Why So Many Emerging Markets Are Blowing Up Right Now

a lot. There are a lot of things around the world this year that maybe in another year would be seen as more systemic or troubling. All kinds of hotspots and arabs and protests basically everywhere you look. Yeah. So, as someone who's in Hong Kong and has been for the past six months, one of the really remarkable things about this year is just how fast we've seen social

unrest basically spread around the world. I think Hong Kong was the first place where it really cropped up this year, but then we saw lots of protests in South American countries, we saw them in the Middle East yet again, and a lot of these are still taking place, of course, and it takes a while to sort of get through the impass with protesters. Yes, and there there's all these protests. You know, they have multiple causes, but each is in

some level inextricably tied to something in the economy. Maybe the economy or some economic decision is a spark. Of course, everything is very complex, but all kinds of things related to public subsidies and pension systems and cutting of government support for various domestic programs, they seem to frequently, uh play a part in the unrest, and of course that feeds into the perception of economic and financial stability everywhere that you see these things flare up. Yeah, I totally agree.

There's always an underlying economic trend in a lot of the dissatisfaction that we're seeing around the world. Absolutely so Today on the podcast, we're going to be speaking to an investor who has been looking at world markets emerging markets for a long time, knows a lot about how these types of things play out or how they don't play out. Maybe learn something about the connection between unrest, fiscal problems, financial stress, bond markets, and how investors can

think about these situations. Yes, I like this one, and before we start, we should just throw out there that one of the really interesting things about all this social unrest and how it affects the fiscal situation of countries is that when it comes to debt sustainability, we don't

really have an overarching bankruptcy regime for the world. Right, every country is sort of different, so you never quite can be sure how these things are going to play out, and each country might experience a very very different outcome, exactly right. So with that, uh, with that intro, I want to bring back Paul McNamara. He's a portfolio manager at GAM Investments. He's been on the show before, one of our favorite people to talk to here. So Paul,

thank you very much for joining us. Thanks very much for having me so interesting year in your line of work, huh, certainly has been. I mean, you know, apart from I mean, I think Lebanon is probably the one in terms of social unrest, but international investors always I think, you know, make good good villains um in the know for for evil capitalism, and I think, you know, in terms of

sovereign debt. There was a thing in the in the New York Times recently when a bunch of hedge funds tried to stop Puerto Rico from spending money on sort of protecting the population from storm damage so that they could repay in full the debt that the hedge funds had bought in the forties. So, yeah, it's an interesting place to be. Um, well, why don't we start with Lebanon. We're going to sort of bounce around from place to place, I think, given that we are talking about emerging in

frontier markets. But I'm particularly interested in Lebanon because I remember when I was out in the Middle East. You know, every once in a while, when you were talking about debt sustainability with an analyst, or when a piece of research cross my desk, it would say something like, Lebanon has a public debt to GDP ratio of something like a hundred fifty percent, which is really really eye catching and probably worse than the majority of even emerging market countries.

And yet every analyst, every research note would kind of swat that away as not really relevant for the time being. And yet something has changed this year and suddenly everyone is very, very worried about Lebanon situation. What was the catalyst for the current crisis yeah, I mean it's hard, it's hard to put your finger on. I think once the government really realized that push was coming to shove. I mean, like you say, Lebanon's ratios have been absolutely horrific.

We usually look at, for example, of current count deficit or a budget deficit of six percent seven percent of GDP as being unsustainable. Lebanon's current count deficit is around twenty of GDP. I mean, most of these ratios are completely off the charts. The reason why I think people have kind of said, oh, well, Lebanon's different is they've

been in the wrong place for a long time. I mean, as as Joe kind of noted, I've been doing this job for a long time, and even in the late nineties when I started out doing this, Lebanon was already running some very peculiar numbers. But what's happening, I think with with rising rates. I mean Lebanon is the one country. I mean Ponzi scheme or pyramid scheme are terms which get thrown around a lot, you know, and and often

very unfairly. But I think Lebanon is one country where that accusation really begins to stick because what happens is that Lebanese, either nonresidents or of non residents claiming to be residents, or you know that there's not a huge

transparency where the money comes from. Bring their money into Lebanon and and you know, and instead of running, you know, sort of yield getting to say one percent one and a half percent on the dollar deposit in a bank anywhere else, you're getting nin on dollar deposits in the Lebanese banking systems. And people thought that was a great trade. They brought their they brought their money back. Basically, the

government spent the money. The central bank used the money to prop up the peg of the of the Lebanese pounds at a touch over a thousand, five hundred to the US DO and it was it was the classic situation. The currency became uncompetitive, huge trade deficits as huge amounts were imported. But every year, you know, the country needed not just to finance the current account deficit, but also

very significant redemp redemptions of of foreign debt. And what's happened this year is that foreigners stopped being willing to roll over the debts, or the Lebanese or whoever it was, it was the end user of these debts, So the banks became absolutely desperate for those foreign dollars, and at that time the supply of those dollars also dried up. Now that could be associated with some fairly unpopular kind of austerity measures, including I think attacks on WhatsApp conversations.

You know that it's easy to kind of to point to a hundred different things. But finally a situation which had always looked unsustainable actually became unsustainable, and you've got some very strange situations happening at the moment. There are no formal capital controls on the Lebanese economy, but there are de facto controls that you know that if you want to take a large cash deposit, you'll find that you're restricted to maybe a couple of hundred dollars per

day to take out of a bank. It's very difficult to make transfers abroad. That you know that a dollar in a Lebanese bank is absolutely not worth a dollar in any other bank. That although the official rate for the Lebanese pound is in one place, there's a there's a gray market where the delirious we've heard around thirty cheaper. So it's all the signs that you quite often associate with countries going wrong. You know, these the official rate

deviating from from the practical rate. Theoretically you can move money around, in practice you can't. So but yeah, I mean what it's the old thing, you know, what can't go on in the end won't go on, And Lebanon looks to be moving much close to that moment of truth. This dynamic that you mentioned in which Lebanese banks were offering extremely high rates of interest, so that are foreign holders of dollars would bring their money back into the country.

Is that unusual or is that something that you see from time to time in countries that have very high demand for hard currency. It's a bit retro really, I mean it used to be much more common because it's it's something that you typically associate with pegs. So, you know, go back twenty years and nearly every country, I mean that's effectively all the countries in Asia, most Latin America had pegs to the dollars or mixed pegs to the dollar and the end and the the Deutsche mark as

it was then. But you know, as all the you know, as peg after peg broke, with I think Russia being the most glaring example. Of this thing of paying up massively for something linked to a dollar. It's really it's it's a very unusual thing to see these days. There are very few, very few pegs left in the world. But yeah, it's something that we've seen in many places before,

and it doesn't you know. And once you get to that point where X number of Lebanese pounds or or a dollar in Lebanon aren't the same as a dollar off shore, that's when things start to spin out of control quite quickly. So the implication here, I guess is that the Lebanese Central Bank was basically underwriting the country's banks and sort of encouraging them to suck in foreign influence so that it could maintain the peg exactly. So does that mean that banking or a financial crisis is

now basically inevitable in Webinon? Inevitable to words us very carefully about Lebanon, it's certainly left to itself. I'd say it's absolutely inevitable. What we find a lot of place people are placing their hopes on. Are the Lebanese looking for a sponsor, you know, either the Saudias or the Iranians. I mean domestic politics in Lebanon is really is really very complicated. But the various richer energy exporting states are often seen as maybe a sort of a magic well.

I suppose a sovereign sugar daddy, which could be which because these some Lebanon is a small country, that seems the only plausible way out. Certainly, the I m F or any of the at any of the other global lenders would be most unlikely to allow that to go ahead, you know, to pump money into the economy without seeing something to address the underlying imbalances. You mentioned the uncompetitiveness

of the currency. What is the I mean if in theory, when you hear about uncompetitive currencies, you think about, okay, that choking off some sort of domestic sector, some domestic say export sector. What if in a sort of more properly managed or more flexible currency, what does leban What is the main potential for Lebanon to improve its terms of trade? I mean, I think it's got great potential

as a service center for the Middle East. I mean sort of Historically, you know, before the rise of Dubai, Lebanon was was a big trading center. You know, in trading centers like Hong Kong everywhere else have gone on to be the financial capital of their regions. I think the civil war and various other things in leban and other reasons. You know why why that didn't happen there, You know, it's it's a very attractive tourist destination, is

very well educated population. I mean that there are plenty of areas where where the country could maybe be more competitive. And also there's a very very large diaspora, and in many other countries around the world, just you know, of foreign remittances are enough to keep to keep an economy going.

But you know, looking at looking at Lebanon now, and even allowing the fact that you know, a substantial recession is pretty much guaranteed in the event of the of the peg breaking, a devaluation of something, you know, over effectively, say, harving the value of the currency really doesn't look like much of a stretch here. So a devaluation is essentially

a debt restructuring in this context. And I did promise that we were going to talk a little bit about international bankruptcy regimes or the lack thereof mechanism by which these actually get results. And one of the interesting things about Lebanon is that it has issued debt to international investors, and I think some of those bonds do have collective action clauses in them. So are we going to get a sort of repeat of the Elliott Argentina situation here?

It looks it's very likely that they're going to try. I mean, the stuff that's that's at risk of the the Elliott Argentina situation is really the older debt because

most collective action clauses. You know, if you get about three quarters of the debts together, and most of this debt is held by or a very large proportion of this debt is held by Lebanese banks or Lebanese residents, especially the older bonds which don't have these collective action clauses, because what you tend to find is that vulture investors choose one or two specific issues and try and own a blocking stake in those bonds, rather than hoovering up sort of odd odd bits of the bonds at a

few cents in the dollar, I mean at the moment, and the Lebanese debt is generally sort of trading, you know, high thirties and forties, not really down at the level where distressed investors would find it interesting. I mean, a lot of the debt that Elliott brought in Argentina, we think was trading twenty cents in the in the dollar or below. But absolutely it's vulnerable, you know, especially, I mean, if you've got a cap it's fine sev the investors agree,

and then the remaining twenty five have no choice. They're automatically sort of bailed in. But it's the older bonds which don't have these clauses, which I think are particularly vulnerable. And you know, we've seen it in Greece as well. You know that there have been other cases where foreign law bonds are effectively senior and that the investors get

get paid, get paid in full. Paul, you mentioned there that even though we've seen a pretty dramatic drop in the price of Lebanese debt, it's not yet trading at distress levels. Why is that, because again, when you look at the actual metrics for the country, it's really really hard to see how it will get itself out of this situation. So why isn't the debt being valued as such? It's very hard to say. I think there's you know that there's there's a certain residual belief in you know,

sort of the sugar daddy from from the Gulf. The yields are sort of high, high teens now, although twenties. It's quite an expensive thing not to be invested in, and a very expensive thing to be short. They have got significant reserves, so you know, there's every chance that even if things do ultimately go wrong, they could certainly

postpone default for for a year or more. And I think it's a combination of those uncertainties, but certainly, you know, given these prices, I'd rather be a seller than a buyer of Levanese debt. I have a weird question, and it's it's gonna be kind of a curveball, and it's something that I wonder about from time to time. But

it's just something on my mind just now. You know, every once in a while, you get you read about some country that's in some sort of extreme distress, the running out of money, the banking system is running out of dollars. We're talking about that with Turkey. A couple of years ago, things quieted down. Why is it so rare for countries to just completely collapse Alla Venezuela, like we all know and have Venezuela in our head is

just a country in which everything has gone. But that's pretty rare in the grand scheme of things, and so you know, you might get some extreme recessions from time to time, but you rarely get all out economic armageddon. Even when the math looks horrible. I can only agree. I mean, you get degrees. I mean Argentina in two thousand and one was another thing, you know, where where you know, there were fears of people going hungry. Uh, Fortunately the country is a huge food export, as they

had surplus food. I think in Iceland we came very close to the edge there. They were lucky in that, you know, they have ample power use of hydro and geothermal. But yeah, I know, countries, countries in the wrong place where things go absolutely wrong. I mean Venezuela. It took years of work, It took over a decade, first first Shavez and then Maduro, until you've got the country completely reliant on the oil price being kind of north of a hundred dollars, so once it dropped much below there,

the situation was completely unsustainable. I mean, these countries are very unpleasant places to be, you know, and very very unpleasant places to be poor. I mean, even though Turkey has gone quiet, there's a lot of people living very miserable lives. But I think, you know, just the political pushback that once the country gets gets right close to the edge, you do need effectively a secret police, which is what you've got in Venezuela, to prevent the governing

overthrown and replaced by something more rational. So I think politics is probably the only answer I can really come up with their So, Paul, uh, We've done Lebanon and a little bit of Venezuela. But of course the other country we wanted to ask you about is of course Argentina, which is in the midst of it seems like they're talking about yet another debt restructuring. What's the most likely

outcome there? And I guess my biggest, biggest question for the Argentina situation is why do international investors continue to buy Argentina in debt even though it's defaulted several times? I think the greater full theory that's you know, a lot of international data, I mean, the vast majority of international debt investors. The key question is, you know, will this be more expensive or will I make money over the next month, regardless of whether this is sustainable in

the long term. I mean, if you look at the Argentine Century Bond, which you know, even that people who bought it an issue if they, if they were fairly nimble, managed to manage to make a little money at least, I think that you're just not paid to punish a country for past sins. I mean absolutely, I think sovereign

date investors are chronically optimistic. Um, you know, the last time around in Argentina they borrow an absolutely phenomenal amount of money and sort of drove Argentina's ratios off the wall. But I think just the the incentive horizon for your average debt investor is a lot shorter than it takes a country to go bust. So, Paul, we've seen this return of trouble in Argentina, obviously you mentioned Lebanon. We're also seeing it elsewhere in South America right now, similar issues.

You see issues in Chile, Colombia and elsewhere. And I'm curious so in the developed world, and we've been talking a lot about it on this podcast lately. In fact, in the developed world, there's no doubt that there is a lot of debating in rethinking sort of conventional macro wisdom and this idea about how best to stabilize the economy. They're roll of monetary policy versus fiscal policy and so forth.

The sluggish growth post crisis has caused a sort of rethink, are we do for something like that when in the developed world, because you see these sort of tried to true efforts that i M. F comes in and has some package, it fails inevitably, or it fails frequently because the terms of the package run up against domestic politics, or you see some country in Vain trying to hold onto some peg, and this idea that I'm not sure what is e M. Macro stability in need of a

broader rethink. That's a very good question. You know, I don't have a good answer. I mean, clearly political tolerance is being stretched, you know, by this long period. I think, especially in the Anglo Saxon economies, we haven't seen wages rising, We've seen massive inequality. It's you know, it's but it's worked very well for the wealthy. It's worked much less for everybody else. And you know, and clearly the cracks are beginning to show, you know, things like Brexit in particular,

which is a hobby horse of mine. Oh, I haven't noticed that the triumph of the triumph of populism, I think owes a lot to that. I think, you know, the big question for the Western countries is, you know, is what the impact of the next recession where you know, instead of people sort of seeing, you know, all the wealth accreasing to a few people are suddenly sort of struggling to meet their mortgage payments and stuff like that.

I think that's when, you know, some very serious questions are going to be asked about, you know, whether you can have and this is the question, you know, whether you can have political stability when the economy isn't working for the majority of people. I mean, this was I think Chile is the best example of that, you know, because it is the one which is most purely economic. Is that the Chilean economy at a macro level has been doing very very well, certainly better than almost any

other economy in South America over that period. But the gains have all overwhelmingly accrued to a few people. And I think, yes, I think there are definitely questions M and E M about how long that's sustainable for And I think a period of macro stress, you know, it's going to make those questions much more glaring. But the differences, and you know, I think this is why Chili you get a lot of demonstrations which I think may may

may eventually quietened down. Unlike Argentina, unlike Lebanon, you know, unlike Venezuela. Countries with with monetary sovereignty can hang on a lot longer. You know that they can print the money without completely debasing their currencies, you know, and all the countries that we're talking about are really countries which which don't conform to I'm not a huge believer in m MT, but the idea is that it only applies to monetary sovereigns. And you know, none of those countries are,

by anybody's definition, monetary sovereign. So I think monetary sovereigns can probably hold out a lot longer. Paul Joe very diplomatically said you were an experienced emerging market investor in our intro, So I'm just curious, is there is there anything about this year or the past year twenty nine teen that has actually surprised you in your emerging market experience,

something that you weren't expecting. The thing is that we've we've got this far without more serious problems in other places. You know that that you know that we've had a long period of stability, and I think the same with

everybody else. It's been the longest period since god knows when without a recession that kind of Lebanon and Argentina they're very significant for the people who are there, but in the context of global markets they're tiny, you know, sort of you know, and even as debt markets, they're much smaller than Brazil or Russia or Turkey. So I think the fact that you know that it's all been in very small, marginal countries, you know, all countries with

very specific problems like Venezuela, has been the surprise. I think, you know, the fact that Turkey was able to pull itself back from the brink very quickly, that Brazil has been able to cut interest rate, you know, to an unprecedented degree. Markets are really pretty relaxed, and I'm you know, that's what I think we've been struggling with a bit. You know, you mentioned what we were talking about Lebanon, and of course it absolutely applies to Argentina and the

whole saga with Paul Singer. How important is having good legal expertise to investing in these markets to understand exactly what you're buying? I mean it helps. I mean I think, you know, most people in my position would know how to how to read a or not how to read, but you know, would have a grasp of some of the concepts. And you know, if we didn't, we've been

educated over the last few years. You know. I think a number i'd throw out there is that, you know, having been sued for ten years by Elliott, that that Singer's vulture funds. The Argentine government actually ended up paying his legal fees, which were, as if I remember right, about two hundred and thirty five million dollars. So yes, good legal advice is worth It is worth an awful lot. I mean, just just as a note, I think Singer bought debt with a face value of other round four

hundred million dollars. They paid less than twenty cents on the dollar, and they took back we think it's sort of over two billion dollars was what article ultimately ended up paying them. So yeah, getting your legal advice straight is really worth quite a lot. Paul. One last thing I remember, you know, I think the last time we had you on, I think we're discussing the crisis and

Turkey and your timing about when that would turn. I mean, you just mentioned they brought themselves back from the brink, was very good, And I want to just sort of go back to this idea that for people who are in the weeds on this stuff, but who are interested, what are the things that you look for. Specifically, Let's say, even though the headlines may look awful in a country this the some sort of corner has been turned such that they can return to some sort of stability or sustainability.

The awkward truth is that, you know, for a bounce of payments crisis, specifically a big recession, and to be honest, a recognition that the recession is inevitable is usually what fixes these things, because you fix a big external deficit by imports collapsing, not by growing exports. I mean, people love to say restoring competitiveness, but it's not. It's just people not having the money to buy imported goods. Usually, plus of the improvement comes from a collapse in imports,

which means a domestic recession. So once we see things beginning to adjust a big drop in property prices, we see activity slowing down, we see interest rates going up. You know that this recognition that you know that that that there is a reckoning is usually a sign that that that leads the problem is being addressed and that the worst will soon be over. Is a corollary to that, is it a warning sign of who might be the

next in the line of crisis? If economic expansion is associated with a dramatic widening of the trade deficit exactly that that that combination of very high domestic credit growth and external deficit, that's definitely something that we look for as a country where things are going wrong. Paul McNamara, great to get your perspective, and we'll have you again on in another year to talk about all the new crises that will inevitably pop up in the latest emerging

market crisis. Yeah, there's there's gonna be something new, So looking forward to get your perspective. Thanks PAULA, Thanks pretty much. Thanks Paul, so Joe, I always love talking to Paul, partly because he brings, you know, decades of experience to any discussion of emerging markets. But I think decade decades, but I think it's also really important to get like the actual investors side of things to explain some of

the dynamics. So his point about how investors aren't actually paid to punish a country for past mistakes and that it's actually very expensive to avoid investing in some of these markets, I think is a really important one. Yeah. I think so too. I mean, because it's easy enough to look at a country like Argentina and say, oh, how many I don't know how many dozens of times

they've defaulted over the last century or whatever. But you know, this idea that maybe investors aren't all complete idiots and still have reasons to invest in a country despite that

trek record, I think is makes a lot of sense. Yeah, And the other thing, A lot of this reminded me of, well A, I think your question about whether or not there needs to be a new paradigm for emerging markets is a good one, and it definitely brought a lot of flashbacks from my like international witical economy classes in university. But be uh, the notion of you know, large parts of the world actually being tied very closely to the

US dollar and there by the Federal Reserve. So you know, Paul mentioned at the very beginning that part of what sparked Lebanon's crisis was just the rise and interest rates in the US, which kind of caused its problems because it of course has a pecked currency. Well, exactly right. You remember we had our episode with a Fuddel Koboo and um Paul was saying, you're not really a big

fan of MMT. That's fine. Nonetheless, this idea that the sort of paradigm view which we think emerging markets must grow, which is export competitiveness, currency stability and so forth. You know, it continues to get tested and this idea that you know, we do, I do think we have this macro rethink in the West. A recent episode where we talked with

Robert Skidelski was very much about that. It does feel that, you know, you look at these situations like again Argentina, and however much the I m F sunk into that program and you wonder whether a much deeper discussion needs to be had about how macro stability and emerging markets. Yeah. Absolutely, And the interesting thing is, I think there have been some noises coming out of the I m F and certain policymakers in Washington about rethinking some of these programs

and some of the approaches to debt sustainability. So interesting stuff going on, interesting to have, interesting times, great to talk to Paul. Yes, indeed, all right, this has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Why Isn't All? You can follow me on Twitter at the Stalwart And you should definitely follow our guests Paul mcnum era. He's on Twitter at m Underscore.

Paul McNamara. I think many people agree, one of the most interesting and insightful people around on the space end. Be sure to follow our producer Laura Carlson at Laura M. Carlson as well as this week's substitute producer to for Foreheads. He's at foreheads T. Be sure to follow the Bloomberg head of podcast, Francesca Levy at Francesca Today, and check out all of Bloomberg's podcasts. There's so many good ones. Onto the handle at podcasts. Thanks for listening.