Could it be different this time?

America sneezes and the rest of the world catches cold, or so the saying goes. Traditionally, whenever anything goes wrong it has generally occurred in the perceived riskier developing world, and even if the problem was on the other side of the planet (like in Russia or Argentina), the entire emerging markets class would inevitably be punished as one. Risk aversion would kick in and almost vacuum-like, money would be sucked out of the developing world into the safe arms of the developed world.

This perceived superiority of the developed world transcends into South Africa as well. I was recently asked whether we don’t face a greater risk because our Government is supposedly less ‘Ivy League’ educated than its Western peers. By implication, we were perceived as insufficiently educated. Whilst the ‘Ivy League’ part of that sentence is probably true, I have no idea and am certainly not qualified to debate the relative education levels of our Government versus others.

What I will say however is look what that ‘Ivy League’ education has done to them! South Africans seem to be largely unaware of how financially superior we are compared to the supposedly less risky developed world. I constantly see Government being judged on the two C’s – Crime and Corruption. Indeed, we as a nation spend our time (quite correctly) obsessing over these topics. Without in any way belittling their significance, not nearly enough credit is given to the financial prudence that has been demonstrated in South Africa over the past 16 years.

Whilst there is no doubt that taxpayers’ money is not always optimally spent, the succession of finance ministers and Reserve Bank heads that includes Trevor Manuel, Tito Mboweni, Pravin Gordhan and Gill Marcus, deserve enormous credit for resisting the urge (and for stopping others) from borrowing recklessly and spending madly beyond our means. And it must have been tempting, as the needs of homeless, hungry South Africans are far more obvious and justifiable than the needs of the average European, the increasing demands of which have led to the fiscal bankruptcy currently imploding Europe.

The chart below shows by how much the developed world has been spending more than they are bringing in from a tax perspective. While spending more than you are raising in taxes is fairly common, there is a point at which it becomes unsustainable.

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Source: April 2010 WEO and IMF 2010 estimates

And of course, when you run short of cash, you borrow in order to provide. The amount you owe as a country as a percentage of the size of your economy is illustrated very clearly in the debt as a percentage of GDP chart.

 (Click on image to enlarge)

Source: April 2010 WEO and IMF 2010 estimates

In fact, our Government’s lack of opposition ironically probably allowed them to focus on the right things to do, as opposed to the US, UK and European models, where both newly elected and incumbent parties, for fear of the electorate and their narrow margin of electoral safety, have over the years been reluctant to remove benefits, and in order to ensure future political survival, have been inclined to keep giving more. Eventually, you are giving so much more than you have got, and the system either implodes as you are currently seeing in Greece, and potentially certain others, or you have to cut back on spending and raise taxes which is what most of the developed world has to start doing as soon as possible.

So what’s happening now?

The proverbial dog has caught the tyre. You can’t carry on spending more than you earn forever. Essentially it could have gone on for longer, but the credit crunch speeded up the process. The debt problem was moved from company balance sheets to country balance sheets and hence Angela Merkel is quite right to complain that the countries saved the banks and now those same banks are attacking the countries that saved them.

The EU is rallying around Greece. Fixing a debt problem by administering more debt is like fixing an alcoholic with more alcohol. It just defers the problem. The problem is also that it’s not just Greece; they all owe each other so much money and they also owe France, Germany and Britain lots of money. Europe is not in great shape and the Euro should therefore remain under pressure.

The interesting thing to watch is what happens when things settles down. During the turmoil, there will be the traditional ”rush to safety", but once the storm passes, this time it may be different and you will most probably see investors shun the developed world which is going to have to raise taxes and limit spending for many years to come, in favour of the emerging world, such as South Africa, with stronger financial health and potential growth.

One note of warning: In the ten years after the emerging markets collapse of the late nineties, emerging markets did what they were told to do, and the developed world ignored the advice they were dispensing. South Africa has done relatively well, but we must avoid the temptation of becoming a welfare state, and the pressures will be there going forward. Otherwise, we too could look like Greece in ten years time.

What should investors be doing?

The current environment is very confusing for investors. Equities ran hard, and though you have seen a correction, they are by no means cheap. Equities are more attractive than other options, however. Which equities and which currencies? Investors would therefore be well advised to stick to asset allocation balanced funds, where a professional will make all these decisions on your behalf. The professional won’t always get it right, but given their education, experience and access to information, they should get it right more often than the average investor.