Argentina in default for second time in 13 years

S&P declares Argentina to be in default for the second time in 13 years and the third in 25. Inflation is likely to hit 40% this year and the Peso has already lost a quarter of its value this year, measured against the US Dollar.

Messages? This time isn’t different, sovereign debt crises happen all the time, ignore currency risk at your peril and there are many reasons governments can default on their debt.

Argentina teetering towards default

I’ve been working with a few insurers and reinsurers on credit risk recently. We’ve had plenty of reasons to think about it, what with new regulations (SAM, Basel III) and South African government downgrades. However, sometimes I get the impression that credit risk is viewed as an academic risk, as something that happens to others, micro lenders and maybe banks.

In South Africa, we’ve had incredibly few corporate bond defaults and most market participants don’t even know that the South African government “restructured” some of its debt in 1984 and so has, in fact, defaulted on contractual bond obligations.

In a recent credit risk and capital workshop, I raised the issue of Russia defaulting on Ruble-denominated debt in 1998, a big part of what led to the collapse of LTCM. Again, these events are often figured as “exceptionally unlikely” and not even worth holding capital.

Well, in the news, Argentina is about to default. Again. They have been one of the most regular defaulters on sovereign debt in the last couple of centuries. They’re also an example I often use of “currency pegs” doing precious little to mitigate currency risk except on a day to day basis.

More on that in another post (yes, I’m hoping to post a little more regularly in the coming months.)

Chinese debt a serious worry?

I’m not really that close to developments in the Chinese economy. It is a large, complicated beast that is quite different from our own. Over the last year or so I’ve heard more and more from people who generally speak sense that the debt levels in China and the awful investment projects used to show the appearance of a strongly growing economy form a worrying pair of forces.

House of Debt (a newish blog, seems interesting) has a post covering some of these risks to the Chinese and therefore global economy, with charts! I may post on these issues from time to time as it’s beginning to feel more and more relevant.

Education, CAs and how long is long to study

A recent Moneyweb article poses the question of whether Chartered Accountants in South Africa should study longer.

The problem is that high schools are failing learners and many accounting students start out with significant literacy and numerical weaknesses in their learning.

Now, as it turns out, I’m not a supporter of increasing the required length of study because some students (even, perhaps, a majority) need more time to complete the work.  I see no reason to enforce an arbitrarily longer study period on students who are perfectly capable of making it in the current and long-standing term of the programme just because some students are entering with inadequate preparation.

I’m not oblivious to the challenges of education in South Africa. I’ve blogged regularly on how education shortcomings are the number one cause of economic challenges and unemployment in South Africa. I’m also not saying that we should simply raise entry requirements as that would exclude many students with the potential to be successful CAs because of imperfect high school level preparation.

What I suggest is an optional (at the choice of students or the university) post matrix, pre-CA year to cement the basics.

The nature of this course would be that the majority of candidates electing or being required to attend this extra year would be previously disadvantaged. I also see it as a perfect opportunity to make tuition cost for this pre-CA year count fully towards cost in the first year of the BComm or BBusSci course should the student meet the requirements. Thus, there is no free year of university grade education for all and sundry, but rather for those who benefit from the programme and successfully enter the mainstream CA stream studies their will be limited financial penalties.

In some ways, this subsidy could potentially save the universities and National Treasury some money – better pass rates in later years should shorten the amount of time to graduate, reducing other university and government subsidy costs.  I haven’t worked the numbers, but it is an offsetting impact to consider.

I understand that UCT, certainly for actuarial students, has a very successful programme of tweaking the education route for this with poorer preparation. I don’t have the numbers at hand, but the results apparently have been quite staggering.

Of course, SAICA has a somewhat silly response:

Saica’s senior executive for professional development, transformation and growth Chantyl Mulder said the duration to qualify as a chartered accountant (CA) is already seven years and thus lengthening university studies is not viable.

Stating that it isn’t viable doesn’t actually say anything. The same could be said against a seven year study period of the current were six years. The same could be said against the seven to twenty (and beyond for an unlucky few) years of study for actuarial students and medical specialists. As it is, my understanding is that UCT students pursuing their CA career via B.Bus.Sci have a four year undergrad degree (and what a magnificent degree it is too) and then a final year of GDA study before starting a three year articles period.

The recognition that some CAs take longer than seven years could be taken as evidence that some students need longer. Surely it’s better to prepare a robust eight year programme for those very likely to take longer than seven years rather than leave them to the wolves and an eight or nine year struggle with inadequate preparation? Or even if a parallel rather than serial solution to improving the basic skills is the answer, this has nothing to do with seven years being the magical “right” number.

The final worry itching at the back of my head is that we have all accepted the pernicious degradation of matric quality and have therefore already become used to lower entrance requirements at universities, adding pressure to admissions and possible decreasing the average level of learning. This route as only one destination – lower skilled employees, less international competitiveness, lower economic growth and higher unemployment.

When is revenue lost?

In respect for Nelson Mandela’s death and funeral, many retailers closed yesterday for the day. This Business Day article claims a R300m loss for the retail industry as a result.

Except, no. Some fraction of those sales might be permanently lost, but the income hasn’t been spent and the cash still sits in shoppers’ pockets. The R300m is mostly just delayed.

There will be some impact where closed shops sacrifice sales to open shops.

There might even be some small amount of decreased consumption and therefore increased saving. The article headline wasn’t, “Retailers sacrifice means an increase of R300m in personal savings.”

This is part of an ongoing trend (probably for hundreds of years) for journalists, even respected financial journalists working at a respect newspaper, to seek the most impressive headline. It also reflects our very human tendency to ignore second order effects. Which is a pity because that’s where the really interesting analysis lies.

Sewing seeds of manufacturing growth

The NY Times has a fascinating article on the increasing demand for American made goods, particularly textiles, and the limited supply of labour with the relevant skills.

There is plenty more to the story than just manufacturing increasing in the US – it also includes an historical perspective on the sources of labour in the textile industry over the last two centuries.

The relevance for me and South Africa is – even with our 40% duties on imported textiles, why are we still shedding jobs? In the US, it’s been a desire for higher quality, more reliable quality, shorter turnaround times, cheaper transport costs and a growing discomfort with safety conditions in Asia.

The higher average incomes in the US also make price less of a overriding factor than in South Africa. The COSATU t shirts that were made in China at least once is a clear reminder of how cost impacts buying decisions above almost all else in big parts of our economy. I don’t know whether the quality of our production and the appreciation for buying locally made products is great enough locally yet. The NY Times article spend several paragraphs talking about the need for strong English and Maths skills. We’re still struggling with our legacy of broken education even while we fail current learners. None of this helps to take advantage of these trends.

Manufacturing growth in the US and other developed markets is also driven by increased automation. Higher real wage are less critical when automation in eras decreasing the amount of labour required. Possibly counterintuitively, this increases the demand for labour in developed countries even while decreasing global demand for labour.

Wages for cut-and-sew jobs, the core of the apparel industry’s remaining work force, have been rising fast — increasing 13.2 percent on an inflation-adjusted basis from 2007 to 2012

If you look at a graph of the share of US GDP that goes to labour compared to capital, it’s been a steady decrease for decades. I can only imagine the same is true in South Africa. The increased use of automation (including new robots that work more interactively with humans in auto plants) may drive this even further.

So is this a story that bodes well for South Africa? We should be a low (lower than the US and Europe anyway) wage producer so developed market manufacturing should hurt our export industry. Given that we import textiles from China, should we maintain hope – against all experience of the last two decades – of regaining a meaningful textile industry? Or do we need to recognize that Africa should be our biggest export area and we should leverage our proximity, both geographical and cultural, and focus on our competitive advantages over the Chinese? Where is our Industrial Policy in any of this?

Why equity matters

Income inequality is a bad thing. It’s a suboptimal scenario. This isn’t something that is debatable. It follows from a few fairly fundamental principles:

  • Wealth demonstrates diminishing marginal returns.  This is evidenced through risk aversity and other empirical studies
  • Happiness does generally increase with wealth, but at a decreasing rate.
  • There’s plenty of evidence that living in an area where others have more money than you makes you unhappy, even if you’d be happy with the exact same amount of money in a neighbourhood where you earned more than average.

In other words, taking money away from the wealthy to give to the poor makes the wealthy less unhappy than it makes the poor happy. More equal incomes will improve over happiness. Although I suspect the action of “taking away from the wealthy” has a certain inherent bias to unhappiness itself.

Intrade and the Prisoner’s Dilemma

Ok, it’s not exactly the Prisoner’s Dilemma, but it tastes the same.  Members of prediction market Intrade, have to decide whether to cooperate or be selfish.

The exchange is insolvent. It seems like the operator didn’t separate member money from its own money and then spent it. This basically makes it a ponzi scheme. It can keep operating as long as it keeps operating. There are sufficient member balances that it still has positive cash. As soon as it accounts for these liabilities to members, it is insolvent.

So, members are offered the chance to agree to a voluntary reduction in their claim and/or conversion to long-term investment. If nobody agrees, the exchange will be liquidated and everyone loses out and any inherent value in the exchange disappears. If enough agree, then those who don’t agree get to withdraw their full funds.

Under this argument, the incentive is for each member to be selfish. Let’s see why.

There are two scenarios – enough accept the terms, too few accept the terms.

If too few accept the terms, the payout is the same whether you agreed to accept the terms or not. So that won’t affect the decision. If there are enough who accept the terms, those who declined will get paid out in full.  The only way it makes sense or an individual to accept the terms is if the value of accepting the terms is greater than 100% of their account balance. This might be the case if they were converted to an equity value in the business and believed in its ongoing sustainability, but seems pretty unlikely.

The equity value has been massively damaged by the damage to brand value of the exchange. Outside parties or existing members wishing to take an equity stake need to consider carefully the extent of brand damage already and the $700,000 shortfall needed to restore solvency let alone any capital for future operations and investment.

Bye bye inTrade.