The Hunger Bonds

Ricardo Hausmann

.The Hunger Bonds

CAMBRIDGE – Investing often creates moral dilemmas over goals: Should we aim to do well or to do good? Is it appropriate to invest in tobacco companies? Or in companies that sell guns to drug gangs?
The recent popularity of so-called impact investment funds, which promise to deliver decent returns while advancing social or environmental goals, is based on this unease. Foundations often find that these investment vehicles help them to do good both with the money that they spend on philanthropy and with the endowment assets that yield the returns on which their philanthropy depends.
Nowadays, it is emerging markets as an asset class that should make people morally queasy.

Should decent people put their money in emerging-market bond funds?
The returns of the JP Morgan Emerging Market Bond Index (EMBI+) are heavily influenced by what happens in Venezuela. The reason is simple: while Venezuela represents only about 5% of the index, it accounts for about 20% of its yield, because the yield on Venezuelan debt is about five times larger than that of other countries in the index, a reflection of the huge risk premium that Venezuela faces. Moreover, the price volatility of Venezuelan debt – the highest in the EMBI+ – accounts for a disproportionate share of the index’s daily price movements.
You might invest in the EMBI+ because it promises higher returns, or because you want to make your savings available to a larger segment of humanity. But if you do, you will root for Venezuelan debt, which means wishing for really bad things to happen to Venezuela’s people.
As has been widely reported in the media, Venezuela is experiencing one of the most calamitous economic collapses ever, accompanied by massive doses of political repression and human-rights violations. So investing in the EMBI+ means that you rejoice when Wall Street analysts inform you that the country is literally starving its people in order to avoid restructuring your bonds.
Your happiness is easily explained: Venezuelan imports, after having collapsed by 75% from 2012 to 2016, are down more than 20% in the first quarter of 2017. That’s good news for you as an EMBI+ investor, because it means that more money is left to service your bonds. Meanwhile, Venezuelans are involuntarily losing weight and searching for food in garbage piles. Sure, it’s a humanitarian catastrophe. But, to you, it’s a fabulous investment opportunity.
Now assume that you want to hold Venezuelan debt because you are hoping that President Nicolás Maduro will lose power and that a more sensible, democratically minded government, more in line with your moral compass, will emerge. Even in that case, you will still want the gains from Venezuela’s future recovery to be used preferentially to service the old debt issued to finance the corruption and national destruction brought about by Maduro and his predecessor, Hugo Chávez. You will not be rooting for the recovery of livelihoods that Venezuelans deserve after having lived through this nightmare.
You will also be rooting for US judges to seize assets and impound money to pay you. In fact, analysts who are bullish on Venezuelan debt have been lobbying the government and opposition leaders with an implied threat: even considering a restructuring of your bonds, they point out, will allow those managing your assets to cause havoc in Venezuela.
If you are a decent human being, investing in Venezuelan bonds should make you feel “mildly nauseous,” to borrow a phrase recently used by former FBI Director James Comey while testifying to the US Congress. Emerging-market fund managers feel a similar discomfort. They currently spend a disproportionate share of their time “getting the Venezuelan call right,” because their bonuses are based on their over-performance relative to the index – of which Venezuela is the main driver.
The less morally burdened among them bask in the recognition they receive for having been right to predict that Maduro’s government would decide to starve its people rather than restructure the bonds you hold. Analysts and bondholders have also lobbied the government and the opposition not to seek financial support from the International Monetary Fund, for fear that the international community will demand that you accept a significant “haircut” on your investment, as has been required of Greece’s creditors.
That would probably not be “good for the credit.” Analysts and bondholders have also lobbied the opposition-controlled National Assembly to recognize Venezuela’s external debt in exchange for the freedom of political prisoners, implying that the payment of your bonds can be secured through ransom.
So, should you stop investing in emerging-market funds just because 5% of your savings would go toward financing Venezuela? Clearly, this would punish other countries that are innocent bystanders in the Venezuelan mess. There must be a better way.
There is. The solution is to demand that JPMorgan immediately exclude Venezuela from the emerging market bond indexes it calculates, thereby freeing fund managers from the need to compare their performance with hunger bonds. Over time, JPMorgan should introduce a Decent Emerging Markets index, which would save you from moral anguish by ensuring that only countries adhering to minimal standards of respect for their citizens are included. The DEM would allow you to root for higher returns on your savings without wishing for human misery. You could do well, without feeling bad.

The Fragile Truce Between Bonds and Stocks

This year has been good for both bond and stock investors. To rely on that benign picture lasting looks risky

By Richard Barley

While hopes of a rapid boost to U.S. growth from President Donald Trump’s administration have faded, equally there has been little action on topics that might concern markets, such as greater barriers to trade. Photo: tiziana fabi/Agence France-Presse/Getty Images

That didn’t take long. Stocks have got their mojo back, with the mid-May wobble sparked by U.S. political turmoil seemingly fading from investors’ attention. Perhaps more puzzlingly, bond investors are enjoying gains too.

Indeed, there appears to be a fragile truce between asset classes. Bonds have kept their poise even as stocks have gained, with the S&P 500 Thursday hitting a record high. U.S. Treasurys have returned 1.7% so far in 2017, according to Bank of America Merrill Lynch indexes, with bonds maturing in 15 years or more up 3.9%. Even as the U.S. Federal Reserve moves ahead on tightening monetary policy, financial conditions have actually been easing.

Many of the risks that investors were worried about at the start of the year have failed to turn into real problems, helping equities to perform well. In particular, politics hasn’t been the disruptive force it might have been. While hopes of a rapid boost to U.S. growth from President Donald Trump’s administration have faded, equally there has been little action on topics that might concern markets, such as greater barriers to trade. Europe’s elections have offered no shocks, and the French vote was followed by a surge in risk appetite, boosting stocks and corporate bonds in Europe. Bonds meanwhile have taken comfort from signals from central bankers that point to extremely gradual shifts in monetary policy.

But how long can this persist? The key perhaps lies more in the bond market than in the stock market, where earnings have been strong, providing fundamental support. Bonds hardly look attractive, with long-dated yields still at remarkably low levels versus prospects for nominal growth. Yet bond investors appear willing to accept these returns for now: 10-year government bond yields in the U.S., U.K. and Germany have been trading in a very narrow range for much of the past six months. Any selloff has proved short-lived as investors continue to search for yield.

The path of inflation is likely to be crucial. The pickup in inflation in advanced economies this year has been amplified by the recovery in the price of oil. That effect will now diminish, and central bankers are still concerned that inflation hasn’t become self-sustaining. As a result, both bonds and stocks can make a case for gains: growth is decent, but inflation is quiescent.

But if inflation does hold up and central banks strike a less accommodative tone, then it is bonds that will suffer more than stocks.

So far this year has been good for both bond and stock investors. To rely on that benign picture lasting looks risky.

Why Russia Can’t End the North Korea Crisis

By Xander Snyder

Normally, it is China, not Russia, that acts as a negotiator with the North Koreans. But lately, Moscow appears to be stepping up its efforts to mediate talks with Pyongyang relating to its nuclear weapons program. These efforts, however, are unlikely to effect any real change since Russia lacks the means to persuade North Korea to change its course. They are, in reality, an attempt by the Kremlin to appear more influential than it actually is.

Mediating Talks

In a recent call with South Korea’s special envoy, Song Young-gil, Russian President Vladimir Putin said he would be willing to send a team to mediate talks between South and North Korea.

Referencing the recent U.S. deployment of the Terminal High-Altitude Area Defense system, or THAAD, in South Korea, Putin said the North Korean nuclear issue can’t be solved through military conflict and instead must be approached from a diplomatic angle. Putin took the opportunity to challenge THAAD’s effectiveness, noting that North Korea possesses long-range artillery that the system can’t protect South Korea from.

But Moscow and Pyongyang seemed to be getting closer even before Putin made this offer. In late April, Russia’s ambassador to North Korea, Alexander Matsegora, and North Korea’s vice foreign minister of U.S. affairs, Han Song Ryol, met to discuss cooperation between the two countries. Although Russian media claimed that the ambassador urged restraint on Pyongyang’s part, North Korean state media claimed that the Russians “expressed understanding” for North Korea’s position.

People watch a screen showing news coverage of the Pukguksong-2 missile rocket launch at a public square in central Pyongyang on May 22, 2017. KIM WON-JIN/AFP/Getty Images

There have also been moves to make travel between the two countries easier. In mid-May, a new ferry service between Vladivostok, Russia, and Rajin, North Korea, began operating. The two countries also agreed in March to increase the number of North Korean labor migrants in Russia, where approximately 50,000 North Korean workers already reside. By all appearances, Russia is beginning to take a more active role on the Korean Peninsula.

But just because Russia wants to play a greater role on the peninsula doesn’t mean it can.

These recent Russian moves actually show how limited Moscow’s influence in North Korea really is. There’s not much Russia can do to actually influence North Korea’s behavior, so instead it volunteers to act as a mediator, which costs Russia nothing. And if its offer is accepted, it would at least raise the Kremlin’s profile in the region and make the high-risk situation more difficult for the U.S. to manage.

Russia’s Options

There are two ways Russia could really exert influence over North Korea. The first is through military force. But using military means to stop North Korea from developing a nuclear weapon is unrealistic for Russia since it’s already preoccupied with Ukraine and the Middle East. Russia, moreover, sits within range of many of North Korea’s ballistic missiles, and should Pyongyang actually develop the ability to attach a nuclear warhead to one of them, Russia would be exposed.

Russia’s second option is to use economic measures to persuade North Korea to stop its nuclear program. Since this option appears more viable, it deserves some scrutiny. Though economic data for North Korea are scarce, some estimates indicate its gross domestic product is between $20 billion and $30 billion, with exports accounting for roughly $3 billion to $3.5 billion. That means that exports could account for roughly 20 percent of North Korea’s GDP. China is by far North Korea’s largest trading partner, accounting for roughly $2.3 billion (or 65-75 percent) of North Korea’s total exports and roughly $3 billion (or 85 percent) of its total imports.

Russia, on the other hand, imports less than $6 million worth of goods from North Korea. Its exports to North Korea total roughly $80 million, which is still a very small amount. To exercise a credible economic threat, a state must first have a degree of leverage. Russia entirely lacks this pull over North Korea and therefore cannot credibly claim to have any substantial influence over its behavior.

North Korea is unlikely to respond to economic threats unless they would have a substantial impact on its economy. Take, for example, sanctions against North Korea’s largest trade product, coal briquettes, which account for nearly 35 percent of North Korea’s total exports. In November 2016, the United Nations imposed sanctions that limited North Korea’s aggregate coal exports to $400 million or 7.5 million tons. This move restricted the country’s trade with Beijing, since nearly all of North Korea’s coal is exported to China. Despite questions about China’s willingness to adhere to this sanction – out of fear that the economic impact on Kim Jong Un’s government could destabilize North Korea, which China wants to avoid – China appears to be complying with the sanctions so far.

On April 7, China ordered a number of North Korean ships full of coal cargo sitting in Chinese ports to return to North Korea. Thomson Reuters Eikon, which tracks international ship movements, appeared to confirm that about a dozen North Korean ships full of coal subsequently returned to North Korea.

North Korea has lost roughly $550 million worth of export revenue because of these sanctions, 92 times the size of North Korea’s exports to Russia. But even this move has failed to stop North Korea from conducting more ballistic missile tests. Any economic pressure Russia could put on North Korea is unlikely to achieve a better result. Economically, Russia has little leverage over North Korea, and increasing the trade relationship to even a fraction of its current levels with China would take years.

What’s in It for Russia

Russia has good reason to want to appear influential in North Korea. If it could appear capable of managing Pyongyang, Russia would improve its negotiating position against the U.S. over issues like Ukraine and the Middle East. Negotiations are all about give and take, and appearing to have influence over North Korea would provide Russia with something to trade in exchange for U.S. concessions elsewhere. North Korea is a relatively low-risk area for Russia but a high-risk one for the U.S., so the U.S. couldn’t afford to completely ignore any interference by Russia. North Korea would have no problem with maintaining the perception that it’s close to Russia since it would give Pyongyang an additional partner to work with and increase its diplomatic maneuverability. Since the U.S. was hoping to have China’s help in resolving the North Korea issue, if Russia inserted itself into the mix it would further complicate that plan.

Russia also shares a small border with North Korea, roughly 11 miles (18 kilometers) long.

Sending a mediation team creates the appearance – at little cost – that Moscow is being proactive in protecting Russia’s interests in its periphery. This plays well for Putin, who wants to appear to be a strong leader who protects Russia’s interests abroad despite the growing challenges at home.

But North Korea is not actually willing to sacrifice aspects of its nuclear program since it believes this would endanger its security interests, and therefore these attempts to play mediator and influence the Kim government are nothing more than a charade. Russia knows this, and the West knows Russia knows this, which means these recent diplomatic moves are little more than a low-cost gamble that, if they were to pay off, would give Russia only a slightly better position in negotiations elsewhere.