Category Archives: Balance of Payments

Mexico in the 1980s vs. US today

February 19, 2020 By in capital flight, economic problems in emerging countries, economics, macroeconomics, Strategy, Uncategorized Tags: , , , Leave a comment

bull market = strong economy?

Does stock market strength always mean a booming economy?

The short answer is no.

Mexico in the 1980s

The best illustration I can think of is Mexico in the 1980s.  That economy was a disaster, which played out first of all in the currency markets, where the peso lost 98% of its value vs. the US$ during that decade.  Despite this, in US$ terms the Mexican stock market was hands down the best in the world over the period, far outpacing the S&P 500.

How so?

…a domestic form of capital flight is the short story.

An incompetent and corrupt government in Mexico was spending much more than it was taking in in taxes but was loathe to raise interest rates to defend the peso.  Fearing  currency depreciation triggered by excessive debt, citizens began transferring massive amounts of money abroad, converting their pesos mostly into US$ and either buying property or depositing in a bank.  This added to downward pressure on the peso.  In September 1982 the government instituted capital controls to stem the outflow–basically making it illegal for citizens to convert their pesos into other currencies (Texas, which had been a big beneficiary of the money flow into the US, will remember the negative effect stemming it had).

With that door closed, Mexican savers turned to the national stock market as a way to preserve their wealth.  They avoided domestic-oriented companies that had revenues in pesos.  They especially shunned any with costs in dollars.  They focused instead on gold and silver mines or locally-listed industrial companies that had substantial earnings and assets outside Mexico.  The ideal situation was a multinational firm with revenues in dollars and costs in pesos.

today in the US

To be clear, I don’t think we’re anything close to 1980s Mexico.   But it trying to explain to myself what’s behind the huge divergence in performance between companies wedded to the US economy (bad) and multinational tech (good) I keep coming back to the Mexico experience.  Why?

I don’t see the US economic situation as especially rosy.   Evidently, the stock market doesn’t either.  In tone, administration economic policy looks to me like a reprise of Donald Trump’s disastrous foray into Atlantic City gambling–where he made money personally but where the supporters who financed and trusted him lost their shirts.

What catches my eye:

–tariff and immigration actions are suppressing current growth and discouraging US and foreign firms from building new plant and equipment here

–strong support of fossil fuels plus the roadblocks the administration is trying to create against renewables will likely make domestic companies non-starters in a post-carbon world outside the US.   Look at what similar “protection” did to Detroit’s business in the 1980s.

–threats to deny Chinese companies access to US financial markets and/or the US banking system are accelerating Beijing’s plans to create a digital renminbi alternative to the dollar

–the administration’s denial of access to US-made computer components by Chinese companies will spur creation of a competing business in China–the same way the tariff wars have already opened the door to Brazil in the soybean market, permanently damaging US farmers

–not a permanent issue but one that implies lack of planning:  isn’t it weird to create large tax-cut stimulus but then until it wears off to launch a trade war that will cause contraction?

Then there are Trump’s intangibles–his white racism, his sadism, his constant 1984-ish prevarication, his disdain for honest civil servants, his orange face paint, the simulacrum he appears to inhabit much of the time, the influence of Vladimir Putin…  None of these can be positives, either for stocks or for the country, even though it may not be clear how to quantify them.   (A saving grace may be that the EU can’t seem to get its act together and both China and the UK appear to be governed by Trump clones.)

 

my point?

Two of them:

1.If you were thinking all this, how would you invest your money?

Unlike the case with 1980s Mexico, there’s no foreign stock market destination that’s clearly better.  China through Hong Kong would be my first thought, except that Xi Jinping’s heavy-handed attempt to violate the 1984 handover treaty has deeply damaged the SAR.  So we’re probably limited to US-traded equities.

What to buy?

–multinationals

–that are structural change beneficiaries

–whose main attraction is intellectual property, the rights to which are held outside the US,

–with minimum physical plant and equipment owned inside the US, and

–building new operating infrastructure outside the US, say, across the border in Canada.

As I see it, this is pretty much what’s going on.

 

2.What happens if Mr. Trump is not reelected?

A lot depends on who may take his place.  But it could well mean that we return to a more “normal” economy, where the population increases, so too economic growth, corporate investment in the US resumes, domestic bricks-and-mortar firms do better–and some of the air comes out of the software companies’ stocks.

 

 

Trump on trade: unintended consequences?

February 5, 2019 By in Asian economic development, China, economic problems in emerging countries, economics, government economic policy, Uncategorized Tags: , , , , , 1 Comment

A straightforward analysis of what Mr. Trump is doing would be:

–tariffs slow overall growth and rearrange it to favor protected industries.  There’s no reason I can see to believe something different might happen in the US

–apart from the third world, protected industries tend to have domestic political clout but to be in economic trouble.  In my experience, these woes come more from bad management than from foreigners’ actions

–the go-it-alone approach is a weak one, since it provides ample scope for a target country to shop tariffed goods through an intermediary

–the apparently arbitrary way the administration is acting will cause both domestic and foreign corporations to reconsider future capital investment in the US.

 

There are, however, two other issues that I think have long-term implications but which aren’t discussed much.

–tariffs may cause industries that have moved abroad to retain labor-intensive work practices (and continue to use dated industrial machinery) in a lower labor-cost environment to return to the home country.  If such firms come back to the US, it won’t be with the old machinery.  New operations will be very highly mechanized. In other words, one likely response to the Trump tariffs will be to accelerate the replacement of humans with robots in the US.

–as I see it, China is at the key stage of economic development where, to grow, it must leave behind labor-intensive work and develop higher value-added industries.  This is very hard to do.  The owners of low value-added enterprises have become very wealthy and powerful.  They employ lots of people.  They have considerable political influence.   And they strongly favor the status quo.  The result is typically that the economy in question plateaus as labor-intensive industries block progress.  In the case of China, however, the threat that the US will effectively deny such firms access to a major market will kickstart progress and deflect blame from Beijing.

 

If I’m correct, the effect of trying to restore WWII-era industry in the US will, ironically, achieve the opposite.  It will accelerate domestic change in the nature of work away from manual labor.  And it will run interference against the status quo in China, allowing Beijing’s efforts to become a cutting-edge industrial power to gather speed.

 

 

the EU today: structural adjustment needed

July 14, 2016 By in economic problems in emerging countries, economics, emerging markets, EU financial crisis, Japanese development, Long-term themes, Uncategorized Tags: , , , , , Leave a comment

Let’s assume that my description of the EU ex the UK is correct–that beneficiaries of the traditional order (the elites) are, and will continue to be, successful at thwarting structural change that would rock tradition but produce higher economic growth.

How should an equity investor proceed?

There are two schools of thought, not necessarily mutually incompatible:

–the first is that in an area where there is little growth, companies with strong fundamentals will stand out even more from the crowd.  This lucky few will therefore gain much of the local investor interest, plus the vast majority of foreign investor attention.  If so, in places like continental Europe or Japan one should look for fast-growing mid-cap companies with global sales potential for their products and services.  These will almost certainly outperform the market.

The more important question for an equity investor is whether they will do as well as similar companies domiciled and traded elsewhere.

–my personal observation is that the general malaise that affects stock markets in low-growth areas like Japan or the EU infects the fast growers as well.  The result is that they don’t do as well as similar companies elsewhere.  I haven’t tried to quantify the difference, but it’s what I’ve observed over the years.

It may be that the local market is offended by brash upstarts.  It may be that local portfolio managers deal only in book value and dividend yield as metrics.  It may simply be the fact that local laws prevent owners from eventually selling to the highest bidder, thereby damping down the ultimate upside for the stock.  One other effect of a situation like this is, of course, that entrepreneurs leave and set their companies up elsewhere.

 

The bottom line for a growth investor like me is that these areas become markets for the occasional special situation, not places where I want to be fully invested most of the time.  Because of this, and because of Brexit, the UK assumes greater importance for me.  So, too, Hong Kong, as an avenue into mainland China.  And to the degree I want to have direct international exposure–which means I want to avoid the US for whatever reason–emerging markets also come into play.

 

A final thought:  one could argue that the lack of investment appeal I perceive in Japan and continental Europe has nothing to do with political or cultural choices.  Both areas have relatively old populations.  If it’s simply demographics, signs of similar trouble should be appearing in the US within a decade.  I don’t think this is correct, but as investors we should all be attentive to possible signs.

 

internal and external economic adjustment

July 12, 2016 By in Balance of Payments, currency effects, currency markets, economics, Uncategorized Tags: , , , , , Leave a comment

This is ultimately about the euro and the EU.  Today’s post is about creating a framework for thinking about this issue.

It’s a condensed version of a longer post I wrote six years ago on Balance of Payments (actually, a series, for anyone who’s interested).   Although a big simplification of what is actually going on in the world, it highlights what I believe is a central structural issue facing the EU and Japan today   …and potentially the US, at some point.

 

imports and exports

The residents of any given country typically don’t consume only items made in that country.  They buy imported goods as well.  In fact, the marginal propensity to consume imports is normally higher than the marginal propensity to consume, meaning that as spending increases imports rise at a faster rate.

paying for imports

The country as a whole gets the money to pay for imports in one of a number of ways:  it can make things to sell to foreigners, it can use accumulated savings, it can sell assets to foreigners or it can borrow.

imbalances

In an ideal world, every country would make and sell exactly enough goods and services through export to pay for the imports it purchases.  That’s seldom the case, however.

chronic deficit

Consider a country that, year after year, buys more from foreigners than it can pay for with the proceeds from what it sells.  To continue consuming foreign goods at the same rate, such a country has to either sell assets, like land or companies, or borrow from foreigners.  At some point, however, it will reach the limits either of what it has that others want to buy or the amount foreigners will lend.

This situation sets the stage for a potential foreign currency/trade/economic growth crisis.

internal/external adjustment

Here’s where we get to internal/external adjustment.

There are two ways of dealing with this issue:

internal

–the government can slow down overall consumption (essentially, create a recession) by raising interest rates/taxes by enough to decrease consumption of foreign goods and services

–domestic industries can voluntarily restructure themselves, with/without government help, to improve quality and lower prices so they make more things foreigners will want (unlikely to happen on a large scale)

–the government can erect tariff or regulatory barriers to imports, to try to redirect consumption to domestic goods (almost always a bad idea:  look at the US auto industry since the mid-Seventies)

None of these actions are likely to win unanimous applause from voters.  And if legislative action produces negative results, it will be completely clear who is to blame.  So politicians everywhere, and particularly in badly-run countries, tend to not to want to choose any one of them.  Instead, they most often opt for the external adjustment route.

external

–This means to encourage or embrace a decline in the local currency versus that of trading partners.  That simultaneously makes foreign goods more expensive for locals and local goods cheaper for foreigners.  Devaluation will encourage exports and inhibit imports, achieving the same end as rising interest rates, but without the sticky legislative fingerprints attached.  It’s those horrible foreign exchange markets instead.

 

More tomorrow.

 

 

 

 

 

 

Make in India?

April 29, 2016 By in economic problems in emerging countries, emerging markets, India, Uncategorized Tags: , , Leave a comment

I’m not sure exactly why I’m on a foreign markets/economies kick, but I think I’m pretty close to the end of it.

India and me

I’ve been fascinated/horrified by India economically for over twenty years.  On the one hand, the country has lots of potential, based on a huge internal market and a large, well-educated workforce.  On the other, economic success for India continues to rely on how favorable the monsoon season is.  The country’s leaders are clearly aware of, and dismayed by, the fact that nations they may regard at any given time as peers soon leave India behind in the dust.  But not that much has changed over the time I’ve been observing.

“Make in India’

“Make in India” is the marketing slogan the Narendra Modi administration has chosen to promote foreign direct investment, a time-honored tool for simulating economic progress through technology transfer.  Think:  Japan, Korea, Thailand, Malaysia, China…  The road map is clear.  The only question is whether a country has the political will to make the journey.

rules for success

I thought I’d try to list in this post, loosely in order of importance, what’s needed to attract foreign firms to create a business in a developing country.  They are:

–a large pool of trained, or trainable, workers

–roads and ports, to get output from the manufacturing site to market

–sources of electric power, clean water and telecommunications

–a stable legal system, so the rules of the game are clear at the outset and the goalposts don’t get moved after a firm has committed capital

–protection for intellectual property.  A generation ago, multinationals dealt with this crucial issue by sending to the Third World only the tools to make machines that were already obsolete in the First.  By and large, that’s no longer a viable option.   Because in today’s world technology transfer means not only how to organize and run a business but also current trade secrets, protection of intellectual property is more crucial than ever.

–it’s always nice to have a large internal market, so that the success of a factory doesn’t depend solely on export orders

–it’s also nice to have an eco-system of available suppliers and support industries grouped nearby.

How does India stack up?

It has a large internal market and a big pool of potentially available workers.

…

The physical infrastructure has never been great, in my experience   …and India has never seemed to me to have effectively in made infrastructure development a high government priority.

India has always struck me as distinctly unwelcoming to newcomers, and to foreign enterprises in particular.

Mr. Modi says he wants to change that.  Whether he will be able to is another question.  So, too, is whether he really means what he says.