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Marikana - A major red flag overseas and at home
By Clem Sunter. Originally published on News24, 29 August 2012 One of the points that Chantell Ilbury and I have been making for the last few years is that we live in an ultra-competitive world; and, if we want a better life for all, we have to stay in the Premier League of nations. Relegation to the Second Division or, worse still, descending into a Failed State kills any chance of achieving the levels of economic growth (6 to 8% p.a.) necessary for a universal upliftment in South African living standards. Alas, no matter what words of comfort are offered by our government ministers when being interviewed by an international news agency, Marikana has done enormous damage to our brand of being a thoroughly modern democracy at the tip of Africa - indeed an exceptional model for the rest of Africa to follow. Just for starters, if this incident happened in America, Britain, Europe, Canada, Japan or Australia, the government would have immediately resigned and fresh elections called. The closest example I can think of in magnitude to this tragedy occurred on 30 January 1972 in the Bogside area of Derry, Northern Ireland when 26 unarmed civil-rights protesters and bystanders were shot by soldiers of the British Army. It became known as Bloody Sunday. Thirteen died immediately and one succumbed to his injuries four and a half months later. Northern Ireland was a highly troubled region at the time. It will take a huge amount of effort to restore our image of being a decent, moral society and an attractive investment destination. Rather than trying to predict the findings of the commission of inquiry into the tragic incident itself, I would prefer to give my list of actions to begin the path of recovery in the eyes of the world as well as of our own citizens. 1. Implement employee share ownership programmes across all mines. Having been in the mining industry all my life, I am very much aware that we should be doing all we can to improve the conditions of the miners at the face. The problem with tripling wages is that it could lead to the closure of shafts or even whole mines. It would be much better to do what Kumba has done and bring in the miners as part owners. That means they will do well in good times for the mining industry but are less likely to be retrenched in hard times. For me, anyway, it makes much more sense for the ownership of the mines to be extended to the workers rather than for the mines to be nationalised. 2. Stop militarising the police. The game of an army is to use maximum force to defeat the enemy. The game of the police is to impose law and order using minimum force. They are totally different games requiring completely different strategies and tactics. They should never be combined as this only increases the odds of a disaster like Marikana. 3. Cease cadre deployment. The flag of violence has always been our principal flag for assigning a probability to our Failed State scenario. Criminal violence has been around for a long time but now you can add public violence caused by frustrations over lack of service delivery. The only way the latter is going to improve is to hire individuals and companies with proven track records to do the job. So much could be done for so much less money if the normal management principles that are part and parcel of running any competitive world-class business in the private sector are adhered to by the players in the public sector. 4. Achieve a new economic accord. For over a year now, I have been proposing the idea of an Economic Codesa to try and align our UI economy of big business, the union and government with the U2 economy of entrepreneurs and small business. At the moment, we have parallel economic universes with no linkages between the two and little if no hope for the inhabitants of the U2 economy. It will require a private-public partnership of note to create the possibility of integrating the two universes and thereby ushering in a new era of economic democracy and freedom. It has to start with a big bang accord to which all parties commit. When something like Marikana happens, you want to make sure that the tragedy of it all compels people to take a different and better path to the one they were on prior to the event. Let's change step while the emotions are still raw so that nobody in the entire saga died in vain. You cannot turn back the clock, but you can create a better future.
Keeping the red flags down
By Clem Sunter. Originally published on News24, 28 March 2012 There are two reasons why Chantell Ilbury and I provide red flags for downside scenarios. The first is to allow people time to take action on their own behalf to ameliorate the impact of such scenarios on their organizations or personal lives. The second is to give them the chance, collectively with other people, to keep the red flags down in order to minimize the probability of Armageddon-type scenarios becoming reality. Such is the case with our most negative scenario for South Africa which we call “Failed State”. It is where we join the likes of Somalia, Afghanistan and Syria because the level of violence and unpredictability surrounding our future rises to a point where foreigners are too afraid to come here, let alone invest in any new business here. Yet again we are isolated from the rest of the world, but this time not as a result of sanctions but through being perceived as too high a risk. We have four red flags and one tendency associated with the “Failed State” scenario. A tendency is like Japan being located in a seismically active zone of the earth’s crust, so it has a higher probability of earthquakes. At the moment, we attach low odds to the “Failed State” scenario. But if any of the four flags rise or the tendency turns into reality, watch out – the odds are increasing and it is time to seek protection. Actions of the first kind in the first paragraph are to keep your passport up to date; possibly look for a job overseas; take as much of your wealth offshore as you are legally allowed to do; and if you own a business expand the geographical footprint elsewhere in Africa and overseas. In a “Failed State” scenario, the rand could fall to 100 against the US dollar (after all it has devalued by a factor of 10 since 1980). Nevertheless, being patriotic, it is actions of the second kind which hold more interest for Chantell and myself. Let me therefore list the flags and tendency and provide the countermeasures to keep them down and out of play. The first red flag is nationalisation as many of our trading partners would regard it as a retrogressive step of the worst possible kind. The policy has failed miserably in most of the countries where it has been implemented and anyway the question universally asked is: How on earth would the government afford to pay fair value for the mines and the banks? It would push our national debt to GDP ratio from its current modest level to something approaching that of Greece. Not paying fair value on the other hand is tantamount to confiscation which would be a total turn-off for foreign investors. The ANC appears to have arrived at a similar conclusion so this flag is down at present. But the best way to keep it there is for the mining companies and banks to initiate major employee share ownership programmes. The capital of this country would not be shared with government but with the workers. It would no longer be perceived as monopoly capital. The second red flag is a clumsy implementation of national health insurance which leads to a decline in the quality of private medical care. This could cause another mass exodus of skills, since young talented people in particular put a high premium on access to decent health care for themselves and their families. The way to keep this flag down is for the major private sector health care players to offer to go into partnership with the government in regard to the management of the big state hospitals. Thus, a stampede towards the private hospitals can be avoided when the public have freedom of choice on where to go for medical care. The third red flag is a media tribunal with punitive powers. This flag has partially risen with the passing of the secrecy bill. Muzzling the media is as bad as undermining the independence of the judiciary. It can precipitate a quantum leap in corruption as there is no longer the fear of exposure. The way to keep this flag down is to campaign for a very narrow definition of a secret, preferably only military ones. The fourth red flag is potentially the most toxic and lethal – land grabs. The latter could even be the trigger for a civil war in South Africa. Already the fear of this flag rising has caused the number of commercial farmers to diminish and constrained new investment. This flag will only be kept down by bringing all the major players in agriculture together in an Agridesa (i.e. an agricultural equivalent of a Codesa) to negotiate a land reform programme with a reasonable chance of success. The tendency arises from the three characteristics shared by all the Arab countries that have gone through the Arab Spring: abnormally high youth unemployment; a growing alienation from society by those unemployed young people; and active social networks. South Africa has all three factors which means our own version of the Arab Spring could be only one random event away. Measures to stop this tendency turning into reality may include tax incentives for companies to take on young recruits out of school and train them; an easing of labour laws for small business to give them the flexibility to employ extra staff; teaching pupils entrepreneurial skills as part of the curriculum; and some form of national community service. By articulating the “Failed State” scenario as a low probability, high impact event – what Nassim Taleb refers to as a Black Swan – Chantell and I hope that we have provided an adequate motivation for everybody to take action to keep the red flags down.
The Demographic Flag
By Clem Sunter, originally published on News24 on 21st December 2011 In September 1989, I remember a conversation I had with the pick of the great futurists in the world at the time - Pierre Wack. It took place at one of our annual scenario planning sessions which were held overseas. Our favourite venue was the Spreadeagle Hotel, an inn in Midhurst, Sussex which dated back to 1430. I always felt that scenario planners could think more imaginatively about the future if they had a bit of liquor inside them. Anyway back to the conversation. Pierre says to me: "Do you know that two flags have gone up on Japan which suggest its imminent demise?" This surprised me no end as Pierre was married to a lady of Japanese descent. I responded: "What on earth makes you think that, Pierre?" If you remember back to the late 1980s, we all anticipated that Japan was going to be the star of the 1990s (more or less like we feel about China today and its performance in the 2010s). Japan had averaged at least 7% per annum economic growth for the two decades leading up to the 1990s. Indeed we all talked of "nemawashi", the Japanese practice of preparing a tree to be transplanted by digging around its roots. This should be applied to companies seeking to transform themselves, we surmised. Pierre's answer was unforgettable: "The first flag is declining golf club membership in Tokyo. The Japanese are golf fanatics and if they are resigning from the clubs, then something is happening to their disposable income which is not being captured in the media. The chances of the economy hitting the wall in the short term have gone up sharply. The second flag is to do with what happens afterwards. It won't be a 'V-like' recovery. It won't be a 'U' or 'W' of longer duration. It will be an earlier letter in the alphabet - an 'L' or flat low growth for a long time. "The reason is that the second flag is a long-term influential one. It is the future demographics of Japan. It is a rich, ageing society. That does not bode well for Japan's export competitiveness; its domestic spending patterns except in the area of health products; and the amount of money that has to be set aside by the government to care for the elderly." Pierre's analysis was right on the money. Three months later, the crash occurred and Japan's economic growth over the last 21 years has averaged one percent per annum. The quality of life of an ordinary Japanese citizen in this steady state economy has not deteriorated dramatically. What has taken the biggest hit is the stock market. When Pierre made his prophecy, the Nikkei index was on its way up to a whisker below 40 000 in December 1989. It now stands below 8 500 or nearly 80% below its peak more than two decades later. Who said that equities are bound to increase in value if you select a long enough period? Not in Japan. The grounds for recollecting this conversation is that if Pierre were alive today, he would probably have said the same about Europe. The population is getting older and in countries like Italy the number is actually declining. Not good for economic prospects nor for stock markets. On top of that, you have the short-term flag of vastly over-borrowed governments and the possibility that interest rates on Italian and Spanish debt could go through the roof - like they have done in Greece. That would be the beginning of the "L" or, as some call it, Eurogeddon. The demographic flag in America is more positive as the age-group in their mid-to-late 30s is set to increase over the next five years. In China, the one-child policy since 1978 is scheduled to cause havoc in 30 years' time. It may be the first nation to grow old before it gets rich. In the words of that old South African advertisement, it makes you think, doesn't it?
Scoring our own goals?
By Clem Sunter, originally published on News24 on 13th July 2011 The level of anxiety is definitely rising in South Africa. As Chantell Ilbury and I say, we cannot eliminate your anxieties; but we can structure them in a way that you can have a rational conversation about them. We still think the scenario gameboard we have used for the past few years, to examine different possible paths that South Africa could take, is relevant. Here it is:  We have been in the Premier League since 1994 when we became a proper democracy. It consists of the 59 nations listed in the IMD World Competitiveness Yearbook, which comes out in May every year. After the turn of the century, we were in the mid-to-late 30s, which is where we should at least be given that we are the 32nd largest economy in the world. However, we fell to 53 in 2008 because of international concerns over the quality of our infrastructure, especially in light of the rolling black-outs of Eskom. In 2009 and 2010, we were promoted back to 48 and then 44 as none of our banks had to be bailed out during the financial crash. By contrast, in 2011 we were dumped back to 52 on account of policy uncertainty having an adverse impact on foreign direct investment. So we are back in the relegation zone and there are three scenarios over the next five years. The first is that we get our ducks in a row and move back into the 30s where we rightfully belong. We are the only African country listed in the Premier League at the moment. The second scenario is that we fail to get our ducks in a row, shoot a few own goals and get relegated into 2nd Division. We lose our premier position in Africa to Nigeria, they replace us on G20 and we join the bulk of the Third World – poor but peaceful. Companies will still make money here as they do in other Third World economies, but for the government it will be exceedingly tough. They won’t get the tax revenue they got in the Premier League and they certainly won’t get the access to international capital that they currently enjoy – just when Eskom needs another R800bn for its next generation of power stations. If the flag of violence goes up, we move into a scenario called Failed State where we join the likes of Afghanistan, Somalia and Libya. Other nations turn their back on us because we are too unpredictable and violent for any kind of trading relationship whatsoever. Obviously, the violence in South Africa at the moment is nothing like it is in Libya even when you include the statistics on violent crime. So we accord this scenario a wild card probability of 10%. Nevertheless we have four subsidiary flags, which – if they start rising – will increase the probability of this scenario. The first one is nationalisation - which will be viewed by the majority of the world as an extremely retrogressive step. The second is a clumsy implementation of national health insurance, which leads to a decline in private medical care. The latter will trigger another major exodus of young talent from this country, as their major priority is quality education and healthcare for their children. The third flag is a media tribunal with punitive powers. The first journalist that is sent to jail for spilling the beans on a prominent individual will trash our reputation of being a liberal democracy at the tip of Africa. Moreover, it will open the floodgates of corruption, as it will no longer be counterbalanced by the fear of exposure. The fourth flag is an outbreak of land grabs, which will surely lead us down the same path as the country north of us. None of these subsidiary flags are raised at the moment; so we put the Failed State scenario on one side as a wild card and concentrate on Premier League versus 2nd Division. We have three flags to decide whether we are going up to the first or down to the second scenario. The first flag is around inclusive leadership as it is those nations that are united as a team which have gone up the Premier League fastest. The outstanding example is Singapore which in 2011 is No 3 after the US and Hong Kong who are joint No 1. We give Jacob Zuma a tick in this category; but we are as worried – as most people are – about some of the divisive statements coming out of the ruling party. The last thing South Africa wants to become right now, given the global hard times, is a racially polarised team. The second flag is about pockets of excellence. If we use our pockets of excellence to raise the entire performance of the team, good flag. If we dumb them down, exceedingly bad flag. SARS, the Red Cross Children’s Hospital in Cape Town and 5 000 out of 28 000 schools are pockets of excellence which can be used to inspire others to better performance. The worst outcome would be the politics of envy dragging them into mediocrity. The third flag is around creating a strong new economic order, bearing in mind that there is no example of a country that has grown at more than 7% per annum for more than 10 years that is not outward-looking. We need to play to our strengths in the intensely competitive export game by concentrating on going downstream on our resources, converting the success of last year's Soccer World Cup into becoming a premier tourist destination and leveraging off our current status as an influential gateway into Africa (Walmart being a good start). On the internal economy, it is all about creating a culture of entrepreneurship and a supportive environment in which that culture leads to the formation of one million new businesses by 2020. Thereby five million new jobs will be created. China opened the doors to entrepreneurship in 1978 and is now the second largest economy in the world. The US has always celebrated entrepreneurship, innovation and individual excellence. At present, we give a 50% probability to remaining in the Premier League (down from 60% a few months ago as a result of our eight-place drop in the 2011 global rankings). We give a 40% probability to a drop into 2nd Division. If you combine this figure with the 10% probability for Failed State, it is now 50/50 on whether we stay above or go below the central line on our scenario gameboard. We are at a tipping point; and that is why we need a Codesa III to discuss how to liberate our economy and give the entire citizenry their economic freedom and self-esteem.
Deal or no deal
By Clem Sunter, originally published on News24 on 29th June 2011 People who have read my last article on redirecting Julius Malema will realise we are at a second tipping point around economic freedom, in contrast to the first one around political freedom in the early 1990s. Moreover, just as the first tipping point required Codesa I and II to negotiate a new political democracy for the country, we need Codesa III to negotiate a new economic democracy. It is now a case of a new deal to launch South Africa onto the growth path of becoming a winning nation; or no deal plunging the nation into penury or, worse still, civil war. Codesa III will require different players at the table including business, agricultural bodies and trade unions alongside the major political actors. Other community-based organisations, NGOs, business schools and various academic experts will be required for aspects of the debate. Following in the footsteps of the previous Codesas, an open debate must lead to decisions and actions ushering in a new economic order. We have done it before, we can do it again. The agenda will be different. Here is the one I propose; but obviously Ebrahim Patel and members of the National Planning Commission must be involved in formulating it:
This agenda is just a straw dog to motivate people to add their own issues. However, the idea of a big-bang event like Codesa III should not be lost. It is infinitely preferable to a series of smaller meetings behind closed doors, which will probably lead nowhere. We have to make the whole process transparent with extensive media coverage. We have to achieve a set of measurable outcomes to which the players attending the meeting commit themselves. Finally, we have to have a system that monitors progress so that strategies and tactics can be adapted in light of successes and failures down the line.
Redirecting Julius
By Clem Sunter, originally published on News 24 on 24th June 2011 You have to hand it to Julius Malema. He is a headline-grabber of note; he sticks rigidly to what he believes in; he delivers his popular message with such ferocity and charisma that he attracts truck-loads of adoring fans; and he knows when to say sorry. Moreover, he has done one thing for which he should be given credit. He has taken the Establishment - political, business and other - completely out of its comfort zone by focusing on the point that radical measures have to be implemented to turn a highly unequal, exclusive, lop-sided society into something which the writers of the Freedom Charter would be proud of. For me that is common cause; but where I differ is on the tactics to get there. Nationalisation and land grabs - with or without compensation - are dead-end policies. Nationalisation without compensation will result in sanctions being re-introduced against South Africa by the US and EU, as it will be perceived that their citizens - the ones who have invested here - will have had their assets stolen from them by the South African government. International travel restrictions on members of the Cabinet will probably be applied as well. Nationalisation with compensation at fair value will mean that a trillion rand will have to be diverted from health, education, welfare and law and order to purchasing the targeted assets. In other words, the opportunity cost will be enormous. The only alternative is for the government to borrow the money - if they can - which will send South Africa's national debt to GDP ratio through the roof. Land grabs, on the other hand, will in the worst-case scenario precipitate a civil war. People who sing liberation songs like "Kill the Boer" should remember that the first modern freedom-fighters were the Boers - well before Swapo, Zanu-PF and the ANC. They effectively held the British imperialists at bay for the first half of the Boer War at the turn of the previous century. It was only when Kitchener introduced concentration camps and herded their women and children into them with an absolutely appalling loss of life, that the war turned in Britain's favour. Neither being a pariah or highly indebted state in the case of nationalisation nor being a country riven by civil war in the case of land grabs will sort out the problems of unemployment and living on desolation row. The only way the problem can begin to be resolved is to follow the philosophy of Steve Biko, an equally charismatic character, who before he was cruelly murdered in the 1970s basically expressed the view that handouts do not improve your self-esteem: doing it for yourself does. That is as true today - in the world of Facebook and Twitter, which have enormously increased the power and freedom of individuals - as when he said it in the 1970s. So if I were Julius, I would take Steve's ideas on board because they are so much more inspirational and relevant to the members of Generation Y than the old-fashioned and discredited policies that the state should become the centre of everything. I say this coming from a family in the UK where my socialist ancestors not only wrote nationalisation into the Labour Party constitution (Beatrice Webb), but actually implemented it across the board (Stafford Cripps who was Chancellor of the Exchequer in the late 1940s and made Julius look positively unambitious by comparison). Needless to say, everything is back in the hands of the private sector apart from the National Health Service, which in retrospect was a worthwhile initiative. Rather than trying to destroy Malema, I would urge him to consider redirecting his energy down the path outlined by Steve Biko. I would be asking him actively to engage with Business Leadership SA and AgriSA as to how a more inclusive and participative economy can be created and how one can transfer an appropriate proportion of land from white to black farmers without diminishing agricultural productivity. All of this will take time. It cannot happen overnight in one quantum leap. Perhaps he and his colleagues in ANCYL should also go on a leadership programme at GIBS. Get out of the confines of the ANC into the real world. Furthermore, instead of harping on about expropriation of this or that asset which will not create one extra job for the youth of this country, I would like Julius to change his pitch and demand three things: 1. We raise the quality of education in this country to give young people the power to do their own thing; 2. We provide the entrepreneurial space in this country so that young people have the freedom to do their own thing; and 3. We celebrate South African pockets of excellence like Siyabulela Xuza (who has a minor planet named after him by NASA) in order to give young people the confidence to do their own thing. That is just so much more funky a vision than having everyone work for the state or be dependent on the state. As Michelle Obama said a few days ago at the Regina Mundi Church in Soweto: "You are your own liberator." Amen.
Global Flags update - A lamentation of black swans
By Clem Sunter, originally published on 18th March 2011 What do you call a group of black swans? A lamentation. As the phrase black swan is now applied to low probability catastrophes, ever since Nassim Taleb's book on the subject in 2007, the collective noun is appropriate. We have had our fair share of catastrophes this year – the floods in Australia and the earthquakes in New Zealand and Japan, the latter one moving the main island 2.4 metres in its location. Chantell Ilbury and I foresaw more smacks from Mother Nature in our breaking futures for 2011, but nothing on the scale of what has happened. Then, of course, there is the unrest in the Middle East, which is unprecedented in terms of the number of countries involved at the same time. Moreover, lurking under the radar at the moment are the European debt crisis, which has not gone away as well as the yawning US budget deficit. All in all, we have a lamentation of black swan events, which could change the short-term course of the world considerably. One must also add into the mix the terrible impact of the tsunami, which followed the Japanese earthquake and the current possibility of radiation from the damaged nuclear reactors posing long-term health risks to the population in the vicinity. Remember Japan represents 10% of the global economy and plays an enormous role as a component supplier and end-product-producer in the world's manufacturing industry. At the beginning of this year, I wrote an article entitled The Global Tightrope, which featured the following scenario diagram for the next five years:  The two mainstream scenarios were "Ultraviolet" depicting a two-speed world where emerging economies grew three times faster than advanced economies mired in debt; and "Hard Times" painting an ugly flat "stagflationary" world of low economic growth for everybody. The flag indicating which of the two scenarios was in play was China's annual GDP growth. If it stayed in the 8-10% range, we were in "Ultraviolet"; and if it fell below 6% we were heading into "Hard Times". At the time we gave China's economic prospects the benefit of the doubt and accorded a 40% probability to "Ultraviolet" and a 30% probability to "Hard Times". Given the lamentation of black swans, we now reverse those two probability figures and make our favourite scenario "Hard Times" with "Ultraviolet" in second place. We think it is increasingly difficult for China to continue to grow at the pace it has done for three reasons: the likelihood of an economic slowdown in Japan which is one of its principal trading partners; a jump in oil prices above $150 a barrel in the event that unrest spreads to other authoritarian regimes involved in OPEC; and possible unrest in China itself as a result of food price inflation. It is already 15% per annum. "New Balls Please" and "Forked Lightning" remain the outliers, the first scenario being a short-term utopian recovery for advanced and emerging economies alike; and the second being the dreaded double-dip scenario precipitated by another crash in financial markets and a loss of faith in the US. The two flags for "New Balls Please" – a significant drop in US unemployment and a reduction in its national debt-to-GDP ratio – remain firmly down. So we still give it only a 20% probability. As for "Forked Lightning", our sole flag was a sudden jump in the 10-year US Treasury bond interest rate to over 5%. In fact, with the flight from equities, the rate has recently declined to 3.3%. Thus, it remains a wild-card scenario with a 10% probability. So much can happen over the next few months that you have to keep our scenario gameboard permanently in your head; and adapt your plan of action as the probabilities change. The curse of interesting times is upon us.
Global Flags update 2011 – The Global Tightrope
If Ben Bernanke were in the circus rather than chairman of the US Federal Reserve Bank, he would be a tightrope walker. On the one hand, he has done everything to stop the Great Recession turning into the Great Depression with his monetary stimulus measures. On the other hand, he wants to avoid stagflation – a condition of low economic growth but rising inflation and hence rising interest rates. In other words, he does not want to repeat the mistake made by Alan Greenspan earlier this century which contributed to the Crash of 2008. Let us analyse the tightrope he is precariously perched on in terms of scenarios, flags and probabilities:  On our latest scenario we have chosen two axes. On the left of the horizontal one is a "U" denoting a long economic slog of at least five years before the world as a whole experiences a sustainable recovery. On the right is a "V" where 2010 was a year of transition, 2011 will see a mild recovery and 2012 we are truly back in business. On the top of the vertical axis is a World operating as one unit and, on account of globalisation, sharing a common destiny. At the bottom is a world that is becoming increasingly divided either because of differing economic prospects or as a result of rising tensions, protectionism or regional strife. The interaction between these two axes yields four possible scenarios. Going clockwise, the first is "Hard Times" or a classic "U" for everybody where unemployment rates remain painfully high for much longer than people anticipate. The second scenario is "New Balls Please" where Bernanke is the hero of the day, but the economic game is very different in its revived form. Resources are scarce as the East vies with the West for economic supremacy. "Ultraviolet" is a two-speed "UV" world where emerging economies experience a recovery in the short term while advanced economies labour on under a mountain of debt. "Forked Lightning" is a double-dip repeat of the early 1930s when the Crash of 1932 eclipsed the Crash of 1929. Currently, we are in the "Ultraviolet" scenario and it is our favourite over the next five years with a probability of 40%. The flag to indicate we are moving into the universal "Hard Times" upper-left quadrant is a dip in China's economic growth rate below 6%. So many emerging economies in Africa and elsewhere as well as advanced economies like Germany and Australia are dependent on China's continued success. If China falters, the multiplier effect kicks in. We give "Hard Times" a 30% probability which is lower than "Ultraviolet" because it is odds on that the Chinese economic miracle remains in place. The flags for "New Balls Please" are a decline in the US unemployment rate below 6% and a general drop in national debt to GDP ratios among advanced economies. The former is still at a historic high around 9½% and the latter are continuing to climb since governments have only just begun to rein in their budget deficits. We therefore accord "New Balls Please" a 20% probability at this stage on the grounds that the conditions for sustainable recovery are elusive. As for "Forked Lightning", our principal flag is a jump in the 10 year US Government Bond rate above 5%, which would indicate a loss of faith in the dollar as a reserve currency. Other flags are a national default of note in Europe, a trade war erupting between America and China or a massive conflict in the Middle East or between the two Koreas. Essentially, a gust of wind blows Bernanke off the tightrope and the finely crafted balance he has put together falls apart. None of these flags is up at the moment and we therefore assign "Forked Lightning" a 10% wild-card probability. Our advice to clients, however, is to monitor the flags constantly and adjust the probabilities as the flags go up or down. Equally, there may be other flags we have not thought of or even other scenarios. Whatever your preferences, this approach is more sensible than betting the shop on a single forecast. It makes you more nimble when things change.
The South African Flags
The hedgehog approach to the future is to try and project it in a single, expertly derived forecast. If and when the 'expert' forecast proves wrong, it is belatedly amended. Foxes, on the other hand, hold multiple scenarios in mind; and as the future unfolds, they gradually adjust the odds they give to each scenario. This involves far less shock and horror because whatever happens, it is usually captured in one or other scenario. Moreover, as the odds on the scenario change, foxes modify their strategy accordingly - whether they are running a business, investing money in the market or taking someone out on a first date. It involves a continuous evaluation of the signs and possibilities and, where something really unexpected happens, immediately incorporating the event into the scenario mix. The steps are straightforward. First, identify the scenario that you are actually in at the moment. Second, look at the possible pathways that could lead to the other futures and convert them into plausible scenarios. Third, select the flags that would suggest you are moving from the present scenario into the other ones. Fourth, based on whether these flags are up or down (or at half-mast), assign relative probabilities to the different future scenarios. Then, on a balance of evidence in front of you, survey your options and make the most appropriate decision. Each scenario should be a unique, internally consistent narrative that requires its own special response from you as a player. Foxes work out the best response beforehand so that they know what to do if the scenario materializes. They can then adapt faster than their competitors to the new circumstances. Let's apply this process to the possibilities for South Africa in light of the country's 2009 General Election (and against the backdrop of the global economy in recession). We have been in the 'Premier League' scenario, shown on the gameboard below, since 1994 - the year of our first truly democratic election. For most of the time since then, we have resided in the middle of the league, which is where we should be. We are not a Manchester United (about to beat America, Japan, Germany and China). We are more like a West Ham or Manchester City.  Nevertheless, according to some global surveys, we have lost considerable ground in the rankings, which puts us perilously close to the 'Relegation Zone'. Reasons given are that violent crime is driving talent out of the country; HIV/AIDS is shortening the lifespan of the average South African; our infrastructure is showing signs of disrepair; and some of our industries (such as our textile industry) are looking distinctly uncompetitive compared to Eastern players. Given our current predicament, there are three alternative scenarios (all shown on the gameboard above). The first one is that we get relegated to the 'Second Division', where the bulk of the Third World resides - poor but peaceful. Companies will still make money (as they do in plenty of Third World countries); and they will always have the option of extending their geographical footprint into other African countries, or even overseas. By contrast, for the Government the scenario is an unmitigated disaster because they can't change clubs! Certainly their tax revenue will be a whole lot less than they received when they were in charge of a Premier League nation; and they won't have the same access to international capital. Altogether it makes the perfectly honourable maxim of 'a better life for all' seriously harder to achieve. The flag for this scenario is that we disappear from the 'A' list according to an increasing number of internationally accredited surveys. The second scenario is 'Failed State' into which the principal flag for entry is widespread political or criminal violence. Examples of countries either in or on the border of 'Failed State' are Somalia, Pakistan and Iraq. Nothing trashes a national brand like violence. The world turns its back on you. The peaceful nature of the 2009 elections in South Africa means that the current odds on this scenario are negligible. It is more like a cautionary tale. This leaves the third scenario that South Africa returns to the middle of the Premier League - comfortably outside the 'Relegation Zone'. There are three flags associated with this scenario. The first one is inclusive leadership. The last thing that South Africa ought to be in the global 'Hard Times' scenario is a divided team. Inclusivity means on the one hand keeping the rich minority - who have the capital and a fair measure of skills - on side; but also creating the opportunities for the marginalised poor to become part of the mainstream economy. In other words, it's a delicate balancing act, and it's reassuring that Jacob Zuma has made inclusivity central to his initial presidential theme. The second flag is to show tangible results in rectifying the problems that have caused South Africa's recent slide in the Premier League. This has nothing to do with ideology on the Left or the Right, and everything to do with back-to-basics management. The best way for South Africa to raise this second flag is for all of us to recognise the pockets of excellence that exist in our midst and then benchmark other similar organisations against those pockets of excellence. For example, while there are many complaints against service delivery in the public sector, there is one world-class Government department - the South African Revenue Service. It is as good as any revenue collection service in the world. All other departments should be benchmarked against the excellence of delivery of SARS. In the health sector, a pocket of excellence is the Red Cross Children's Hospital in Cape Town. It shows that a properly managed state hospital can combine state-of-the-art equipment with medical care for children only obtainable at the best hospitals in Western capital cities. The third flag is about the evolution of a dual-logic economy consisting of an outward-looking economy that earns enough foreign exchange to cover the country's export bill (which is real issue since the current account deficit is around 7% of GDP); and an inward-looking economy that creates enough new jobs to make a dent on our appalling unemployment rate of 23,5%. The success of the outward-looking economy revolves around choosing one's spaces carefully in light of how competitive the global economic game is. South Africa has three spaces where it can dominate: mineral and agricultural resources, but we need to add more value here before we export them (a pocket of excellence being our wine industry); tourism, which can benefit from our ability to host major sporting events; and playing the gateway role into a continent that is opening up for business. South Africa is the 'America' of Africa in that it produces 30% of the continent's GDP with a little less than 5% of the continent's population. Such a position confers huge competitive advantage in this particular trading space. The success and inclusivity of the inward-looking economy will very much depend on the growth of small business in South Africa and overcoming the problem of a 'two worlds' economy. We have a First World formal sector and a Third World informal sector with virtually no linkage between the two. Yet a glance at the 'Premier League' reveals that the three countries that made it to the top fastest all began their ascent with an entrepreneurial burst of energy - Japan and Germany after the Second World War and China after 1978. They are now respectively the 2nd, 4th and 3rd largest economies in the world. Family-owned businesses were a critical element in the lift-off. Consequently a flag that will demonstrate progress in this area will be the transformation of the micro-lending industry. Why not invite Nobel Laureate Dr Muhammad Yunus, who founded the Grameen Bank in Bangladesh, to be a consultant on what we should do here? A second flag comprises more generous tax incentives to compensate for the risk of starting a small business, e.g. offering a complete tax holiday on profit up to a cumulative total of R1 million and exemption from capital gains tax for investors in businesses below a certain size. The odds that we give at the moment are 70% to a U-Turn in the 'Premier League' and 30% to being relegated to the 'Second Division'. This may sound optimistic to some; but we're probably out of the 'Relegation Zone' already, not because we've gone up but because the rest of the world has gone down. A positive flag is that in the 2009 World Competitiveness Yearbook, produced by the International Institute for Management Development, South Africa has risen to 48th out of 57 countries, compared to 53rd out of 55 last year. Reasons given include our resilience to the global financial crisis and our recovery from the rolling electricity blackouts experienced at the beginning of 2008. Indeed, our financial and insurance sectors have almost escaped the whole toxic debt tsunami unscathed; and we are relatively unencumbered by debt as a nation. In addition, despite the dramatic decline in our GDP, we shall probably experience a shallower 'V' than Europe and the US. All these sporting events on our calendar act as an excellent gap-filler. On top of that, Zimbabwe has every chance of resurrecting its economy in the near future, for which we will act as a gateway. On the other hand, we have to make tangible progress in the areas where we rank lowest in the 'Premier League' - unemployment, brain drain, available skills, life expectancy/health problems, pupil-teacher ratios in secondary schools and organised crime! In conclusion, we feel that South Africa is not a bad place to see out the global economic 'Hard Times', or even the 'Perfect Storm' if it looks like engulfing the world. Obviously quite a few young South Africans living overseas agree with us. They are returning home.
The Global Flags update July 2010
Just over a year has elapsed since I wrote the article on global flags, scenarios and probabilities. It's time for an update. Below is the latest global gameboard that we use in strategy sessions with clients:  Going clockwise from top left, we start with "Hard Times" continuing for the world economy for another three to five years. It's a "U" scenario across the globe. The reason this scenario has credibility is that the problem which created the "Hard Times" in the first place - the magnitude of debt owed by governments, businesses and consumers - has not gone away. All it has done is change in nature from a private sector problem concerning the solvency of the banks to a public sector problem concerning governments which are running up large budget deficits, and racking up an unacceptably high level of national debt. The latter problem is more difficult to solve. Whereas governments could justify bailing out the banks because taxpayers might lose their bank deposits, it is a much harder case to argue when governments start bailing each other out. Moreover, while a superfund may solve the liquidity problem of financially strapped governments in the short term, it does nothing to resolve the competitiveness of those nations in the long term. Indeed, it can even undermine any industrial renaissance by allowing the recipient nation to defer tough decisions. All in all this scenario presumes the mess takes a long time to clean up. The second scenario, "New Balls Please", is currently backed by Tim Geithner and Ben Bernanke, two heavy-duty American punters. In it, we're over the worst, 2010 is a year of transition, 2011 will see a mild recovery and 2012 we're back in the game. It is a V-shaped recovery rather than a U-shaped recession. We gave this scenario its name after Wimbledon where a new game requires new balls. There are four critical differences between the old and new game: the banks will be more heavily regulated; credit will be harder to get; the East will be the economic equivalent of the West; and more effective resource supply/ utilisation in the face of growing scarcities of metals, oil, food and water will be the basis of the next wave of technology. The third scenario is called "Ultraviolet" or "UV" to indicate a two-speed world, some regions going through a "U" while others experience a "V". We would nominate Europe, the UK and Russia for a "U" and Brazil, Africa, China and India for a "V". Japan could go either way having undergone a 20 year "U". America likewise in light of the government there having to rectify its budget deficit. The last scenario, "Perfect Storm", is a seriously deep "U" triggered by a combination of political and economic events, including another major war, nuclear terrorism, widespread national defaults or an upsurge in protectionism. It portrays an unstable, hostile world where recession is replaced by depression. At present, Chantell and I give only a 20% chance to "New Balls Please" because two of the three flags which would indicate the scenario is in play are firmly down and only one is half up. The two flags down are a serious reduction in unemployment and in debt worldwide. The one half up is an improvement in property values and stock markets, but not to pre-recession levels. We attach a 30% probability to "Hard Times" and 40% to "Ultraviolet", the flag differentiating the two being the near-term performance of the Chinese economy. If China has a wobble because of labour problems or the property bubble bursting there (as it did in Japan in 1990), it's "Hard Times" or double-dip for all. Otherwise it's a "UV" world; and, with the Chinese authorities having the confidence to allow a limited float for the Yuan, this is looking increasingly likely. We treat "Perfect Storm" as a wild-card scenario, giving it odds of 10%. The rising tension between North and South Korea, the standoff between the West and Iran over its nuclear programme and the continuing war in Afghanistan are all potential flags. Nevertheless, as we say to our clients, please disagree with our flags and probabilities if you feel we are wrong. We just think it is more sensible to have a structured debate around scenarios, flags and probabilities than to bet the whole shop on a single projection, however expertly it is crafted.
Market Flags
A three horse race2009-07-30 12:20Clem Sunter In response to my last column about the history of making money on Wall Street, "Tuscanite" asked whether I could provide some scenarios and probabilities on the future of the market - specifically the Dow Jones Industrial Average. Here they are. The DJIA Derby is a three horse race. The favourite to win over the next five years is "Hard Times", which assumes a U-shaped recovery for the global economy. In other words, things aren't going to get worse, but they are not going to get better either for an appreciable period. The magnitude of debt is the cause of the recession and all the US and UK governments have done so far is increase the size of the problem. It takes years for them to reduce their budget deficits (and total debt) to a reasonable proportion of GDP. Meanwhile, rising inflation will cause a hike in interest rates and that, together with higher taxes to pay off the government debt, will make a significant dent on any resurgence in consumer expenditure. All in all, the US and UK economies stutter between growth and stagnation. This scenario parallels the one that prevailed from 1966 to 1982 when the DJIA oscillated between 700 and 1 000 on no less than five occasions. Likewise, in the foreseeable future, it will oscillate between 7 000 and 10 000 as a mixture of good and bad flags provoke greed and fear alternately among investors. In this type of market, the best strategy is to trade in and out of stocks and catch the highs and lows of the DJIA. The second horse in the race is a young stallion called "New Balls Please" which has some heavy-duty punters such as Obama, Bernanke, Brown and Darling. The recovery is V-shaped and all the indicators start turning positive later this year. In 2010, the property market turns, car sales pick up and unemployment falls. Nevertheless, it will be a new game requiring new balls. Firstly, credit will not be easy to obtain for a long time. Secondly, the banks will be more heavily regulated and will no longer be able to gamble depositors' money on the derivatives market. Thirdly, the East will catch up to the West and probably lead the recovery. Fourthly, a new technological wave will power the next boom, as the emphasis shifts from improving the flow of information to improving the use of energy and moving away from fossil fuels. This scenario is equivalent to the one that America experienced between 1942 and 1966 when the war started turning in the Allies' favour. US government debt at the time was more than 100% of GDP and fell continuously thereafter on account of the acceleration of economic growth in the 1950s. The DJIA went up 10 times from 100 to nearly 1 000. The breaking news in "New Balls Please" is that the DJIA has already launched itself in an ascent to 100 000 and this is the perfect time to get in for a long-term investor. The third horse is a sneaky outsider called "Forked Lightning". In this scenario, the worst is yet to come because of some unexpected shocks to global stability at a time when confidence and stability are already fragile. The shock could be the eruption of a trade war between China and America/Europe, a military conflict over Iran's stated objective of developing a nuclear capability, swine flu turning really lethal or a national bankruptcy much larger than Iceland. The markets just plunge. The reason for the name "Forked Lightning" is that in this scenario, the DJIA repeats its dramatic behaviour between late 1929 and mid-1932. It peaked in September 1929 at 381 before dropping to just below 200 at the end of November. It thereafter recovered to 294 in mid-1930 before free-falling to 41 in mid-1932 (losing 89% of its peak value). In modern times, the DJIA fell from 14 164 in October 2007 to 6 547 in March 2009 before recovering to its current level of 9 000. In "Forked Lightning", the DJIA would establish a new low (below 6 000) in the next couple of years. Hence, the best strategy is to be in cash and bonds. So what are the odds on the three horses? At the moment Chantell Ilbury and I give a 60% probability to "Hard Times", a 30% probability to "New Balls Please" and a 10% probability to "Forked Lightning". Given the recent recovery in Wall Street, the market appears to be attaching higher odds to "New Balls Please" and a zero chance to "Forked Lightning". Let's say 50-50 "New Balls Please" to "Hard Times". We differ with the Wall Street bookmakers because there are no positive flags fluttering in the breeze at the moment. Things are less ominous, but they're not looking up. In the end, you as the reader must make up your own mind and place your bets accordingly. Remember buyers and sellers have exactly the opposite scenario in mind when any transaction takes place on the stock exchange. That's why the investment game is so interesting! The beauty of round numbers2009-07-23 07:44Clem Sunter You are 10 years old, living in New York in 1916. Your father establishes a trust for you and puts in a variety of blue chip shares worth $10 000. He then whisks you off to the Amazon jungle because he is a keen botanist. You are essentially cut off from the world because you develop an interest in botany too while you work alongside him. All the dividends on the shares in the trust are remitted to you as living expenses. Twenty six years later in 1942, you make your first return visit to New York and check up on the value of your trust. The lawyer who looks after it says that it is still worth $10 000, having risen to just over $30 000 in 1929 and fallen to $4 100 in 1936. You are relieved you missed the drama and are reassured that your trust still has its capital intact. Back you go to the isolation of the jungle. In 1966, after another twenty four years you decide to celebrate your 60th Birthday in New York and ascertain the latest value of the trust. To your delight it has multiplied nearly ten times to close on $100 000. That makes you very happy as you trek back to the jungle for your final stint. You reflect on how different the result was for 1942 to 1966 compared to 1916 to 1942, despite the fact that the intervening periods were similar in numbers of years (24 versus 26). Finally, you retire hale and hearty and come back to New York in 1982 sixteen years later. You pay a visit to the same legal firm expecting another substantial increase in the value of your trust. This time the lawyer has a resigned expression as he tells you that your trust has not appreciated at all. It is still worth about $100 000. So in light of the fact that you have been a fairly successful botanist, having discovered a couple of brand new plant species and made a fortune out of one of them as a medicinal herb, you decide to leave the capital in the trust. At the ripe old age of 93, after seventeen years of luxurious retirement in Long Island, you think it is time to take one last look at your father's trust. Lo and behold, its assets amount to $1 000 000 making you, as the sole beneficiary, a millionaire at the end of the millennium (or worth $66 000 in 1916 terms). Even though your father has been dead for a long time, you want to give him a hug for reaching this important milestone. Once more, you can't help noticing that the two periods, 1966 to 1982 and 1982 to 1999, were similar in length (16 versus 17 years). The morals of the story So what are the points you should take away as an investor?
This shows just how important yield is in the scheme of things.
The Global Flags
It's no good just writing scenarios. You have to supply the flags that would suggest you are moving from one scenario to another. Moreover, as the flags go up or down, you must adjust the probabilities that are assigned to each scenario. This means continually assessing the changes in the environment around you 24/7. For example, in late 2006 the world was still firmly in the 'Long Boom' scenario on the right of the global gameboard illustrated below:  But we identified one flag that - if it rose - would signify the end of the boom. The flag was a decline in asset values in the US, particularly property and equities. Our reasoning was that American consumers were borrowing more to spend more and the only reason they could borrow more was because they were worth more. If their assets started diminishing in value, that game would come to an end. Furthermore, since American consumers are two-thirds of the US economy and the latter is 30% of the world economy, a halt in consumer spending in America would precipitate a global 'Hard Times' scenario (pictured on the left of the above gameboard). In January 2007, the official US property index started falling and, by mid-year, with that flag half up we were giving a 50% probability on a shift from 'Long Boom' to 'Hard Times'. When the stock market turned later in the year, we upped the percentage to 80%. By December 2007, we were saying to clients that, according to our analysis, 2008 would most likely be a horrid year. Indeed it was, and the globe moved firmly into the 'Hard Times' - classic recession -scenario the like of which has not been seen since the early 1980s. We missed the flag of toxic debt, but our motto is: "it is much better being vaguely right than precisely wrong". So what are the scenarios and flags now? There are two exits from the 'Hard Times' scenario (see diagram below). The first is a recovery along the lines suggested by Ben Bernanke and Barack Obama where green shoots will proliferate in the remainder of 2009 and lead to a mild recovery in 2010.  By 2011 we'll be back in the game but it will be a new game that we call 'New Balls Please'. Credit will not be as easy to obtain as it was in the 'Long Boom'; banks will be more heavily regulated; the East will be the economic equivalent of the West (a historic moment bearing in mind that the West has dominated the global economy since 1400); and a new technology will propel the new game, probably around new energy sources and energy savings given the importance of addressing the issue of global warming. The flag for this scenario is a continuous improvement in US property prices over a period of at least three months. Another clear flag would be a drop in the US unemployment rate. Neither flag has risen as yet, but commentators are already talking about a bottoming-out of the property market, while the monthly figure of jobs lost is now declining. We therefore accord this scenario a 60% probability despite no clearly visible positive signs. Some of you reading this article may vote for a lower figure, but this is the whole point of our methodology - to get people debating not only the selection of the flags but also their estimate of each scenario's probability. The second exit from 'Hard Times' is a much more sinister scenario called 'Perfect Storm', which is also depicted on the above gameboard. It is a protracted recession or depression resembling a 'U' rather than a 'V'. The 1930s was an obvious example, but in a way Japan has been in a similar scenario since 1990. It is sobering that the Dow Jones Industrial Average only recovered its peak before the 1929 crash in 1954. Likewise the Nikkei is still around 25% of its December 1989 peak. We have four flags to indicate the approach of a 'Perfect Storm'. The first is the intensification of protectionism in the form of trade barriers that would fragment the global market a great deal more than we see today. The second is a major war to stop nuclear weapons ending up in the hands of terrorists - or, if they do, a nuclear strike on a Western city as envisaged in our letter to Mr Bush in June 2001. Obvious candidates for a war are Iran, which has nuclear ambitions, and Pakistan, which already possesses nuclear warheads. Whichever, it would be much larger than Iraq and sorely test America's already overstretched budget. Bad economic times make for a divisive world; Hitler would never have ascended without the Depression. Moreover, North Korea is once again a problem. The third is a national bankruptcy of note. We have already had Iceland, but if a European Union member goes down (e.g. Hungary, Poland or Ireland), the event would severely disrupt the international monetary system. The fourth is a meltdown in China where the halving of the economic growth rate triggers widespread social unrest, possibly causing a switch from outward-looking to inward-looking government policies. China becomes a brake instead of an accelerator on the world economy. None of these flags is flying at the moment, but the probabilities of one rising in the near future are growing. At present, we accord a 40% chance to the 'Perfect Storm', which is significantly up on the odds we were giving at the beginning of the year. There is also a hybrid scenario where we have a V-shaped recovery, but it proves to be a 'False Dawn'. The flag is an increase in the American inflation rate without any reduction in debt during the recovery process. As interest rates rise to compensate for the higher inflation, so do the loan defaults (yet again) and we have a repeat of the present recession. Only it is a much deeper one. Consequently, the flags that differentiate 'New Balls Please' from 'False Dawn' are a significant decline in America's total debt-to-GDP ratio and a decline in its household debt-to-income ratio. If pressed, we would split the 60% probability of a 'V' outcome equally between these two scenarios. To summarise then, we give a 30% chance to a long-term sustainable recovery, a 30% chance to a short-term (say 5-year) recovery followed by another crash, and a 40% chance to no recovery at all. We hope this informs people sufficiently to calibrate the size of the bet they are prepared to take as a proportion of their own individual wealth or the wealth of their companies. It's all about weighing up the impact of each scenario in terms of the potential for profit or loss and then, on the balance of probabilities, deciding on a strategy which matches your risk profile. Good luck, watch the flags and be prepared to adapt your strategy if the probabilities change (or a new scenario emerges). No other approach can handle the sheer unpredictability of the future and the volatility of the markets today. |