Strangulation economics: Can SA benefit? Bruggemans at his best

South African economist Cees Bruggemans has a refreshing way with words, in particular when he uses them to demystify complex economic concepts. In this article, Bruggemans explores the idea of “strangulation economics”. It is a concept that can be applied to South Africa, but also more broadly in the world, he reckons. He covers a range of countries that are guilty of strangulation economics in this long, but interesting, essay. – JC

Is there such a thing as Strangulation Economics?

If there is, could South Africa be a beneficiary or a victim? My premise is that both are possible, and both are happening to us, but in two very different instances, though both are energy-based.

The returns and penalties are turning out to be enormous. Both could have been predicted 10 to 15 years ago, and were, but mostly didn’t register. Today, we can repent at leisure regarding the one (with as yet no end in sight) and relish the other (for as long as it lasts, which could be longish).

Strangulation Economics doesn’t have a promising history.

Napoleon tried to shut Great Britain down by isolating her, denying her the lifeblood of the Continental trade. It didn’t quite work. The British diversified in favour of the American trade, while smuggling turned the Continental trade barrier into a Swiss cheese. It helped that the Russian Tsar didn’t play ball.

A large effort from both sides during WW1 and especially WW2 tried blockading and denying access to needed raw materials, central to the submarine war, but both parties circumvented it, by bringing superior resources to bear (America) and by using new technologies (Germany eventually making do with oil from coal and other substances).

South Africa felt the hot breath of cultural and trade sanctions during the apartheid years, and these were in the first instance demoralizing (emphasizing as a country being on the losing side of the argument), but were not effective enough (not comprehensive) to do enough damage, even if the autarky it encouraged severely wasted capital and development opportunity for the poorer parts of the population.

The SA game was only seriously up when financial isolation was formalised. All it needed was the visit of one American banker (appropriately named Butcher) to call up outstanding foreign loans and push exposed and fragile SA into debt default which it took a decade to recover from, sacrificing yet more development.

More examples are on offer. Today, whenever the world is in an undeclared state of war, sanctions and isolation are pressed into service to exert the kind of pressure that tends to invite behaviour changes.

On the old adage that if you have them by the short and curlies, their hearts and minds will follow.

Modern technology helps, with especially international banking systems today so heavily integrated that if the American lawgiver imposes its will, few global institutions will resist her. In the process, any country can effectively be shut down, and is.

This tool has in recent years been most effectively used against Iran. It has not stopped that country from functioning, but it has been a way of influencing the international discourse.

Russia is another belated example of what happens when one gets into undeclared disputes with the West (and medieval-inclined Russia has been doing so for a number of years under the leadership of Putin, especially of late).

But trying to stifle trade and finances ultimately do have their limitations, inviting evasive actions. Putin running off to the Chinese, gas hat in hand, being one example.

A much more effective way of reducing a country’s oxygen supply is to reduce its ability to earn foreign exchange. Especially in cases of one commodity wonders, getting its export price to collapse effectively denies income that previously might have been spent mischievously.

Only last September, in his sixth address to the United Nations General Assembly, an otherwise mostly ineffective body, US President Obama called on Muslim leaders in the Middle East to take steps to address the spread of extremism and intolerance. In essence.

“that means cutting off the funding that fuels this hate. It’s time to end the hypocrisy of those who accumulate wealth through the global economy (oil, gas) and then siphon funds to those who teach children to tear it down”.

In other words, cut off the oxygen supply of the baddies, don’t keep rewarding poor global citizenship, stand together against forces of intimidation, savagery and what not.

Some 200 years ago, Washington cleaned out the Barbary pirates in their Algerian enclaves, the first serious business of the new US navy. Today the action focuses on a much larger footprint, from the frozen artic Russian north down to piracy off the Horn of Africa, and civil wars raging up and down North and West Africa, the Middle East and beyond.

Was somebody listening to the Obama speech (or had foreknowledge of it?), was serious help on the way, or was this all only just righteous imagination?

Although the oil rout had commenced in late June, it only got slowly underway, like a stealth, cloaked effort. It was really only in September and October that the price slide gained serious momentum, oil finally collapsing in a heap once Saudi (& Kuwait) formally showed its hand in October-December.

Was it only coincidence that the Obama UN speech took place on 24 September and within the week (on 2 October) Saudi signaled its comfort with current high global supplies and relatively low prices (as US oil prices dipped through $90)?

Saudi & friends were switching from being price maximisers to defending own oil market share, making it official that a lower global marker price was in order to squeeze a few too many production marginals, safeguarding Saudi energy leadership in the very long term.

Except that the global oil price would have to fall quite a way to take out enough marginals, and keep them out, while also tempering technology efforts aimed at achieving greater energy efficiency and less GDP intensity, and also safeguard these constraints for the long-term.

In other words, not just a short-term oil price squeeze but a long-term strategic restructuring, the closest example in a totally different context being ex-Fed chairman Volcker addressing runaway US inflation expectations in the late 1970s by shifting from controlling interest rates to controlling liquidity (and letting interest rates settle where they needed to be to do the job of killing off inflation expectations).

Very brutal, very effective, the way markets work.

But in doing so, Saudi & friends finally did what Obama & friends must have been hoping for a long time. Cutting off the wealth stream that feeds extremism.

In a way ironic, for it has been long known that Saudi has been slipping good money to all kinds of bad causes for years, in some instances genuinely backing such causes, but in other instances probably being insurance monies, payoffs, buying off good behaviour by getting the baddies to focus elsewhere?

Still, revolutions have a way of eating their own children and the Sunni Royal House of Saud must at some point have come to the realisation that watersheds had been crossed. What was it? Iran getting close to a deal with the West (and still going nuclear)? Russia reasserting itself in ways that were not promising? The Arab Spring creating far too much unrest and instability everywhere? The raging Syrian situation, the tenuous Iraqi configuration? The growing Islamic tensions inside Europe. The menacing way Americans have of asking you whether you are with them or against them? Or simply America slowly moving out, leaving the region to its own devices?

The global fault lines run through the middle of Saudi, like cross-hairs, as conflict rages for thousands of kilometers, north-south, east-west, and too many of the neighbours potentially going nuclear, and not being of the true (Sunni) faith.

Iran in recent years has experienced what it is to get financially sanctioned. Just as it thought it could escape this slow garroting by doing a ghost of a deal, Saudi action intensifies its struggle by setting new global energy markers, potentially for decades to come, greatly reducing its national income flow.

In turn, much fewer means to support war in the neighbourhood, be it Syria, Lebanon, Gaza, but also further afield, East and West.

As to Russia, it still sits on forex reserves of $400bn, and it can reapply autarky to its economy, but that is still a slow garroting, which its leaders may or may not understand. Good global citizenship offers far greater returns, but in its absence there is the hard way, short of war, of getting confronted with the consequences of being odd man out in the 21st century.

At least, that could be the reasoning of some people, and all they need to do is shut down your banks, or your export earnings by collapsing its price, for the reality to hit home, sooner or later.

It makes the rest of this decade, and the 2020s, of a different texture than what went before. With what outcomes we have to wait & see. Meanwhile, South Africans may end up with a $50-60 oil marker for years to come, just half the $100-120 marker of recent decades.

That’s a major windfall, for which we are well positioned. Thank you, world, as much the clever technologists, the fracking wildcatters & the Saudi Royals. A most unlikely combination, but then that’s politics (economics, too).

As to the other form of strangulation economics, I presumably only need to say “Eskom” and “government” to sketch what I have in mind? In 2007 it was coal supplies that started electricity blackouts. We have now progressed to power stations coming apart or switching themselves off due to poor maintenance, even as new stations are late, over budget and apparently iffie. To which we, too, apparently want to add a nuclear adventure (for is that policy only energy oriented, or broader?).

Limited Eskom resources have been used in such way as to have painted us into an ever tightening corner, where electricity supply cannot keep up even with constrained demand. This condition will not be lifted soon. It will take a long time during which the risk of electricity interruption will be high, and damaging to industrial output and new fixed investment.

It probably won’t kill us, but its strangulation of our development in a technical sense will be as certain as what apartheid politics in another era did to this society and economy, preventing them from reaching full potential this decade, and possibly next one’s too if this trajectory isn’t changed shortly.

With the one hand, SA is being provided generously with another global windfall, yet with the other hand through own effort it is throwing away what used to be a strong infrastructure card. Such wasted opportunity.
Is modern Strangulation Economics effective in shutting things down and make people see the error of their ways? If it gets too costly, most people are inclined to do so, of which outcompeted Communist USSR and Apartheid South Africa were only two examples.

Modern examples will be interesting to watch as they play out.

Reference

Carol Lee & a Jay Solomon “Obama calls for unity to combat extremism” Wall Street Journal 25 September 2014

George W Bush “Decision Points” Virgin Books 2010

Nicole Friedman, Cassie Werber & Laurence Fletcher  “Saudi move unsettles oil market” Wall Street Journal 3 October 2014

Noel Mostert “The Line upon a Wind – the greatest war fought at sea under sail 1793-1815” Vintage Books 2007

* Cees Bruggemans is Consulting Economist at Bruggemans & Associates.

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