CFA Society Chicago Book Club:

How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

Following the CFA Society Chicago 2015 Annual Conference held on May 7th which focused on emerging opportunities in Latin America, the CFA Society Chicago book club met on May 19th to discuss “How Latin America Weathered the Global Financial Crisis” by Jose De Gregorio.  The author was the governor of the central bank of Chile during the global financial crisis.

When analyzing Latin America, economists tend to focus on LA-7 which represent 90% of the output of Latin America.  LA-7 represents the countries with greater than $100B in GDP including Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.  Brazil and Mexico represent 2/3rds of the output of Latin America.

Leading up to the global financial crisis and depending on country until the 80s and 90s, growth was rather weak due to high inequality, low openness to trade, weak institutions, high inflation, and unsustainable fiscal policies.  Though in the 80s and 90s, structural reforms began to take place and the benefits were seen about a decade later.  Chile for example was one of the first to benefit after the structural shift to an independent central bank and a flexible FX policy.

Latin America was surprisingly resilient during the global financial crisis given the many shocks there have been over the 70s, 80s, and 90s.  Part of the resilience came from sound macroeconomic management and strong financial systems.  Structural reforms that took place prior to the global financial crisis such as floating FX rates acted as shock absorbers.  Other structural reforms included a more open economy and inflation targeting to help lower volatility.  It has been found that the greater the credibility of the central bank, the lower the volatility of inflation.  The commodity super-cycle of the early 2000s drove an expansionary boom in Latin America given the large dependence on commodity exports.  What also helped Latin America was China’s double-digit growth leading to higher demand of copper from Chile, soybeans from Argentina, or oil from Venezuela.  The commodity boom provided a nice cushion of wealth for the times that lay ahead.  The large build-up of financial reserves resulting from the commodity super-cycle were initially expected to be used as insurance against rising FX rates but the reserves ended up providing a cushion during the global crisis.  Some countries diversified their economies away from being dependent on a main commodity export which further provided downside protection.  Chile for example was able to diversify away from copper and keep it from being a driver of the business cycle.  Latin American countries also were less levered than the advanced economies.  Mexico on the other hand was the worst performer during the financial crisis due to the proximity to the US and large trade agreements.  Unlike during the Asian Financial Crisis, the terms of trade improved for Latin America helping to lead to a more resilient economy over the 08-09 period.

In summary, key drivers that helped Latin America weather the global financial crisis were a terms of trade boom, inflation control, the commodity super-cycle, structural reforms, credible central banks and financial systems, less leverage, sound macroeconomic management, and diversifying their economies away from being dependent on a single export.  Major risks to Latin American countries include falling commodity prices, continued populism, hyperinflation, poor infrastructure, a weak educational system, high inequality, and not doing enough on the reform front.

 

Upcoming Schedule:

June 16, 2015: The Billion Dollar Mistake: Learning the Art of Investing through the missteps of Legendary Investors by Stephen Weiss

July 21, 2015: On Saudi Arabia: Its People, Past, Religion, Fault Lines – and Future by Karen Elliott House

*(NOTE: Those who attend the July Book Club meeting will receive a free copy of “Superpower: Three Choices for America’s Role in the World” by Ian Bremmer)

August 18, 2015: Superpower: Three Choices for America’s Role in the World” by Ian Bremmer

September 15, 2015: The New Cold War? Religious Nationalism Confronts the Secular State by Mark Juergensmeyer

October 20, 2015: TBD

CFA Society Chicago Book Club Discussion:

The Forgotten Depression: 1921: The Crash That Cured Itself by James Grant

The CFA Society Chicago Book Club met for their monthly meeting on April 21, 2015 to discuss The Forgotten Depression, by James Grant.  We went around the room and shared our backgrounds and kicked off our discussion on the 1920-1921 “Forgotten Depression”.  About a decade before the Great Depression of 1929-1933, there was a volatile economic downturn that lasted from January 1920 to July 1921.  It could be said to be the last governmentally unmedicated depression with the hero being the one and only invisible hand.

A surprise to many was when the war ended in November 1918, the postwar depression and deflation most expected didn’t immediately happen.  Inflation was in the double digits during the war and continued into 1919.  When peace didn’t immediately yield deflation, many thought the inflated war time wages and prices were here to stay.  Increased prices invited speculation and the speculators were lured by the low and easy money.  Businesses that should have gone under stayed afloat due to the easy money and ability to refinance.  Investors, farmers, and businesses expected the double digit inflation to continue into the 20s.  It didn’t happen.  The auto industry ended up collapsing in 1920 as Ford and GM both invested based on their forecast of rising prices.  Farmers had it worse than autos as farmers borrowed heavily to plant fencepost to fencepost in anticipation of rising prices.  In NYC, National City Bank lent unwisely against the collateral of sugar in Cuba.  By 1921, prices collapsed to 1913 levels.  Finally people began to see that the speculative nature following the war had collapsed.  NYSE stock prices fell 40%, unemployment which was not yet measured was certainly in the double digits, corporate profits collapsed, exports halted, demand dried up, and there was a run on the banks.    Benjamin Strong who was governor of the Fed at the time was a believer in the classical approach to money and banking.  When Benjamin Strong reflected on what was to come, he advised that there will be heightened unemployment, there will be deflation, there will be hard times, but the bad times will end and the economy will move forward.

By 1922, we saw a liquidation of labor that turned out to be what launched the roaring 20s.  The period can also be described as the Great Inflation followed by the Great Deflation with the volatile recession lasting a short 1.5 yrs peak to trough.

 

Upcoming Schedule:

May 19, 2015: How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

June 16, 2015: The Billion Dollar Mistake: Learning the Art of Investing through the missteps of Legendary Investors by Stephen Weiss

July 21, 2015: On Saudi Arabia: Its People, Past, Religion, Fault Lines – and Future by Karen Elliott House

*(NOTE: Those who attend the July Book Club meeting will receive a free copy of “Superpower: Three Choices for America’s Role in the World” by Ian Bremmer)

August 18, 2015: Superpower: Three Choices for America’s Role in the World” by Ian Bremmer

September 15, 2015: TBD

 

To sign up for a future book club event, please click here:

http://www.cfachicago.org/apps/eve_events.asp

CFA Society Chicago Book Club Discusses

Bust; Greece, the Euro, and the Sovereign Debt Crisis by Matthew Lynn

The CFA Society Chicago Book Club met on March 17 to discuss Greece and how the debt crisis came to be and the outlook going forward.  Matthew Lynn’s 2011 book, Bust; Greece, the Euro, and the Sovereign Debt Crisis was a fantastic read and encouraged a very in depth discussion.

Just two short years after the collapse of Lehman Brothers, Greece faced mounting debts resulting from easy borrowing driven by cheaper rates after arguably fiddling its way into the Euro in 2001.  The Euro was created in 1999 to promote three key components.  1) Promote open trade across European borders minimizing FX risk, 2) Initiate a more dynamic, prosperous, and innovative Europe, and 3) Provide price stability with the intention of competing with the USD as a global safe haven currency.  Interestingly, countries like Portugal and Greece with much poorer credit quality were able to borrow Euros as easy as Europe’s strongest country, or Germany.  By becoming part of the Euro, countries resulted in a loss of national sovereignty and could no longer devalue their way out of debt as they did in the past.  Nor could they target a lower currency to export their way to growth.

Understanding Greece involves taking a look at the country’s history.  There have been predominantly two Greek families in power post WWII.  Post WWII, Greece never modernized while the North became industrial powerhouses.  Greece has had to rely on shipping, tourism, and agriculture.  They never heavily targeted investing in manufacturing like the North.  Greece has defaulted on numerous occasions including 1826, 1843, 1860, and 1893.  In 1997, the Greek Central Bank had to raise rates from 10% to 150% to stop the currency from going into freefall.  When evaluating whether Greece was suitable for the Euro, Greece was initially denied in 1999 but by July 2000, supposedly inflation was down to 5% and the budget deficit was only 1% of GDP gaining Greece entrance into the Euro effective 1/1/2001.  Once Greece switched to the Euro, we saw the Greek economy create strong growth but rising trade and budget deficits.  With low rates and the ability to borrow, Greece was riding an illusion of prosperity.  The 2004 Olympics held in Athens was a giant cost to the country.  Millions were spent on new stadiums that unfortunately tend to collect dust once the games are over.  In September 2004, it was reported by the Greek government that the accounting was incorrect and the country should never have been in the Euro.  The EU did nothing about it.  Greece continued to not play by the rules running up a higher and higher budget deficit to GDP.  Tax evasion and bribery has been common corruption we have seen in the country.  The Greek Pension system certainly doesn’t help the deficit as the retirement age is significantly lower than that of countries in the North.  Unmarried woman for example receive their parents pension if they are unmarried which discourages employment.  The Euro was not meant to be a currency you joined to become a stronger country, it was meant to only include the strongest countries to ensure price stability.

It was not only Greece that was incentivized to borrow at the ultra low rates once joining the Euro.  We saw very similar issues in Portugal.  Spain’s borrowing fueled a real estate boom that resulted in high growth but with relatively low productive growth making Spain less competitive.  Ireland cut its corporate tax rate luring corporations from all over driving the per capita income to one of the highest in the world.  The lower ECB rates resulted in Ireland’s excessive borrowing and an artificial property boom.

Germany on the other hand was running a surplus while the Club Med countries were running deficits.  Postwar Germany is said to be an economic miracle.  West Germany had strong growth driven by a stable currency, low inflation, hard work, brilliant engineering, and a frugal mindset.  Germany was not in favor of the Euro given their strong stable currency.  Germans tend to live within their means and avoid borrowing and credit cards.  The culture of Germany includes saving, living within their means, manufacturing, and frugality.  This all seems to diverge from the cultures of the Club Med countries which has led to where we are today.

After just under a decade, once 2009 hit following the credit crisis, we began to see the negative impacts of the excessive borrowing of peripheral Europe.  We saw downgrades from S&P and Fitch in late 2009.  Stocks in Greece began to fall, yields spiked, and bailout discussions began.  Germany did not want to bailout Greece.  The No Bailout Treaty of the EU also stated that each member state was responsible for its own public finances which was a precondition for long term growth in Europe.  From the end of 09 through May 2010, much debate and meetings took place to resolve the European sovereign debt crisis.  To protect the Euro, Merkel ended up compromising breaking the No Bailout Treaty and coming together with the IMF to bailout Greece, Portugal, and Spain among others in the trillion Euro bailout.  This resulted in the ECB for the first time buying government bonds helping to lower rates and increase prices to stabilize the Club Med countries.  Austerity programs across the Club Med countries were initiated and confidence was restored in the Euro.  Government salaries were frozen and social programs were cut.  Italy was forced to cut wages or suffer stagnation.  The question remaining was, did the EU and IMF provide a cure, a short term fix, or poison to the region?

It seems as though Greece has tended to follow the script of new government and new spending program, then falling GDP, austerity, and another EU bailout.  Excessive borrowing without investing in manufacturing led Greece to where it is today.  The author believes that once the moral hazard of providing bailout funds was initiated, the Euro was destined to fail.  He believes it was a major policy mistake to put politics in front of economics by creating a single European state.  He argues that bringing together the very strong economies of Germany and France with that of Greece, Ireland, and Portugal was a major mistake.  He argues that the markets should decide the outcome and it would have been better long term to let Greece go bust rather than provide a bail out.

Upcoming Book Club Schedule:

April 21, 2015: The Forgotten Depression: 1921: The Crash That Cured Itself by James Grant

May 19, 2015: How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

June 16, 2015: TBD

July 2015: TBD

Aug. 2015: TBD (NOTE: Those who attend the Aug Book Club meeting will receive a free copy of Superpower: Three Choices for America’s Role in the World by Ian Bremmer. This is his new book and was released May 2015.)

Sept. 2015: Superpower: Three Choices for America’s Role in the World by Ian Bremmer

Sign up for a future book club event.