Global Market Insights | A Fisher Investments Blog

Unmasking Russian Corruption

Fascinating piece in Wednesday’s Wall Street Journal on the many hurdles to Russian political freedom:

Fraud Cases Tossed by Russia Judges

Richard Boudreaux, The Wall Street Journal

Russia’s future seemed somewhat promising after the Soviet Union’s fall, but thus far the economy hasn’t quite lived up to that potential. Over time, markets tend to fare best in free countries, where the rule of law prevails, elected officials are held accountable and resources are allocated most freely. Governments with more consolidated power tend to redirect capital toward the individuals, industries and institutions they need to placate in order to strengthen their grip—think special privileges, subsidies and the like. This is what we’ve witnessed under Vladimir Putin, and it prevents money from going where it would otherwise go to boost economic growth.

 More political freedom would likely bring freer markets, benefitting all Russians in the long run. Unfortunately though, based on how Russian courts are handling the hundreds of allegations of election fraud, it seems the country has a long, long way to go.

Scaling That £1.004 Trillion Mountain

British debt dominated headlines on Tuesday, when the Office for National Statistics announced the UK’s net public debt reached £1.004 trillion in December 2011—an all-time high.

In a vacuum, a £1.004 trillion sounds huge, and that sheer magnitude has some commentators questioning its implications for the British economy. However, without additional context, the debt load’s absolute size doesn’t mean much—a better perspective is scaling relative to the size of the economy as measured by Gross Domestic Product (GDP) and viewing that figure with an appropriate historical frame of reference.

The UK’s final 2011 GDP tally isn’t in yet, but according to The Guardian, the December debt total is around 64.2% of GDP. How does that compare with historical figures? Exhibit 1 plots the UK’s net public debt as a percentage of GDP from 1700 through 2010.

 

Exhibit 1: UK Net Public Debt as a Percentage of GDP, 1700 – 2010

 

Source: HM Treasury, UK publicspending.co.uk; as of March 2011.

 

Relative to GDP, British debt has increased over the past few years, but today’s levels remain far below historical highs—the UK has regularly had higher relative debt over the past three centuries without ill effect over time.

For example, think about the historical context of the big hump from 1750 to 1850—the British Empire was the global military and economic superpower, all the while maintaining relative debt two to nearly five times higher than today. The Industrial Revolution began in Britain during this period, only later spreading to continental Europe and America—countless manufacturing and other technical innovations emerged from Great Britain. And the UK has remained a major global player in the century and a half since.

In short, if Britain could prosper then while regularly exceeding three times today’s relative debt, the current level shouldn’t necessarily prove problematic over time.  It’s possible Britain may go on to struggle, but if so it won’t be singularly due to their debt.

One Down, Two to Go?

After weeks of debating with EU and IMF officials, Hungary finally took the first step toward reversing some of its controversial (and EU treaty-violating) new laws on Friday. Prime Minister Viktor Orban said he’d modify recent central bank reforms, dropping the provision that merged the bank with Hungary’s financial regulatory agency, PSZAF (which indirectly politicized the bank, since Orban would head PSZAF and effectively be central bank chief Andras Samara’s boss).

 A word of caution though: The change isn’t a done deal. Orban said the right things, but that doesn’t guarantee he follows through. Any changes to the law need to clear Hungary ’s parliament, and Orban only committed to “make proposals to this end.” Parliamentary procedure could scupper those proposals. In fact, one shouldn’t discount the possibility of Orban manipulating proceedings to that end behind the scenes, ultimately getting his way while being able to tell the European Commission he at least tried to do as they asked (and hopefully still get his bailout).

Additionally, the central bank law was only one of three measures in EU officials’ sights. Last week, the European Commission formally warned Hungary it has one month to amend last year’s media and judiciary reforms, otherwise it faces treaty infringement proceedings in the European Court of Justice. If ruled guilty, Hungary stands to lose EU voting rights and billions of euros in desperately needed aid. Ongoing bailout negotiations are also likely contingent on these changes if the EU participates. However, addressing the European Parliament on Wednesday, Orban said he doesn’t want even one euro from the EU—only a provisional credit line from the IMF, which thus far has only targeted the central bank reforms. So it seems Orban’s goal is to concede as little as possible.

Still, wait and see—despite Orban’s Strasbourg address, his delegates continue negotiating with both the EU and IMF, so more reform reversals are still possible. Orban will probably continue making every effort to avoid further changes, considering these measures consolidated his Fidesz party’s grip on power. He won’t surrender easily. But the EU and IMF could still force his hand, restoring some of Hungarians’ freedom in the process.

For more detail on the reforms in question, see my recent MarketMinder column, “Hungary’s Crossroads.”

Inflation Watch

British inflation receded a bit in December, slowing to a 4.2% annual rate thanks to falling fuel prices and the fading effects of the early 2011 value added tax (VAT) hike.

Exhibit 1 shows how each category of goods and services contributed to the overall rate. Falling fuel prices are evident in transport costs, which slowed the most. Slower increases in clothing demonstrate the higher VAT’s waning impact—some firms began increasing prices before the higher tax took effect, and these early hikes are now dropping from year-over-year comparisons. This phenomenon should increase over the next couple of months, as the VAT-related price hikes continue falling out of the annual rate, and the inflation rate will most likely continue declining over the period ahead.

This should be positive for the UK ’s economy. Slower inflation should help boost real disposable income (disposable income adjusted for inflation, which has been negative for several months), easing the strain on British consumers looking forward. It also gives the Bank of England additional flexibility as they consider future monetary policy moves.

 

Exhibit 1: December Inflation Detail

 

Source: Thomson Reuters, as of 17 January 2012.

(Figures may not sum due to rounding)

 

Indian Insight

Tom Bawden at The Independent has a good piece on India ’s latest attempt to attract foreign investors.

Indian Tiger Fights to Regain its Bite

You may recall India ’s government ran into controversy when it tried to open its retail markets to foreign firms. We’ll see whether these new efforts are any more successful…

 

Hungary’s Endangered Freedom

For most folks, New Year’s Day is a time of celebration and optimism. But in Hungary, January 1, 2012 is more foreboding: On that day, Hungary ’s new constitution took effect, and that document strips much of their society’s freedoms. Inside Budapest ’s opera house, the government celebrated its “crowning achievement.” Outside, tens of thousands of Hungarians protested.

Since Prime Minister Viktor Orban took power in 2010, he’s been on a mad drive to consolidate power. The new constitution brands one opposition party as a “criminal organization.” The judiciary, central bank and press have all been brought under his Fidesz party’s control—much to the consternation of the European Court of Justice, considering these measures violate the Lisbon Treaty.

Orban has also angered officials with his economic policies, which include taxes and regulatory changes aimed squarely at foreign firms operating in Hungary —also treaty violations, pending judgment in the European Court of Justice. Meanwhile, the country remains mired in a three-plus year financial crisis, its currency (the forint) is near record lows relative to most major currencies, and it can’t finance debt on the open market.

All this means Hungary needs its second bailout in three years, which could be an opening for a return to freedom. Negotiations with the EU and IMF are scheduled to resume in January, and officials have said Hungary must make hefty political and economic concessions if it wants their assistance. The media, central bank and justice system all appear to be in European officials’ sights.

The economic severity of Hungary ’s situation means the country likely needs external aid, but whether Orban makes concessions is far from certain. His party leans heavily toward fascism, and his regime has become increasingly authoritarian—and though he toes the EU party line abroad, his rhetoric at home is alarmingly nationalist. And a law passed on Friday, which gives the government power to levy special taxes to fund any fines imposed by the European Court of Justice, suggests he’s not averse to making his citizens pay for his undemocratic policies. This continued defiance perhaps opens the possibility Orban could shun the EU and IMF and turn instead toward Russia , where Vladimir Putin might be more tolerant of ascendant authoritarianism.

Hopefully, for the sake of the Hungarian people, Orban makes a New Year’s resolution to agree to the EU and IMF’s requests to reverse his undemocratic, economically misguided policies. This is one to watch in 2012.