened during this process - the poor and needy were elevated while the proud were humbled. This brought some form equality, or equilibrium to the society.

What is then implied when we claim to be disciples of our moral leaders but do not follow them? It can only mean two things: Either we are hypocrites, or we are sincere followers but somehow are not able to live according to their moral code. If we hold this moral code in high esteem then surely all our available energy should be spent on trying to live morally. But since most of us do not spend all our energy on this it would mean that most of us are hypocrites. This matter is more serious. Instead of realising our corrupt nature we are completely oblivious to it or in denial. I guess this is why we become so disdained with many Christians who give us plenty of examples of false judgment. And most often you will hear an excuse and justification for their actions rather than a simple acknowledgment of being in the wrong and trying to set the record straight. Not only are a majority of these excuses illogical but it also reveals something sinister about our ideas of morality, good and evil and life.

I find myself bemused at trying to figure out how to change people's attitudes towards racial differences, class divisions and image perception. The only answer is love. Yes, the same love that you have heard from many people, read about in books and even experienced. But the honest truth is that our society is crumbling due to a lack of love. More dissent and hatred is replacing values that are essential to being human. Many books have been written about Love thy neighbour as you love yourself. Our wise God knows what is best for us. Even if you don't believe in a God, seeing the world from our neighbour's eyes might just soften our hardened and unlearned hearts about humanity.

But love has a cost too. It requires sacrifice. And the sacrifice is the ego. It is pride inhibits the ability to love those around you. It is not about survival of the fittest. There is also no joy in spending hours hating others, ignoring the plights of the needy and impressing on others that you are important. Let go. Work hard. In the end the investment is worth it. If you really want to discover who you are and what your purpose is then you need elevate the needy and humble yourself.

The world is a mysterious place where interesting events unfold and people from various backgrounds change continuously. We are part of something and we need to learn that to be part of that something means to love. We cannot function as individuals, but a collective species we may make great strides in doing what is best for each other. May God forgive us our many trespasses and may he guide our bodies, minds and hearts to seek and follow His will first.

Vanity humanity

We have simply come to accept certain social norms. Seldom do we question them and more often we embrace them. It is has been some time since I have heard of the word vanity. Vanity is the excessive belief in one's own abilities or attractiveness to others. Nowadays vanity is associated with glamour magazines that are read by billions of people. These magazine names appear at the top of Google’s search results.

What is it about ourselves that we so incessantly obsess about? The human body has always been a marvel for many societies and was especially emphasised during Greek and Roman periods. Little has changed.

The pursuit of perfection and the exercise of control are fundamental in explaining vanity. Both, however, are illusory. Humans are not perfect and the idea that we have control over a volatile and random world is slightly misguided. The body is subject to gravity and will over time decay before it reaches its terminal condition – dust. Control is subject to a person’s ability to influence many factors around him such as accidents, disease, money, maintaining a healthy body, etc. Combinations of these factors are countless and any perfect exercise of control over these factors is unlikely.

Another factor leading to vanity, and probably the most important, is pride. I have spoken in length about pride in previous posts. But once again this little devil emerges as a main culprit in making the human spirit ill. Humanity’s ambition to be like gods causes us to obsess about perfection. And this perfection manifests itself in the exterior rather than improving our minds and souls. Our appearance takes precedence over anything and soon we don’t see how silly we really look.

What makes humans different from one another? Nothing much; we want to be differentiated and, more worryingly, we want to be better than everyone. We spend excessive amounts of our money and time in sculpting a body or creating an image “worthy” of our thoughts. Instead of taking a balanced and healthy view about our image we have become sick with our own vanity and created something that is not original and more importantly something that is not ourselves. It is not original because you recreate an image of something that exists in a poster, in a movie or in a song. In fact you lose yourself in wanting to become something else, something that society dictates such as what beauty is. The irony is that in the pursuit of trying to fill a void by focussing on the outward we become emptier.

Vanity is a sad fate if you really think about it deeply. It takes up too much of our precious time, time that we can spend more productively such as the pursuit of wisdom, caring for the needy or spending time with family and friends. Vanity makes the individual the subject and everything else becomes of secondary importance.

There is very little good that could come from a vain life. We know that the pursuit of perfection is a futile exercise, because as humans, we cannot be perfect. We know that control is transitory and evades our clutches all the time. We know that elevating the self means sacrificing loved ones and we know vanity is a destroyed of originality. Despite all of these consequences, we make a conscious decision to ignore it. We choose this knowing all the problems. This could only mean that the mind is not in a healthy and balanced state.

To find a cure for this disease we need to ask ourselves, again, some very deep and difficult questions: Who are we? We are humans and not gods and humans inevitably fail. Where are we heading? We are heading towards death and the process is decay. We have limited time to do worthy things and it would seem like such a waste if we spend most of this time on ourselves. What are worthy things? This is perhaps the most difficult question to answer when it comes to vanity. I would argue that there is a hierarchy of worthy pursuits in life: Searching for the subjective knowledge of our existence (for me this wisdom manifests itself in getting to know God and living for Him), living in harmony and loving each other, gaining knowledge about how the world works and then, maintaining a healthy body.  

   

I almost did not want to write this entry. There are so many wise sayings, paintings, books and songs about this topic that it almost seems over-explored. I think, however, that it is good to remind ourselves of our shortcomings, it is better to acknowledge our fallibility humans and it is best to be humble about what humanity is. Only then can we see the world without tainted lenses.

See also:

http://www.nationalgallery.org.uk/paintings/harmen-steenwyck-still-life-an-allegory-of-the-vanities-of-human-life

http://en.wikipedia.org/wiki/Narcissistic_personality_disorder

A different South Africa

How does a nation turn from its evil ways? Is it possible for an almost absolute corrupt country to change into a moral example of citizenry? I have witnessed firsthand the possibility of change and I have seen its inner workings. Once this machine of change finds momentum it is almost impossible to stop. I have recently visited Rwanda. In 1994 its Hutu population attempted to wipe out the Tutsis. Widespread hatred, classification, an air of superiority and a nation brainwashed led to an unforgivable massacre. So it was only natural for me to assume that my arrival in Rwanda will be filled with vivid images of a country still seeped in war-aftermath. To my surprise I entered a country void of civil strife. Its streets are clean and its people friendly. Though I could clearly see different races, there was no trace of classifying someone as Hutu or Tutsi. I was told of a story where a mother lost three children during the genocide only to forgive the perpetrators who are now her friends and protectors. As far as I could see, people live in harmony with a unifying goal of uplifting their country. The government has strong leaders having nothing of a corrupt culture and promoting good work ethic. The country has opened itself for foreign influence and is humble enough to accept skills transfers from anyone willing to offer it. It is the first time that I have experienced a nation happy with its leadership. Many explain this phenomenon as a miracle that only God could have performed. In fact, the country seems to build its image around Christian doctrines. I cannot help but to try and determine why and how people are able to just forgive one another and move on in the pursuit of progress.

I contrast this with my observations about South Africa. In 1994 it had its first free and fair democratic elections. It had a Truth and Reconciliation Commission that seemed to have failed. Instead of promoting a culture of forgiveness it promoted a culture of retaliation in the form of affirmative action, restitution and redistribution. Instead of using the existing resources to teach and promote equality it sought to replace it by ineffective systems like lowering school standards and replacing labour that could have contributed to building a better country. Instead of electing capable leaders it decided to elect corrupt politicians and lazy parliamentarians. Of course it is unfair to label all of South African politicians like this, but this is definitely the view of the majority of South African's. Uneducated leaders often make poor policy decisions that benefit only a minority while impoverishing the majority. We observe and read about politicians granting favours to some people, throwing lavish parties, increasing their wages by preposterous amounts that are not linked to productivity. We see them build empires or little villages and giving tenders to friends and family members, we observe how they escape the hands of justice and accept money from people with hidden motives. If its leadership lacks moral fibre it comes as no surprise that the people will follow in similar vain. I observed personally how people get mugged on the street; no one has the courage to intervene. Police officials are too fat and scared to engage and are "obviously" too lazy to help. The country is in dire straits silencing those who want to make a change.

We have created a culture of laziness, corruption and worst of all - entitlement. South African's are angry and have not yet forgiven each other. There is an air of hatred and revenge instead of a spirit of forgiveness. Has justice not been served? Do more people need to suffer for the wish of revenge to dissipate? Does South Africa need to enter a period of absolute chaos before they pull themselves together?

The solutions to our problems are simple and implementable. If a country like Rwanda improving then there is no reason why we can't do it also. Let us use the constitution as a starting point and follow suit with implementable changes. I propose something simple like this:

• Be strict and disciplined. Do not tolerate things that unsettle society. Be harsh on criminal offences. The frequency and the degree of crime is proportional to the penalty on disobedience. Communicate effectively the punishment for theft, murder, rape and corruption. Ensure that sentences are passed on fairly and do not pardon an act of crime but forgive the criminal. Punish hate speeches or dehumanising words and acts. Make sure that people who classify others are punished and fine people for littering  
• Welcome help. Do not sideline a group of people who have valuable skills to offer that are much needed to build this country. Do not alienate skilful people for they can easily be put to use in other countries that welcome them - this constitutes as a forgone opportunity. Do not make it difficult for skilled people from abroad to enter South Africa. There is so much we can learn from each other - we just need to be humble enough to accept it
• Create a sense of community. Take care of your resources and your environment together. Clean the streets and encourage a culture of cleanliness. Take pride about the things that you have instead of envying things that you do not have. Rebuild, or simply build each other up by being involved in community projects and various community outreaches
• Stop looking into the past. While we should never forget the past, we should learn from the past. If things do not work simply change them. Stop hoping for good change to come automatically and stop blaming events of the past for current failures. Accept the failures and address them immediately in the most effective and efficient manner
• Have a unified purpose in mind. Have an overarching theme for the country - something that is inclusive of every person and something that creates purpose and self-worth. Be sure that everyone understands and is educated in these goals and emphasise the responsibility of everyone to ensure the success of these things

If only we were to follow Christ's example of servitude, love, forgiveness and a sense of justice we would be able to overcome these stumbling blocks. We cannot do this as mere individuals. We need to hold hands and focus our hearts on Christ.

Debt and economic growth

What is the impact of higher debt on economic growth? This is not an easy to answer question. Some analysts will have you believe that debt, and here I am referring to government debt, is either bad for growth or good for growth. These thoughts about debt can be summarised under mainly three ideologies:

·         Barro-Ricardian: Indifferent between taxes and government debt; households only care about  present discounted value taxes

·         Keynesian: Debt can be welfare enhancing increasing both current and future consumption

·         Neoclassical: Debt reduction has positive effects on investment through lower interest rates

My personal view is that debt on growth incorporates all three views with some views being stronger under certain conditions. Economists often use a solvency rule for analysing whether government debt is sustainable. This solvency rule inherently assumes that debt cannot be rolled over and that there is a point at which any change in government finance decisions cannot curb the growth in debt. In other words you will perpetually borrow more funds to finance maturing debt or you will simply have to default.

There are good reasons why government debt can be bad. Funds used for financing higher debt service costs could have been used to do something more productive. Higher debt, if perceived unsustainable, can lead to massive capital outflows - thus a reduction in foreign investment. Often higher interest rates are required to attract additional financing which increases debt service costs even more.

But, debt can also be good. Especially if government borrowed funds to be more productive - i.e. there is a future return for the borrowed funds.

We can then see that debt has a direct impact on growth only in the way expectations are formed. Debt itself  does not necessarily add or subtract to growth since debt is only an accumulation of public finances (public finances directly affect growth). These expectations create investor fears and confidence, which leads investors to either to purchase government bonds or to sell them or not to purchase new bonds.

Simple figures or simple statistical tests often inform people's views on debt. Take as an example a simple scatter plot of South African debt and economic growth since 1980 - It shows that the level of debt is associated with positive economic growth (if you plot a trend line through the bubbles). On average it would seem that higher debt is associated with increasing GDP growth. But using such simple figures would be a very misleading representation of the effects of debt on growth. Some authors (just read about the recent Reinhart and Rogoff controversy) suggest that such figures, accounting for many cross countries and a long enough history, show us meaningful results. It must be added that these attacks ignore a lot of the other good research (and more serious research for that matter) that Reinhart and Rogoff have done. The point that I am trying to make is that we cannot simply infer relationships between any two variables without knowing whether other common factors influence debt and GDP while also controlling for possible feedback loops between debt and GDP -  debt, interest rates and economic growth are endogenous - that means that they influence each other: Higher debt accumulated through government investment programs can increase economic growth while higher economic growth makes it easier to finance debt. Higher debt levels are associated with higher debt service costs which are linked to a risk premium (given that debt increases), but at the same time higher interest rates increases debt (this is if monetary policy has interest rates rising). Thus one needs to properly account for the future path of all these variables in a simultaneous setup to determine whether debt is truly sustainable. This is exactly why looking at the aggregate debt level is wrong - one needs to analyse the composition of debt and all its contingent liabilities (as an example if Eskom defaults then government guarantees will finance the default).

Figure 1: Government debt and economic growth

Or you can use more fancy statistical techniques that tell you at which point debt will have a negative impact on growth - smells like a Laffer curve:

Figure 2: Simple growth regression with debt and debt square

If one were to believe the results of Figure 2 it would suggest that a debt to GDP ratio higher than 42% would lead to less economic growth.

Unfortunately the past is not always a good predictor of the future (and these figures and econometric tests all depend on data collected from the past). If that were the case then we would be able to predict recessions! So using simple Figures and statistics are not that useful in determining debt sustainable.

While debt sustainability is certainly part of solvency calculations, it is the role of expectations that are important: Let's say you want to invest your hard earned cash in government bonds - most likely you will look for a good  and safe return (remember you are a risk averse investor) with a degree of certainty that you will get your principal and the interest back when the bond reaches some date (bond maturity). Your views on good returns are informed by the monetary policy interest rate and a certain risk premium (the risk premium is some kind of incentive that the government pays you for purchasing a bond - this is linked to the probability of default). The higher the probability that government will default on its debt obligations, the higher the risk premium (here measured as simply the yield on government bonds). And here is the tricky part - what actually informs the probability of default? 

Rating agencies use various probability models to tell us how safe our debt is...but just what makes one country's debt more sustainable than another? Why can Japan have debt well over 100% to GDP, have very small GDP growth numbers while other emerging market countries run a risk when debt exceeds 60% of GDP. Are the Japanese better at paying back the principle and interest rate than South Africa? Both countries finance the majority of their debt domestically and thus avoids currency risks and sudden stops in capital flows. Both countries print their own money, but South Africa has higher inflation which decreases the real value of debt over time while Japan has long periods of negative inflation which increases the real value of debt over time. Once again it would seem like expectations is the main character  in making debt sustainable or unsustainable. 

While this blog entry does not advocate that any country ramp up debt, it does question the views of the market on debt sustainability. It is obvious that if governments ramp up debt with no expected return tax payers will finance the debt and receive nothing in return...when debt runs away at crazy interest rates that are required to finance debt service costs then people might have to make crazy adjustments by paying higher tax rates up until the point where the country is forced to default. But at which point is debt unsustainable? I don't think rating agencies have this right either. Like any good financial investor, a future bond holder should analyse the reasons for why debt is accumulated - ff it is simply to finance transfers or higher government wages then there is a good possibility that government won't make a return. Unless higher wages translate into higher savings which are used for investment purposes.

In essence, the issue regarding the effect of debt on growth seems to be somewhat stupid since we cannot truly measure expectations - we just see it after the fact (higher credit spreads, capital outflows etc.). And we cannot understand expectations completely because they are even different for countries with similar economic conditions. Perhaps the closest we can get is that people follow sometimes silly rating agencies - and these guys might influence expectations. But you can already see some kind of decoupling of expectations to ratings: after the recent SA bond downgrade yields and credit default spreads hardly increased.

And SA has actually done a good job - a majority of debt has been accumulated to finance investment projects. It is up to the government and us to tell us what the expected returns of these projects are. But for now I would not worry about SA debt being unsustainable or whether it is hurting economic growth ;0)

Why do we feel so lonely and so empty?

We live in a world where technology makes life easier. We live in a world where entertainment takes away the lonely nights. We live in a world that defines a set of rules in order for mankind to succeed. Yet, we live in this world feeling empty. We live in this world in isolation. Hardly anyone questions the design of the world. Have you for one instance thought about the concepts we value so much like money, prestige and importance. All three are illusions that build up the image of the self. We have been living a lie and our souls know it. Our minds have accepted these lies. This is called confirmation bias. The world throws out a theory and the standard reaction of the mind is to accept that theory. As soon as a few accept that theory we are introduced to herd bias. And so we form cultural trends and rules for everyday "successful" living. We earn a living from something that has no value. Money is linked to a statutory input and for some reason we believe that a note carries the power to purchase something that is tangible. We drive "fancy" cars. Just why is a car "fancy"? Is it because it has leather seats? Why do we think leather seats are fancy? Is it because of resource scarcity? And so we can question mainly everything that has wealth, power or status attached to it. Most of us don't do anything valuable with our hands. We simply think about things, make sums, write computer code...but we are not really contributing to making society a better place. Of course a better society can be subjectively interpreted. But here I simply mean that a better society is one that has substance to it, where we care for everyone and put the needs of others before the self, and one strives for the eternal rather than the temporary. The eternal here is harmony with God and man (you don't have to agree with this definition). We have set up an image of what man ought to be. This image has been refined through the ages. And through the ages this image has become more perverted and more hollow. We strive to be like this image and we call him the Super Human. In essence he is god. And so we replace one form of idol worship with another, but this time it is the image of man.

So instead of becoming ourselves, we lose ourselves by trying to become something that we are not. In fact, we would do anything to become that image. We want to become something completely imaginary. Yet by doing this we have become simply empty. There is no joy in that. We worry about the most ridiculous things just because we have not become that image. We fool ourselves by thinking we have control over our future, and because of this we constantly worry about tomorrow. Our pride, our self-importance has betrayed us in the deepest sense.  The Bible has it right, for you to gain life you need to lose your life. You need to become less of yourself and let God take control. I really believe this is the natural order of things. Thus, in order for you to really become yourself you need to let go of yourself.

How does one do this? Through learning and working really hard at it, but most of all relying on God who started good in you to see it to the end.

Once again Kierkegaard points us to the Bible. He tells us to humble ourselves and learn from the lilies in the field and the birds in the sky. They are joyful and are joy themselves. They have joy because they are exactly what they are - lilies and birds. They are completely obedient and this obedience leads to joy. They are completely obedient because they just live like they are suppose to. They do this in everything that they do, whether it is basking in the sun, singing while building a nest or even withering under sever conditions, they do so in a joyous fashion.

We are an unhappy species because we over-complicate matters. We are suppose to be just humans and nothing more. You cannot be God, you cannot be supreme ruler, you cannot be the most important and you are definitely not immortal. Yet we toil and spin to gain an illusory place in this world.  By knowing what we are not we can come get somewhat closer to what we are. But in the affirmative, we are simply God's representatives on earth. We are suppose to create order when disorder appears. We are to make beautiful the things that have become ugly. But, most of all, we ought to glorify God. When God tells us to put our worries and troubles on Him, who then are we to disobey? Have we become something that we are not - have we become our own creators? We can only be human and nothing more. The sooner we accept this the quicker we will let go of silly and empty pursuits. Only then can we become, like the lily and the bird, joyful. Once again, the cure for despair is becoming oneself through God. There is nothing more to it than that. It is rather simple. We have just blurred this process.

So, are we too far down the rabbit hole? Have we reached the point of no return? Have we lost ourselves completely never to be found again? We are definitely bound by the world's rules, but only in flesh. Our souls are still free only if it/we wills/will it. Slowly but surely the fake identity of the world will lie exposed, and then your heart will turn from it because it is just so damn ugly. All of this reminds me of the matrix - the red or the blue pill kind of choice. We have lost ourselves only because we let go of God. Thankfully God calls us to Him no matter how many times we have rejected Him. Kierkegaard yells from the grave: let the lily and the bird be your master and learn from them. Be yourself as the lily is simply a lily and the bird simply a bird.