Tag Archives: emerging markets

Economics of intellectual property laws

As reported in the Wall Street Journal, Thailand has strengthened its intellectual property laws.  Long considered one of the worst countries for property laws, the article focuses on the country’s recent efforts in copyright law as related to music. Long considered a hotbed for piracy and counterfeit merchandise, this could signal that one emerging market is ready to grow.

The United States has some of the best property rights in the World.  However, in some cases, even the holders of some US copyrights have found that it is best not to defend them.  As the RIAA has found out, it may not be worth the trouble.  Thailand is responding to lawsuits brought by GMM Grammy, a Thai record label, against local performers who have been playing “…whatever people want to hear”.  These lawsuits are unpopular with the public, who compare the music style to American Jazz.  Music aside however, what might the economic ramifications be if Thailand was actually serious about protecting intellectual property?

Upon closer inspection, Thailand’s copyright laws rank a mathematically impossible 23rd out of 18 in its region. Typo aside, Thailand would seem to be in desperate need of property laws. Research by Keith Maskus shows that they could see more benefits then just the musical innovation.  Intellectual property laws by themselves don’t stimulate foreign investment in developing countries; If that where the case, Botswana would have more foreign investment then Italy.  Maskus’s research shows that while ultimately it is a choice at the firm level about whether to directly invest in a foreign country or not, the level of legal protection must be considered.

If the country can manufacture modern goods, as well as having a market to sell them in, then property laws can provide incentive for foreign investment.   Thailand fits this definition.

Even if the effect of enhanced IP laws isn’t foreign investment, there are still very compelling economic reasons for Thailand to protect its ideas.  Such laws encourage innovation as opposed to imitation, as well as ensure that those responsible for an idea get compensated for their work.  While IP laws can be imposed to early, creating economic inefficiencies, Thailand may have developed enough to warrant some protection, and that is something they should use as a sign of their economic success.

Emerging markets have been taking a beating recently.  Recent political unrest has resulted in a worsening economic outlook for Thailand.  Thailand can reverse this course and return to being the fastest growing economy in the world.  Thailand can do this by focusing on the property rights that matter.  Once the country has its political house in order, its experimentation with music copyrights should be expanded into patents and private property.



Which Emerging Markets were hit the hardest by FED tapering?

When Yellen said in February that the Fed would continue its tapering policy, emerging markets took a big hit.  Investors began to flee from the more risky emerging market economies back towards the US.  The flow of capital out of the emerging markets led to their currencies weakening and many central banks having to step in to stabilize currencies by raising interest rates.  Turkey, Brazil, South Africa were some of the countries that were hit hard by the capital flight.  The economic downturn that emerging markets saw is not something new.  Throughout history, tighter monetary policy usually leads to economic struggles in emerging markets.  The Asian, Latin American, Mexican crisis all were in response to the Fed rising interest rates.  When the US has lower interest rates, emerging markets can borrow more because of the lower cost to finance their debt.  Once US interest rates rise, or the Fed tightens monetary policy, it becomes more expensive for emerging markets to maintain their level of debt.  The lower US interest rates also forced investors to search for higher yields which also contributed to the movement of capital to emerging markets.  Two months later, the question becomes, which emerging markets were hurt the most by the Fed tapering.

A recent article by the Wall Street Journal analyzed the publishing of a recent paper by the National Bureau of Economic Research.  The paper found that it was the strong emerging market economies that were harmed the most by the Fed’s tapering announcement.  When I read this, at first I was surprised.  But as I thought about it more, it made more sense that stronger emerging markets would lose capital the most.  When investors were looking for higher yields, it would make sense that they would head to the economies with the next strongest fundamentals.  The NBER paper, written by Hutchinson, Binici and Aizenman, believes that emerging market economies with current account surpluses, high international reserves and low external debt were the ones that had the most flight of capital when the Fed announced tapering.  I believe that it was these strong fundamentals which were the reason why investors decided to send capital to the emerging markets.  The movement of capital to these emerging markets strengthened their currencies against the dollar and when the Fed announced tapering, it led to a large exchange rate depreciation.  I’m not surprised that the countries that attracted the most investment, because they was the next safest alternatives, lost capital the fastest.  The easier that capital flows, the more likely it will return to the safest option when that options yield increases.

“How” to Invest in Emerging Markets

Emerging markets sell-off began a few weeks ago with volatility not appearing to die down anytime soon. This was due to a variety of factors that spanned from a Fed announcement about cutting down its bond buyback program to political corruption. But a WSJ article headline “How to Invest in Emerging Markets Now” drew my eye. “Wow I can make money!” I thought to myself. But after reading blurb after blurb of the article I came to the very end disappointed with the lack of a “how-to” that I was promised.

This brought my recollection back to reading this past weekend’s paper about “A Word of Advice.. On Advice” by Joe Queenan. As his argument pertained to personal investing advice, no one with good advice to give will give it… openly. Asymmetric information is the basis for financial gains through trade (like arbitrage).

Lets say this was a “how-to guide” though. Like was mentioned in class, a lot of American’s don’t have enough in foreign assets. This is basically shooting themselves in the foot. Diversifying risk is an important principle of investing and emerging markets are a good place to start. So this sounds like a good idea for someone like me to try and make some profit. Even with emerging market’s currencies appreciating against the US dollar in the long term, many other students and I don’t have the assets to actually do anything very profitable.

The equation for ROR (rate of return) is exhibit A. The cost of investment isn’t just the money put into the markets. Its also the time to manage the portfolio. It’s the opportunity cost we have as well. During what some consider the most valuable portion of our lives, is it worth it to forgo other opportunities with money and invest? Is it worth it to start serious saving? Some shmuck college kid like me with hardly at money, isn’t going to get much of any where with oversea assets, taxes and fees to their government’s content. It’d be nice to even try to break even there.

But this doesn’t sound right… I heard time after time again that saving is crucial. But especially now, where returns on investments aren’t high and my bank’s saving accounts interest is hardly above zero, perhaps I should be spending my money now and enjoying my life to the fullest. Now is the time to spend money for those overseas trips and not save in overseas markets.

Remember: The usual rules of investing apply. After fees, active investors on average underperform low-cost index-based funds—even in emerging markets.


(Revised) Turkish Lira in Trouble Again

The central banks in many of the emerging market countries (Turkey, South Africa, India) have jacked up interest rates in an attempt to stop the slide in their currency’s value relative to the dollar. Idealistically, rate increases will stabilize the market and draw buyers back in.

The sell off by investors started last week after Chinese manufacturing reported a slowdown and has continued since then. Turkey made headlines last night after their midnight meeting concluded when they spiked up the emergency interest rate from 4.5% to 10%. While recovery seemed hopeful at first, the currency issue did not see much improved after a few hours.

First a little back story:

Turkey’s economy has been booming up until now. However, for approximately 20 years before Prime Minister Recep Tayyip Erdogan took office, inflation was very high in the country. Many Turks were generally unfaithful of their currency and would usually exchange/invest in the US Dollars or rare minerals like gold or silver with the intention of protecting themselves from inflation. In 2005, Erdogan put policies to stabilize inflation. The lira faced renomination, erasing six zeros essentially, followed by many inflation controlling policy. The Turkish people gained confidence once again with the lira and things were great with a fast growing economy and a below $2 exchange rate with the U.S. With the recent shift in the exchange rate once again, the Turkish people’s expectation for inflation may skyrocket, repeating the fresh-in-mind problem that many of them had suffered 20 or so years before. Expectation for inflation is a self-fulfilling prophecy. So in addition to this short-term problem, Turkey may fall into a much greater heap of troubles. Erdogan, in his third term, hopes to instill confidence to prevent a loss of trust in the lira. Erdogan has been publicly against an “interest rate lobby” despite the recent gusty spike, worried that it will choke Turkish growth. Once again I think this interest rate spike was necessary, but not sufficient. Uncertainty clouds the mind of many investors.

Paul McNamara, a large emerging-markets debt portfolio manager at GAM in London, showed a lot of uncertainty when sharing some his takeaways. He cites when the Euro was in trouble in 2012 and Mario Draghi reassured investors that the European central bank would do whatever it takes to keep the Euro.

“This is definitely not a Draghi moment that changes everything. It’s not 100% clear that this will work; stresses in Turkey are driven by fundamental factors. It takes Turkey in the right direction, but this could be grotesquely painful for the domestic economy. The chance of a run on Turkey is significantly lower, but it is still possible.”

Francesc Balcells, same job as McNamara but with more assets at Pacific Investment Management Co., shared much more insightful information saying:

“The rate hike makes more difficult for people to sell the lira, but this doesn’t mean necessarily people are coming in.”

“Let’s face it, the external environment is not generous with heavy borrowers with large current-account deficits. The Turkish central bank did the right thing but ultimately this was necessary but not sufficient.”

My recommendation is that Turkish government ensures faith in the Lira for its citizens who remember the hyper inflationary times not too long ago. The central bank should ensure compensate for inflation, protect its currency, just whatever it takes to prevent its citizens from investing in the US Dollar or gold. Hopefully, Turkey won’t fall back into another high inflation time. Their goal of improving their currency exchange rate was helped with the exchange rate spike, but the issue of inflation and an ever-growing deficit may still put-off potential investment from people like McNamara and Balcells. The vast economic improvement in Turkey after Ergodan did amazing things for a country that has, since it’s founding, had very strong ties to the West. Diversifying to Eastern markets has restored much of the confidence and prosperity by opening up new doors. The emerging markets deserve to recover sooner than later for the sake of improved standards of living around the world and a stable global market.


[Revised] QE Tapering and its Effect on EMs: Russia’s Hands-Off Policy

As many have mentioned in their blog posts already, the Federal Reserve did not surprise anybody today by cutting back its bond-purchasing program by $10 billion, just as it said it would. Coincidentally, I had an interview with both Bank of America and Deutsche Bank today. Needless to say, that was a main topic of discussion during the interviews. Thanks to writing these blog posts each week, I was prepared.

One of the things that has been emphasized and is something I talked about a lot in the interviews is the effect QE tapering would have on emerging markets. I expected interest rates would rise after the Fed’s announcement, but due to increased investor demand the yield on 10-year U.S. Treasury bonds hit its lowest point since November (2.685%). The main reason is that investors seem to be shying away from risky investments in troubled emerging markets, in favor of less risky U.S. bonds. Even U.S. stocks took a tumble as the S&P 500 fell 0.38%.

An interesting case study for analysis of the effect of QE tapering on EM’s is Russia. Contrary to most emerging markets who are desperately trying to increase interest rates in order to stabilize their dwindling currencies, Russia isn’t even putting up a fight, letting the markets pull the ruble down without restraint.

At first glance this strategy seems unwise. As the article states, a weaker ruble means:

  1. Russian imports become more expensive, making it difficult for Russian companies to upgrade technology because equipment imports rise in price.
  2. Russian spending power abroad is slashed.
  3. Increased doubt of the ruble could significantly increase demand for foreign currencies, weakening the ruble even further and causing a surge in an already high inflation rate.

However, after closer inspection Russia’s hands-off policy has some validity.

 ‘A weaker ruble acts as a useful shock-absorber,’ said Ivan Tchakarov, economist at Citibank in Moscow, adding that letting the ruble slide gives the central bank a way to ease the impact of slowing global demand for Russia’s main commodity exports without risking higher inflation.”

Not only do Russia’s commodity exports become more attractive abroad, but also one of the main arguments against a weak ruble- high inflation- is avoided. The reason? In an already frail Russian economy, producers cannot afford to pass on the higher costs they are facing to consumers. They’d lose more revenue by increasing their prices than by absorbing the costs of a weak ruble. Although this isn’t by any means sound long-term monetary policy, I can understand why Russia is acting the way it is given its circumstances. A 6.5% inflation rate coupled with a shrinking current account surplus doesn’t give Russia much leeway to pursue quantitative easing or similar policies.

(Revised) Should the Fed be responsible for the sell-off in emerging markets?

Not surprisingly, the Fed decided to scale back its bond purchase program by $10 billion a month on last Wednesday, bringing the monthly total down to $65 billion. It is also worth mentioning that the decision was unanimous, which was the first time there has not been a dissent at a policy meeting since June 2011.

Again, the Fed emphasized that its exit strategy would be data-dependent – if there is strong evidence of improvements in the overall economy, mainly signaled by unemployment rate (below 6.5%) and inflation target (around 2%), it could continuously taper the bond purchase in “further measured steps at further meetings”, said the Fed chief Ben Bernanke.

Therefore, the $10 billion cut seems reasonable, given that the U.S. economic fundamental is improving and the Fed has become more optimistic about the nation’s future. Nevertheless, the decision could be somewhat controversial if the current situation of emerging markets is taken into consideration.

In the past few weeks, there has been a significant sell-off of emerging-market assets, partly due to the expectation of the Fed’s tapering. The reason behind is fairly simple – the U.S. economy is on the right track and the liquidity created by QE is decreasing, so investors tend to re-allocate their assets from those risky markets to the U.S. on its stronger risk-return payoff. As a result, the Fed statement surprised some people because of the complete ignorance of emerging markets.

From my perspective, the ignorance was grounded by two key reasons.

First, the turbulence in emerging markets was also caused by economic slowdown and uncertainties in developing nations. The Chinese manufacturing shown by its below-forecast PMI (Purchasing Manager’s Index) triggered pessimistic outlook on domestic consumption of the world’s second-largest economy and threatened the growth in other energy-dependent nations such as Brazil and Argentina. The weakening euro was hit by a return to record-low inflation in the euro zone and in particular, the Turkish lira was under attack due to political scandal and a wide trade deficit in that country.

Second, more importantly, although the Fed’s QE has a worldwide impact and even led to market distortion in some nations, the American central bank is only committed to assessing the health of the U.S. economy and taking actions accordingly. That is to say, the tapering decision should be based on the strength of economic recovery in the U.S. rather than in the rest of the world. Richard Fisher, President of the Federal Reserve Bank of Dallas claimed that the Fed should end its bond-buying stimulus effort as quickly as possible, and added in this time of unsettled global markets, the Fed has to pursue policies that benefit the American economy.

Therefore, the Fed is primarily responsible for the U.S. economy because of its role as the American central bank. Nevertheless, given the fact that it is the most influential central bank in the world and the QE has been injecting massive financial liquidity to many other countries, international cooperation on monetary policy is still something to expect.

Specifically, on one hand, the International Monetary Fund, an organization aimed at fostering global growth and economic stability, should further take advantage of its research and statistics to keep track of the economic health of its member countries and advise them, especially those developing nations, on economic management and capital flow control. On the other hand, the U.S. should take more responsibilities by making its tapering process more understandable and adjusting the pace in line with market expectations. As the Indian central bank governor Rajan said: “Industrial countries have to play a part in restoring that, and they cannot at this point wash their hands off and say we will do what we need to, and you do the adjustment you need to.”

Don’t Let a Rising Yen Scare You Away from Investing In Japan

In recent blog posts I’ve spent a significant amount of time thinking about and discussing the effect the recent selloff of emerging markets will have on the global economy. Continuing with this theme, today I want to take a closer look at the effect the selloff has had on Japan (WSJ article), the third largest world economy (here’s a full ranking for those who are interested).

As I explained toward the end of a previous post, investor doubt in emerging markets has sparked a huge capital flow into safe haven economies like the U.S. and Japan because they are traditionally considered a safe investment. At first glance, this seems like good news for the economies of the U.S. and Japan. A strong currency at home usually implies the economy is growing; consumers are optimistic and purchasing power abroad increases. Unfortunately, however, this view hasn’t been reflected in Japanese share prices. The 225-share Nikkei Stock Average is down 13% since the beginning of 2014, compared to only a 5.2% drop in the S&P 500.

A closer look at Japan will give us a good idea about why some investors are not confident about Japan’s future. As the article states:

A year ago, optimism centered on the Bank of Japan‘s aggressive easing measures, which pushed down the yen’s value, which benefited large Japanese exporters by boosting the value of overseas earnings when converted into yen.”

It makes sense. Investors who had invested in Japanese companies previously were attracted to them because of the comparative advantage these companies had over companies located in countries with more valuable currencies. Now that this advantage is fading away, investors are worrying corporate profits will dwindle.

I would argue, however, that this view is a bit skewed. Although a strong yen hurts exports, Japan’s economy as a whole is showing signs of growth. These signs may even be strong enough for Japan to get out of its period of long-endured deflation:

  1. Housing starts in 2013 rose to the highest level in five years”
  2. “Japanese industrial output was recently at its highest in more than a year”
  3. “The unemployment rate fell to a six-year low of 3.7%.

Furthermore, as I’ve discussed before, I don’t think that the current capital inflow into Japan will last. After investors realize that their doubts in emerging markets were exaggerated by groupthink, capital will flow back out of Japan and Japanese exports will become more attractive once again.

China’s Slowing Growth Rate: A Misleading Indicator for Emerging Markets

The recent announcement of a single digit 2013 Chinese growth rate  (7.7% to be exact) sent many investors with money abroad into a selling frenzy. Fears of a slowing Chinese economy made investors question not only their ventures in China, but also their investments in China’s main source of resources: commodity-rich emerging markets. As a result, emerging markets suffered tremendously this past month.

The natural question to ask after seeing such investor uneasiness, is how much of it is justified? I disputed the legitimacy of some of the China and EM doubt toward the end of my last blog post, but I want to elaborate more on it in this one.

In a recent WSJ article, executive chairman Adam Molai of Savanna Tobacco, a Zimbabwean cigarette maker, put it nicely:

When times are great, people smoke more. When times are difficult, people smoke more.

I would venture to argue that a similar inelastic-demand claim applies to most commodities being bought by China, not just tobacco. The fact of the matter is even though the growth rate has slowed, Chinese demand for commodities from its emerging market suppliers has been either growing or stable. And the data backs it up:

  • “China’s iron-ore imports totaled 73.4 million tons in December, close to the record a month earlier and up almost a fifth from the beginning of 2013.”
  • “Australia-based Rio Tinto, one of the world’s largest producers of iron ore, is planning to increase production by nearly a quarter by 2017, based largely on its outlook for China. It estimates Chinese demand for steel rose 7.5% last year compared with 2.2% the year earlier.”
  • In September, state-owned China Power Investment Corp. signed a $6 billion deal to mine bauxite in Guinea, which holds up to half of the world’s reserves of the aluminum ingredient.”

Furthermore, even within China there is possibility for growing demand. As the article points out, Chinese migration to the cities has been increasing. This inevitably leads to more demand for new housing and infrastructure in metropolitan areas.

Lastly, even if we were to accept that Chinese demand for foreign resources is slowing, this is still not a good enough argument to move so much money out of emerging markets. The reason being many African emerging markets, such as Angola (Africa’s second biggest oil producer behind Nigeria), are experiencing significant growth in their middle class populations. This growth will compensate for some of the decreased Chinese demand as middle class Africans begin to buy more consumer goods.

In summary, it’s strange to me to see such a capital outflow from emerging markets. Steady Chinese demand for foreign commodities, growth in Chinese migration to metropolitan areas, and the growth of emerging markets’ middle class populations should convince investors to come back sooner rather than later. I think that within the next couple of months we will begin to see capital flow back into emerging markets as investors realize their mistake.

(Revised) Cold War politics in 2014?

Ukraine has recently become the new battleground in the ongoing Russia vs the West influence war.  Ukraine is has been facing economic troubles since the latter end of 2013 which saw the Government of President Viktor Yanukovych reject an EU association agreement that would see Ukrainian exports head to the EU and accept a Russian deal that offered Ukraine $15 billion bailout that would tie Ukraine economically and politically to Russia.  The Ukrainian government’s approval of the Russian deal, which forces Ukraine to import a set amount of natural gas from Russia, is what led to the ongoing political unrest and protests that have plagued Kiev.  In response to the protests, the Ukrainian President dissolved his cabinet, which consisted of many pro-Russian politicians, in hopes of stemming the unrest.  Unfortunately, Russia this past week decided to withhold the rest of the bailout money due to Yanukovych removing the pro-Russian Prime Minister.  The US and EU have come forward with a new plan that would require Ukraine to enact political and economic reforms.  The economic reforms that Ukraine would have to face are a devaluing of its currency, and rising natural gas prices and signing the association pact with the EU that would open up the EU to Ukrainian exports.

While I do believe that the Russian bailout pact restricts Ukraine’s sovereignty, the US and EU plan may be too painful to implement with such low political stability.  The further devaluation of the hryvnia, Ukraine’s currency, would harm the Ukrainian public and reduce their ability to consume.  Though top US officials believe that the Ukrainian public’s problem with devaluation may not be as large as believed.  Due to recent Fed tapering and the flight of investors out of emerging markets, the Ukrainian hryvnia has already become substantially devalued.  This would mean that it would be less of a shock to the Ukrainian public if the devaluation continued a little bit longer.  The raising gas prices are also a sticking point when it comes to public sentiment.  As the weather begins to heat up in the spring though, the falling demand for gas would allow the Ukrainian government to increase the price of natural gas without causing the public to feel the pain of the increase.  Unfortunately for Ukraine, while the US and EU plan is the best in the long run, because it has Ukraine’s long run economic benefits in mind, the plan hinges on political reforms that are too difficult to implement.

With the recent crisis in Ukraine, I thought it would be a good time to revisit Ukraine.  Since Ukraine ousted the pro-Russian prime minister for a pro-Western prime minister, Russia has intervened in the Crimean province of Ukraine.  The Crimean province is predominantly Russian ethnicity but was gifted to Ukraine back in 1994.  The Russian presence in Crimea has caused ripples around the EU and world markets.  NATO members and EU member states worry about how to respond to Russia’s show of force.  The United States is in a tight position because they need to show NATO and EU that they can protect the other members.  The crisis in Ukraine has caused EU stock prices to drop because investors believe the crisis will go on for a long time.  Russia has used its Gazprom ties to apply pressure on Ukraine by stating that they may shut off their energy due to unpaid bills.  To combat Russia’s mounting pressure,

the EU plans to provide an 11 billion-euro ($15.3 billion) aid package and is prepared to drop tariffs on about 85 percent of the bloc’s imports of Ukrainian goods, according to EU Trade Commissioner Karel De Gucht. Ukraine wants as much as $15 billion from the International Monetary Fund.

I believe Ukraine needs this package otherwise they face a repeat of 2009 when Russia shut off energy and caused the world economy to stutter.  It looks as of now, the only thing the US can do without causing direct conflict, is to support Ukraine through economic and monetary funds.  The US doesn’t want to directly confront Russia but they are pushing for the IMF to agree on a bailout package.  The next few weeks will be crucial to see what happens in this resurrection of Cold War politics.


U.S. Stock Market 2014- to worry or not to worry?

Recently, the Dow Jones Industrial Average has been down 5.3% from its Dec. 31 record. Most market managers expect the market trouble to hang around for a while and also believe that things will not get much worse. However, there are still two sides to the debate. The other side that predicts a volatile market still has strong reasons for their claims.

Furthermore, the largest contributing factor to the performance of the stock market is the economic trouble that many developing countries are facing. If conditions end up worsening in emerging market economies, markets could fall further. However, few professional investors seem to share these fears. They view the pullback as a natural occurrence- like a storm that hits about every year. Even though the Dow hasn’t fallen 10% since the middle of 2011, investors are even talking about percentages larger than 10% without sounding too upset because they anticipate that stocks will finish with gains at the year’s end.

The optimists “generally believe the U.S. economy has cut costs and made other adjustments that will let it keep rebounding, even as developing countries suffer because they aren’t prepared yet for a world with softer demand for their commodities, components and other exports”. These money managers encourage their clients to buy even in bad conditions when prices fall. Overall, the notion of investors in the WSJ article was that they were not worried about long-term conditions. Their perspective was also justified by the fact that if markets continually go up, you will get bubbles. They believe that it is the occasional weakness that keeps them on their toes.

Moreover, as a reaction to the anticipated stock market risk, treasury-bond prices have risen because investors have ran to them for safety. With the Fed’s recent reduction in financial stimulus, many investors think interest rates will rise on future bonds- which means the prices of existing bonds will decline.

To the contrary, those who anticipate the stock market to become less-bullish in the near future make a valid argument. Much of the risk is contingent on the conditions in emerging market currencies. This was a prime reason to why the Dow had its worst week since 2011- investors fled risky assets. Also, the value of the Argentinian peso plunged and China’s huge manufacturing sector has been showing signs of weakness. Overall, I personally believe that volatility decline in developing markets will be the key factor leading investors to buy again.