Anyone out there know what a recession is?

The South African Reserve Bank defines a recession “as at least two consecutive quarters of negative economic growth.” A slowdown, on the other hand, is a period where economic growth remains positive but contracts slightly. Dave Mohr, Citadel’s chief inv

Five warning signs that point to recession

Mohr believes we can identify five leading indicators of a South African recession. They include whether the world is in recession or not, big swings in capital flows to the domestic market, debt deflation, inflation and a collapse in world commodity prices. An honest assessment of these variables should answer the question on most of our lips. Let’s consider each of these indicators to find out if we’re headed for a recession.

First we need to determine whether the world is in recession. To do this we must consider America’s contribution to the global economy. Mohr estimates that the top three world economies (by dollar purchasing power) are the USA with 28%, the European Union with 29% and Japan with 11%. Growth in these regions, which account for almost 70% of the world’s economy, is under severe pressure. Many analysts believe the US is already in recession based on that country’s unemployment numbers and housing market crash. The only hope for emerging markets stems from the ‘decoupling debate’. But unfortunately those who believe in decoupling are clutching at straws. Well respected economists Steven Roach notes that the only way to believe in decoupling is to deny globalisation! The world, if not in recession, is certainly poised for a significant slowdown. And that’s something South Africa won’t avoid.

That brings us to movements in the country’s capital accounts. Net capital flows into South Africa are at record levels – almost 8% of GDP last year. Because of the country’s towering current account deficit Mohr estimates capital inflows will have to remain around 5.5% of GDP in the next few years. Any severe capital shocks could leave the domestic economy reeling. Regarding the third indicator we can report that debt deflation is looming. Historically, each period of debt deflation in the last three decades has been followed by a domestic recession. And if the news on the first three indicators is not bad enough you should consider that South Africa’s inflation credibility is at stake too. Mohr believes Reserve Bank governor Tito Mboweni will face severe pressure to ‘tighten’ his grip on the local economy in coming months. He also notes that we are in danger of forgetting our inflation target. We should be gunning for 4.5% CPI (the middle of the 3% to 6% range) rather than the 6% everyone is now praying for.

Commodities could soften the blow

The shining light among the five leading ‘recession’ indicators is commodity prices. We are all familiar with the fantastic run in precious metals prices over the last five or more years. Gold surged through $1 000 per ounce earlier this year and is up from lows of around $250 in mid-2002. Platinum remains resilient too, posting massive gains and holding ground above the $2 000 per ounce level. The same story plays out with any number of commodities – whether base or precious metal – and whether prices are set on the open market or negotiated.

The problem is when international investors tire of the resource ‘story’ these commodity prices could fall extremely hard. Take gold for example. The precious metal has already lost more than $100 per ounce since its recent $1 030 high. And for a while it fell below $900 per ounce. Copper and platinum exhibit similar wild volatility. Given the warning signs from the first four indicators a big drop in commodity prices will probably trigger full-blown domestic recession.

Those who believe government’s massive infrastructure expenditure will pull the country through will be sorely disappointed. Mohr says “economic growth is not about spending; but rather about real production.” With South Africa’s mining and manufacturing production under constant threat from erratic power supplies we could be in for a rough ride over the next few years.

Are we clinging to a sinking ship?

South Africa is a medium size, commodity dependent country boasting a developed financial sector. We are very much part of the global village and will be unable to avoid the economic slowdown currently affecting the developed world. What investors need to remember is a recession is a normal part of the business cycle. The country has survived no less than six recessions since the 1970s. And each recession is followed by another period of growth.

Editor’s thoughts:
Citadel certainly makes a strong case that South Africa is nearing or already in an economic recession. Do you think we’re at the edge of a new recession or have the economists jumped the gun? Send your comments to gareth@fanews.co.za, or respond below.