Repricing the World

By John Mauldin

The viral fog is starting to thin. US coronavirus case growth appears to be slowing, albeit at a tragically high level. Governments and businesses are thinking about the next stage.

On the other hand, fog tends to return when the weather is right.

Might this virus come back, as seems to be happening in Japan and Singapore?

We shouldn’t relax just yet.

Nate Silver’s FiveThirtyEight site published an information-filled comic about the wide gaps in various “scientific” virus models. Just as in investing and climate change, accurate models are difficult.

Just a sample:

Source: FiveThirtyEight

We know everything has changed, but we don’t yet know how. This all happened within weeks instead of unfolding over years like other major crises. We haven’t had time to process it all, much less prepare for it.
There’s nothing like a Bretton Woods plan for the next phase. We’re making it up as we go along. So are our leaders. And they are often relying on models everyone knows are flawed, but they have to start somewhere.

My friend Mark Grant summed it up nicely in his letter this week.

We are peering into the void, of the great unknown, and trying to make sense of an array of data that doesn’t fit any economic models, because we have never been here before, and we don’t know how to model for economic conditions that have never existed before, in anyone’s lifetime.

I will readily admit that I use models all the time. I try to understand their limitations. Most business people use models to plan out any new venture or predict the next year or so. The successful ones use a mathematically imprecise tool called “the fudge factor.” They assume that something will go wrong and try to allow for problems. If there is no problem, then they have “excess profits.” But if there is one, they are ready.

I believe we will look back at some of these models and say they were too conservative. But that is in hindsight. What if they weren’t? Unlike a business, it wouldn’t be just a dollar loss, but lost lives. They did the responsible thing and built in a significant fudge factor because the data was all over the place.

All that said, investors and business leaders still need some kind of outlook to guide our strategy going forward. Of course it will be tentative, but we can adjust as we gain clarity. The important part is to not let the uncertainty paralyze us.

Developing our own individual strategy going forward, not being paralyzed, is indeed the primary focus for the first-ever Virtual Strategic Investment Conference. Here’s my official announcement message.

I was disappointed to have to cancel this year’s SIC in Scottsdale. It was clearly going to be the best ever. But as I and my team thought about it, there has never been a more important time for a virtual conference. After a few phone calls, I realized that I could put together an even more powerful gathering of the best minds and thought leaders in the world.

We will present a live virtual conference for five days between May 11–21. Our technology will let you ask questions just as if you were physically there. I have restructured the agenda to focus on what the economy will look like over the next six months and in a post-vaccine world. We know that it will be different. You’ll hear from thought leaders who can separate the signal from the noise, showing you what’s important and where the opportunities are, and of course what to avoid.

I honestly believe this will be the most important SIC I have ever hosted.
There has never been a more urgent time as confusion reigns and the need for clarity is paramount.

This conference will not be about hunkering down, but finding opportunities and moving forward.
The Age of Transformation is going to accelerate. We will cover every nook and cranny of the investing, geopolitical, and political landscape.

And what a lineup of speakers! Here are just a few of the almost 30 already confirmed:

  • Celebrated investor Leon Cooperman

  • Ian Bremmer and George Friedman on geopolitics

  • Michael Pettis coming to us live from Beijing

  • Felix Zulauf live from Switzerland

  • The entire Gavekal team, Louis and Charles Gave plus Anatole Kaletsky

  • Dr. Mike Roizen hosting some of the finest epidemiologists in the world

  • Barry Ritholtz and China expert Jonathan Ward

  • Political mavens Bruce Bartlett and Bruce Mehlman.

Of course we will have David Rosenberg, Lacy Hunt, and this year Ben Hunt, along with Jim Bianco to give us insights on Federal Reserve policy and bonds.
There will be a special focus on technology as my good friend Peter Diamandis has agreed to join us from Silicon Valley along with Karen Harris of Bain and technology wizard Cathie Wood.

There are too many to mention but it will be the biggest collection of forward-thinking brainpower gathered anywhere this year.

The price is less than 10% of the live event, let alone travel and hotel.
You will be able to watch the conference from the comfort of your home or office, either live or reviewed at your leisure, plus read the transcripts. Ask your questions.

Again, don’t procrastinate. Click here and register now.

Nothing Like Normal

In my experience, finding the right answers often begins with asking the right questions. With so much uncertainty, it’s hard to know where we should look first.

My friend Dave Rosenberg (who now practices independently at Rosenberg Research) recently distilled the issues into three questions. Writing in his morning letter, Rosie said,

There are three issues that economists and strategists have to address for their clients:

1. Trying to predict when the chokehold over the economy will end and what that will look like.

2. How deep a shock is the current recession going to be and what does the recovery look like in the near term.

3. What is the longer-term fallout on the economy, the markets, and society?

These are indeed a good way to focus our thinking.

Let’s dig into each. I’ll give you Dave’s quick answer and then add my own thoughts.

Regarding question #1, it is a very tough call and depends on so many medical variables. President Trump hinted that he will be relying on his gut instinct. In any event, if I had to guess, we will be seeing a partial reopening in some areas beginning in May. I sense the one metric that is really important here is health care capacity (hospital beds, ICUs, ventilators).

I believe easing the business and movement restrictions will depend highly on local conditions. The viral outbreaks spread in ways we don’t fully understand. Keeping so many people out of circulation seems to have helped but these closures aren’t sustainable indefinitely. We have to end them fairly soon. 

Dave notes, and I agree, that top priority goes to keeping the healthcare system ready for the worst. We need to have facilities, equipment, supplies, and staff to treat a number of patients that may still be quite high plus all the other medical needs that have been sidelined. We can’t allow more of these “overwhelm” situations as occurred in Italy and New York.

Some have suggested we just isolate the most vulnerable people: those over age 60, or with immune system, lung, or other problems. That would probably help but wouldn’t be simple. You’re still talking about a big part of the population, plus the younger caregivers who would come in contact with them, plus the caregivers’ families. That’s not sustainable for long, either.

Dr. Michael Roizen of the Cleveland Clinic is helping prepare a paper for Ohio and other states about how to think about reopening their states. You can see some of his data here. Note that it is data and NOT a written presentation.

He includes this chart about death rates in Ohio, which look much like data from New York, China, and Italy.

Clearly the risk of death rises dramatically with age.

But that changes if you factor in other health issues. High blood pressure, smoking, being overweight, lack of exercise, all contribute to increased morbidity.
So you can be younger and still be in a high risk category because of your health.

The US still needs to sharply ramp up testing before we can ease the restrictions. It is getting better and some private labs even report excess capacity now that they’ve worked through the initial backlog. But we need much more to be confident, probably millions of tests a day. We just have to bite the bullet and make it happen.

Again, with the caveat that local schedules will vary, I think Dave is right that we can begin reopening in May. But note how carefully Dave said it (my emphasis):

“A partial reopening in some areas beginning in May.”

We are not all going to emerge from our holes, blink at the sunlight, and proceed merrily into spring. I expect a drawn-out process, possibly interrupted in some places if new cases begin growing again.

Some governors are talking about allowing restaurants to open at 50% capacity. How’s that going to work for their cash flow? Not to mention jobs? Still, we have to start somewhere, cautiously. Everything is a trade-off.

In the near term, it’s going to look quite different. Masks will be mandatory some places and socially expected in others. Most people will stay close to home. Even if you’re willing to get on a plane or train, you’ll risk being caught in someone else’s outbreak and unable to get home. Few will want to do that.

Just a few weeks ago, my 2020 plans included 8–10 trips to New York City (and train rides to Philadelphia). Now? No plans at all. It’s all up in the air.

And that’s another big unknown. Governments can’t simply order the economy reopened. Consumers and businesses have to agree and all will make their own choices. Like everything else, it will be a cost-benefit analysis. Is the benefit of going to that restaurant worth the risks of going out in public, in proximity to possibly infected strangers? Maybe so, but fewer will want to as long as this virus is still a threat.

Life will be nothing like the “normal” we knew just a few months ago until we have an effective vaccine and most people are inoculated. That’s at least eight months away, maybe longer. Talk of a V-shaped recovery is fantasy. Some recovery, yes, but we aren’t going to just pick up where we left off. Social distancing is incompatible with the kind of economy we have always known. As long as it persists, the old economy is gone.

Math Problem

Dave’s second question was about how deep the shock will be, and what are the near-term recovery prospects. His answer:

As for #2, it looks now as if the US economy has contracted as much as 40% at an annual rate for the second quarter. Canada could be even worse, as the aggregate index of hours worked plunged at an 80% pace alone in April. The stimulus from the Fed, Treasury, and Congress is significant in size, but is still more to ensure survival rather than classic Keynesian demand-side effects.

I don’t disagree with any of that, except to note that GDP is an imprecise yardstick for reasons I described just two months ago. We use it because we have nothing better. But whatever the yardstick’s flaws, the economy’s direction is clear. Experts differ only on the downturn’s magnitude.

Here, courtesy of Schwab’s Liz Ann Sonders, is a roundup of GDP forecasts.

We are in such uncharted waters, any of these could be right. The average forecast seems to show a 30% to 35% drop. That’s as good a guess as any.

It will be bad, whether it is V, U, L, or W-shaped.

These numbers are so large we start running into a math problem. If you lose 33% and then make 33% the next quarter, you are still in the hole. Recovering from a 33% loss requires a 50% gain. Anything less and you are still in the hole.

I am trying to imagine how such a sharp recovery could happen between now and October. The only scenario that comes to mind would be some kind of magic-bullet COVID-19 treatment that keeps people out of intensive care and which we can quickly deploy at scale.

That would let everyone breathe easier until we have a vaccine. And it could happen, too. Gilead just reported positive results from their Remdesivir drug, for instance. But do you bet your life on it? Not yet, which means recovery will be a lot slower.

Here are the WTO’s full-year GDP estimates for various areas, via Saxo Bank.

To get a V-shaped GDP recovery, we need to see a V-shaped demand recovery, and that’s just not in the cards. Here’s Ian Bremmer.

There's also the broader question of getting people to participate in the economy. Obviously, in this environment you're not going back to crowded bars and restaurants, movie theaters, concerts, and sporting events any time soon. All of these can be reconfigured with fewer consumers, health check screening, improved health measures, and the like, though whether they can remain profitable at that level is another question entirely.

And then you have the question of how many people have the money to spend, even under those circumstances. With businesses under stress across the economy, they need to improve efficiency. And they will—most every CEO I know has been telling me how they'll be able to make more money with fewer people over the coming decade. They're now being pushed to figure out those cost savings immediately, all at once.

As one Fortune 100 CEO said last week: "I guarantee that our company, like many others, will operate with fewer people, smaller buildings, and far more efficient ways of doing business." So the fourth industrial revolution is about to become the post-industrial revolution for large numbers of former workers; medium term, that feels to me like a minimum of 10% of the economy. Consumption across the board will be hit accordingly.

I am not so sure of that last part. If operating more efficiently with fewer people, smaller buildings, etc. were so easy, these CEOs would (and should) have already been doing it. I’m not sure they appreciate how different life will be.

I completely agree with Ian that employment will not come back to previous levels any time soon. Government benefits aren’t going to replace all the lost income, either. The hit to demand will be severe and suppress GDP growth for a long time.

A Few Thoughts on Unemployment

The economic data not only doesn’t fit the models, it doesn’t fit the charts.
Literally. You’ve probably seen the recent weekly jobless claims in bar chart form. Here is one example.

Source: GZERO Media

We know from unemployment insurance claims we have lost at least 22 million jobs in the past four weeks. Unemployment in the 20%+ range, perhaps even approaching Great Depression levels of 25%, would not be surprising, depending on how fast we begin to open the economy back up.

The unemployment insurance model was created in a world that has long since passed. So many of our children and indeed, consultants and the self-employed, are in what has come to be called the gig economy. They had been making a living in the gig economy, often doing 2 to 3 different jobs, none of which paid unemployment insurance and none of which gave them enough money or verification to be able to claim it.
Yes, some of it was under the table. But it makes no difference if they are hungry and can’t eat or find a place to sleep. In one sense, if we can bail out companies and their corporate bonds (which is often private equity) which are indeed going to be zombie companies in the post-vaccine world, as everything will change, are the people working in the gig economy any less necessary or worthy?

Many private surveys indicate between 25 and 30% of workers had engaged in non-traditional or gig work on a supplementary or primary basis in the preceding month. Since large-scale public surveys, like those administered by the Bureau of Labor Statistics, tend not to ask about supplemental work, these private surveys are some of the best estimates we have of supplemental or occasional gig workers.

Dear gods, we are all in this together. If we ignore that large a percentage of the labor force, we are digging a deeper recessionary hole than we can ever imagine, one that will not show up in the data that economists so very much love until much later. When it is too late to do anything about it.

Think on these things as we worry about things like deficits and debts. We are trying to rebuild not only the US economy, but that of the world. Bill Gates is very correct in this: We have to defeat this virus globally in order to be able to be safe locally. Or accept a much-reduced growth in the economy.

Repricing the World

Dave’s final question was about longer-term fallout.

Now for #3, we are going to be in for a prolonged period of social distancing and our personal and commercial lives will remain restricted. The focus will be on savings, cash conservation, ensuring adequate essentials on a personal basis, and inventory/working capital on a corporate basis. The government dis-saving via massive deficits will be offset by rising precautionary savings rates in the private sector.

Economic change begins with individual changes in behavior. People respond to new incentives and eventually the responses add up. I have written about the Paradox of Thrift, where individual savings are good but everybody saving actually reduces GDP. I think after this current crisis/recession the propensity to save will be much higher. Our spending incentives will be different. So what are the new incentives, and how will they change us?

Well, most obviously, we are seeing that personal safety isn’t easy or guaranteed. It is no longer enough to drive carefully, take your vitamins, and avoid rough neighborhoods. The threat is invisible and anyone, even the people you love, could be carrying it. This will have a deep and long-lasting effect on personal relations and spending patterns.

We are going to think very differently about some previously well-established things, and it will certainly affect their prices. Right now, crowded concerts or sporting events are simply off limits. Soon we may allow them with modifications: wear a mask, stay six feet apart, and so on. But being in a crowd, being shoulder-to-shoulder with your fellow fans, is part of the experience. It won’t be the same. And because the product has changed, the price will likely change, too.

That’s a problem not only for artists and athletes, but also the many people whose jobs revolve around such events. Ditto for restaurants, hotels, many other businesses. They will be repriced, probably downward.

But right now, the Federal Reserve is spending trillions to make sure companies don’t default. Maybe in some cases that makes sense, but it also calls into question who is bearing credit risk. Why should bondholders get paid for risk someone else is bearing?

Then again, if we allow the high-yield and leveraged loan market to collapse, we guarantee a deeper recession. Is that what we really want? Just so we can punish the “bad guys” who overleveraged? Another trade-off…

The same is true for stocks. This week the US government spent billions bailing out airlines. What should have happened—and did happen in the past—is the airlines go bankrupt and courts sort out their obligations. Not this time, and maybe not ever again. If so, there is no reason stock valuations should reflect risk shareholders aren’t taking.

We don’t know how this will develop, or how quickly, but I think it is far more likely to bring asset price deflation than inflation. We are going to reprice the world. Probably including your part of it.

Staying at Home

Like most of you, I am staying at home. But I seem to be busier than ever. This will be a short ending with a link to a fun musical presentation about the coronavirus experience. But before you click on that one, register here for the Virtual Strategic Investment Conference. As I said, it will be the most important conference I’ve ever hosted. You really want to attend in the safety of your own home or office. I guarantee it will be powerful and change your life.

Have a great week. I assume you are doing what I’m doing, calling old friends and catching up. That part of the quarantine has been very rewarding.

And assuming that you’ve already signed up for the SIC, here is that link I promised.

Your thinking it is time to end the lockdown analyst,

John Mauldin
Co-Founder, Mauldin Economics

Stringent and stingy

Emerging-market lockdowns match rich-world ones. The handouts do not

Few emerging-economy governments can afford a generous fiscal response

When the global financial crisis struck emerging economies in 2008, two kinds of exodus ensued. Footloose capital fled their financial markets and migrant labour left their cities for the bosom of their hometowns and villages. Since the “coronacrisis” struck, the first exodus has recurred on an unprecedented scale: foreigners took over $83bn out of emerging-market shares and bonds in March, according to the Institute of International Finance, a banking association, the largest monthly outflow on record. But the exodus of labour has been hampered by governments’ efforts to shut down transport and lock down populations, in order to slow the spread of covid-19.

At least 27 emerging economies have imposed nationwide restrictions on movement, according to a tally kept by Thomas Hale and Samuel Webster of the Blavatnik School of Government at Oxford University.

Vietnam became the latest candidate for the list, requiring its citizens to stay home until April 16th. Pakistan’s prime minister, Imran Khan, once warned that a lockdown would bring hunger and ruin. But even Pakistan “has swiftly moved from we can’t afford lockdown, to we can’t afford not to lock down,” notes Charlie Robertson of Renaissance Capital, an investment bank.

All countries have spared “essential” goods and services from restrictions. But what counts as essential? India’s list, derived from a law passed in 1955, at first failed to mention feminine-hygiene products, causing confusion.

South Africa scrambled to add toothpaste and baby products to a list of “basic goods” that had omitted them. There have been errors of inclusion too. Days into its lockdown, South Africa’s government discovered that some pubs had been mistakenly awarded certificates to operate.

Even industries deemed essential can suffer from broader restrictions. One pharmaceutical plant in northern India says it can produce, but not ship, its wares. A maker of medicine capsules eventually won approval to keep operating. But by then some of its employees had left town and others were scared to return to work.

Whereas previous crises have imposed a financial constraint on economic activity, this disaster has imposed a “physical constraint”, points out Alberto Ramos of Goldman Sachs, a bank. He expects Latin America to suffer its worst contraction since the second world war, exceeding even its debt crisis of the 1980s. Much depends on how long the lockdowns last.

India’s is due to be lifted on April 15th, but restrictions may linger in states with high numbers of infections, points out Priyanka Kishore of Oxford Economics. Several of those states, including Maharashtra and Karnataka, are among the biggest contributors to India’s economy. If 60% of the country remains locked down until the end of April, she calculates, up to 10% of India’s gdp in the second quarter could be lost.

The lockdowns in many emerging markets are as tough as in the rich world, or more so, suggests an index created by Mr Hale and Mr Webster measuring the “stringency” of a government’s response to the pandemic.

But unlike their richer counterparts, few emerging-economy governments can match this stringency with an equally generous fiscal response, according to numbers collated by Sherillyn Raga of the Overseas Development Institute, a think-tank (see chart).

Malaysia may be one exception. It has unveiled a relief package with a face value of over 16% of gdp, including loan guarantees, wage subsidies and even free internet during the period of social distancing.

Not many other emerging economies can enact anything similar. India, for example, has announced a plan to help the poor worth 1.7trn rupees ($23bn), only about 0.8% of gdp. Even that includes previously budgeted outlays that will merely be spent sooner. South Africa’s fiscal response has been inhibited by rising borrowing costs.

Last week Moody’s became the last of the big three credit-rating agencies to strip it of its investment-grade status, calculating that the government’s budget deficit this fiscal year would exceed 8% of gdp and that its debt, including its guarantees to state-owned enterprises, would rise from 69% of gdp to 91% by 2023.

Central banks have been a little more adventurous, cutting interest rates despite the slump in emerging-market currencies. Some, including those in Colombia and South Africa, will emulate America’s Federal Reserve by buying government bonds in the open market to reduce volatility. Indonesia will cut out the middleman: new rules allow its central bank to, in extremis, buy bonds directly from the treasury.

But no emerging market, almost by definition, can afford to ignore its exchange rate entirely. Russia’s central bank, for example, recently refrained from cutting interest rates because the rouble has tumbled so dramatically in the wake of the country’s oil-price war with Saudi Arabia. The tussle caused oil prices to dip below $20 a barrel this week, according to America’s benchmark, for the first time since 2002.

In some countries (such as Argentina), governments still have substantial foreign-currency debt. In others, companies do (Turkey). And in still others (South Africa), a large share of local-currency debt is held by foreigners, who will be reluctant to roll over their holdings if the currency becomes unmoored.

In order to measure countries’ vulnerability, analysts at Morgan Stanley, a bank, have calculated the amount of hard currency emerging economies would need to service their foreign debt this year and cover their trade balance, if oil prices remain low, remittances from overseas workers drop by 25%, export earnings from tourism and travel disappear, and foreigners dump a third of their holdings of shares and bonds.

They then compare this amount to these countries’ foreign-exchange reserves (see chart). Many emerging economies would lack enough reserves to meet their needs, leaving them reliant on further foreign borrowing in hostile markets.

In such circumstances, some emerging economies will turn to the imf. Indeed the fund says over 80 countries have already asked for some form of help in recent weeks. Others may extend their lockdowns into the financial realm. In a report published on March 30th the United Nations Conference on Trade and Development argued that some countries should impose capital controls, with the imf’s blessing, to “curtail the surge in outflows”.

Having prevented labour from moving freely within their borders, some overstretched emerging markets may now be tempted to stop capital moving freely across them.

Universities are pleading for a bailout to paper over their failures

Many pursued a high-risk strategy of debt and expansion; now they must work together or go to the Wall

Camilla Cavendish

Artwork for FTWeekend Comment - issue dated 04.04.20
© Jonathan McHugh 2020

Are universities too big to fail? As Covid-19 sweeps the globe, some UK universities, highly dependent on foreign students and summer courses for income, are looking into the abyss.

Allowing a university to go bust would be devastating for students in the middle of their courses, and for some local economies. Higher education has been central to urban regeneration, and has grown almost as fast as the tech sector. Manchester university has 39,000 students; University College London has 38,000, twice as many as a decade ago.

Nevertheless, the sector’s demand for a £7bn bailout feels a bit rich. A good university is an immeasurably precious thing. It can foster the spirit of inquiry we are seeing among the scientists battling coronavirus. But the universities have been playing a dangerous game. Many have pursued a high-risk strategy of expansion, indebting themselves to attract overseas students’ fees, and treating students as cash cows.

It is not axiomatic that UK taxpayers should now take on the financial risk of bridging what will be a shortlived hit to revenue — or not without a quid pro quo.

Nor is it entirely universities’ fault that they are in this position. They were encouraged by evangelists for undergraduate tuition fees to act like businesses. Facing the loss of other government revenue alongside rising costs, they sought to become part of a market.

Unfortunately, too many decided this meant paying vice chancellors hefty salaries and hiring expensive senior managers. Between 2005 and 2018, the number of university marketing and public relations staff rose nine times faster than the number of academics.

Professors became bit-part actors in an arms race to attract lucrative customers — overseas students can be charged two or three times the domestic rate. To find them, some universities have even resorted to paying agents’ commission. A quarter of all students at UK universities are now from overseas, according to the Higher Education Statistics Agency.

While it is right to seek the best and brightest, the effect on standards of expanding undergraduate numbers has been dubious at best. There has been an explosion in unconditional offers made to teenagers in UK schools, leading to fears that some students fall shy of what they could achieve at A-level.

Pre-degree “foundation years” for students with lower grades are another source of additional income for institutions. The 2019 Augar Review of post-18 education recommended abolishing them, since similar courses already exist in further education colleges at a fraction of the cost.

Many institutions have never really made the transition to understanding their customers, in spite of the transition to a market model. Some cram in students, and offer far too little contact time with academics. Fewer than half of UK undergraduates say they get good value for money, according to the Higher Education Policy Institute, and that’s probably more than a comment on the beer in the student union bar.

When I mentored a London university undergraduate a few years ago, I found that she often struggled to know what she was supposed to be working on. Her course was full of jargon, her supervisor changed frequently, and the mental health support was minimal. It was a dispiriting experience. The first in her family to go to university, she deserved much better.

The irony is that tuition fees were supposed to make universities more responsive to undergraduates, with student choice driving up standards and producing a wider range of options. Yet far from seeing a profusion of differently-structured courses at different prices, we have seen an almost uniform rush to maximum fees for the traditional three-year degree beloved by parents.

Instead of investing in teaching, many institutions racked up debt to build new facilities: sports halls, libraries and student flats — many no doubt welcome but not all necessary. Borrowing by universities trebled to £12bn between 2010 and 2018, with universities continuing to leverage up even after the uncertainty of the Brexit vote.

While policymakers run in ever tighter circles to improve the chances of bright kids from deprived backgrounds in the UK, the easiest way for institutions to improve their finances is to reduce the overall number of Brits.

The pandemic has already wrought huge uncertainty among this year’s A-level candidates about their grades and university offers. It would be even more upsetting if their preferred institution was to close its doors. That is more likely to happen if higher-status universities seek to cannibalise the market, poaching from other institutions lower down the pecking order to fill places left vacant by foreign students.

This exposes the central dilemma: either there is a market, in which universities compete for students and some may go to the wall; or universities work together through this crisis. The sector cannot have it both ways by simply demanding a bailout.

In 2018, Michael Barber, head of the Office for Students, the higher education regulator, warned universities not to expect bailouts, after a report that three were on the brink of bankruptcy.

While a pandemic is an unforeseen emergency, Sir Michael would be right to demand that any institution which gets support invest in its offer to students, not in marketing. With four universities ranked in the global top 10, I have no doubt that Britain’s future rests on being a global research powerhouse. But we need the teaching to match.

The writer is a senior fellow at Harvard University and an adviser to the UK Department of Health and Social Care

The Big Read


Bolsonaro, Brazil and the coronavirus crisis in emerging markets

The country’s struggle to cope with plunging commodity prices is complicated by political infighting

Jonathan Wheatley in London and Andres Schipani in São Paulo

© Adriano Machado/Reuters

On the Thursday before Easter, Jair Bolsonaro stopped off at a bakery near the presidential palace in Brasília. Sipping a Coca-Cola and eating a pão de queijo, Brazil’s president posed for photos with his arm around employees and supporters. The following day the former army captain visited a pharmacy in the city.

“No one can hinder my right to come and go,” he told a tightly-packed throng of journalists.

Mr Bolsonaro, a far-right populist who surged from semi-obscurity to power in 2018, was making a show of defying the social distancing rules recommended by his own health officials to stop the spread of coronavirus. On Easter Sunday, his popular health minister, Luiz Henrique Mandetta, a doctor who had spearheaded the measures to tackle Covid-19, pushed back on what many see as the anti-science approach of the president.

“When you see people going into bakeries, to supermarkets, this is clearly something that is wrong,” said Mr Mandetta, whose air of competence has drawn comparisons with Anthony Fauci, the scientist advising US president Donald Trump.

Speaking to TV Globo, he added that Brazilians “don’t know whether to listen to the health minister or to the president”.

On Thursday, Mr Mandetta was fired.

Brazilian President Jair Bolsonaro (L) and his Health Minister Luiz Henrique Mandetta sanitize their hands wearing face masks during a press conference related to the new coronavirus, COVID-19, at the Planalto Palace in Brasilia, Brazil on March 18, 2020. (Photo by Sergio LIMA / AFP) (Photo by SERGIO LIMA/AFP via Getty Images)
Luiz Henrique Mandetta, right, the doctor who had spearheaded the measures to tackle Covid-19, hands Jair Bolsonaro hand sanitiser © Sergio Lima/AFP/Getty

Across the developing world, the pandemic is causing a devastating economic crisis — even in countries where the disease has barely arrived yet. Economies are being battered by collapsing revenues from oil and tourism and sudden capital outflows. The IMF, which has warned about the steepest recession since the 1930s, has already received requests for emergency support from more than 100 countries.

While developed nations are throwing money at their slumping economies and struggling health systems, even many of the richest emerging markets lack the resources to act in the same manner.For Brazil, the pandemic is a double blow.

The economy was already in a parlous state, having yet to recover from a sharp recession in 2015-16. Its public finances were under heavy pressure even before the pandemic; mounting a fiscal response to the decline in the demand will create even greater strain.

On top of that, it has a dysfunctional federal government, with an ideologically-charged president openly opposing the strategy for fighting the disease proposed by many in his cabinet, senior lawmakers and the bulk of state governors, even some who were until recently allies.

Marcos Lisboa, an economist and head of the Insper business school in São Paulo, warns that the pandemic has hit the Brazilian economy when it was least prepared. “This crisis arrived when Brazil was very fragile after several years of low growth, and with a government incapable of taking co-ordinated action in the face of the outbreak,” he says.

“The lack of leadership, the lack of co-ordination, the lack of public policy have turned this into chaos.”

Chart showing investors have fled emerging markets with Brazil and Mexico hit hard by outflows

Brazil now has more than 36,000 cases of Covid-19, registering 188 deaths on Thursday alone.

But the country felt the financial impact of coronavirus long before its first registered death on March 17. While the global financial crisis was a slow-burning event that took months to spill over into many asset classes, in countries such as Brazil Covid-19 took a matter of weeks.

The Brazilian real was already under pressure at the start of the year as a result of the weak pace of recovery and a steady drop in Brazilian interest rates. As global markets woke up to the threat of coronavirus in late January, a moderate sell-off in the real turned into a rout. The currency has lost more than a quarter of its dollar value this year.

Foreign investors began selling Brazilian stocks, then bonds, at an accelerating pace. Stocks on the São Paulo exchange lost almost half of their value between late February and late March, recently recovering some ground. Even large, well capitalised companies with huge cash buffers such as oil group Petrobras and mining company Vale saw their long-dated foreign currency bonds lose 30 to 40 cents on the dollar — at any other time, a signal of impending debt restructuring or default.

“It happened so quickly,” says Roger Horn, senior emerging markets bond analyst at SMBC Nikko, a New York broker. “People weren’t thinking about recovery value; this was priced to panic.”Across emerging markets, foreign investors dumped assets on a scale never seen before.

According to the Institute of International Finance, equity and bond markets in 21 large emerging economies suffered cross-border outflows of $95bn in two and a half months from January 21, more than four times the amount that left in the same period after the start of the global financial crisis in September 2008.

Mandatory Credit: Photo by JOEDSON ALVES/EPA-EFE/Shutterstock (10616679e) Brazil's new Minister of Health Nelson Teich (L) and Brazil's President Jair Bolsonaro (R) pose during Teich appointment, at the Palacio do Planalto, in Brasilia, Brazil, 17 April 2020. Brazil appoints new Minister of Health, Brasilia - 17 Apr 2020
New health minister Nelson Teich with Jair Bolsonaro © Joedson Alves/EPA-EFE/Shutterstock

This adds up to a sudden break in the supply of credit and a sharp tightening of financial conditions. Across corporate sectors, any certainty about the future dissolved. Capital expenditure slowed almost to a standstill.

In Brazil, the economy ministry last month cut its forecast of growth in gross domestic product this year from 2.1 per cent to zero. The IMF expects far worse: it estimates a contraction in Brazil’s economy of 5.3 per cent, deeper than the 3.5 per cent decline in 2015 and far worse than the 0.1 per cent contraction in 2009 during the financial crisis.

Brazil and other big emerging economies came through that crisis relatively unscathed, thanks largely to stimulus measures across the globe and especially from China, which sucked in commodity exports from much of the developing world.

This crisis is different.

As the IIF said in a recent report it is synchronised across the world and set to be markedly worse than the 2008-09 crisis. For emerging markets, the outlook is especially bleak.

Latin America and the Caribbean, along with emerging Europe, will suffer the steepest contraction, according to the IMF, with output falling 5.2 per cent this year. Only emerging Asia will grow, by 1 per cent according to the Fund, thanks to China and India.

Even before the coronavirus crisis, the large emerging economies had been struggling to reproduce the levels of growth seen in the 2000s, when they outpaced advanced economies by a wide margin.

The end of the commodities supercycle, declining returns on international trade and disruption of supply chains caused by the US-China trade war had already raised big questions about what, if anything, would drive their economies in the future.

“There are no longer those big turbo engines to boost EM growth, and this is really a challenging question,” says Phoenix Kalen, emerging markets strategist at Société Générale in London. Before coronavirus, she says, the expectation was that developed markets would stagnate over the medium to long term and emerging markets would eventually slow to a similar pace.

Now “we can write this year off,” she adds. “As we come out of the crisis we will still have to answer questions — will there be a new wave of infections, will consumer demand normalise to previous levels, how much will capacity use rebound?”

Emerging economies are also entering this new crisis against the backdrop of sharply higher levels of debt. Over the decade to the end of 2019, according to data collated by the IIF, the total debts of the 30 largest emerging markets rose from $28tn to $71tn, or from 168 per cent of GDP to 220 per cent.

WASHINGTON, DC - APRIL 05: Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, speaks alongside U.S. President Donald Trump at a press briefing with members of the White House Coronavirus Task Force on April 5, 2020 in Washington, DC. On Friday, the Centers for Disease Control and Prevention issued a recommendation that all Americans should wear masks or cloth face coverings in public settings. (Photo by Sarah Silbiger/Getty Images)
US president Donald Trump listens to scientific advisor Anthony Fauci © Sarah Silbiger/Getty

Government debt also rose strongly in some economies, up from 65 per cent of GDP in Brazil to 89 per cent in the last decade, and doubling in South Africa from 32 per cent of GDP to 64 per cent.

As GDP contracts and the amount of debt rises in response to the coronavirus crisis, those ratios are likely to increase. The IIF says South Africa’s government debt could soon rise to an unsustainable 95 per cent of GDP.

“What we’ve been saying consistently is that, yes, the debt is manageable now, with these interest rates at this level of risk appetite,” says Sonja Gibbs, head of sustainable finance at the IIF. “But under other circumstances it won’t be. We are now in other circumstances.”

In Brazil, she notes, while the biggest companies may have cash buffers, the corporate sector as a whole does not. Overall, the ratio of short-term debt to cash among Brazilian companies is 66 per cent, according to the IIF’s analysis, one of the highest levels among large emerging economies.

Brazil, along with South Korea and Mexico, is among a handful of countries to have been offered swap lines of $60bn each from the US Federal Reserve — a repeat of its action in the crisis of 2008-09. This gives those countries a lifeline of dollar liquidity to meet financing needs.

But other emerging economies have been left out.Late on Friday, Brazil's economy ministry laid out an emergency support package of R$1.2tn ($223bn) — equal to the entire projected savings over the coming decade from last year’s landmark pension reform.

It includes support for the poor, for workers, local governments and businesses as well as the health sector. But it is not clear how far it will reach into the real economy. Only about a quarter is new money.

A woman beats a pot from her window as she protests against Brazil's President Jair Bolsonaro's during the coronavirus disease (COVID-19) outbreak in Rio de Janeiro, Brazil, March 24, 2020. REUTERS/Pilar Olivares - RC2OQF9JQVD2
In recent weeks large numbers of Brazilians have taken part in a nightly 'panelaço' while chanting 'Bolsonaro out!' out © Pilar Olivares/Reuters

Into this rapidly deteriorating economic outlook, the erratic outbursts of Mr Bolsonaro have only added to the sense of drift. The public dispute between the president and Mr Mandetta had been escalating for weeks. While the former health minister warned that the health system was likely to come under intense pressure in May and June because of the pandemic, Mr Bolsonaro insisted last weekend that the virus “looks like it is starting to go away.”

Adopting many of the positions articulated by Mr Trump in recent weeks, Mr Bolsonaro has pushed for a prompt reopening of the economy and promoted the use of malaria drugs chloroquine and hydroxychloroquine to treat people with the virus — advice that Mr Mandetta said was not yet backed by sufficient scientific evidence. The president has referred to Covid-19 as little more than a “sniffle”.

He has clashed with several governors who have largely supported the advice to impose lockdowns. In late March, Ronaldo Caiado, the conservative governor of the central state of Goiás and a one-time ally, said the president’s approach was “totally irresponsible”.

On Thursday, Mr Bolsonaro slammed Rodrigo Maia, the powerful speaker of the lower house of Congress, after he had hailed Mr Mandetta as a “true warrior” of public health following his sacking. However, the new health minister, Nelson Teich, has supported social distancing, suggesting the president might not completely reverse policy for dealing with the pandemic.

Jair Bolsonaro visits bakery in Brasilia - screen grab taken from a video posted on Eduardo Bolsonaro's Twitter page:
Jair Bolsonaro eats a 'pão de queijo' at a bakery near the presidential palace in Brasília © BolsonaroSP/Twitter

While his counterparts including Alberto Fernández in Argentina and Martín Vizcarra in Peru have imposed strict lockdowns in their countries and saw their approval ratings rocket, Mr Bolsonaro’s popularity has fallen. A poll released by Atlas on Thursday showed that 76 per cent of Brazilians opposed sacking Mr Mandetta, while 58 per cent disapproved of Mr Bolsonaro’s handling of the country.

In recent weeks large numbers of Brazilians have taken part in a nightly panelaço — a time-honoured South American tradition of banging pots and pans — while chanting “Bolsonaro out!” outside their windows or on their balconies. Some opposition politicians have even started to talk about an attempt to impeach the president — although most political analysts believe this would be unlikely in the midst of a crisis.

Unlike Dilma Rousseff, his leftist predecessor whose ratings sunk before her impeachment, he still holds a powerbase of support, but critics warn about the impact of his performance during the crisis.

“In addition to the risks he poses to democracy and public health, Bolsonaro also brings the country to a standstill while we all wait for his erratic decisions,” says Daniela Campello, a professor of politics at the Getúlio Vargas Foundation. “Will we survive?”

The $40 Trillion Problem

by: Lyn Alden Schwartzer

- Most of the Fed's liquidity operations, ultimately, are to support the U.S. treasury security market.

- The U.S. debtor nation status plays an important role in why the Fed is on the hook to provide foreigners with dollar liquidity.

- Keep an eye on international markets with positive net international investment positions; they could do well post-virus.

Over the past several weeks in response to the COVID-19-induced global economic shutdown, the U.S. Federal Reserve has announced an unprecedented number of operations to relieve or bail out various markets, as the lender of last resort.
Eric Basmajian provided a solid breakdown of the operations in place as of a couple of weeks ago, and that article is certainly worth a read. The Fed has expanded the monetary base to buy Treasuries and other securities at a record pace, has put in place various lending facilities, and has opened a record number of currency swap lines with other countries.
This article takes a look specifically at some of the Fed’s international operations to help readers understand why the rest of the world is currently the Fed’s problem. The short version is that most of what they are doing is ultimately to protect the U.S. Treasury market.
It’s The Debt, Not Just The Virus
Many analysts are focused on the impact of the virus itself, which is indeed very large. Nearly 10 million jobless claims were filed in the United States in the past two weeks due to the shutdown of restaurants, travel businesses, casinos, physical retail, and parts of several other industries, and that can’t be understated. Job losses are likely to continue as well.
However, the sheer speed of the market’s crash, and the unprecedented actions by the Federal Reserve and other central banks around the world to support the credit market, point to an even larger issue: we’re likely in the later stages of a global debt supercycle. The sheer amount of debt in the world makes temporary income disruptions a lot more financially impactful than they would be in a system with less leverage.

As of 2019, global debt surpassed $250 trillion, which is more than 250% of the world’s GDP.
In the United States, our total debt (government, corporate, and household) is around 350% of GDP, which is the same ratio of debt that we had back in 2007 at the start of the previous financial crisis (although during the crisis, it ended up reaching as high as 380%):
Chart Source: St. Louis Fed
We have less mortgage debt relative to GDP, but most other types of debt, especially sovereign debt, are higher as a percentage of GDP in 2020 than in 2007. We just re-arranged where the debt is concentrated, and pushed it up especially to the sovereign level.
The $40 Trillion Problem
The U.S. dollar is used around the world for purchasing commodities, settling a large portion of international trade, and providing financing for companies between nations. However, the usage of the dollar has exceeded the growth of the U.S. economy and U.S. money supply, which along with other factors has led to a global dollar shortage. This shortage becomes particularly acute during global economic slowdowns or recessions, such as in 2008, 2016, and 2020 when trade diminishes and commodity prices fall in dollar terms.
There is a lot of dollar-denominated debt held by institutions outside of the United States. The Bank for International Settlements estimates this figure at over $12 trillion. It’s much smaller than the amount of dollar-denominated debt within the United States, but can be just as problematic because dollars are more scarce outside of the United States.
And it’s worth noting that these $12+ trillion in dollar-denominated debts mostly aren’t owed to lenders in the United States; institutions in various countries lend to others in dollars.

When global trade slows down and commodity prices fall, the global dollar flows diminish from a roaring river to a small stream, so these dollar debts suddenly become a lot harder to service thanks to a scarcity of dollars outside of the United States relative to the size of these debts.
Here’s the BIS chart of ex-USA dollar-denominated debts:
Source: BIS
Back in 2008, when ex-USA dollar-denominated debts were about $5-$6 trillion and global trade slowed down, the Fed did currency swaps with several major ally central banks, to ensure they have adequate dollar liquidity to supply their institutions with.
In 2020, they’re doing currency swaps with the same countries, but also nine new ones including several emerging markets.
In addition, the Federal Reserve has an international repo operation, meaning that foreigners can lend their Treasuries to the Fed as collateral in exchange for dollars.
Many readers may be wondering, why is this the Fed’s problem?
Why does the United States need to provide dollar liquidity to the rest of the world, who have $12+ trillion in dollar-denominated debts and a shortage of dollars to service those debts? Why not just let it all burn down, i.e. let it all default, outside of the United States?
For sure, it’s not out of the kindness of the Fed’s heart.
Instead, it’s because the U.S. is a debtor nation, and providing dollars is required if the Fed wants to ensure stability in the U.S. Treasury market and the rest of the U.S. economy and capital markets.
As I described in my article about the Great Depression, after World War I, the United States became the world’s largest creditor nation, meaning that Americans owned more foreign assets than foreigners owned of American assets.
However, due to persistent trade deficits as the world reserve currency (meaning more wealth flows out of the country each year than into the country), we lost creditor status and entered debtor status starting in the 1980s, meaning that foreigners now own more American assets than Americans own of foreign assets.
When the 2007/2008 financial crisis began, the U.S. net international investment position was equal to about -10% of U.S. GDP. It has worsened significantly since then in just those 12 years, and is now about -50% of U.S. GDP.
Chart Source: St. Louis Fed
Specifically, foreigners own $40 trillion in U.S. assets, including portions of our government debt, corporate debt, stocks, and real estate. Americans own just $29 trillion in foreign assets.
So, we have a negative $11 trillion net international investment position (NIIP deficit) with the rest of the world, which equals about -50% of our $22 trillion GDP.
Chart Source: U.S. BEA
Today, Japan is the world’s largest creditor nation, meaning that they have the largest absolute positive NIIP. This means that the gap between the amount of foreign assets they own vs. the amount of Japanese assets foreigners own is larger in absolute terms than any other country.
Germany, China, Taiwan, Switzerland, Norway, Singapore, and Saudi Arabia are also high on the list of creditor nations in absolute terms.
The United States is the world’s largest debtor nation, meaning we have the most negative absolute NIIP. We’re the world’s worst in absolute dollar terms, and one of the low ones in terms of NIIP as a percentage of GDP, although several countries like Ireland and Spain are worse in those relative-to-GDP terms, so we’re not at the very bottom in that sense.
The reason why this matters, is that foreigners have two ways to get dollars when they really need them. They can participate in international trade, or they can sell their U.S. dollar-denominated assets. In healthy markets, they choose the first option (and are generally net buyers of U.S. assets with the dollars they receive through trade), but during a global slowdown or recession, that trade dries up.
So, when dollar debts need servicing, they are forced to sell U.S. assets to get dollars. In fact, that’s one of the key reasons why international central banks hold foreign-exchange reserves in the first place; to backstop external obligations if necessary.
This is why the dollar tends to briefly spike higher during recessions. International trade slows, dollar-denominated debts become an international problem, and everyone scrambles to get their hands on dollars.
And this is why the U.S. Federal Reserve has a $40 trillion problem at the moment. There is a global dollar shortage, and with international trade and commodity prices so low, dollars outside of the United States are in short supply relative to the size of the dollar-denominated debts that those dollars need to service.
Therefore, many institutions, both public and private, need to tap into their store of reserves, sell U.S. assets, and get U.S. dollars. Foreigners held $40 trillion in U.S. assets going into this crisis, of which nearly $7 trillion were U.S. Treasury securities (bills, notes, and bonds).
Foreign-holding data for U.S. Treasuries gets updated monthly and with a considerable time lag, but the large subset of foreign holdings of U.S. Treasuries at the Fed’s custodian account is updated more frequently. It’s an incomplete data set, but a more rapidly-updated one, and it shows us that foreigners sold at least $119 billion in Treasuries in the past four weeks:
Chart Source: St. Louis Fed
That chart shows the trade-weighted dollar index in red and the value of Treasuries held by foreigners at the Fed as custodian in blue. Whenever the dollar spikes higher, foreigners start selling Treasuries.
Those few weeks in mid-March, when the blue line went vertically down meaning that foreigners were rapidly selling Treasuries, is when Treasury yields spiked, Treasury bid/ask spreads widened to the point of becoming uninvestable, and when long-term Treasury security prices crashed. For example, the iShares 20+ Year Treasury ETF (TLT) suddenly dropped by 16% and the Pimco 25+ Year Treasury ETF (ZROZ) dropped by well over 20%:
During the long-duration Treasury security crash, the Fed then began rapidly ramping up its bond-buying program, and introduced a new range of dollar liquidity assistance operations.
The problem for the Fed is that there are not sufficient buyers for Treasuries anymore, especially at a time when foreigners were aggressively selling and some domestic leveraged hedge funds with Treasuries were unwinding positions.
Ever since the repo spike in September 2019, the Fed has been the main buyer of Treasuries via “money printing.” For lack of sufficient buyers, and a large amount of Treasury security supply due to large government deficits, the central bank is now monetizing U.S. government debt. In other words, the Fed is bailing out the Treasury market.
They do this by creating new dollars, and using those new dollars to buy Treasury securities on the secondary market. It was when Treasury security prices were crashing back in mid-March that the Federal Reserve’s balance sheet expansion went truly vertical:
Chart Source: St. Louis Fed
The Fed’s balance sheet has shot up rapidly over the past month to buy Treasuries and other credit securities, to try to backstop the market and provide liquidity. They’re currently running at a $500 billion or more weekly expansion rate, although they are looking to slow that rate a bit in the weeks ahead.
To address this without having to outright buy everything, in addition to a record number of currency swap lines with other central banks now in place, the Fed has initiated a foreign repo operation.
Foreigners can now lend Treasuries to the Fed for dollars rather than outright sell Treasuries on the open market to get dollars, and this will apply to basically any country that has Treasuries and an account at the Fed.
This facility should help support the smooth functioning of the U.S. Treasury market by providing an alternative temporary source of U.S. dollars other than sales of securities in the open market. It should also serve, along with the U.S. dollar liquidity swap lines the Federal Reserve has established with other central banks, to help ease strains in global U.S. dollar funding markets.
In addition, the Fed recently changed leverage ratios for U.S. banks so that they can hold more Treasuries and less cash, which is another way of bailing out the U.S. Treasury market by trying to increase the available buyers, so that the Fed isn’t stuck as basically the only large buyer.
To ease strains in the Treasury market resulting from the coronavirus and increase banking organizations' ability to provide credit to households and businesses, the Federal Reserve Board on Wednesday announced a temporary change to its supplementary leverage ratio rule. The change would exclude U.S. Treasury securities and deposits at Federal Reserve Banks from the calculation of the rule for holding companies, and will be in effect until March 31, 2021. Liquidity conditions in Treasury markets have deteriorated rapidly, and financial institutions are receiving significant inflows of customer deposits along with increased reserve levels.

The foreign operations are particularly interesting to me. It’s an awkward position for the Fed, because they are lending dollars to creditors of the United States in exchange for collateral, so that the creditors of the United States don’t keep hard-selling U.S. assets, especially including U.S. Treasury securities. And any securities that those foreign creditors do sell, the Fed ends up buying outright.
Practical Applications
In the long run, this amount of deficit spending driven by new money creation is likely dollar bearish (and I think the consensus underestimates the extent of deficit spending in 2021, 2022, etc), but not until the global dollar shortage is sufficiently alleviated.
Right now, most central banks are treading water in terms of dollar liquidity until trade increases again. In response to foreign selling-pressure, the Fed will keep aggressively buying U.S. Treasuries and other securities, and keep providing liquidity with swaps and repo operations. We’ll see if they take other actions as well.
More broadly, if we look back at the 2008/2009 global recession, the U.S. stock market double-bottomed at the same time as the dollar index double-topped:
Chart Source: St. Louis Fed
As long as the dollar remains this strong or strengthens further, it will be challenging for U.S. asset prices to rise on a sustained basis, in part because foreign holders of those assets would be more inclined towards being net sellers of those dollar-denominated assets to get dollars. The Fed’s liquidity operations and eventually a resumption of trade, can alleviate this dollar shortage in time.
But for as long as trade remains in peril due to COVID-19 shutdowns, this remains a risk. Only when the dollar falls vs. other currencies would it be easy for U.S. asset prices to rise on a sustained basis.

Emerging markets tend to be particularly dollar-sensitive, because they rely the most on foreign funding relative to their GDP. However, many investors treat emerging markets as one big basket, when the reality is that they are all quite different.
As it relates to the global dollar shortage, some nations have enough dollar-denominated assets to cover their dollar-denominated debts, while others do not.
This chart shows the foreign-exchange reserves of several major emerging market nations as a percentage of their GDP, as well as their dollar-denominated debts as a percentage of their GDP, that they went into this crisis with:
Data Source: BIS and several central bank websites
The EM currencies with more FX reserves than dollar-denominated debts, such as Taiwan, South Korea, China, Malaysia, and Thailand, have held up rather well in this crisis. They have positive NIIPs and when push comes to shove, they have enough U.S. assets to sell to support their dollar-denominated debts. Although they are all under pressure at the moment like everyone else, most of them are creditor nations, which makes a large difference in the end.
On the other hand, the EM currencies with less FX reserves than dollar-denominated debts, and generally with negative NIIP positions, such as Turkey, Indonesia, Mexico, Chile, and South Africa, have lost more value over the past couple months. They are at the mercy of global markets and possible IMF assistance, because they don’t have enough dollar-denominated assets to cover their dollar-denominated debts.
They are debtor nations, like the United States, but with liabilities in a currency that they cannot print. These markets could have strong upside potential in a weakening dollar environment, but don’t really have any agency in the matter and thus have high risk.
There were some exceptions to this trend. For example, Russia has more FX reserves than dollar-denominated debts, and has a positive NIIP as a creditor nation, but as a major oil-producing nation, its currency has taken a hit anyway in this extremely low oil price environment. Saudi Arabia’s currency is pegged to the dollar so they didn’t experience a currency decline at the moment. Brazil’s currency was also hit a bit harder than its ratio of FX reserves to dollar-denominated debts were imply, because it’s also a large oil-producing nation.
So, in this EM currency sell-off, EM currencies that either had a large oil-producing reliance, or shallow FX reserves relative to dollar-denominated debts, were hit the hardest.
In this current sell-off overall, emerging markets have had very similar performance to the S&P 500 so far in terms of drawdowns from their YTD highs:
Back in 2008/2009, when the dollar rose in response to the global recession and dollar shortage, the MSCI Emerging Market Index that tracks equities in emerging markets (EEM) was crushed. The index was hit particularly hard because it went into that crisis extremely overvalued, unlike today where emerging markets were already priced for value.
When the dollar fell in 2009, after all of the Fed liquidity injections and the beginnings of a global economic recovery collectively alleviated the dollar shortage, the emerging market index shot up by 100% in about 10 months. For EEM, this translated into a move from roughly $20 to $40 per share.
As the dollar weakened, the monetary conditions in several EM countries effectively eased, allowing for a rebound in both fundamentals and asset prices.
It’ll be interesting to see how the next year or two plays out. Value-minded investors may wish to look into international markets that are currently at low valuations, but that are creditor nations with sufficient reserves to cover any dollar-denominated debts that they have. The risk/reward potential is rather favorable towards them in my view, for investors that take a long-term perspective.
Final Thoughts
Keeping an eye on the global dollar shortage, the Fed’s actions to supply dollar liquidity, and the resumption of global trade (in part dependent on higher commodity prices), is helpful for determining when U.S. and global asset prices will be under less selling pressure, all else being equal. That seems obvious, but many analysts are focused just on the economics and virus news, when in reality, the global dollar situation is similarly important.
Likewise, noting the difference between creditor nations and debtor nations in terms of NIIPs helps investors manage risk by seeing which currencies are most at risk in a dollar-spike scenario, and explains why the Fed is effectively forced to provide so many foreign liquidity operations if they want to support the U.S. treasury market.
I share model portfolios and exclusive analysis on Stock Waves. Members receive exclusive ideas, technical charts, and commentary from four analysts. The goal is to find opportunities where the fundamentals are solid and the technicals suggest a timing signal.

We're looking for the best of both worlds, high-probability investing where fundamentals and technicals align, and we identified a ton of bearish setups in the past couple months leading up to this crash in our "Where Fundamentals Meet Technicals" series.