Latin America’s Middle-Class Mirage

Eduardo Levy Yeyati

25 September 2013

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BUENOS AIRESRising incomes across the developing world will bring some 400 million people into the middle class by 2020, up from 1.8 billion today. Their increasing spending power, especially on non-essential consumer goods and services, is being hailed as the great hope for the global economy. But closer examination of their economic circumstances suggests that these new consumers are neither as wealthy nor as secure as we may think.
The vast majority of the middle-class expansion is taking place in emerging Asia. But a similar socioeconomic shift in Latin America holds important lessons for rapidly growing markets everywhere. Latin Amercia’s middle class grew by around 50%, to 152 million, from 2003 to 2009, accounting for around 30% of the continent’s population – a proportion that undoubtedly has grown since.
This remarkable economic transformation has been presented as proof of successful pro-growth policies pursued in previous decades. Higher employment, rising wages, cash transfers to the poor, and state pensions have all helped to fuel progress. But, while policies that reduced the atrocious poverty and narrowed the yawning income inequality that persisted throughout the 1990’s must surely be applauded, the welfare gains associated with this performance may prove to be weaker than hoped.
An obvious problem lies in the fact that we measure the size of the middle class according to household-income data, but with little knowledge about these households’ patterns of saving. If today’s higher incomes are consumed and tomorrow’s incomes decline (which is likely if the economy slows), middle-class households with no savings buffer could easily slip back into poverty.
And, as a recent World Bank report (which I co-authored with Augusto de la Torre) pointed out, although data on household wealth are sparse, surveys suggest that low- and middle- income families, especially in Brazil and Argentina, tend to buy depreciating assets such as cars and televisions, rather than invest in houses. Such households are especially vulnerable if their purchases are financed by credit. With consumption rising faster than incomes, and with larger debts to finance, households may end up worse off – an irony often missed by those advocating wider access to banking services.
Nor do transfer payments or higher pensions provide much of a sustainable basis for spending. Almost every social-security system in the region is losing money. A declining proportion of paid benefits are covered by workers’ contributions, and few countries are saving enough to bridge the deficits. Eventually, the books must be balanced, and this will probably happen at the expense of future social spending.
Another, perhaps more important reason not to celebrate is that higher incomes do not necessarily translate into a better quality of life. A large part of household consumption includes public-sector goods and services. The same new middle-class worker who now enjoys a higher real income also endures a two-hour daily commute on packed and hazardous trains or buses, purchases private health insurance to escape the long lines in under-resourced hospitals, and pays for private education for their children to avoid decrepit school buildings operated by a strike-prone public-education system.
To some extent, poor public services can be seen as the flipside of the middle-class consumer boom in emerging economies. State subsidies and transfers have boosted private incomes, but often at the expense of investment in transport, security, and utilities.
In short, there is a difference between a society with a growing middle class and a middle-class society. Living standards in the latter are high (and more equal), owing primarily to the better public services that they provide.
This might seem an obvious shortcoming that governments would readily sort out. But there are political reasons why they do not. Voters tend to credit increases in minimum wages, pensions, and social transfers to the government that provides them. By contrast, the benefits of public investments are slower to be felt, and their beneficiaries are more diffuse. Politicians operating on short electoral cycles inevitably target public spending at potential supporters.
But, as societies become richer, the demands of the electorate become more nuanced. When disenchanted middle-class voters take to the streets, Latin America’s leaders will have to explain to them why better schools and trains tomorrow require saving more today.
Eduardo Levy Yeyati, former Chief Economist at the Central Bank of Argentina and Head of Emerging Markets Strategy at Barclays Capital, is Director of Elypsis Partners, Professor at Universidad Torcuato Di Tella, and President of the Center for Public Policy (CIPPEC).

Brazil’s future

Has Brazil blown it?

A stagnant economy, a bloated state and mass protests mean Dilma Rousseff must change course

Sep 28th 2013

FOUR years ago this newspaper put on its cover a picture of the statue of Christ the Redeemer ascending like a rocket from Rio de Janeiro’s Corcovado mountain, under the rubricBrazil takes off”. The economy, having stabilised under Fernando Henrique Cardoso in the mid-1990s, accelerated under Luiz Inácio Lula da Silva in the early 2000s. It barely stumbled after the Lehman collapse in 2008 and in 2010 grew by 7.5%, its strongest performance in a quarter-century. To add to the magic, Brazil was awarded both next year’s football World Cup and the summer 2016 Olympics. On the strength of all that, Lula persuaded voters in the same year to choose as president his technocratic protégée, Dilma Rousseff.

Sincé then the country has come back down to earth with a bump. In 2012 the economy grew by 0.9%. Hundreds of thousands took to the streets in June in the biggest protests for a generation, complaining of high living costs, poor public services and the greed and corruption of politicians. Many have now lost faith in the idea that their country was headed for orbit and diagnosed just another voo de galinha (chicken flight), as they dubbed previous short-lived economic spurts.

There are excuses for the deceleration. All emerging economies have slowed. Some of the impulses behind Brazil’s previous boom—the pay-off from ending runaway inflation and opening up to trade, commodity price rises, big increases in credit and consumption—have played themselves out. And many of Lula’s policies, notably the Bolsa Família that helped lift 25m people out of poverty, were admirable.

The world’s most burdensome tax code
But Brazil has done far too little to reform its government in the boom years. It is not alone in this: India had a similar chance, and missed it. But Brazil’s public sector imposes a particularly heavy burden on its private sector, as our special report explains. Companies face the world’s most burdensome tax code, payroll taxes add 58% to salaries and the government has got its spending priorities upside down.

Compare pensions and infrastructure. The former are absurdly generous. The average Brazilian can look forward to a pension of 70% of final pay at 54. Despite being a young country, Brazil spends as big a share of national income on pensions as southern Europe, where the proportion of old people is three times as big. By contrast, despite the country’s continental dimensions and lousy transport links, its spending on infrastructure is as skimpy as a string bikini. It spends just 1.5% of GDP on infrastructure, compared with a global average of 3.8%, even though its stock of infrastructure is valued at just 16% of GDP, compared with 71% in other big economies. Rotten infrastructure loads unnecessary costs on businesses. In Mato Grosso a soyabean farmer spends 25% of the value of his product getting it to a port; the proportion in Iowa is 9%.

These problems have accumulated over generations. But Ms Rousseff has been unwilling or unable to tackle them, and has created new problems by interfering far more than the pragmatic Lula. She has scared investors away from infrastructure projects and undermined Brazil’s hard-won reputation for macroeconomic rectitude by publicly chivvying the Central Bank chief into slashing interest rates. As a result, rates are now having to rise more than they otherwise might to curb persistent inflation.

Rather than admit to missing its fiscal targets, the government has resorted to creative accounting. Gross public debt has climbed to 60-70% of GDP, depending on the definition—and the markets do not trust Ms Rousseff.

Fortunately, Brazil has great strengths. Thanks to its efficient and entrepreneurial farmers, it is the world’s third-biggest food exporter. Even if the government has made the process slower and costlier than it needed to be, Brazil will be a big oil exporter by 2020. It has several manufacturing jewels, and is developing a world-class research base in biotechnology, genetic sciences and deep-sea oil and gas technology. The consumer brands that have grown along with the country’s expanding middle class are ready to go abroad. Despite the recent protests, it does not have the social or ethnic divisions that blight other emerging economies, such as India or Turkey.

An own goal for Dilma Fernández?
But if Brazil is to recover its vim, it needs to rediscover an appetite for reform. With taxes already taking 36% of GDP—the biggest proportion in the emerging world alongside Cristina Fernández’s chaotic Argentina—the government cannot look to taxpayers for the extra money it must spend on health care, schools and transport to satisfy the protesters. Instead, it needs to reshape public spending, especially pensions.

Second, it must make Brazilian business more competitive and encourage it to invest. The way to do that is not, as the government believes, to protect firms, but to expose them to more foreign competition while moving far more swiftly to eliminate the self-inflicted obstacles they face at home.

Brazil’s import tariffs remain high and its customs procedures are a catalogue of bloody-minded obstructionism. More dynamic Latin American economies have forged networks of bilateral trade deals. Brazil has hidden behind Mercosur, a regional block that has dwindled into a leftist talking-shop, and the moribund Doha round of world-trade talks. It needs to open up.

Third, Brazil urgently needs political reform. The proliferation of parties, whose only interest is pork and patronage, builds in huge waste at every level of government. One result is a cabinet with 39 ministries. On paper, the solution is easy: a threshold for seats in Congress and other changes to make legislators more accountable to voters. But getting those who benefit from the current system to agree to change it requires more political skill than Ms Rousseff has shown.

In a year’s time Ms Rousseff faces an election in which she will seek a second four-year term. On her record so far, Brazil’s voters have little reason to give her one. But she has time to make a start on the reforms needed, by trimming red tape, merging ministries and curbing public spending. Brazil is not doomed to flop: if Ms Rousseff puts her hand on the throttle there is still a chance that it could take off again.

Global Insight

September 25, 2013 5:48 pm
Merkel wins the battle but Germany shifts to the left
FDP and AfD, both to the right, did not win any seats
Like two great armies licking their wounds after a bloody medieval battle, Germany’s mighty Christian Democrats and their eternal Social Democrat challengers find they may well have to sign a peace treaty before they have even buried their dead.

Angela Merkel, the clear victor, wants a stable government to deal with the lingering eurozone crisis, fear of another global slowdown, and deep social and demographic challenges at home. The chancellor may have won the battle, but her CDU (plus the Bavarian CSU) is five seats short of an absolute majority.
She has no natural conservative ally, since the liberal Free Democrats, her present partners, fled the battlefield without a single seat. She has to find a majority with her erstwhile opponents, either the SPD or the Greens.

It is a painful prospect for all of them, and no surprise that wounded Social Democrats are unhappy about doing any deal. Some reject a “grand coalitionout of hand. Others want to put any agreement to a full-party plebiscite.

Quite apart from the negotiations taking many weeks – it took 65 days to produce a similar coalition in 2005 – a referendum might produce a truculent rejection by the rank-and-file.

The loyal footsoldiers of the SPD, especially on the left, do not want to throw in their lot with the victor and give up all their cherished social policies. Not least, they want a statutory minimum wage, and tax rises on the rich to finance more spending.

It is not a very comfortable prospect for Ms Merkel, either. The chancellor knows she will have to make some real compromises. Policies and jobs are the bread and butter of coalition talks. With the SPD, that means taking on leftwing policies – even tax rises – that might infuriate her conservative supporters.

On the other hand, she is in the pleasant position of being able to choose her future partners. If the SPD goes off in a huff, or asks for too much, she can threaten to do a deal with the environmentalist Greens.

So what can Germany’s partners learn from what seemed to be such a clear-cut election result?
For a start, the disappearance of the FDP from the Bundestag will make a difference. The party has been a pale shadow these past four years, divided on Europe, vacillating between playing poodle to Ms Merkel and sniping at government policy. But it has always been a champion of less government and more market-oriented policies. All the parties left in the Bundestag, including Ms Merkel’s Christian Democrats, are instinctive regulators.

That is true of financial regulation, and measures such as a financial transaction tax, which is common ground for the CDU/CSU, the SPD and the Greens. The FTT may never get off the ground in Europe, but it will not be for want of trying in Berlin.

Second, the centre of gravity of the new Bundestag is just to the left of centre, although more than half the national vote went to the right. The FDP and the eurosceptic Alternative für Deutschland, both on the right, fell just below the 5 per cent needed to win seats.

The far-left Linke party will hold the balance of power. Indeed, if the SPD joins the CDU in a grand coalition, the Linke will lead the opposition. They have one more vote than the Greens. But no one wants to form a government with them because they are anti-Nato and often anti-EU.

One thing is certain: the next German coalition will be more pro-European than the last. FDP doubts about eurozone bailouts were always a worry for Ms Merkel. The Greens are Germany’s most pro-European party, followed by the SPD.

A grandblack-redcoalition is still the most likely outcome, but Ms Merkel can flirt with the Greens, too. It is their chance to be the new kingmakers of German politics. They might lose some leftwing supporters from the old fundamentalist wing of ex-1968 revolutionaries, but “realistGreens and Ms Merkel’spragmatistChristian Democrats could yet make a workable combination.

Copyright The Financial Times Limited 2013.


The big issues

The finance sector is doing part of its job right

Sep 28th 2013

GLOOMY headlines predominate in the banking industry. JPMorgan Chase was this month fined nearly $1 billion by regulators in relation to the “London Whaletrading scandal. Barclays and Credit Suisse have already revealed that revenues in their fixed-income sales and trading divisions were poor in the third quarter; Citigroup, Deutsche Bank and others are expected to say something similar. Trading volumes seem to have slumped over the summer as investors contemplated the potentialtapering” of bond purchases by the Federal Reserve (such inactivity may well continue now that the Fed has delayed its taper).

But trading is only part of the banking business, and banks are only one part of the finance industry. Elsewhere, there is plenty of positive news. Fund managers are looking happier. Inflows into global equity funds reached $26 billion in the week ending September 18th, the highest figure in more than 20 years, according to Bank of America Merrill Lynch. The equity rally is now sufficiently established that investors have overcome their memories of the dark days of 2008. The party mood is such that analysts at Citigroup are forecasting London’s FTSE 100 to reach 8,000 by end-2014, a thousand points above the record high reached back in 1999.

A renewed enthusiasm for shares pushed global equity issuance to $540 billion in the first nine months of the year, according to Dealogic, a data provider. That is a 12% increase on the same period in 2012. The British government has managed to offload part of the stake it acquired in Lloyds Banking Group during the crisis.

Private-equity firms are selling off stakes in some of the companies acquired during the 2006-07 buy-out boom. More equity flotations are on the way, including Britain’s Royal Mail and America’s Twitter. That is good news for banks’ capital-markets desks.

Meanwhile, the bond markets are not as moribund as the slump in trading revenues might suggest. Total debt issuance may have been down in the first nine months of the year, but high-yield issuance reached a record $358 billion, according to Dealogic. That figure includes the largest-ever high-yield issue, from Sprint, an American telecoms group.

That deal was overshadowed by the $49 billion raised in a single day by another telecoms group, Verizon. Almost a third of the issue was in the form of 30-year bonds, an indication that there is plenty of appetite for long-dated corporate debt.

That Verizon’s debt was issued to help finance an acquisition—the purchase of a minority stake in the group’s wireless operations—has bankers salivating. “This deal will make chief executives reconsider what is possible,” says one senior financier. Bosses have been cautious about big bids in recent years but their animal spirits may now be awakened. Big mergers and acquisitions not only create income for investment banks through underwriting equity and bond issues but also generate large advisory fees.

It is not hard to see a virtuous circle developing, at least from the perspective of the markets. Retail investors will pour money into equities, driving share prices up; higher share prices will encourage more M&A; and M&A talk will push the stockmarket up even further.

Perhaps the biggest cause for celebration in the finance sector is the revival in banks’ share prices. Bonuses these days are paid in shares as well as cash; the equity element is often locked in for years. So the slump in bank shares in 2008 and 2009 was doubly damaging to bankers: many lost both their jobs and a chunk of their wealth. The rally over the past 18 months (see chart) will cause them to get out the Porsche brochures once more.

Others will not be celebrating this news, of course. Having caused the crisis of 2008, the popular view is that Wall Street has prospered much more than Main Street from the recovery. But one of the banks’ main jobs is to raise money for companies. So when the capital-markets desks are busy, that is good news for the economy. Trading may be subdued, but trading is important only in so far as it creates liquidity, and liquidity is important only in so far as it encourages investors to provide capital for firms. The Verizon deal shows there is no problem there.

Residents of Main Street can also comfort themselves that the bankers are still far from happy. Just as farmers moan about the weather, gather a group of financiers in a room and pretty soon they will start grumbling about the regulators. There is no sign that this burden is going to dissipate any time soon.

viernes, septiembre 27, 2013



$1,300 Gold Is A Gift


Recently an article was published arguing that the downtrend in gold (GLD) that began in September, 2011 was the beginning of a long gradual bear market. The author provides the following "arguments":
1) Technically the rise in gold from 2002 to 2011 is similar to the rise in gold from 1971 to 1980. It will therefore follow the trajectory that we saw from 1981 onward.

2) As the Federal Reserves "tapers" and ultimately tightens this will have a negative impact on gold, and gold should see negative price action similar to that seen in the 1980s.

3) Gold's inflation-adjusted returns from 2002 to the present day have been excessive, and consequently unsustainable.

Each of these arguments is flawed, as I will demonstrate.

1: Technically the rise in gold from 2002 to 2011 is similar to the rise in gold from 1971 to 1980. It will therefore follow the trajectory that we saw from 1981 onward.

In presenting this argument the author provides the following chart.

Aside from the more general flaw of the argument that correlation does not imply causation (i.e. just because it happened in the 1980s doesn't mean it will happen again), the similarity that the author is pointing out simply doesn't exist in the way he implies. First, the rise in the gold price from 2002 of about $300/ounce to the 2011 "peak" of $1,900/ounce is a mere 533% increase. The rise from $35/ounce in 1971 to $850/ounce in 1980 is a 2,330% increase. The author explains that the rise in the 1970s was more pronounced than the more recent one because inflation was higher back then. As I discuss below this is simply not true. The bull market in the 1970s saw an initial rise in the first part of the 1970s, followed by a substantial correction (not unlike the one we are currently seeing), only to see a phenomenal 8-fold increase over just 5 years. I should also point out that while the gold price peaked at $850/ounce, gold barely traded in the $700s and $800s. The bull market ended in a mania where the price was rising substantially every day. The top that was formed in 2011 was the result of a modest price rise from about $700/ounce in 2008 to $1,900/ounce three years later. There was no blow-off top or spike to suggest that the final top was in as there was in 1980. In fact as recently as last year the price reached within 10% of the all-time high.

Second, the author's timelines for both bull markets are conveniently similar in duration. A more detailed analysis of the two bull markets shows that this is inaccurate: the earlier bull market was far longer. While the earlier gold bull market seemingly began in the early 1970s, to assert this is to demonstrate a lack of understanding of the gold market during the Bretton Woods Era, and the period immediately following. The reason that the bull market in gold did not begin earlier is that it was fixed at $35/ounce by the Bretton Woods Agreement, whereby countries that stored their gold in the United States in order to keep it safe from the Nazis during World War 2 agreed to accept U. S. Dollars for their gold with the understanding that their dollars could be exchanged with the United States for gold at a rate of $35/ounce. While the $35/ounce price was officially renounced on August 15, 1971, when president Richard Nixon closed the gold window (effectively ending the Bretton Woods agreement), a market that was separate from America's $35/ounce price fix was operating for years before this. The following chart shows that the gold price began to fluctuate to higher levels as early as 1968.

(click to enlarge)
(Source: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform).

We can go back even further and find a brief price spike to $38/ounce in 1960.

(click to enlarge)

In addition to finding price movements, which were ultimately curbed in order to save the Bretton Woods Agreement, we can pinpoint the beginning of the earlier gold bull market on significant historical events, such as de Gaulle's proposal to return to the gold standard in 1965.
While it is impossible to re-write history it is fairly clear that the gold bull market would have begun long before 1971 if the price of gold were not pegged to $35/ounce by the U. S. Government. Therefore the timeline parallel is unfounded, and, like most bull markets, the ongoing one in gold should last for several more years.
2: As the Federal Reserves "tapers" and ultimately tightens this will have a negative impact on gold, and gold should see negative price action similar to that seen in the 1980s.
There are two issues with this argument. The first is that there is no evidence whatsoever that the Federal Reserve has any intention of "tapering" or tightening. The Fed has been grossly misleading when it comes to their quantitative easing policies, and the past four years have been peppered with Fed claims that these programs would cease. Of course they have just gotten bigger. Until there is evidence to the contrary, there is no reason to believe that this pattern will shift. Assuming that it continues we will likely see more quantitative easing in the future, not less.
Second, let us suppose that there will be tapering and eventual tightening. Historically there is no evidence that this will cause the gold price to fall. Had our author shorted gold upon Fed tightening during the last gold bull market he would have done horribly. As the following chart of the Fed's benchmark interest rate shows, he would have shorted gold into the end of the mid 1970s correction that was followed by an 8-fold increase in the gold price.


Not only can gold rise in the face of tightening, but note how high interest rates were during this time frame. Even an enormous amount of tightening in today's market wouldn't stop the gold bull run--as the chart shows it can rise in the face of mid to high single digit interest rates. Seeing that the earliest that rates will rise is 2015-16 (assuming you believe the Fed's comments), we will almost certainly not see rates as high as those seen in the 1970s for many years after that. Thus the gold price can rise for many more years, and quite substantially at that.
3: Gold's inflation-adjusted returns from 2002 to the present day have been excessive, and consequently unsustainable.

There are several issues with this argument. First, what are excessive returns? Second, there is no reason why any level of return is unsustainable. Investors who decided to sell an asset on the basis that it had risen too much in value would have missed out on enormous opportunities from Intel to Apple, to Silver Wheaton. Third, the author basis this claim on the CPI, which is the Bureau of Labor Statistics' measure of inflation. As I argue extensively in this article, the CPI grossly understates inflation. I will not go into the details here, but to summarize:

1) The rate of inflation is much higher than the CPI implies. It is probably in the mid to high single digits, and some people might experience a higher "personal" inflation rate. This is evidenced through price data of several essential items that people must buy.

2)The BLS uses two tricks to lower the CPI: hedonic adjustments and substitution. The first is based on the argument that as time goes by consumables get better, and therefore part of the price increase is the result of improvements, not inflation. The second is based on the argument that if prices rise for some things, then consumers will switch to consuming other things. While both arguments seem to make sense I argue that they do not, and that they serve to lower the stated inflation rate.

3) The government has incentive to have the BLS understate inflation. It has several expenses that are tied to the stated inflation rate such as COLAs to social security beneficiaries and interest payments on inflation protected securities. Therefore one should look to another party for data on inflation.

While the gold price has risen in inflation-adjusted terms, as I estimate inflation to be (about 6%-7%), the return has been rather modest. Further, if we consider that there was inflation while the gold price was falling in the 1980s and 1990s then gold has a lot of catching up to do.


With the gold price sitting just above $1,300/ounce, down from over $1,900/ounce two years ago it is no wonder that there is so much pessimism in the market. But we have established, contrary to the bearish viewpoint:

1) The gold bull market is still relatively young, and it has yet to reach a point of manic buying.

2) Gold bulls have little to fear from the Federal Reserve. Even if it surprises me and tapers and tightens this is no reason to sell your gold. In fact, if the last gold bull market can tell us anything, it is that we can potentially see enormous gains in gold while the Fed is tightening.

3) Gold has certainly performed well over the past decade, but this is no reason to sell it. While it has outpaced inflation, it hasn't done so by much, and it has to catch up for the inflation that was created during the bear market of the 1980s-1990s.

With that being said we can certainly see further price declines in gold. In the 1970s gold fell by 50% in the middle of the bull market. One more down-leg would not be surprising. But this is an ideal time to be accumulating. In 5 or 10 years it won't matter much whether you bought at $1,200/ounce, $1,300/ounce, or even $1,600/ounce, because the price will be much higher. With that in mind $1,300/ounce gold is a gift.