Global Market Insights | A Fisher Investments Blog

More Trouble in Hungary

Storm clouds are gathering once again in Hungary. 

Over the summer, things appeared to be improving there. Prime Minister Viktor Orban’s government had amended prior legislative changes that would have limited the central bank’s independence and eroded some personal freedom. The need to comply with EU treaties, it seemed, would trump Orban’s ultra-nationalist aims.

Now, however, it appears optimism was premature. Orban may have adjusted the central bank legislation to comply with the EU’s requirements, but in practice, he’s still managed to strip the bank’s independence. In 2011, Orban appointed four “non-executive members” to the bank’s board, and these individuals have steamrolled monetary policy in Orban’s preferred direction, overruling bank President Andras Simor and his deputies.

Orban has been dissatisfied with Simor’s monetary policy since he took office in 2010. Simor has focused on preventing runaway inflation—a real risk in Hungary, where the currency is near all-time lows. Orban, however, wants monetary policy to be much more accommodative in order to offset the contractionary effects of his economic policy. Because he’s slapped banks, telecom and energy firms with extraordinary taxes, banks aren’t lending, businesses aren’t investing, and Hungary’s economy continues stagnating. Hence, Orban wants to slash interest rates to get capital moving again so he can keep these harmful taxes in place.

Simor would rather not play along—he understands loosening monetary policy will increase the risk of inflation and won’t fix Hungary’s underlying economic and policy issues. But rather than listen to reason, Orban seems content to continue forcing his agenda. Simor’s term expires next March, and Orban’s deputies are already eyeing a “new strategic alliance” with a central bank chief much more aligned with their interests—interests that likely include doing whatever it takes to artificially boost growth before the 2014 general election. A policy turnaround—something Hungary needs desperately—appears sadly unlikely.

Austerity in the UK

After Chancellor George Osborne read this year’s Autumn Statement, I could hardly visit a financial news website without seeing an article about the economic consequences of the UK’s austerity plan.

Here’s the trouble with this: Austerity means different things to different people, and no two austerity plans are alike. In countries like Greece and Spain, austerity means crippling tax increases and real public spending cuts—one big reason these nations are in deep recessions.

In the UK, austerity means something different: Yes, there are tax increases, but there aren’t actual spending cuts. Or, put simply, spending hasn’t fallen from year to year, and it’s not projected to. Instead, the government’s cut the rate of future projected spending increases—it will spend more from year to year, but not as much more as initially planned. That makes articles referring to broad spending cuts inaccurate.

To help put this in perspective, here’s a chart of the projected spending from each of the Autumn Statements (or the previous government’s equivalent, the Pre-Budget Report) since 2009.

 

*Shaded areas represent actual outturn. All other figures are official projections.

In 2009, the previous government planned to increase spending by approximately £20 billion each year through 2015. When the coalition took over in 2010, Chancellor George Osborne cut the planned increases to £10 - £15 billion per year. He eased a bit in 2011, but in this year’s statement, he reduced the planned spending increases again.  

Here’s another way of looking at it.

 

 *Shaded area represents actual outturn. All other figures are official projections.

Of course, that’s not to say the UK’s version of austerity has been easy on UK citizens. Civil service jobs have been cut, pension and benefit increases haven’t kept pace with inflation, and some programs have received real spending cuts. Many folks have felt a pinch from these cuts and the tax increases. But the continued spending increases do make it tough to argue the austerity program alone is responsible for recent economic weakness—something I’d encourage readers to keep in mind as they sift through the media’s analysis. 

 

 

 

¹Source: 2009 Pre-Budget Report, HM Treasury

²Source: November 2010 Economic and Fiscal Outlook, Office for Budget Responsibility

³Source: 2011 Autumn Statement, HM Treasury

⁴Source: 2012 Autumn Statement, HM Treasury

 

Weighing the Leveson Report

Wondering whether the storm over Lord Justice Leveson’s report on wrongdoing among UK newspapers could impact UK markets? Check out my latest MarketMinder column: 

The Tempest in Westminster

You may not think press regulation has much bearing on markets, but the deepening fractures within the coalition very well could.

 

A Lesson in Free Trade From Korean Cinema

Free trade agreements are great for capital markets—they boost international commerce, with exporters and consumers reaping the benefits. But many believe they’re a negative for domestic producers, especially in industries that haven’t had much foreign competition. Once trade barriers are torn down, folks fear the influx of foreign alternatives will drown local producers.

This fear is somewhat reasonable—foreign products can erode domestic producers’ market share, especially if they’re cheaper (as they often are, given lower labor costs in many parts of the developing world). But this isn’t automatic. As long as domestic producers continue providing products people want, and at a reasonable price, they’ll have a market—they may just have to become more competitive in order to stay viable.

Sometimes governments will launch “trade adjustment assistance” programs to help domestic firms through the transition process, either advising on how to adjust business models or even providing temporary subsidies. But the benefits of these programs are questionable—they’re not cheap for governments to provide, and the federal support lowers businesses’ incentives to become more competitive on their own. France provides a good example: French automakers couldn’t weather competition from technologically superior South Korean cars, so François Hollande’s government decided to subsidize the industry. Why would French automakers go to the trouble of revamping their product if subsidies can keep them afloat?

Now, contrast this with the South Korean film industry.

Enterprise, Not Government Protection, Helped Film Industry Flourish

In 2006, the Korean government removed the cap on foreign films, providing a deluge of competition for Korean filmmakers. For the next four years, audiences for Korean films dwindled as Korean moviegoers opted for superior Hollywood movies.

But in 2010, Korean filmmakers fought back. They didn’t ask the government for subsidies or renewed trade barriers. Instead, they simply made better films! Filmmakers got more creative, tackling more varied genres and more interesting—and often, more uniquely Korean—subject matter. Scripts and production values improved, as did acting quality. As a result, more than 100 million Korean moviegoers saw domestic films in theaters this year, and Korean films started becoming more popular overseas.

In short, Korean filmmakers’ self-determination not only saved their industry domestically, but made it more internationally competitive—allowing it to fully benefit from Korea’s free trade agreements with the US, EU and ASEAN.

So next time anyone tells you free trade is a losing proposition, tell them Korea’s story.

Turning Japanese? I Really Don’t Think So.

The other day, I read an editorial in South Korea’s Chosun Ilbo suggesting Korea’s economy might soon go the way of Japan’s:

Is Spendthrift Korea Following Japan Into a Long Slump?

The logic: Korean consumer spending trends resemble Japan’s in the late 1980s, just before its economic crash—a crash that marked the end of Japan’s economic miracle and the beginning of two decades (and counting) of deflation and low growth. Hence, Korea must be on the verge of crashing and burning in a similar fashion.

This is a flawed argument though—consumer spending habits didn’t cause Japan’s crash and aren’t responsible for the malaise that followed. Japan’s troubles result more from weak demographics, flawed economic policy, lack of domestic competition and trade protectionism.

The Korean editorial also references a piece from the US’s Foreign Policy  magazine, which takes a deeper look at some of the similarities between Korea and Japan and draws the same conclusion.

Turning Japanese

Among the similarities highlighted here are the huge conglomerates that have historically dominated both nations’ economies—keiretsu in Japan and chaebol in Korea. The piece argues Japan’s failure to break up the keiretsu and increase competition among domestic producers is one big reason Japan has stalled, and it foresees similar weakness in Korea 15-20 years from now if Korea’s government can’t crack down on the chaebol.

In my view, this is only half right. Stagnant keiretsu have contributed mightily to Japan’s woes, but a key difference between the keiretsu and chaebol mitigates the risk of the same thing happening in Korea.

Japan’s six major keiretsu are all centered around banks—the banks have cross-shareholdings in the keiretsu affiliates and subsidiaries, and these companies have partial ownership of the banks. This makes it too easy for these firms to secure corporate financing—because of the cross-shareholdings, banks have a vested interest in supporting them and, problematically, keeping struggling affiliates afloat. This is why Japan has so many so-called “zombie companies”—companies that should fail and make room for smaller firms with more growth potential.

In Korea, the chaebol are legally separated from banks—no chaebol’s holding company is allowed to own a stake, however small, in a bank. Hence, chaebols’ affiliates and subsidiaries—and sometimes even the main holding company itself—can and do fail. During the late 1990s Asian financial crisis, known in Korea as the IMF Crisis, 25 chaebol went bankrupt, including one of the top-five. In Korea, the chaebol must stay competitive and profitable in order to survive. And the chaebol at the top of Korea’s economy today are quite adept at this.

That said, the need for chaebol reform is a legitimate concern in Korea. Because of the cross-shareholdings and ruling family members’ dominance of the companies’ executive boards (chaebol are all family-run), corruption runs rampant. Cross-shareholdings also give the chaebol incentive to award contracts to their own affiliates, shutting out smaller competitors who might offer a better product or service. And trade barriers designed to protect the chaebols’ dominance of Korean markets further stifle competition, making goods more expensive for Korean citizens.

Both candidates in Korea’s upcoming presidential election are campaigning chaebol reform. The ruling Saenuri party’s candidate, Park Geun-hye, is pledging to improve corporate governance, while her opponent, the Democratic United Party’s Moon Jae-in, is pushing for limits on cross-shareholding. Their proposed measures might help increase competition within Korea, but in my view, tax reform and free trade should be top of the list. Lowering Korea’s trade barriers will accomplish two things: It will make it much easier and cheaper for smaller firms to compete internationally, and competition from foreign goods would help fragment domestic markets, providing an opening for new market participants. Making the corporate tax code more equitable—it heavily favors the chaebol—would make it even easier for small firms and entrepreneurs to profit and grow. The chaebol will continue to play a role, but Korea would get a new growth engine, and all Koreans would benefit from cheaper goods, more choices and—importantly—more employment options.

But the need for chaebol reform doesn’t make Korea the next Japan. Korea’s pretty competitive globally, and its fundamentals are plenty stronger than Japan’s. There are just key policy steps the next government could take to help take Korea to the next level.

For more on this, check out my recent column on Equities.com, “Competition, Gangnam Style.”

 

Ken Fisher on the US’s Fiscal Cliff

Though the so-called fiscal cliff is a US issue, it’s getting lots of notice globally—the US still comprises about half the global stock market, and most observers think the tax increases and federal budget cuts scheduled to begin next year could weigh on shares.

As my boss, Ken Fisher, recently wrote in Financial Times, however, that fear’s misplaced:

Fiscal Cliff? It’s More of a Rolling Plain

Ken Fisher, Financial Times

As he explains, the $984 billion in budget cuts over the next 10 years sounds astronomical, but when you scale it properly, the picture improves. Most of these cuts aren’t real spending cuts—they’re cuts to the projected rate of future spending. Yes, federal spending will shrink next year, but it’s projected to grow each year thereafter—just by less than initially planned.

In 2013, total federal spending is projected to be $9 billion less than 2012—spending cuts will be deeper in the year’s first half, but spending increases in the second half will offset much of these. The US’s economy is strong enough to handle a net $9 billion less in federal spending next year—the private sector is healthy, profitable and growing. $9 billion amounts to about 0.06% of US GDP. For comparison, this year, federal spending fell by about 0.2% of GDP, and though this weighed on GDP growth, the economy still grew—private-sector components were more than strong enough to offset the government’s smaller contribution.

As for tax increases, if all the planned hikes take effect, it won’t be great—tax hikes generally hinder economic growth—but it wouldn’t be disastrous. Income tax rates would revert to levels seen in the 1990s, which are still at the low end of the historical range—and the 1990s were an overall great time for stocks. Higher capital gains taxes might make investment a bit less profitable, but history shows capital gains tax increases don’t cause bear markets—because so many other variables impact market returns, sometimes stocks have risen after tax increases, and sometimes they’ve fallen.  

With that said, it’s highly unlikely the fiscal cliff plays out as widely feared—Congressional negotiations may seem stalled, but everyone in Congress has a vested interest in delaying or watering down at least some of the components, which would dramatically lessen the impact. Some provisions will stay—the tax increases tied to the Affordable Care Act will stay, and the small temporary reduction to payroll taxes will likely end. But Congress should compromise on an extension of the 2001/2003 tax cuts.

As it stands, both US political parties want to extend at least some of these cuts. The Republicans in the House of Representatives passed a bill to extend them for everyone, while the Democrats in the Senate have passed a measure to extend them for everyone except those earning over $250,000. But several Democratic Senators who won seats in traditionally Republican states in 2008 are up for re-election in 2014, and they won’t want to lose to Republican challengers—their likely fate if they allow these taxes to rise. Hence, these Senators likely support a measure to extend the cuts for everyone—with the full support of Democratic party leadership, which will want to keep the party’s majority in the Senate.

This won’t happen immediately, however, and maybe not until after January 1, 2013. And market volatility may very well return in the interim. But looking longer term, it’s highly unlikely stocks fall off the fiscal cliff.

Welcoming Mark Carney to the BOE

Are you wondering what the appointment of Mark Carney as the next Bank of England Governor means for the UK economy and markets? If so, check out my latest column for Equities.com.

Good Luck, Mr. Carney!

In short, Carney seems well qualified, and his appointment was a pleasant surprise. But I recommend tempering expectations, as he’ll have his work cut out for him. 

 

Tax Increases—The Good Kind

In general, I’m not a fan of raising taxes—after all, the more you tax something, be it income, sales, corporate profits, investment activity or what have you, the less you get. But Wednesday, I read an article about tax increases that just about made me dizzy with glee.

In Communist Cuba, the Tax Man Cometh

Under the paternalistic communism of old, Cuba didn’t have much need for taxes. 90% of economic activity came from state-owned businesses, which turned all revenues over to Fidel Castro’s government. The government would then return a small portion to the companies to fund operations and pay workers (at very low wages) and then spend the rest freely on social welfare.

However, over the past two years, Raul Castro’s government has introduced some free-market reforms, legitimizing private commerce. This enabled every single Cuban to earn more and improve their quality of life, and many have seized the opportunity to start small businesses. Much of their economic activity, however, has gone untaxed—even as these individuals continued receiving the government’s blanket subsidies.

Now, that’s changing: Cuba has published its first comprehensive tax code since the 1959 revolution.

For one of the world’s last remaining communist enclaves, this is huge. If Raul Castro were set on clinging to Leninist ideals, he’d simply seize all private corporate profits and extend the old system. But by choosing to tax profits and incomes while allowing private companies and entrepreneurs to continue operating freely, he’s signaling Cuba’s nascent capitalism is here to stay. The new code even includes incentives for private businesses to expand and hire more workers—Cuba, it seems, wants to grow.

What’s more, the government also plans to replace blanket subsidies with a more targeted welfare system, bringing Cuba more in line with the rest of the world. At least socially and economically, it appears Cuba’s getting out of the 1950s and into the 21^st century.

Here’s hoping political reforms aren’t far behind.