Saturday, 24 September 2016

Trump Bleeds Mexican Peso: a ´Peso Problem´ or Prediction?

According to Deutsche Bank, the Mexican Peso (MXN) is now the world´s cheapest currency on three fundamental valuation metrics: MXN purchasing power beats others; effective exchange rates are at historical lows; and the fundamental equilibrium exchange (external and internal balance) has dropped into the sink. [i] The question is: does the cheap Mexican Peso reflect a “peso problem” or a rising probability of a Trump presidency?
The term “peso problem” is often attributed to Milton Friedman in comments he made about the Mexican peso market of the early 1970s when the interest rate on Mexican bank deposits exceeded the interest rate on comparable U.S. bank deposits, despite a hard peg of the peso to the US dollar since 1954. Peso problems can arise when the possibility that some infrequent or unprecedented event may occur affects asset prices. The event must be difficult, perhaps even impossible, to accurately predict.

The event now is a Trump presidency that hopefully will never materialise. The markets have tended to assume that Hillary Clinton would win the election but the polls have narrowed and some have Donald Trump ahead. No doubt, a Trump victory would be a disaster for emerging market assets. Countries that run a heavy bilateral trade surplus with the United States would suffer from isolationist and protectionist U.S. policies. Countries that rely on financial markets to fund their current account deficits would suffer from a rise in US interest rates as a result of loose fiscal/tight money policy mix under a Trump presidency. Société Générale has found that Treasury bond yields tend to rise when Mr Trump gains in the polls while emerging market currencies (and the Mexican peso in particular) tend to fall. Citicorp economists recommended this summer to short the MXN as a “Trump trade”.[ii]



A Trump victory would be negative for the entire emerging market asset class – with perhaps the notable exception of the Russian market as Western sanctions would likely be withdrawn. So far, however, MXN has priced in substantial Trump risk premia.  MXN has underperformed emerging market currencies (EM FX) since May (use of MXN as a hedge for EM risk), but this underperformance has accelerated recently. According to Deutsche Bank, MXN has decoupled from external factors such as the oil price or the S&P500, being increasingly driven by Trump risk premia.

Scary prospects if the MXN is a reliable predictor of the outcome of U.S. elections to be held in November! By contrast, the MXN risk premia would unwind with a Trump election loss, implying scope for substantial MXN appreciation. Consequently, there is significant room for MXN appreciation (round 20%) if Trump loses the election. So if you like neither candidate – like so many – you can still sweeten the outcome with your personal MXN bet.







[i] Gautam Kalani and Guiherme Marone, “MXN´s Trump Card”, Deutsche Bank Research, 19th September 2016.
[ii] Dimitra DeFotis, „4 Trump Trades For Emerging Market Uncertainty”, Barron´s, 2nd August 2016.

Thursday, 1 September 2016

Reflections on the G20 Hangzhou Summit

Yawn, we are approaching another G 20 summit. Yawn because these summits have a history of proclaiming self-evident truths that subsequently aren´t implemented. Their promises are as quickly forgotten as their stiff photo snapshots with 30 or so ´world leaders´.  The 2016 G20 Hangzhou summit, planned to be held on 4–5 September 2016, will be the eleventh G20 meeting. China’s slogan for this summit is “Towards an innovative, invigorated, interconnected, and inclusive world economy.” Who could object?
What are the macroeconomic stakes?  First, to stimulate growth, fiscal expansion in G20 surplus countries is urgently required. Second, G20 structural policy should focus on rolling back the protectionist measures taken since 2008 in the G20. Third, monetary policy is largely exhausted. At the  G 20 Brisbane summit held in 2014, G20 leaders set the goal of lifting GDP by at least 2 percent by 2018. Yet, despite unprecedented monetary stimulus much of the G20, GDP growth  projected for 2016 remains well below target growth in the Euro area (1.6%) and in Japan (0.3%), according to the IMF (WEO Update, July 2016). Don´t blame the host, China: In 2015, China contributed roughly 30 percent to global economic growth-even with its growth slowing to 6.9%, the increment of GDP that it added to the world was around $760 billion.
The policy package required for achieving the Brisbane goal – monetary, fiscal, structural – seems to have relied excessively on the central banks to do a growth job for which they aren´t assigned.

·         Monetary policy: The collateral damage of monetary easing has been the danger of competitive devaluations, notably of the Japanese Yen.  G20 policymakers have repeatedly pledged to refrain from competitive devaluations and not to target exchange rates for competitive purposes.  China hopes to constrain Japan on FX intervention and to limit further downside for the EUR and GBP (CICC, Daily Briefing, 24 August 2016) with the help of the Hangzhou summit. According to Deutsche Bank´s August 2016 FX valuation snapshot, the Chinese Yuan ranks with the Swiss Franc as the most overvalued currency on all metrics used (DB effective rates; FEER; PPP). From China´s perspective then, there is little room for monetary easing elsewhere but in Beijing. It would be disingenuous to ask Beijing for more appreciation, also from a global growth perspective.
·          
Graph: The Yuan - the most expensive G20 currency

Source: Deutsche Bank Research, FX Valuation Snapshot, 31. August 2016

·         Fiscal policy: In contrast to monetary policy, there is ample room in G20 surplus countries for fiscal expansion. G20 surplus countries beggar their neighbors by crowding in foreign demand via their savings-investment surplus. Within the G20, China, Japan, South Korea, Russia, and the Eurozone ran a balance of payments surplus last year of over $1 trillion, on average 4 percent of their GDP. In the case of Germany, the surplus is currently over 8 per cent.  The G20 needs to blame Drs. Schäuble and Merkel directly and forcefully to drop their pathological fixation on the “black zero”, the balanced fiscal budget with no red ink. Raising public spending and lowering income taxes in the G20 surplus countries are the most direct way to stimulate world demand and growth in times of zero interest rates.

·       Structural policy: Priority action for the G20 should be a standstill and rollback of trade protectionism. While global trade stagnates, FDI into G20 nations has yet to break out of a narrow range witnessed since 2009. According to the latest report by www.globaltradealert.org – a pre-G20 summit briefing on investment and protectionism - the sustained violation of the G20’s pledge on protectionism has resulted in nearly 4,000 trade barriers and distortionary incentives. Seven G20 members have implemented more protectionist measures this year compared to their crisis-era annual average: Australia, the US, UK, Saudi Arabia, Italy, France and Germany. The five BRICS countries, by contrast show a better trade policy performance, but only in comparison.


Graph: Ranking G20 Member Protectionism

Source: FDI Recovers? The 20th GTA Report, CEPR Press 2016.


Name and shame specific G20 countries (as outlined here) that are first and foremost responsible for global lackluster growth: this is the noble task that G20 leaders, especially US President Obama, will face this weekend. On Tuesday, 6th September, the world will hold G20 leaders accountable.

Friday, 5 August 2016

"Democracy" and "Corruption" in the BRICS




This essay will present some recent numbers on the status of democracy and on corruption for a selected group of countries, covering the BRICS and other emerging markets of systemic importance. The analysis is descriptive, comparing 2015 with 2005 data on country rankings provided by the Bertelsmann Foundation, the Economist Intelligence Unit and Transparency International. It also explores the interaction of (subjective or impressionistic) measures of democracy and perceived corruption by looking at rank correlation coefficients.
Shifting Wealth (defined here[i]) has been in decline. Income per head convergence, social inclusion and the accumulation of foreign assets have slowed down or even reversed in the BRICS and other emerging countries. Nobel laureate Michael Spence has recently attributed the BRICS slowdown to external factors[ii]:
“Developing countries are facing major obstacles – many of which they have little to no control over – to achieving sustained high growth. Beyond the headwinds generated by slow advanced-economy growth and abnormal post-crisis monetary and financial conditions, there are the disruptive impacts of digital technology, which are set to erode developing economies’ comparative advantage in labor-intensive manufacturing activities.”
Other observers have stressed governance issues. Corruptions scandals involving the political leaders in Brazil, Malaysia and South Africa; the strengthening of authoritarian rule in China, Russia and Turkey; and the lack of social inclusion fanning internal conflict top the list of concerns. The Guardian[iii] has recently concluded:
To take their rightful place in the 21st century, the Brics countries must create more open, accountable, and trustworthy systems of governance. This is a challenge of leadership, not profit and loss.“
Both democracy and corruption can matter for sustaining growth and development, although the relationship is much more complicated than many governance zealots would have us believe.
Barro (1996)[iv] has analysed growth and democracy (subjective measures of freedom) for a panel of about 100 countries from 1960 to 1990. His findings suggest a nonlinear relationship in which more democracy enhances growth at low levels of political freedom but depresses growth when a moderate level of freedom has already been attained. He also finds that improvements in the standard of living—measured by GDP, health status, and education—substantially raise the probability that political freedoms will grow.
The Transformation Index of Bertelsmann Foundation (BTI) includes ´democracy status´. This political component tries to quantify an unweighted composite of measures for stateness; political participation; rule of law; democratic institutions; political and social integration. Table 1 reports for the five BRICS (in bold) and seven relevant emerging countries how country rankings have developed in the past decade, from 2005 to 2015.

Table 1: BTI Status Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
+
20
19
China
+
85
84
India
-
24
28
Indonesia
+
52
39
Mexico
-
27
41
Morocco
-
79
94
Nigeria
-
66
85
Russia
-
46
81
Saudi Arabia
-
93
100
South Africa
-
16
26
Singapore
-
22
25
Turkey
0
34
33

For the majority of countries, Barro´s earlier finding that economic progress furthers democracy (´freedom´) is not confirmed. Western press sentiment that the BRICS have failed to become democratic during their Golden Age seems to be confirmed. Country rankings (for a sample of 130 countries) deteriorated (and in most cases the index scores) in eight of the twelve countries selected here. But not always where some would expect it. Sure, Russia scores the worst decline but it is fairly closely followed by OECD members or darlings Mexico and Morocco. Among the BRICS, only China and India kept their ranks, albeit at grossly different levels. The only major emerging country to rise markedly in the BTI rankings over the period is Indonesia.

Table 2: EIU Democracy Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
-
42
51
China
+
138
136
India
-
35
37
Indonesia
+
65
49
Mexico
-
53
66
Morocco
+
115
107
Nigeria
+
124
108
Russia
-
102
132
Saudi Arabia
0
160
160
South Africa
-
29
35
Singapore
+
84
74
Turkey
-
88
97

Table 2 presents the Economist Intelligence Unit (EIU) Democracy Index ratings, again for the thwelve selected countries and the ranks in 2005 versus 2015 for 167 countries. The EIU Democracy Index is based on five categories: electoral process and pluralism; civil liberties; the functioning of government; political participation; and political culture. Based on their scores on a range of indicators within these categories, each country is then itself categorised as one of four types of regime: “full democracies” (20 countries only); “flawed democracies”; “hybrid regimes”; and “authoritarian regimes”. (Note that France is now considered a ´flawed democracy´ by the Economist…).
Among the BRICS, the EIU finds only Russia (??) to have slightly move up in the democracy rankings, from extremely low levels. The score in the other four BRICS deteriorated, as it did in OECD members Mexico (confirming the BTI) and Turkey. (What has the OECD Governance directorate been doing in all those years?). Strong improvements are found over the past decade in Indonesia (BTI agrees), Nigeria, and – WTF! – Saudi Arabia.
Sustained growth can also be endangered by a rise in corruption. Mauro[v] has found some subjective indices of corruption to lower investment, thereby lowering economic growth. According to the media, corruption scandals involving the presidents of Brazil, Russia and South Africa as well as anti-corruption drives in China suggest this is indeed a problem in most BRICS. Transparency International produces a Perceived Corruption Index, again a subjective index (Table 3).

Table 3: TI Perceived Corruption Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
-
70
76
China
-
70
83
India
-
70
76
Indonesia
+
130
88
Mexico
-
70
95
Morocco
-
79
88
Nigeria
+
142
136
Russia
+
121
119
Saudi Arabia
+
70
52
South Africa
-
51
61
Singapore
-
5
8
Turkey
-
60
66

Popular and press sentiment about corruption seem confirmed by the TI index. All BRICS recorded deteriorating country rankings in a sample of 167 countries, except Russia (sic!). OECD members Mexico and Turkey dropped sharply in the corruption rankings, as did Morocco. Strong improvements, by contrasts, were noted in Indonesia and Saudi Arabia.

Table 4: Rank Correlation BTI, TI, & EIU 2015
- Spearman´s Rho (p-value in brackets)-
Year
BTI 2015
TI 2015
BTI 2015
/
/
TI 2015
0.43 (0.165)
/
EIU 2015
0.76* (0.004)
0.18 (0.58)
*denotes significant by normal standards.

Rank correlation measures (Spearman´s ρ) do not indicate a significant relationship between the two democracy measures (BTI, EIU) and the TI corruption rankings. The relationship between democracy and corruption is complicated, as suggested by a vivid debate in India, for example. The only significant relation noted in Table 4 is among the two subjective democracy measures provided by Bertelsmann and The Economist.

Some tentative conclusions: The BRICS have mostly receded in international country rankings on subjective measures of both democracy and corruption. But this finding would not necessarily imply that this undermines long-term growth. The link between more ´democracy´ (as Bertelsmann and The Economist understand it) and more economic prosperity seems weaker than often thought, both over time and across countries. After all, Singapore´s authoritarian capitalism and China´s market socialism have gone a long way along rising wealth. The relationship between corruption and democracy seems weak as well. Or should we say: it´s complicated Maybe the, say, Brazilian corruption scandals will reinforce its independent judiciary and hence democracy in the end.




[i] ShiftingWealth Blogspot, “Defing Shifting Wealth”, 4 April 2011.
[ii] Michael Spence, Growth in a Time of Disruption”, Project Syndicate 27th July 2016.
[iii] The Guardian, “Has the BRICS bubble burst?“, 27 March 2016.
[iv] Robert J. Barro, „Democracy and Growth“,Journal of Economic Growth, March 1996, Vol 1, Issue 1, pp 1-27.
[v] Paolo Mauro, „Corruption and Growth“,The Quarterly Journal of Economics, Vol. 110, No. 3 (Aug., 1995), pp. 681-712.

Wednesday, 20 July 2016

With Romer back to a US-inspired World Bank? (extended)

Paul M. Romer, mostly known for his seminal contribution to endogenous growth theory and defender of special zones (´Charter Cities´), will be the next chief economist of the World Bank. His nomination last Monday was greeted with overwhelming enthusiasm[1], especially by academic peers.
With Romer, the World Bank can strengthen her profile as knowledge bank. That should help to differentiate the multilateral fauna of development banking. It was Paul Romer who enriched growth theory by endogenizing ideas and Know How, rather than treat human capital as an exogenous residual. From his pioneering work it would follow that open economies grow faster in the longer run if they foster institutions and a social model that help create and disseminate know how. From there to Romer´s idea of  “Charter Cities”, new cities in poor countries, is a quick link[2] as urban agglomerations tend to breed the generation and dissemination of ideas.


Romer´s “Charter Cities” are supposed to foster development within poor countries via the creation of new special zones that are free from corruption and where property rights are respected. Europe knows what Romer discovered and re-packaged already since the Middle Ages: Stadtluft macht frei[3]. Serfs could flee the feudal lands and gain freedom in this way, making cities a territory outside the feudal system to a certain extent, similar to “Charter Cities”.
The developmental role of “Charter Cities” is derived from the experiences of the former British crown colony Hong Kong and the Chinese special economic zone Shenzhen. Not only the historical origin of Romer´s concept has a neo-colonial smell, but also the fact that the poor-country government has largely to give up control to foreign investors. Honduras tried the concept in 2011 by modifying the constitution to allow judiciary, police, economics and finance to be removed from central government in new ´special development zones´. Critics have pointed to Honduras´ past as a “banana republic” under US corporate dominance.  Rather than becoming prosperous development poles, special zones or model cities can easily turn into heavens for tax evasion, money laundering, corruption and sweatshops, warned the Neue Zürcher Zeitung already in 2012[4].
I regret that the World Bank reverses the newly-established tradition to select her chief economist from an emerging country. With the former and the current chief economists, the World Bank brought the Chinese and Indian development economists Justin Yifu Lin and Kaushik Basu to DC. To my knowledge, Professor Lin was the first chief economist at the bank who did not come from a North American university[5]. Especially the nomination of Lin had reflected Shifting Wealth, the recalibration of the world toward the East; not just economic or political, but also paradigmatic.
I venture the hypothesis that the choice of a US economist can be explained by multilateral fragmentation, compatible with Hirschman´s exit-voice dichotomy[6]. The US could not prevent establishment of the AIIB, China´s successful attempt to exit the US-led multilateral banking system. Capital-rich China is hard to compete with for the US on the basis of funding alone; but the World Bank may counter the decline in its relative importance on the basis of Know How. Whatever the official rhetoric, the choice of Romer will perhaps help restore the old world of paradigmatic US dominance in development banking.



[1] For a rare criticism, see Norbert Häring, The World Bank on the way back to the Washington Consensus – with Chicago Boy Paul Romer, 19. Juli 2016. Häring equates the poster city Hong Kong with an neocolonial inclination of the future World Bank chief economist.
[2] The Economist, “The World Bank hires a famous contrarian”, 18th July 2016.
[3] For history and English explanation, see https://en.wikipedia.org/wiki/Stadtluft_macht_frei.
[4] Peter Gaupp, “Honduras: Entwicklungspol oder Steueroase?”, Neue Zürcher Zeitung, 4th October 2012.
[5] François Bourguignon came from the Paris School of Economics but had started his academic career in Ontario, Canada.
[6] Helmut Reisen, “Will the AIIB and the NDB Help Reform Multilateral Development Banking?”, Global Policy, Volume 6Issue 3pages 297–304, September 2015.