OPINION: Economic Resilience During Volatile Times: The Need for Discipline, Rigour, and Integrity
Written by: Korsan CEVDET
Originally Posted on Sigma Turkey (no longer available) on 13 February 2020
Twitter: @KorsanCevdet
While economic indicators from the United States are generally positive, there are a number of stress points that are negatively impacting key emerging and developed markets. Amongst the most significant cause of this instability is President Trump’s America First Policy which has resulted in a trade war with China and soured economic relations with traditionally US friendly states, such as Canada, France, Germany, Mexico, and the United Kingdom (UK). This has stifled global trade and production, and damaged consumer confidence. The global slow-down will eventually impact the US as volatility and contraction across key trading partners will reduce demand for American products and services. There are now indicators that the US’s growth trajectory is not as bullish in 2020. Luckily for Trump, the Democrats have not produced a solid challenger and failed miserably with the impeachment proceedings.
Amongst the most significant developments that is affecting the global economy is the Coronavirus. The virus has spread from Wuhan to China’s greater near-abroad, bringing things to a standstill in a number of regions (e.g. Hong Kong SAR) and restricting cross border mobility. The world is now on alert and while it is too early to assess, preliminary cost estimates are above $60 billion for China alone.
Coronavirus aside, the global economy is facing significant risks. A number of emerging markets have been challenged with servicing debt obligations and experienced currency crises (e.g. Argentina and Turkey); geo-political conflicts throughout the Middle East and North Africa appear to be never-ending; and tensions across the Greco-Turkish fault-line (i.e. Greece and Greek Cyprus vs. Turkey and Turkish Cyprus) are increasing with the prospect of offshore oil and gas. The United Kingdom (UK) left the European Union (EU) and must complete its trade negotiations with the EU — will the final exit be hard or soft? How will markets react? What are the implications of an ever-more pro unionist Ireland and a separatist Scotland? Will other disgruntled EU members follow the UK’s lead and leave the EU? Separately, war and climate change are increasingly causing waves of refugees and Fortress Europe does not want to host new comers from primarily Muslim lands. How will all these developments impact our security and the distribution of wealth amongst and within nations?
With each day that passes, we see an increasingly complex and digital world become more integrated and vulnerable to interdependent sensitivities. There are a number of mature economies that are either in, on the verge of, or coming out of recession, including Australia, France, Germany, Hong Kong SAR, Italy, Japan, and Spain. Similarly, key emerging market economies are experiencing serious slowdowns or material levels of regular volatility, namely Brazil, India, Mexico, Nigeria, Russia, South Africa and Turkey. Argentina and Venezuela — they are in shatters. Even before the Coronavirus, there were concerns with China’s credit book as a number of Chinese banks have a disproportionately high-volume of bad debt that need to be carefully managed or China may experience a financial crisis of its own. Will the Coronavirus’s paralysis compound China’s economic challenges? Very likely.
As we should all appreciate, the economic cycle experiences peaks and troughs, and market economies have periods of expansion and contraction. With expansion, we see positive growth, increased business confidence, greater corporate profits, and “green” indicators (e.g. job creation, increased building permits, consumer spending and confidence, production figures, etc.) across the board. This scenario makes politicians gleam with pride as they see it as a reflection of effective policy making and gives them bragging rights. Right? Well, maybe not always. We need to be conscious of how today’s policies can create strategic, long-term risks for tomorrow.
Economic downturns reflect poor corporate results, increased bankruptcies, rising unemployment, and a whole slew of negative news. This scenario is basically the opposite of the rosy picture painted by positive growth and is represented by a stream of “red” indicators. Two consecutive quarters of negative growth means a country is officially in recession; recessions are significant, because they represent systemic negative trends over a pro-longed period that requires substantial attention to alleviate.
If a nation’s economy is prudently managed, then a recovery should be achievable without too much anxiety. Governments often apply a Keynesian approach (i.e. spending projects) to stimulate growth and facilitate its recovery. However, if a nation’s economy lacks rigour and discipline, then the negative trends become almost permanent fixtures. For example, some emerging market countries’ currencies are seemingly always losing value against hard currencies, cannot keep control of inflation, and have double digit interest rates. These are fairly good indicators of financial mismanagement and countries with these symptoms are likely to have regular volatility, excessive risk and debt, and unsustainable growth. When negligence is particularly systemic, we usually see a continuous stream of material problems — one after another (e.g. Argentina is a classic example).
The caveat here is that the relative strength and resourcefulness of a country will determine its ability to orchestrate a sustainable recovery — sustainable being the operative word. The weaker a country is, the more dependent it is on others for assistance, usually with very taxing conditions. One thing is for sure, markets are not kind to those who are irresponsible and financial carelessness catches-up with its culprits. This was demonstrated during the 2007–2009 financial crisis as some of the world’s largest financial institutions were guilty of reckless behaviour (i.e. a combination of investing excessively in high risk, opaque products, collusion, and sheer careless sales practices) and regulatory scrutiny and expectations, in some key markets (i.e. the US), lost its rigour. A number of iconic organizations, such as, AIG, Bank of Scotland, Bear Sterns, Citibank, Fannie Mae, Freddie Mac, Lehman Brothers, Lloyds Bank, and Merrill Lynch, went bankrupt and/or were forced to merge with past competitors and accept government assistance to stay afloat. Institutions that remained had to also significantly de-risk and downsize.
In response to the crisis, a series of regulatory reforms were passed in the US and EU member-states to mitigate prudential concerns and limit the chances of recurrence. Although the crisis was “Made in the USA”, the strength of American institutions enabled it to save the entire global financial system. For Europe, a bad situation became worse as the governments of Greece, Greek Cyprus, Ireland, Portugal, and Spain also went bust between 2010–2013. They required bail-outs and severe austerity programs to enable a recovery. Ten years onward, some are still licking their wounds and have not fully recovered.
As we’ve seen with the global financial crisis and the subsequent European sovereign debt crisis, markets punish those who disregard economic fundamentals and are not responsible. It’s a very slippery slope, because adverse results, inconsistent indicators and bad economic news leads to greater volatility, capital flight, and losses. Things simply spiral out of control. In some scenarios, savvy investors capitalize on the futility of others as high risk situations and desperately needed funding can be a toxic combination for some, yet create profitable opportunities for others. But if the risks are too high, then it will simply be very bad for the perpetrators and require externally dictated assistance. Typically, this results in very painful recovery and structural adjust programs that usually involve with IMF and World Bank. In less extreme instances, the offender may be “helped” by an alternative sovereign lender who is diplomatically depicted as investor who sees great opportunities for the future.
Nevertheless, actuals are actuals and require factual integrity. Accordingly, a nation’s finances have to be regularly and rigorously checked and will be scrutinized by major market actors. Facts do not lie and over the long term, positive performance and well-managed nations (and organizations for that matter) do well. Countries that do not effectively manage their finances, face regular problems and crises. As previously mentioned, symptoms that are easily identified are: high interest and inflation rates (i.e. double digits); a currency that, over the long term, loses value against major currencies; and experiences challenges with fulfilling loan obligations. The last symptom is typically accompanied with regular news or fears of potential default and results in external assistance (a.k.a. bail-outs or diplomatically packaged investment agreements — please note the sarcasm).
In contrast, well managed nations have an effective system of checks and balances; restricts and controls for the unnecessary concentration of power; has independent and competent institutions (e.g. Central Bank and rigorous financial services regulators) that adequately fulfil their obligations and mitigate prudential concerns and risks; maintain a high-level of financial integrity; and take measured (non-excessive) risks that are appropriately managed. Such countries will fare relatively well under most conditions, including adverse circumstances. Figuratively speaking, these countries weather storms well, resourcefully bounce-back from down-turns and systemic challenges, are resilient over the long-term, and foster dynamic and maintainable growth, because they attract talent, investment, and are stable.
So what are our lessons learned and what’s needed to financially succeed? A nation’s budget must be effectively managed and have integrity. Countries have to proactively manage their financing expenses, including debt levels and servicing. Over indebted, uncompetitive, and poorly managed countries will lack transparency and not succeed. They will face regular financial challenges and not be able to facilitate long-term sustainable growth. In short, states must be financially viable, have rigour, and should be supported by a mobile and healthy population. Successful countries must have a strong education system, a vibrant private sector, and a prudent regulatory regime that is effective, efficient and fosters a competitive environment.
Let’s see how our usual suspects fare during these turbulent times.
