Why foreign funds are preferring EM banks?

I was wondering why banks are the first object of desire for foreign funds in the emerging markets. Given the view on the currencies, I expected foreign funds to go after relatively(in currency adjusted terms) cheap EM- hard assets. I did not think banks would be such overwhelming favorites. However, the preference for banks seems to have some logic.

Banks in emerging markets have lower cost of funds as EMs have higher savings. The stress on bank incomes is lower as economy is growing and banks have first claim on the corporate income. Third, despite inflation pressures, FII flows and US FED's near zero interest rates are keeping the interest cost low. This has reduced the probability of defaults for large borrowers. No wonder this is most viable entry point for foreign funds.

Disclaimer

Long SBI

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My book "Subverting Capitalism & Democracy" is available on Amazon

Fighting the Currency War

There is a lot of debate about how to fight the impending currency war. The problems are more from the US point of view rather than elsewhere. Let me explain.

US cannot unilaterally set its exchange rate. 
There are two ways of modifying exchange rate.  One ways is to clearly set the exchange rate and defend it using central bank intervention. This tool is available to smaller economies who peg their exchange rates to the dollar. But it is not available to the US as the economies of other countries depend on the US consumer. Its only way out is to convince other countries, those whose domestic jobs and economies depend on US consumer, to ease the exchange rate. US tried to convince China with the same intent. However, it is not China alone that poses a problem. The entire set of countries that use this export-dependent strategy should revalue their currencies simultaneously. Since these countries are adamantly defending the relative exchange rates, US seems to be in a state of crisis.

The other more fundamental way is to indicate to the world that the stock of money has gone up disproportionately as compared to GDP.  US has tried to print money. But it has not caused any effect. The printed money simply flows out of US into global equities, commodities and other asset classes. Further, if I get more US Dollars I can park them with other economies and wait for exchange rate reset to give me substantial gains. The more exchange rates are suppressed, the more I have to gain.

This conundrum, obscene as it is, is due to the fact that USD is also an international currency. To have a credible effect, the volume of printing must be in relation to global GDP and not simply US GDP. At USD 15 trillion, US GDP is about a third of global GDP. So you need three times more printing. Further, if US currency devalues erratically then the entire burden of currency will fall on US domestic economy. Herein lies the dilemma. It is a lose-lose proposition.

But there may be another way 
I think US may be better served by front-ending its borrowing program. The US can initiate a borrowing program equivalent of 10 years of borrowing. This program should be completed within a year. Only a part of this program will be successful. However, it will pull the global liquidity towards US while money printing is pushing liquidity out of US. It will force other banks to print and buy US bonds or let their exchange rates appreciate. Usually, governments are wary of failed bond auctions. In the case of US, this is not an option for the other countries. They need the US consumer more than US needs them. US can also set trade limits based on amount of USD reserves held. In other words, let other countries put a price on each job they are defending.

However, US needs to have a credible plan to invest this high liquidity that will flow into the country. Using this liquidity, US should get out of the recession.

Then, we must consider unintended consequences. A front-ending of borrowing may upset lenders like China. How China will react to such a policy is unclear. But it is reasonable to assume it won't be pleasant. In effect we will face a lot of unpleasantness. But then it is a war, isn't it?

Notes

Marting Wolf makes a similar argument

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My book "Subverting Capitalism & Democracy" is available on Amazon

Tax reforms - Ezra Klein makes a valid suggestion

Ezra Klein comes around to the idea that I have been talking about for years. He argues that we should get a receipt for our taxes.

A tax utilization break-up

While the general budget does give a broad outline, person specific contributions should be a right of the citizenry. Ezra draws similarity with food ingredients and calorie break up. To take the analogy further, government budget is equivalent of stating national food ingredient and calorie consumption. It makes little sense to the individual. We should get a break up for how our taxes are allocated.

Individual tax allocation choice

I often think about giving the choice of allocating tax dollars to the individual. I believe, in a sense, it will be a pragmatic manifestation of democracy. Embedded within this idea are two critical ideas.

First relates to relation between democracy and empowerment. A first principles analysis suggests that democracy is about empowerment of the masses. Our recent iteration of democracy is masses empowering the government. There is a substantial difference in these two points of view. 

The idea refers to the differences between masses and government. Our iteration of democracy views masses (or citizenry) and government as two separate agents. The result of this differences is evident in intellectual differences in opinion of masses and those of government.

Further more, government is now a seat of power and thus no different from the monarchs and nobles of yore. The first principles seat the power at the hands of the people. It creates government as an agent to exercise this power. Government does not acquire but borrows the power from the people to enable people to exercise their mind and opinion.

The second idea relates to the (wrongful) importance of keeping tax policies away from citizens. Governments, like monarchs and nobles before, believe people do not want to pay taxes. They have no qualms in believing that these same people will understand credit card statements easily. I do not agree with this point of view. I believe, if we trust the citizens to allocate taxes we may get a fairer spending that may actually benefit the citizens.

I believe, by taking away the ability to direct taxes from the citizens, government is limiting democratic rights. Years ago, before the advent of computers, it was not possible to allow citizens to take this responsibility. However, current technology that allows these same citizens to vote in American idol based on performance, can be used to allow citizens to make these important choices.

In sum

Sometimes, by giving responsibility to citizens, we may make them responsible. We can also foresee a possible disaggregation of governments into policy designers and bureaucracy. We do not need to career politician as a policy designer.

Links:

Ezra Klein - Shouldn't taxpayers get a receipt?

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I discuss governments and taxes in my book "Subverting Capitalism & Democracy" is available on Amazon

Roller coaster - Welcome to the first loop

The equity markets are rising the world over. The rise, I believe, is our first loop in the roller coaster out of crisis of 2008. This cyclicality was to be expected. We are, now, close to the pre-Lehman levels for key global markets. Yet, I believe we are still part of the overall down-cycle.

Cyclicality is result of slosh money 

As I mentioned in my book, the cyclicality is the result of slosh money. As I define it, slosh money refers to large pools of capital that can move through the global economic system stressing the archaic regulatory framework. 

Slosh money is herded thanks to lack of divergence of opinions. The lack of diversity of opinions is truly surprising. In times of crisis, the diversity of fund allocation increases, may not be within a fund, but overall between various funds. I do not see this diversity developing.

The down-cycle continues

The down-cycle will continue post these current peaks. I still stand by my 2008 post about cyclicality. The frequency of the down-cycle has come out to be 8 GDP reporting periods rather than 4 as I predicted. The bottom of the next cycle will be deeper and sharper than the first cycle. The next cycle may be, in good probability, the last leg of down-cycle. 

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My book "Subverting Capitalism & Democracy" is available on Amazon

Trade Wars & Currencies

Michael Pettis worries about a trade war between surplus countries and deficit countries. The basis of the war is two fold.

First, the US Dollar is the unofficial world currency. In that role, it has to function as a store of value and a facilitator of international economic growth. As such the US has to bear the responsibilities. This constrains the US Government. 

Second, we can alter or manage other global currencies and its value in US Dollar terms. This comes at a significant costs but it is doable. The most popular method is through intervention by central banks. Central banks buy or sell their US Dollar holding to keep the exchange rates in check.

Problems for US

The impossible trinity applies to the dollar's case in a different manner. US government has open capital system and flexible exchange rate so technically this should be a non-issue. But there is a problem for US. The objective for managing the trinity is to manage the economy and the trinity represents tools to that effect. In the case of the current trade war with US and surplus countries, these tools contradict each other and render US policies useless. The constraints will either cause US to bailout the world or there has to be a restructuring of the global currency system.

A two-level currency system

It is clear that US dollar cannot and should not serve as a global and national currency. A rational solution that maintains the sovereign independence while serving global trade and growth needs comes from a two-level currency system I proposed earlier.

Links:

Micheal Pettis in FT

Yves Smith on Micheal Pettis

Two-level currency system - Rahul Deodhar

PS: This is the 200th post on this blog. I started the blog in 2004 with focus on companies, innovation, investments and ideas about future. Over past few years the focus has been exclusively on the crisis and its solutions. It is read by 20 people every day. Thank you for being by co-travelers.

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My book "Subverting Capitalism & Democracy" is available on Amazon