Despite or because of fiscal austerity: Let´s leave that sterile debate behind and look at the global investment consequences of fragile OECD finances.
A graph from the latest OECD Factbook 2013 shows the rise of government debt
ratios as a percentage of GDP, from the start of the global financial crisis in 2007 until 2011. In a former blog entry here ( “Role
Reversal in Global Finance” ) I had discussed Esward E. Prasad´s (Brookings
and Cornell U) presentation at the 2011 Jackson Hole Symposium. Emerging countries, not just China but China above all, hold debt
claims against OECD countries that find themselves on unsustainable fiscal
trajectories as a result of very, very unpleasant debt dynamics - depressed
growth and rising sovereign risk premia. While in the past emerging market
investors (and emerging country governments) had mostly to worry about the
liability side of public balance sheets, public debt trends in the OECD have
now emerging markets worry about their public assets. “Emerging
markets dump Euro reserves”, read a recent FT article. Likewise, OECD based
widows and orphans should check whether their rents are still funded by toxic
OECD government bonds.
OECD General Government Debt, 2011/10 vs 2007
Percentage of GDP
Source: DOI
: 10.1787/factbook-2013-en
- Deposit
insurance is only insurance for small crises.
- Sufficiently
large bank failures or system collapses are a different matter.
In such cases, small depositors are only safe if the sovereign has both the
ability and willingness to compensate them”.
Source:
Deutsche Bank, Global Economic
Perspectives (3rd April 2013)
There is thus hope for the rents of widows and
orphans: The major emerging countries benefit from significantly improved public
debt dynamics and pursue policies broadly consistent with medium-term solvency,
very much in contrast to many OECD countries. Moreover, local currencies are
structural appreciation currencies as long as the emerging countries continue
to grow faster than and converge with developed countries, adding another benefit
for OECD based investors.
Consider some pull factors. Debt dynamics are
favourable in emerging countries as prospective growth rates continue to exceed
effective interest cost on government debt, as cyclically-adjusted primary
budget balances are in surplus, and as sovereign risk spreads are down with
improved investor sentiment and rating scores.
´Original sin´, i.e. currency and maturity
mismatches, has been largely deleted as emerging-market banks are not only
better capitalized than in the past but have also limited foreign-currency
risks on and off their balance sheets; average term to maturity are not yet
long in some cases (Brazil, Turkey: ca 4 years), but have considerably
lengthened in the past decade.
Unlike in many OECD countries, emerging
countries do not simultaneously display high government debt burdens and
high private credit as a fraction of GDP. Where private credit shares are high
(roughly China 125, Korea 100 and South Africa 140, % of GDP), government debt
is below 40% of GDP. Where government debt is relatively high as a fraction of
GDP (Brazil 65, India 70, % of GDP), private credit shares are solidly below
60% of GDP.
To be sure, it is not all about assets being
pulled toward emerging countries as their debt management has improved. The
very expansive monetary policies pursued simultaneously now in all major OECD
regions, has generated important push effects. A return to higher interest
rates in the US, Europe and Japan would certainly hurt emerging market
government bonds as a large part of institutional assets is still invested from
there. This would be a buying opportunity, as the emerging-country fundamentals
are now more solid than OECD fundamentals.
Orphans and widows would be well served by an
ETF invested in a pool of the major emerging country bonds, such as the Barclays Capital Emerging
Market Local Bond ETF. (Disclosure: I am invested
with 6% of my portfolio).
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