Welcome to deficit country...

…somehow I don’t think that slogan’s going to focus group too well as a welcoming banner to foreigners at our airports next year.  But seriously, is it just us or has the discourse and early analysis of Tuesday’s mini-budget been totally crazy?

Forget the relaxing of capital/exchange controls, forget the talk of maintaining the “inflation target”, forget all that stuff.  Focus instead on what matters: The gargantuanly large projected deficits over the next 3-4 years.  Opposition parties hailed it as a sensible budget and said that the ideals of Trevor Manuel (former finance minister) have not been lost.  Meanwhile, Zwelinzima Vavi of that intellectual mess called Cosatu, said he was disappointed with the budget and feared that Gordhan was treading the same footsteps as Manuel.

Say what?  A union member dissing this budget?  That’s actually quite funny.  This budget was a leftists wildest fantasy.  If all goes to plan SA will double its public debt in 4 years to around 45% of GDP.  The unions and the Reds have been begging for this for years and now they’ve got it.

So what does it all mean?  Well, as Galt said in the previous post, take all the good work Manuel did from 1996 to 2008 and kiss it goodbye.  The ‘fiscal space’ he created will vanish faster than you can say “interest burden”.  It means a big jump to the borrowing requirement.  To be specific, compared with the February 2009 budget, planned borrowing has jumped by well over R300bn over the period 2009/10, 2010/11, and 2011/12.  It’s going to see a pretty big jump in new bond issuance for both vanilla govt bonds and parastatal paper.

Not great news for bond yields.

The reaction in the markets so far has been pretty calm.  Yes the rand has lost ground today (Wed) but not massively so.  One wonders whether the market fully appreciates what was announced on Tuesday.

How about this for a theory: Foreign investors haven’t really reacted much to this news because they are becoming desensitised to public debt levels all over the globe.  Think about it.  Before this recession running a 3% deficit in one year was always considered profligate.  Now governments like the UK and US are announcing 10%+ annual deficits and the markets are hardly bothered.  10%!?  In one year!? Yip, it’s true, and it’s dangerous.

Everyone is getting so numb to debt that one day this whole government debt roll-over ponzi is going to blow up in everyone’s face.  The Keynesian fallacies are still rampant of course. “Don’t worry about the deficits, we’ll grow into them”.  “The deficits are the stimulus we need to grow again”.  “You have to run counter-cyclical fiscal policies”. “Government’s can always inflate their way out”.

Over at The Big Picture there’s a great piece by David Einhorn of Greenlight Capital.  We concur.  When governments get in lala-land spending mode, its time to head for gold.  

“Now, the question for us as investors is how to manage some of these possible risks. Four years ago I spoke at this conference and said that I favored my Grandma Cookie’s investment style of investing in stocks like Nike, IBM, McDonalds and Walgreens over my Grandpa Ben’s style of buying gold bullion and gold stocks. He feared the economic ruin of our country through a paper money and deficit driven hyper inflation. I explained how Grandma Cookie had been right for the last thirty years and would probably be right for the next thirty as well. I subscribed to Warren Buffett’s old criticism that gold just sits there with no yield and viewed gold’s long-term value as difficult to assess.”

“However, the recent crisis has changed my view. The question can be flipped: how does one know what the dollar is worth given that dollars can be created out of thin air or dropped from helicopters? Just because something hasn’t happened, doesn’t mean it won’t. Yes, we should continue to buy stocks in great companies, but there is room for Grandpa Ben’s view as well.”

“I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.”

SA’s fiscal position and government debt obligation looks pretty fantastic compared to the US and UK.  But one luxury SA does not have is the ability to keep interest rates pinned to the floor.  That luxury will soon run out for the US and UK also.  So interest rate risk could bite SA very hard very soon.  And if the US debt game falls into a heap, rates will spike hard.

Have these guys actually considered any of this?