Argentina’s Economic Reform and the Future of Emerging Markets | Global Macro | Ep.88
Summary
Argentina's Fiscal Challenges: The podcast discusses Argentina's ongoing fiscal issues, emphasizing the need for political consensus to implement sound fiscal policies and reduce government expenditure.
Dollarization Debate: The potential for Argentina to dollarize its economy is explored, highlighting the complexities and potential risks involved in such a move.
Emerging Markets Stability: Emerging markets are noted to be more stable now compared to previous decades, attributed to improved fiscal positions and the adoption of floating exchange rate regimes.
Central Bank Independence: There is a trend towards more independent central banks in emerging markets, which is contributing to increased credibility and stability.
Geopolitical Shifts: The impact of geopolitical changes, such as the US-China dynamics and the shift towards securing supply chains, is discussed in relation to emerging market investments.
US Economic Outlook: The podcast addresses concerns about US fiscal policy and its potential impact on emerging markets, noting that while fiscal dominance is a future risk, it is not an immediate concern.
Demographics and Productivity: Emerging markets benefit from favorable demographics and potential productivity gains, which are expected to drive growth compared to developed markets facing aging populations.
Commodities and Energy: The role of commodities in emerging market economies is highlighted, with a focus on how energy demand and production influence economic stability and growth prospects.
Transcript
[Music] What we are facing right now um is you know again we have a new administration that is u delivering in the right policies in terms of a fiscal uh but u the cost that the population is is is bearing in the short run is is is clear. So we are in in the midst of of this process in which without a shift in the way in which the opposition thinks the economy um it will be very difficult to exit the trap. So uh we have a clearly a fiscal problem but that needs a political solution. >> Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world. So you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Neil's Castro Larson. [Music] Welcome or welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macrodriven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan Dunn. [Music] Thanks for that introduction, Neils. Today I'm delighted to be joined by Nicholas Duhabni. He is the founder and CIO of Tenk Asset Management uh an an emerging markets macro fund. He was previously finance minister of Argentina between 2017 and 2019 in the administration of Meritzio Machri. He uh prior to that had a career as an economist at Banko Galitia in Argentina and other banks and has been a board member for several corporations in Argentina as well as being a consultant for the World Bank. Nicholas, great to have you on today. How are you doing? >> Very well and thanks for for the invitation, Alan. It's a pleasure for me to to speak with you here today. Good stuff. Well, we um we haven't had a finance minister on before, so that's definitely a first. So, fascinated to hear about your your background in in policy and in economics and markets. How did you get interested in economics and and the markets in the first place? >> Well, I think that I was uh strongly influenced by u the longstanding history of instability of uh Argentina. So when I was a child, you know, I was uh always thinking, you know, why don't they fix this? Um we were always in the midst of, you know, volatility on on the effects, high inflation, uh quotas. Um I remember being a child and having to do my my parents having to do a lot of uh you know stuff to get um effects uh in in in the midst of um capital controls so as to be able to uh to travel abroad. Uh so um I I was raised in an economy that was um dysfunctional and I think that uh that generated my my interest on on the processes that led to that instability on and on and on and on and on and on and on and on and on and on and on and how uh that can can be uh fixed. And it's not a surprise that many many Argentinians that um are now uh in in in academia uh are are um tilted towards more more to macro than to micro than other uh economists of of the rest of the world. And maybe is this interest in you know in fixing in fixing the country. Um so so I I I grew with the strong interest in in politics uh and economics. At at some point when when I was at at uh at at high school and was uh thinking on my career uh my doubt was u studing uh going to to the law school or or to economics and um I was more inclined to economics. I I really enjoyed maths. Um and um that that's why I think that uh I I I was uh tempted to to study economics. >> Very good. Um, I mentioned obviously you're well known as being a former finance minister in Argentina and you've already alluded to the fact that there's kind of long-standing cycles of crises in in Argentina that seem to recur um uh periodically uh and we're kind of in the midst of a maybe not a crisis but a period of volatility at the moment. I mean looking back at that experience now uh as finance minister any kind of key reflections are the problems intractable in in an economy like that or can they be fixed or uh um is is it very much I suppose the political side of things that's that are that's the challenge as much as the economic >> well yes I think that that Argentina has a political challenge on how to build a consensus around um sound fiscal policies. You know, um Argentina entering into a trap um I think in the early 2000s. Prior to that, you know, we had other other problems in the past. um departing in ' 05 06 uh the administration that was in charge at that time started to a process of uh increasing the size of the government in Argentina driving the the size of the government as as measured in terms of GDP from roughly 25% of the GDP to 42 in just 10 years. So we almost double the size of the government in Argentina. Argentina is a country of middle middle high income. Um and countries like like Argentina with that uh um degree of of of income well typically they do not collect taxes for 40% of the GDP. uh you will not find not even one example of of that. Uh typically middle middle high income countries u can collect between uh 25 and 30 something of the GDP at best. Um so having raised the government expenditure from 25 to 42 meant that Argentina had to finance its deficit well uh with the reserves of the central bank. uh once reserves of the center rank were depleted with uh indeedness uh and when we reach a limit on indebtedness uh basically by printing money. those three ways uh the abuse of the this these ways of financing uh generate a lot of a lot of trouble but the the root is fiscal and to bring down again the size of the government expenditure to a level in which it can be financed by taxes. Well, you have a political problem u a problem that we experienced under M administration because we started to eliminate subsidies uh and we launch um a social security reform and um of course in the short term uh that can create some pain uh in the process of adjustment when President Mly took office the price of the electricity that the households uh paid Okay. Uh cover just 15% of the bill. Okay. Uh same for uh water provision for transportation uran uran transportation. Um in in the case of uh the euro e uran uh uh railways in uran trains you know uh the the price paid by the users just covered 5% of the cost. So we started to correct u these imbalances at the beginning that generates well a change in prices a temporary raise in the in inflation um while you are passing all these increases and eventually uh at some point fixing the fiscal will deliver growth and that will be rewarded by by the voters. But you know uh it's a nonlinear process and you know uh after four years of efforts uh we were defeated in the next election and you know again the people that drove the size of of the government uh uh to double its level took office again and well they started to bring money and well finally they they finished their administration in 2023 with 211% of annual inflation and you know uh with the risk of entering into hyperinflation but um you can do a lot of efforts but it's very difficult for the population to see the fruits of the effort in for years and to reward the administration that is delivering uh on the adjustment. So we need that the opposition improves also uh because you know uh what we are facing right now u is you know again we have a new administration that is u delivering in the right policies in terms of the fiscal uh but u the cost that the population is is is bearing in the short run is is is clear and the risk of the populism coming back to Argentina is preventing investment to pick because the political risk is too high. So the risk of a new default or capital controls and uh so we are in in the midst of of this process in which without a shift in the way in which the opposition thinks the economy um it will be very difficult to exit the trap. So uh we have a clearly a fiscal problem but that needs a political solution. >> Fair enough. I mean, as you say, you do need to kind of kind of circuit break these cycles, these virtuous and vicious cycles. Um, I mean, one one thing that uh I mean, you sometimes see, and obviously it's been mentioned a bit, is is dollarization, and that if you dollarize the economy would be a shock to the economy, I guess, but would would be critical in bringing down borrowing costs and stabilizing inflation. Is that a is that something that could could could change the the the overall dynamic or not? Well, it's a possibility, but somehow thinking about dollarization is also like thinking in magic. First, Argentina does not have the resources to dollarize the economy because you have to, you know, buy all the pesos circulating in in the economy, but in the process of dollarizing uh the economy, all the peso depth that is very short-term will be converted into dollars and you will not have a buffer um at the central bank uh for it to act as a lender of last resort. So Argentina is not in a position in which can dollarize and with the appropriate buffers uh to have the liquidity to convert the peso depth into dollar depth uh and to uh have a central bank that can act as a lender flash resort. Um so but in theory let's assume that you have the money uh and you can dollarize the economy. Now the politicians will not be able to you know overrule uh the the the equilibrium in the budget because they don't have the way to finance it. they will be converted into a better politicians and maybe you know it's uh too ambitious to think that uh by just applying the magic of dollarization we will shift the mindset of uh all the political system in Argentina. Uh so maybe we will be in a more rigid scheme in which the same politicians will be trying to break it and you know at some point if you try to break the equilibrium in an economy that is dollarized. Well, it can it can happen maybe not, but it can happen that the costs can be higher than the ones that you have in an economy that is not tolerated because eventually your mistakes can be converted into a deposit freeze or a default rather than uh a hiking inflation wreck. So, so one uh does not have to be uh dogmatic uh when analyzing dollarization in Argentina because eventually it can be a shortcut uh to stabilize the economy but you know it's a political decision of a leader and um no it can work and maybe it cannot because of of the caveats that I mentioned before. >> Fair enough. So obviously you know you've left uh policym now and you are managing u an emerging markets um macro fund. Um I mean how has your experience as finance minister helped informed your investment process? What I mean you took talked about the political consensus or lack thereof in in Argentina. I guess that's a key dynamic you're assessing when evaluating emerging market credits, but any other ways the the experience has has informed your approach to to investing in emerging markets? >> Well, clearly it it provides you with uh more experience and uh it allows you to be in in in the in the boots of of the policy maker of the other country and you know the political restrictions uh that uh they are facing. you suffer them. Uh and maybe you can be more realistic in analyzing uh the menu of possibilities that the policy makers have when uh delivering their their policies. Uh on the other hand um having been in in office and negotiated the problem with the IMF uh I learned well uh a lot about um how how good programs with uh multilaterals work. uh it's a conditionality and uh it it is more easy for me uh now uh to analyze uh what type of policies will be delivering a country that engages for example with the IMF in terms of uh FX policy which are the options in terms of uh you know uh the FX regime that can be chos uh what the condition conditionality this will will look like. Um and uh clearly you know the experience of having been there is very valuable uh in terms of uh analyzing uh potential programs. >> Sure. So I mean looking at emerging markets more broadly now you know if you look at the the last number of decades I guess of emerging market investing going back to the I suppose it started in the early 80s and Brady bonds etc. And then we had periodic crises um you know obviously the Asian financial crisis and you know the tequila crisis back in back in the '9s but things are have been more stable. I think obviously individual countries have had issues but but not a widpread emerging market uh crisis and I guess more recently you know a number of the emerging markets uh have have you know I suppose now we're hearing more that you know policy is more credible maybe in some emerging markets and say in the US so there seems to be this kind of heightened sense of positivity I mean what's your perspective on that is it is it a structural trend towards lower lower uh yields spreads in EM or is are we just in a in a point in the cycle now where it's favorable? >> Well, I think you know emer markets uh generally speaking are most more stable than you know 20 30 years ago. I have two reasons uh which are fundamental in in explaining uh why EM is much more stable than it used to be. One is that um basically visav the fall in in the improvement of the fiscal position of of the economies and the fall in the inflation rate most of the countries in EM started to finance uh the biggest part of of of their of their deficits or or their financial needs um in uh local currency in the domestic markets. So the mismatch of currencies is is is much lower than it used to be. Typically in the 80s um with very tiny capital markets and still with high inflation rates the financial needs of uh emerging markets were covered with high currency debt. Uh so eventually uh when a terms of trade shock came or a financial shock came you know countries were faced with a mismatch in terms of the flow of future income uh due to tax collection and and the stream of of payments that was denominated in other currency uh and that generated a lot of defaults. The other uh stabilizing factor is that most of the countries inm not all but most of them adopted floating exchange rate regimes. Uh and the floating exchange rate regimes are uh acting also as a buffer uh to external shocks. Um so the combination okay now I can float because I don't have the balance sheet problem of the mismatch of currencies. uh so I'm more more free to float and um the adoption of floating exchange rate regimes you know generated slightly a higher volatility in terms of the nominal effects rate but a higher stability in terms of the uh real uh economy on on how the uh the GDPs uh behave um so the cycles were less pronounced And I think that those two factors are mostly the ones uh behind the explanation of why EM is is doing much better in terms of growth, stability and the rate of defaults that we are seeing than the ones that we had in the past. Um and uh I I think that you know is is remarkable and of course when you take a look at dep is uh you know let's say it's somewhere between 55 and 60% uh uh the the median deployed with levels north of 100 in in advanced economies. So there's an appeal also for for EM coming from from you know lower depths and uh with the advantage now that most of of of those depths are denomin denominated in local currency >> and I mean obviously central bank independence inflation targeting is very topical at the moment and we might talk about that with respect to US later. I mean where do you think central banks and EM score on that? I guess it's there's a wide v variety a wide spectrum across the different EM credits but in general is it fair to say there's been a trend towards more independent central banks or not or at least policy appears to be more credible than than maybe it has been in the past >> clear clearly clearly we are seeing that uh that process um in which um central banks are the process of uh gaining credibility Um so uh and and and you know that credibility arises from you know legal aspects. For example the central bank of of Brazil you know was formally declared independent by law uh just two three years ago. uh it acted uh as as as if it was independent but formally uh still it was uh under the scope of the ministry of finance until the the law was was modified. um you know in in Mexico uh the independence of the censor bank was able to withstand uh a change in in office towards a more populist administration in the when when President Lope took office uh in the case of Peru uh you know we had you know a shift in the presidency uh that was very traumatic with zero impact on the economy basically because of the credibility of the central bank that uh has uh you know close to 30 between 30 and 40% of the GDP in in in reserves. So in my view the the process of uh the increase of the credibility of the central banks in EM uh is is ongoing. Uh some some countries are more advanced than others in in that career. Um but uh it's clearly an an an improvement that is bearing its fruits. >> Okay. I mean one of the u big features of the global landscape has been you know globalization through the the last four decades up until recently and you know so the the idea was for you know companies in the west to outsource production to cheaper emerging markets which was a source of growth uh which would then raise the standard of living in emerging markets. I mean what's your perspective on that dynamic now that globalization is somewhat in reverse and we're into a more bifurcated world with China being more dominant in some emerging markets and obviously the US you know very close to Argentina but maybe less so with with other emerging markets. How does that impact the kind of investing landscape? Well, we we are seeing uh a a geopolitical change uh especially uh since um the first administration of President Trump in the US uh in which uh a lot of attention was was put in terms of uh the reassurance uh of the provision of inputs uh as if you know uh that provision can be disrupted for political reasons in the future. Um and and you know uh after that we had the pandemic of of COVID that also generated a lot of disruptions in the uh in the supply chain in the supply chain. Uh so either for political reasons or because of the you know lessons generated by the disruption uh under COVID you know a lot of advanced economies started to you know pay a lot of attention uh on securing the supply chain of inputs. Um and you know also in the actual administration in the US um not only for security reasons but you know for a very old study version of uh import substitution you know uh like uh in Latin America in the 70s you know uh the administration is focusing you know uh producing America all that they can which u in in my view is is something that in the long run will damage productivity but you know it's uh it's the idea of the administration. Uh so at some point yes this this is impacting the way in which uh investment is flowing to to other countries and uh the factors uh in determining investment in other countries now are not based on pure economic reasons but also in political reasons and that is generating you know a lot of changes and at some point some um instability in terms of uh how to think uh no FDI in in the next few years in in immersion battles. >> Okay. So do you think it's it's a that that aspect is less favorable then in terms of the the outlook for for EM if will we see less F FDI >> at some point? Yes. at some point. Yes. Uh because with less visibility in terms of in which countries it's okay to invest as opposed to in which countries it is not given that you know there's a lot of volatility in terms of tariffs. Let's assume that you invest a lot of a lot of money in a country and then the administration decides to raise tariffs to that country. uh well your investment will will not work as as as expected. So so it will be very unlikely uh that in the midst of this volatility we don't see even a a a slight or mild toll uh to pay in terms of uh of FDI in emer markets. [Music] So obviously I mean you know when when you look at the EM space you assess the individual credits but but they are obviously heavily influenced by by the outlook more generally in in markets um and uh you know I guess uh we've seen quite stable yield levels in the US over the last while not not notwithstanding the kind of concerns around that levels in the US I mean when you look at you the the US from the perspective of you know I guess from the lens of of an EM investor. Presumably, it is the outlook is becoming more worrying given the the usual scorecard you would use. But what is your evaluation? >> Well, um uh first um well the the US is experiencing you know two two phenomena at at the same time. One is uh that uh the inflation that was generated by the you know excess of demand uh due to its monetary and fiscal policy in the aftermath of of uh co uh is gradually receding. Uh in our view, you know, there were policy mistakes uh in in in that period, you know, in a period which supply was suffering, you know, a contraction due to the pandemic, the authorities pushed the demand very heavily uh both by monetary and fiscal policies and in in my view uh the part of the monetary policy was totally unnecessary. No, the the help of the authorities should have been focused on you know providing the necessary goods and services to the population that was affected by the pandemic but trying to compensate on the demand side. The contraction in the supply side generated by the pandemic was clearly a mistake. That explain that explains a big part of the inflation differential that we saw in the US as compared to some EM economies or even Europe. So we have to blame in part uh the Federal Reserve for start starting late uh to to adjust its monetary policy and because of the excess of expansion at the beginning of the pandemic but also the the treasury that was you know too expansionary u during uh the the pandemic and its aftermath. But at this point those policies are fading away and we are seeing that they you know some components of the inflation rate uh that were affected by these policies are starting to recede. Clearly you know shelter that was very you know difficult to to break in terms of uh coming to price increases that were close to the target of of the Federal Reserve. now is is converging to a level that is compatible with the objective of the Federal Reserve but we are suffering a temporary hike inflation rate due to the increase in tariffs that were delivered by the administration. So we are in a process in which uh we are in a temporary spike of the inflation rate while you know uh the live effects of the inflation rate that was provoked in in 2122 are fading away. In our view those effects uh the ones generated by tariffs are transitory. So um when we analyze the yield curve of the of the US uh well we are more or less comfortable uh with rates slightly above with 4%. We we don't think that eventually we will see rates going up again. Uh the real rate component of that foreign something% is is very very high as compared to to the past. You know in a midst of an economy in which you know real rates should be uh the result of uh real supply of savings as compared to real demand of investment. It's a real phenomena. We are not seeing now, you know, a process of a sharp pick up in investment. So real rates are high and one should ask why real rates are still uh that high in the US and and maybe is because of of the perception that the political influence on on the Fed is is is uh going up and uh eventually that can be pushing the Fed to bring down the shortened rates uh too rapidly and eventually that you know that can lift the long-term inflation rate by an you know an overheating. Uh so that that explains in part the the steepening of of of the curve but uh apart from that uh on the balance of risks uh we are okay with uh long-term rates right now which are basically one of the most important factors when decided on your portfolio of investments in in because uh both the you know the booming and volatility of the 10ear yields and the level are a key component uh of that decision >> and obviously we've heard a lot about fiscal dominance and that as you alluded to the concern in the market the steepening curve um I mean do you think that's a real feature now are we into that point of fiscal dominance or is it the market anticipating this problem down the line >> the market is is is anticipating it you know uh eventually if the US does not correct the fiscal we will enter into a a process of fiscal dominance in the future. Not not yet and I don't think that we are there yet. But of course uh it's clear that some concerns increased about uh that because you know in the last 20 years um we saw a regularity that was you know uh when the Republicans were in office well uh they lower taxes they increased the deficits then uh the Democrats came uh and the guys that were supposed to be more responsible in in economic terms were the guys that fixed the fiscal. It happened during uh the Clinton administration. He which the US, you know, stopped issuing uh 30-year uh treasuries because the debt was shrinking. Uh then uh uh we had the Bush administration in which deficits went up again. had a great financial crisis in which uh some some uh increasing the fiscal was necessary to to fix the financial mess and then the Obama administration drove the fiscal deficit down by roughly one one percentage point of the GDP per year uh and finishing its administration in a you a very sound position uh and uh thing is that after Trump won in which you know again you know we had a push in the fiscal uh the Biden presidency broke the regularity and uh the Democrats this time didn't fix uh the inherited problem from from the Republicans uh and uh well uh and clearly I don't see a serious discussion now in the US on on how to to to fix to to to fix the the fiscal and uh eventually eventually is a discussion that uh needs to take place >> as you say I mean in the experience of Argentina it's the the political consensus is important for for you know addressing deficits and that's obviously not in place in the US at the moment but at the same time it it sounds like you're not worried about kind of an imminent fiscal crisis uh with yields spiking etc that that doesn't seem to be on your radar. No, not not not yet. Clearly not not not yet. Still still the US is in a position in which uh it can finance its deficit and um as as still the inflation rate is uh did not converge to the target of the Federal Reserve. Nominal GDP is growing at the at the higher level that the one that we should see in equilibrium. And uh transitory this is making the fiscal problem to seem uh uh less worrying than than it will be in in the future when the inflation rate converge uh to a lower level uh and nominal GDP uh grows at the slower pace. Uh so debt to GDP will start to you know climb more more rapidly if they don't fix the fiscal. uh but still I think that uh uh that that problem lies some some years ahead of of us. >> Okay. I mean the other factor that tends to be very influential for emerging markets and the outlook there is obviously the US dollar and we've had a decline in the dollar this year and you know coupled with concerns over Fed independence and credibility you know there's a concern at least there was in the market for a while it's the you know about the dollar's reserve status or even just a rebalancing away from from the dollar um particularly with the rising gold as well in the last Well, um, is that an ongoing theme? Do you buy into that argument that that we're into a secular decline? And presumably that would be a positive for EM more generally if that's the case. >> Marginally? Yes. Marginally? Yes. uh you know uh and this derives both from some uh decrease in the credibility of the Federal Reserve because of the of the interference of the executive and also you know uh this process affecting the US dollar stems also from the fact that in this uh new geopolitical world some countries uh are are finding that investing in in gold or you know other currencies will uh uh prevent them from suffering uh sanctions uh from the US that can uh generate you know freezing of of their assets and and the war between Russia and Ukraine also was uh uh a process that affected uh at somehow the role of of of the dollar and its reserve status because you know of the shift that that generate in terms of some preference for gold for some central banks especially China in my view. So it's it's not only the attacks uh on the independence of the Federal Reserve but also some shifts uh in in geopolitical terms that are gen marginal demand uh from from other currencies. just thinking about some of the other kind of structural factors that are influencing kind of markets more generally and and how they may you know influence em in the context. Obviously demographics is a big theme in the west you know the western economies grappling with you know aging populations and uh which will naturally translate into slower labor force growth and weaker growth if you know in the absence of immigration. that's not the case in many emerging markets and places like Africa etc. on a different trajectory is I mean taking a positive perspective that that's a very positive factor for EM but is it that simple or or how do you think about the the demographic uh angle um on EM investing? Oh, it's it's a it's a difference clearly because you know at the end of the day if you perform some some growth accounting uh growth comes from labor uh from investment and from productivity and um on on on the labor side uh you know uh while in advanced economies uh we are seeing a decrease in the population uh in EM still we are seeing healthy a healthy increase in in Lego growth. So uh that's a major shift and clearly that generates a different trend for example in in housing and industries uh uh directly linked to demographics. No. Um so so yes it's it's a factor of uh of dynamism uh that helps uh to sustain this uh differential growth rate that M is displaying against developed markets. I mean I guess coupled with that is the whole AI you know productivity and the growth of robotics etc. And we talked about how maybe historically in that kind of era of globalization you know manufacturing got outsourced to emerging markets and maybe that's would be less the case going forward if if robots can can can perform those tasks. Is that is that a if if demographics are is emotional positive is is AI from that perspective and automation a negative or how do you see it? >> I I don't know you know it's uh very early to understand the impact of AI in many aspects of our lives. I think um at the end of the day, you know, uh every time the humanity experience a jump in productivity due to innovation, you know, we saw more prosperity, not less. Uh so I I tend to have a very optimistic view on uh on the future. Uh but clearly uh there are a lot of moving pieces. So uh it's very hard to to to to understand uh how this will display uh specifically uh but uh as you know fun from a fundamental standpoint higher productivity well it should mean higher real wages and and more prosperity that that that's my fundamental view of of this process. >> Yeah. And obviously in China, we've seen the evolution from kind of manufacturing and cheap cheap manufacturing goods to progressively moving up the value chain. Is that something you're seeing elsewhere in EM? You know, if you look at Indonesia or India, places like that. Um, or is it more a China phenomenon? It's it's it's clearly you know a stylist stylized fact uh of the evolution of every economy. You know typically at the beginning the increase in in in in production is is based on on on manufacturing industry uh in adding value to you know to mining to to the agricultural or or to manufacturing. But then you have all the connected services related to these industries. The services sector starts to expand and then you know typically the share of the economy or or the value added in every economy that is permanently growing. explained just by you know primary or manufacturing activities tend to decrease as a share uh not in value but as a share and you know that's something that you are seeing uh in in in in Chile in in in Mexico in Brazil in you know in the successful stories of of of Africa in in Egypt uh and uh you know It will always look like that. >> Yeah. I mean you you give a number of um examples there and I mean economists and market partition practitioners often split EM into kind of frontier markets and more developed EM etc. I mean, if you're looking at the landscape, is that how you think about it or how do you kind of or is it more from a geographical perspective or how do you kind of slice and dice it in terms of the the investing opportunities? in terms of our investment opportunities I I don't find useful to you know to separate between frontier and non-frontier uh you know or or the rest of EM um you know every country is a different uh history uh and uh you will have or not investment opportunities depending on you know fundamentals and prices and that is not determined by being frontier or not not being frontier. The only way which maybe u the classification between frontier and the rest of VM can be useful is in terms of the sizing of the positions because uh uh typically in in in in the frontier or the so-called frontier economies uh okay capital markets uh tend to be smaller and liquidity uh also to be smaller. So uh and so the positions uh in a portfolio uh should tend to reflect that. Um but that's not always the case. For example, one of the, you know, key or star um histories of the last one or two years is the you know uh local market of Egypt uh which with a stable uh effects uh um and with inflation coming down is delivering very sound results uh in terms of generating high yields as measuring effects uh for holding local tables. and you have you know plenty of liquidity to to invest in that market. Uh so it's a market that can be suitable uh for even large firms investing in y. So you know eventually you know the division between frontier and em can can act as a guideline in terms of liquidity but not always not always sometimes you have frontier economies that have the adequate liquidity. >> Yeah. And with the I suppose the the the maturation of emerging markets does that change how you approach it from an an investing perspective? Obviously you know when when they were more prone to big cycles and crises that created risks but I guess opportunities in the immediate aftermath in a more stable environment are returns more predictable bit less bit more boring or not or is there still enough volatility in the space? Uh yes no no no typically as as as fundamentals improve volatility decreases uh so uh the countries which much better fundamentals uh join the more like beta space than the alpha space. Uh so uh uh their returns are more explained by the general movements in in in rates uh in developed markets uh rather than you know uh specific factors. uh good for them because they are more much more predictable uh and they can attract more capital but uh you will find clearly more juicy deals yields in countries that are still in the process of uh stabilization. when you find the country that is doing uh the right thing but still uh didn't gain full credibility from the markets and you can anticipate that that that's where you know finding that uh is a key component of the return of uh an uh EM investment. I know you're more focused on the EM debt side, but I mean I think on the on the equity side, periodically we hear this discussion about decoupling and can EM perform in the face of, you know, if if if if DM is struggling, could EM genuinely decouple? I don't know if we've ever really seen it. Um I mean what are the the preconditions for for kind of a structural outperformance of EM? >> Well, first you have to find value. Um uh so so you need to see an increase in in productivity in the countries in which uh you are investing. No. Uh so if productivity goes goes up um uh it means that uh margins uh will will go up and you will find more value in that countries and specifically when when you take a look at what's happening with uh uh equities in EM uh in in relative terms uh maybe is the most undervalued asset if you perform the comparison between uh the evolution of uh the equity markets in in in EM as compared to the equity market of the in in the US. So the diversions in in returns in markets in EM as compared to the market in the US is much bigger than the diversions that you will find in any other asset uh that is traded in India. meaning uh currencies uh uh local rates uh or high currency credits. >> Why why is that do you think? >> Well, I think you know for for a very very long time um there was no other equity market in which to invest rather than the the S&P or or the NASDAQ. uh so uh and um basically investors did not put their eyes and their focus in a lot of opportunities that are still uh there in in EM. On the other hand, you know, in the last two three years uh we saw a sharp rebound in the terms of trade uh in in EM. Uh so um and as EM is a net producer of of commodities uh the relative price of commodities BAB other uh goods or services uh improved a lot uh and that is generating uh and improving profitability in many companies in emerging markets. uh uh so there's a lot of hidden value there um and uh value that can be captured by you know uh investors that put their eyes on on EM equities in next three years. >> Yeah. I mean you mentioned commodities and historically em often been seen as a commodity play. Um I mean how how important is that to your process? I mean commodities have as you say prices have increased for some certain commodities like copper etc. less so for on the energy side. Um I mean is that part of the structural bull case or or not for for EM? is a part because uh even when EM economies have diversified a lot in the last uh couple of decades, still is a commodity play, you know, is is is still a commodity play especially uh in terms of uh determining you know how stable or or uh we be the FX rates uh because um you know are very important in terms of the value added of the EM economies but are more important in terms of the share in exports uh of uh of the EM economies. Uh and as many of the EM economies are uh uh floating they they have floating exchange rate regimes the increasing of of commodities determines stability or a real appreciation of of the real exchange rates. Um and and that generates uh again uh visav you know an increase in in the value of the companies uh uh um producing uh commodities. So uh clearly is is a key component of of of the bull case of of here. >> And on the on the energy side just curious to get your thoughts on that. I mean I mean there's a lot of debate about are we seeing this you know peak peak energy demand for um for oil and and and gas etc. I mean we're definitely seeing in the west but on the the flip side is is demand in EM. I mean are EM obviously China has been at the forefront of transitioning into solar but still a heavy user of uh of coal. I mean what's the perspective on the rest of EM? um are is that going to be a an important source of demand for for for oil and and uh related products over time. So >> yeah, you take a look at you know demand for for oil is you know it's pretty stable. It it grows at the pace of uh of the global GDP. uh so the and and the deviation on on the demand side is is very small as compared to uh how the global GDP grows and that that's why you know uh small variations in supply generate large uh shifts in in prices because demand is pretty stable. Um so even when we are transitioning uh from you know oil to know alternative sources of energy that's a very long-term process and uh you know uh for the next 20 years it is clear that uh uh the impact of the production of energy in EM will still be you know a key component of its its exports. uh so so in the long run of course EM economist should prepare for uh another scenario but uh they have plenty of time to do that. >> Sure. Just conscious of time and we're coming up to the hour. I mean looking at the em I mean a whole wide space obviously you manage your fund from a very tactical perspective. It sounds like you see a structural case. I mean is it possible to pick areas, sectors, themes that you think that are going to dominate over the next 3 to 5 years? >> You know, we we don't have like a a view a general view on on themes or or or sectors. you know uh in in in our process we are always screening into more into you know countries uh to find um anomalies in terms of the relationship between fundamentals and and pricing. When we find that anomaly we did dive uh into into that uh history so to understand it better. uh but we don't have like a you know guru view uh uh of fundamental processes you know uh going on because that that tends to generate impacts in prices that you know very long term very unpredictable. So base basing our process of investment on you know in in in longterm uh uh structural shifts uh well has has a problem or how to trade that in the very short run. Yeah, makes sense. And I mean more generally for people who are interested in EM, people who are maybe early in their career or interested in being an EM macro investor, any advice or think obviously your policy experience has been very helpful, beneficial for you, but not everybody's going to get that for what what advice would you give to people if they want to get more proficient in EM debt, EM macro investing? Oh well, there's plenty of uh of uh material uh to study, you know, in international economics and and finance and plenty of authors that devoted uh uh their their careers uh to to study, you know, what happens in in EM. So uh from the early works of uh of uh Rudy Dorbush or Stanley Fisher um to you know Moraurice Optfeld or Ken Rogoff or Carmen Reinhardt or Gisher Malbo plenty plenty of uh of literature to you know uh to to study and to understand you know crisis and the way which this economies perform over time. >> Very good. Well, we um we've had uh uh Kenneet Rogoff on before and and and I'll be interviewing Morris uh Rob Obsfeld coming up soon. So, uh listeners listeners can stay tuned for that. >> That will be very very interesting, you know. >> Yeah. Very good. Well, Nicholas, very much appreciate you coming on today. It's been great to get your perspective on all things emerging markets. So, um uh obviously you're managing your uh tanic acid management so people can follow your progress there. Uh but uh thanks for coming on and and from all of us here at Top Traders Unplugged. Stay tuned um for more episodes coming up and we'll be back soon. >> Thanks Al. >> Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. [Music]
Argentina’s Economic Reform and the Future of Emerging Markets | Global Macro | Ep.88
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[Music] What we are facing right now um is you know again we have a new administration that is u delivering in the right policies in terms of a fiscal uh but u the cost that the population is is is bearing in the short run is is is clear. So we are in in the midst of of this process in which without a shift in the way in which the opposition thinks the economy um it will be very difficult to exit the trap. So uh we have a clearly a fiscal problem but that needs a political solution. >> Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world. So you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Neil's Castro Larson. [Music] Welcome or welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macrodriven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan Dunn. [Music] Thanks for that introduction, Neils. Today I'm delighted to be joined by Nicholas Duhabni. He is the founder and CIO of Tenk Asset Management uh an an emerging markets macro fund. He was previously finance minister of Argentina between 2017 and 2019 in the administration of Meritzio Machri. He uh prior to that had a career as an economist at Banko Galitia in Argentina and other banks and has been a board member for several corporations in Argentina as well as being a consultant for the World Bank. Nicholas, great to have you on today. How are you doing? >> Very well and thanks for for the invitation, Alan. It's a pleasure for me to to speak with you here today. Good stuff. Well, we um we haven't had a finance minister on before, so that's definitely a first. So, fascinated to hear about your your background in in policy and in economics and markets. How did you get interested in economics and and the markets in the first place? >> Well, I think that I was uh strongly influenced by u the longstanding history of instability of uh Argentina. So when I was a child, you know, I was uh always thinking, you know, why don't they fix this? Um we were always in the midst of, you know, volatility on on the effects, high inflation, uh quotas. Um I remember being a child and having to do my my parents having to do a lot of uh you know stuff to get um effects uh in in in the midst of um capital controls so as to be able to uh to travel abroad. Uh so um I I was raised in an economy that was um dysfunctional and I think that uh that generated my my interest on on the processes that led to that instability on and on and on and on and on and on and on and on and on and on and on and how uh that can can be uh fixed. And it's not a surprise that many many Argentinians that um are now uh in in in academia uh are are um tilted towards more more to macro than to micro than other uh economists of of the rest of the world. And maybe is this interest in you know in fixing in fixing the country. Um so so I I I grew with the strong interest in in politics uh and economics. At at some point when when I was at at uh at at high school and was uh thinking on my career uh my doubt was u studing uh going to to the law school or or to economics and um I was more inclined to economics. I I really enjoyed maths. Um and um that that's why I think that uh I I I was uh tempted to to study economics. >> Very good. Um, I mentioned obviously you're well known as being a former finance minister in Argentina and you've already alluded to the fact that there's kind of long-standing cycles of crises in in Argentina that seem to recur um uh periodically uh and we're kind of in the midst of a maybe not a crisis but a period of volatility at the moment. I mean looking back at that experience now uh as finance minister any kind of key reflections are the problems intractable in in an economy like that or can they be fixed or uh um is is it very much I suppose the political side of things that's that are that's the challenge as much as the economic >> well yes I think that that Argentina has a political challenge on how to build a consensus around um sound fiscal policies. You know, um Argentina entering into a trap um I think in the early 2000s. Prior to that, you know, we had other other problems in the past. um departing in ' 05 06 uh the administration that was in charge at that time started to a process of uh increasing the size of the government in Argentina driving the the size of the government as as measured in terms of GDP from roughly 25% of the GDP to 42 in just 10 years. So we almost double the size of the government in Argentina. Argentina is a country of middle middle high income. Um and countries like like Argentina with that uh um degree of of of income well typically they do not collect taxes for 40% of the GDP. uh you will not find not even one example of of that. Uh typically middle middle high income countries u can collect between uh 25 and 30 something of the GDP at best. Um so having raised the government expenditure from 25 to 42 meant that Argentina had to finance its deficit well uh with the reserves of the central bank. uh once reserves of the center rank were depleted with uh indeedness uh and when we reach a limit on indebtedness uh basically by printing money. those three ways uh the abuse of the this these ways of financing uh generate a lot of a lot of trouble but the the root is fiscal and to bring down again the size of the government expenditure to a level in which it can be financed by taxes. Well, you have a political problem u a problem that we experienced under M administration because we started to eliminate subsidies uh and we launch um a social security reform and um of course in the short term uh that can create some pain uh in the process of adjustment when President Mly took office the price of the electricity that the households uh paid Okay. Uh cover just 15% of the bill. Okay. Uh same for uh water provision for transportation uran uran transportation. Um in in the case of uh the euro e uran uh uh railways in uran trains you know uh the the price paid by the users just covered 5% of the cost. So we started to correct u these imbalances at the beginning that generates well a change in prices a temporary raise in the in inflation um while you are passing all these increases and eventually uh at some point fixing the fiscal will deliver growth and that will be rewarded by by the voters. But you know uh it's a nonlinear process and you know uh after four years of efforts uh we were defeated in the next election and you know again the people that drove the size of of the government uh uh to double its level took office again and well they started to bring money and well finally they they finished their administration in 2023 with 211% of annual inflation and you know uh with the risk of entering into hyperinflation but um you can do a lot of efforts but it's very difficult for the population to see the fruits of the effort in for years and to reward the administration that is delivering uh on the adjustment. So we need that the opposition improves also uh because you know uh what we are facing right now u is you know again we have a new administration that is u delivering in the right policies in terms of the fiscal uh but u the cost that the population is is is bearing in the short run is is is clear and the risk of the populism coming back to Argentina is preventing investment to pick because the political risk is too high. So the risk of a new default or capital controls and uh so we are in in the midst of of this process in which without a shift in the way in which the opposition thinks the economy um it will be very difficult to exit the trap. So uh we have a clearly a fiscal problem but that needs a political solution. >> Fair enough. I mean, as you say, you do need to kind of kind of circuit break these cycles, these virtuous and vicious cycles. Um, I mean, one one thing that uh I mean, you sometimes see, and obviously it's been mentioned a bit, is is dollarization, and that if you dollarize the economy would be a shock to the economy, I guess, but would would be critical in bringing down borrowing costs and stabilizing inflation. Is that a is that something that could could could change the the the overall dynamic or not? Well, it's a possibility, but somehow thinking about dollarization is also like thinking in magic. First, Argentina does not have the resources to dollarize the economy because you have to, you know, buy all the pesos circulating in in the economy, but in the process of dollarizing uh the economy, all the peso depth that is very short-term will be converted into dollars and you will not have a buffer um at the central bank uh for it to act as a lender of last resort. So Argentina is not in a position in which can dollarize and with the appropriate buffers uh to have the liquidity to convert the peso depth into dollar depth uh and to uh have a central bank that can act as a lender flash resort. Um so but in theory let's assume that you have the money uh and you can dollarize the economy. Now the politicians will not be able to you know overrule uh the the the equilibrium in the budget because they don't have the way to finance it. they will be converted into a better politicians and maybe you know it's uh too ambitious to think that uh by just applying the magic of dollarization we will shift the mindset of uh all the political system in Argentina. Uh so maybe we will be in a more rigid scheme in which the same politicians will be trying to break it and you know at some point if you try to break the equilibrium in an economy that is dollarized. Well, it can it can happen maybe not, but it can happen that the costs can be higher than the ones that you have in an economy that is not tolerated because eventually your mistakes can be converted into a deposit freeze or a default rather than uh a hiking inflation wreck. So, so one uh does not have to be uh dogmatic uh when analyzing dollarization in Argentina because eventually it can be a shortcut uh to stabilize the economy but you know it's a political decision of a leader and um no it can work and maybe it cannot because of of the caveats that I mentioned before. >> Fair enough. So obviously you know you've left uh policym now and you are managing u an emerging markets um macro fund. Um I mean how has your experience as finance minister helped informed your investment process? What I mean you took talked about the political consensus or lack thereof in in Argentina. I guess that's a key dynamic you're assessing when evaluating emerging market credits, but any other ways the the experience has has informed your approach to to investing in emerging markets? >> Well, clearly it it provides you with uh more experience and uh it allows you to be in in in the in the boots of of the policy maker of the other country and you know the political restrictions uh that uh they are facing. you suffer them. Uh and maybe you can be more realistic in analyzing uh the menu of possibilities that the policy makers have when uh delivering their their policies. Uh on the other hand um having been in in office and negotiated the problem with the IMF uh I learned well uh a lot about um how how good programs with uh multilaterals work. uh it's a conditionality and uh it it is more easy for me uh now uh to analyze uh what type of policies will be delivering a country that engages for example with the IMF in terms of uh FX policy which are the options in terms of uh you know uh the FX regime that can be chos uh what the condition conditionality this will will look like. Um and uh clearly you know the experience of having been there is very valuable uh in terms of uh analyzing uh potential programs. >> Sure. So I mean looking at emerging markets more broadly now you know if you look at the the last number of decades I guess of emerging market investing going back to the I suppose it started in the early 80s and Brady bonds etc. And then we had periodic crises um you know obviously the Asian financial crisis and you know the tequila crisis back in back in the '9s but things are have been more stable. I think obviously individual countries have had issues but but not a widpread emerging market uh crisis and I guess more recently you know a number of the emerging markets uh have have you know I suppose now we're hearing more that you know policy is more credible maybe in some emerging markets and say in the US so there seems to be this kind of heightened sense of positivity I mean what's your perspective on that is it is it a structural trend towards lower lower uh yields spreads in EM or is are we just in a in a point in the cycle now where it's favorable? >> Well, I think you know emer markets uh generally speaking are most more stable than you know 20 30 years ago. I have two reasons uh which are fundamental in in explaining uh why EM is much more stable than it used to be. One is that um basically visav the fall in in the improvement of the fiscal position of of the economies and the fall in the inflation rate most of the countries in EM started to finance uh the biggest part of of of their of their deficits or or their financial needs um in uh local currency in the domestic markets. So the mismatch of currencies is is is much lower than it used to be. Typically in the 80s um with very tiny capital markets and still with high inflation rates the financial needs of uh emerging markets were covered with high currency debt. Uh so eventually uh when a terms of trade shock came or a financial shock came you know countries were faced with a mismatch in terms of the flow of future income uh due to tax collection and and the stream of of payments that was denominated in other currency uh and that generated a lot of defaults. The other uh stabilizing factor is that most of the countries inm not all but most of them adopted floating exchange rate regimes. Uh and the floating exchange rate regimes are uh acting also as a buffer uh to external shocks. Um so the combination okay now I can float because I don't have the balance sheet problem of the mismatch of currencies. uh so I'm more more free to float and um the adoption of floating exchange rate regimes you know generated slightly a higher volatility in terms of the nominal effects rate but a higher stability in terms of the uh real uh economy on on how the uh the GDPs uh behave um so the cycles were less pronounced And I think that those two factors are mostly the ones uh behind the explanation of why EM is is doing much better in terms of growth, stability and the rate of defaults that we are seeing than the ones that we had in the past. Um and uh I I think that you know is is remarkable and of course when you take a look at dep is uh you know let's say it's somewhere between 55 and 60% uh uh the the median deployed with levels north of 100 in in advanced economies. So there's an appeal also for for EM coming from from you know lower depths and uh with the advantage now that most of of of those depths are denomin denominated in local currency >> and I mean obviously central bank independence inflation targeting is very topical at the moment and we might talk about that with respect to US later. I mean where do you think central banks and EM score on that? I guess it's there's a wide v variety a wide spectrum across the different EM credits but in general is it fair to say there's been a trend towards more independent central banks or not or at least policy appears to be more credible than than maybe it has been in the past >> clear clearly clearly we are seeing that uh that process um in which um central banks are the process of uh gaining credibility Um so uh and and and you know that credibility arises from you know legal aspects. For example the central bank of of Brazil you know was formally declared independent by law uh just two three years ago. uh it acted uh as as as if it was independent but formally uh still it was uh under the scope of the ministry of finance until the the law was was modified. um you know in in Mexico uh the independence of the censor bank was able to withstand uh a change in in office towards a more populist administration in the when when President Lope took office uh in the case of Peru uh you know we had you know a shift in the presidency uh that was very traumatic with zero impact on the economy basically because of the credibility of the central bank that uh has uh you know close to 30 between 30 and 40% of the GDP in in in reserves. So in my view the the process of uh the increase of the credibility of the central banks in EM uh is is ongoing. Uh some some countries are more advanced than others in in that career. Um but uh it's clearly an an an improvement that is bearing its fruits. >> Okay. I mean one of the u big features of the global landscape has been you know globalization through the the last four decades up until recently and you know so the the idea was for you know companies in the west to outsource production to cheaper emerging markets which was a source of growth uh which would then raise the standard of living in emerging markets. I mean what's your perspective on that dynamic now that globalization is somewhat in reverse and we're into a more bifurcated world with China being more dominant in some emerging markets and obviously the US you know very close to Argentina but maybe less so with with other emerging markets. How does that impact the kind of investing landscape? Well, we we are seeing uh a a geopolitical change uh especially uh since um the first administration of President Trump in the US uh in which uh a lot of attention was was put in terms of uh the reassurance uh of the provision of inputs uh as if you know uh that provision can be disrupted for political reasons in the future. Um and and you know uh after that we had the pandemic of of COVID that also generated a lot of disruptions in the uh in the supply chain in the supply chain. Uh so either for political reasons or because of the you know lessons generated by the disruption uh under COVID you know a lot of advanced economies started to you know pay a lot of attention uh on securing the supply chain of inputs. Um and you know also in the actual administration in the US um not only for security reasons but you know for a very old study version of uh import substitution you know uh like uh in Latin America in the 70s you know uh the administration is focusing you know uh producing America all that they can which u in in my view is is something that in the long run will damage productivity but you know it's uh it's the idea of the administration. Uh so at some point yes this this is impacting the way in which uh investment is flowing to to other countries and uh the factors uh in determining investment in other countries now are not based on pure economic reasons but also in political reasons and that is generating you know a lot of changes and at some point some um instability in terms of uh how to think uh no FDI in in the next few years in in immersion battles. >> Okay. So do you think it's it's a that that aspect is less favorable then in terms of the the outlook for for EM if will we see less F FDI >> at some point? Yes. at some point. Yes. Uh because with less visibility in terms of in which countries it's okay to invest as opposed to in which countries it is not given that you know there's a lot of volatility in terms of tariffs. Let's assume that you invest a lot of a lot of money in a country and then the administration decides to raise tariffs to that country. uh well your investment will will not work as as as expected. So so it will be very unlikely uh that in the midst of this volatility we don't see even a a a slight or mild toll uh to pay in terms of uh of FDI in emer markets. [Music] So obviously I mean you know when when you look at the EM space you assess the individual credits but but they are obviously heavily influenced by by the outlook more generally in in markets um and uh you know I guess uh we've seen quite stable yield levels in the US over the last while not not notwithstanding the kind of concerns around that levels in the US I mean when you look at you the the US from the perspective of you know I guess from the lens of of an EM investor. Presumably, it is the outlook is becoming more worrying given the the usual scorecard you would use. But what is your evaluation? >> Well, um uh first um well the the US is experiencing you know two two phenomena at at the same time. One is uh that uh the inflation that was generated by the you know excess of demand uh due to its monetary and fiscal policy in the aftermath of of uh co uh is gradually receding. Uh in our view, you know, there were policy mistakes uh in in in that period, you know, in a period which supply was suffering, you know, a contraction due to the pandemic, the authorities pushed the demand very heavily uh both by monetary and fiscal policies and in in my view uh the part of the monetary policy was totally unnecessary. No, the the help of the authorities should have been focused on you know providing the necessary goods and services to the population that was affected by the pandemic but trying to compensate on the demand side. The contraction in the supply side generated by the pandemic was clearly a mistake. That explain that explains a big part of the inflation differential that we saw in the US as compared to some EM economies or even Europe. So we have to blame in part uh the Federal Reserve for start starting late uh to to adjust its monetary policy and because of the excess of expansion at the beginning of the pandemic but also the the treasury that was you know too expansionary u during uh the the pandemic and its aftermath. But at this point those policies are fading away and we are seeing that they you know some components of the inflation rate uh that were affected by these policies are starting to recede. Clearly you know shelter that was very you know difficult to to break in terms of uh coming to price increases that were close to the target of of the Federal Reserve. now is is converging to a level that is compatible with the objective of the Federal Reserve but we are suffering a temporary hike inflation rate due to the increase in tariffs that were delivered by the administration. So we are in a process in which uh we are in a temporary spike of the inflation rate while you know uh the live effects of the inflation rate that was provoked in in 2122 are fading away. In our view those effects uh the ones generated by tariffs are transitory. So um when we analyze the yield curve of the of the US uh well we are more or less comfortable uh with rates slightly above with 4%. We we don't think that eventually we will see rates going up again. Uh the real rate component of that foreign something% is is very very high as compared to to the past. You know in a midst of an economy in which you know real rates should be uh the result of uh real supply of savings as compared to real demand of investment. It's a real phenomena. We are not seeing now, you know, a process of a sharp pick up in investment. So real rates are high and one should ask why real rates are still uh that high in the US and and maybe is because of of the perception that the political influence on on the Fed is is is uh going up and uh eventually that can be pushing the Fed to bring down the shortened rates uh too rapidly and eventually that you know that can lift the long-term inflation rate by an you know an overheating. Uh so that that explains in part the the steepening of of of the curve but uh apart from that uh on the balance of risks uh we are okay with uh long-term rates right now which are basically one of the most important factors when decided on your portfolio of investments in in because uh both the you know the booming and volatility of the 10ear yields and the level are a key component uh of that decision >> and obviously we've heard a lot about fiscal dominance and that as you alluded to the concern in the market the steepening curve um I mean do you think that's a real feature now are we into that point of fiscal dominance or is it the market anticipating this problem down the line >> the market is is is anticipating it you know uh eventually if the US does not correct the fiscal we will enter into a a process of fiscal dominance in the future. Not not yet and I don't think that we are there yet. But of course uh it's clear that some concerns increased about uh that because you know in the last 20 years um we saw a regularity that was you know uh when the Republicans were in office well uh they lower taxes they increased the deficits then uh the Democrats came uh and the guys that were supposed to be more responsible in in economic terms were the guys that fixed the fiscal. It happened during uh the Clinton administration. He which the US, you know, stopped issuing uh 30-year uh treasuries because the debt was shrinking. Uh then uh uh we had the Bush administration in which deficits went up again. had a great financial crisis in which uh some some uh increasing the fiscal was necessary to to fix the financial mess and then the Obama administration drove the fiscal deficit down by roughly one one percentage point of the GDP per year uh and finishing its administration in a you a very sound position uh and uh thing is that after Trump won in which you know again you know we had a push in the fiscal uh the Biden presidency broke the regularity and uh the Democrats this time didn't fix uh the inherited problem from from the Republicans uh and uh well uh and clearly I don't see a serious discussion now in the US on on how to to to fix to to to fix the the fiscal and uh eventually eventually is a discussion that uh needs to take place >> as you say I mean in the experience of Argentina it's the the political consensus is important for for you know addressing deficits and that's obviously not in place in the US at the moment but at the same time it it sounds like you're not worried about kind of an imminent fiscal crisis uh with yields spiking etc that that doesn't seem to be on your radar. No, not not not yet. Clearly not not not yet. Still still the US is in a position in which uh it can finance its deficit and um as as still the inflation rate is uh did not converge to the target of the Federal Reserve. Nominal GDP is growing at the at the higher level that the one that we should see in equilibrium. And uh transitory this is making the fiscal problem to seem uh uh less worrying than than it will be in in the future when the inflation rate converge uh to a lower level uh and nominal GDP uh grows at the slower pace. Uh so debt to GDP will start to you know climb more more rapidly if they don't fix the fiscal. uh but still I think that uh uh that that problem lies some some years ahead of of us. >> Okay. I mean the other factor that tends to be very influential for emerging markets and the outlook there is obviously the US dollar and we've had a decline in the dollar this year and you know coupled with concerns over Fed independence and credibility you know there's a concern at least there was in the market for a while it's the you know about the dollar's reserve status or even just a rebalancing away from from the dollar um particularly with the rising gold as well in the last Well, um, is that an ongoing theme? Do you buy into that argument that that we're into a secular decline? And presumably that would be a positive for EM more generally if that's the case. >> Marginally? Yes. Marginally? Yes. uh you know uh and this derives both from some uh decrease in the credibility of the Federal Reserve because of the of the interference of the executive and also you know uh this process affecting the US dollar stems also from the fact that in this uh new geopolitical world some countries uh are are finding that investing in in gold or you know other currencies will uh uh prevent them from suffering uh sanctions uh from the US that can uh generate you know freezing of of their assets and and the war between Russia and Ukraine also was uh uh a process that affected uh at somehow the role of of of the dollar and its reserve status because you know of the shift that that generate in terms of some preference for gold for some central banks especially China in my view. So it's it's not only the attacks uh on the independence of the Federal Reserve but also some shifts uh in in geopolitical terms that are gen marginal demand uh from from other currencies. just thinking about some of the other kind of structural factors that are influencing kind of markets more generally and and how they may you know influence em in the context. Obviously demographics is a big theme in the west you know the western economies grappling with you know aging populations and uh which will naturally translate into slower labor force growth and weaker growth if you know in the absence of immigration. that's not the case in many emerging markets and places like Africa etc. on a different trajectory is I mean taking a positive perspective that that's a very positive factor for EM but is it that simple or or how do you think about the the demographic uh angle um on EM investing? Oh, it's it's a it's a difference clearly because you know at the end of the day if you perform some some growth accounting uh growth comes from labor uh from investment and from productivity and um on on on the labor side uh you know uh while in advanced economies uh we are seeing a decrease in the population uh in EM still we are seeing healthy a healthy increase in in Lego growth. So uh that's a major shift and clearly that generates a different trend for example in in housing and industries uh uh directly linked to demographics. No. Um so so yes it's it's a factor of uh of dynamism uh that helps uh to sustain this uh differential growth rate that M is displaying against developed markets. I mean I guess coupled with that is the whole AI you know productivity and the growth of robotics etc. And we talked about how maybe historically in that kind of era of globalization you know manufacturing got outsourced to emerging markets and maybe that's would be less the case going forward if if robots can can can perform those tasks. Is that is that a if if demographics are is emotional positive is is AI from that perspective and automation a negative or how do you see it? >> I I don't know you know it's uh very early to understand the impact of AI in many aspects of our lives. I think um at the end of the day, you know, uh every time the humanity experience a jump in productivity due to innovation, you know, we saw more prosperity, not less. Uh so I I tend to have a very optimistic view on uh on the future. Uh but clearly uh there are a lot of moving pieces. So uh it's very hard to to to to understand uh how this will display uh specifically uh but uh as you know fun from a fundamental standpoint higher productivity well it should mean higher real wages and and more prosperity that that that's my fundamental view of of this process. >> Yeah. And obviously in China, we've seen the evolution from kind of manufacturing and cheap cheap manufacturing goods to progressively moving up the value chain. Is that something you're seeing elsewhere in EM? You know, if you look at Indonesia or India, places like that. Um, or is it more a China phenomenon? It's it's it's clearly you know a stylist stylized fact uh of the evolution of every economy. You know typically at the beginning the increase in in in in production is is based on on on manufacturing industry uh in adding value to you know to mining to to the agricultural or or to manufacturing. But then you have all the connected services related to these industries. The services sector starts to expand and then you know typically the share of the economy or or the value added in every economy that is permanently growing. explained just by you know primary or manufacturing activities tend to decrease as a share uh not in value but as a share and you know that's something that you are seeing uh in in in in Chile in in in Mexico in Brazil in you know in the successful stories of of of Africa in in Egypt uh and uh you know It will always look like that. >> Yeah. I mean you you give a number of um examples there and I mean economists and market partition practitioners often split EM into kind of frontier markets and more developed EM etc. I mean, if you're looking at the landscape, is that how you think about it or how do you kind of or is it more from a geographical perspective or how do you kind of slice and dice it in terms of the the investing opportunities? in terms of our investment opportunities I I don't find useful to you know to separate between frontier and non-frontier uh you know or or the rest of EM um you know every country is a different uh history uh and uh you will have or not investment opportunities depending on you know fundamentals and prices and that is not determined by being frontier or not not being frontier. The only way which maybe u the classification between frontier and the rest of VM can be useful is in terms of the sizing of the positions because uh uh typically in in in in the frontier or the so-called frontier economies uh okay capital markets uh tend to be smaller and liquidity uh also to be smaller. So uh and so the positions uh in a portfolio uh should tend to reflect that. Um but that's not always the case. For example, one of the, you know, key or star um histories of the last one or two years is the you know uh local market of Egypt uh which with a stable uh effects uh um and with inflation coming down is delivering very sound results uh in terms of generating high yields as measuring effects uh for holding local tables. and you have you know plenty of liquidity to to invest in that market. Uh so it's a market that can be suitable uh for even large firms investing in y. So you know eventually you know the division between frontier and em can can act as a guideline in terms of liquidity but not always not always sometimes you have frontier economies that have the adequate liquidity. >> Yeah. And with the I suppose the the the maturation of emerging markets does that change how you approach it from an an investing perspective? Obviously you know when when they were more prone to big cycles and crises that created risks but I guess opportunities in the immediate aftermath in a more stable environment are returns more predictable bit less bit more boring or not or is there still enough volatility in the space? Uh yes no no no typically as as as fundamentals improve volatility decreases uh so uh the countries which much better fundamentals uh join the more like beta space than the alpha space. Uh so uh uh their returns are more explained by the general movements in in in rates uh in developed markets uh rather than you know uh specific factors. uh good for them because they are more much more predictable uh and they can attract more capital but uh you will find clearly more juicy deals yields in countries that are still in the process of uh stabilization. when you find the country that is doing uh the right thing but still uh didn't gain full credibility from the markets and you can anticipate that that that's where you know finding that uh is a key component of the return of uh an uh EM investment. I know you're more focused on the EM debt side, but I mean I think on the on the equity side, periodically we hear this discussion about decoupling and can EM perform in the face of, you know, if if if if DM is struggling, could EM genuinely decouple? I don't know if we've ever really seen it. Um I mean what are the the preconditions for for kind of a structural outperformance of EM? >> Well, first you have to find value. Um uh so so you need to see an increase in in productivity in the countries in which uh you are investing. No. Uh so if productivity goes goes up um uh it means that uh margins uh will will go up and you will find more value in that countries and specifically when when you take a look at what's happening with uh uh equities in EM uh in in relative terms uh maybe is the most undervalued asset if you perform the comparison between uh the evolution of uh the equity markets in in in EM as compared to the equity market of the in in the US. So the diversions in in returns in markets in EM as compared to the market in the US is much bigger than the diversions that you will find in any other asset uh that is traded in India. meaning uh currencies uh uh local rates uh or high currency credits. >> Why why is that do you think? >> Well, I think you know for for a very very long time um there was no other equity market in which to invest rather than the the S&P or or the NASDAQ. uh so uh and um basically investors did not put their eyes and their focus in a lot of opportunities that are still uh there in in EM. On the other hand, you know, in the last two three years uh we saw a sharp rebound in the terms of trade uh in in EM. Uh so um and as EM is a net producer of of commodities uh the relative price of commodities BAB other uh goods or services uh improved a lot uh and that is generating uh and improving profitability in many companies in emerging markets. uh uh so there's a lot of hidden value there um and uh value that can be captured by you know uh investors that put their eyes on on EM equities in next three years. >> Yeah. I mean you mentioned commodities and historically em often been seen as a commodity play. Um I mean how how important is that to your process? I mean commodities have as you say prices have increased for some certain commodities like copper etc. less so for on the energy side. Um I mean is that part of the structural bull case or or not for for EM? is a part because uh even when EM economies have diversified a lot in the last uh couple of decades, still is a commodity play, you know, is is is still a commodity play especially uh in terms of uh determining you know how stable or or uh we be the FX rates uh because um you know are very important in terms of the value added of the EM economies but are more important in terms of the share in exports uh of uh of the EM economies. Uh and as many of the EM economies are uh uh floating they they have floating exchange rate regimes the increasing of of commodities determines stability or a real appreciation of of the real exchange rates. Um and and that generates uh again uh visav you know an increase in in the value of the companies uh uh um producing uh commodities. So uh clearly is is a key component of of of the bull case of of here. >> And on the on the energy side just curious to get your thoughts on that. I mean I mean there's a lot of debate about are we seeing this you know peak peak energy demand for um for oil and and and gas etc. I mean we're definitely seeing in the west but on the the flip side is is demand in EM. I mean are EM obviously China has been at the forefront of transitioning into solar but still a heavy user of uh of coal. I mean what's the perspective on the rest of EM? um are is that going to be a an important source of demand for for for oil and and uh related products over time. So >> yeah, you take a look at you know demand for for oil is you know it's pretty stable. It it grows at the pace of uh of the global GDP. uh so the and and the deviation on on the demand side is is very small as compared to uh how the global GDP grows and that that's why you know uh small variations in supply generate large uh shifts in in prices because demand is pretty stable. Um so even when we are transitioning uh from you know oil to know alternative sources of energy that's a very long-term process and uh you know uh for the next 20 years it is clear that uh uh the impact of the production of energy in EM will still be you know a key component of its its exports. uh so so in the long run of course EM economist should prepare for uh another scenario but uh they have plenty of time to do that. >> Sure. Just conscious of time and we're coming up to the hour. I mean looking at the em I mean a whole wide space obviously you manage your fund from a very tactical perspective. It sounds like you see a structural case. I mean is it possible to pick areas, sectors, themes that you think that are going to dominate over the next 3 to 5 years? >> You know, we we don't have like a a view a general view on on themes or or or sectors. you know uh in in in our process we are always screening into more into you know countries uh to find um anomalies in terms of the relationship between fundamentals and and pricing. When we find that anomaly we did dive uh into into that uh history so to understand it better. uh but we don't have like a you know guru view uh uh of fundamental processes you know uh going on because that that tends to generate impacts in prices that you know very long term very unpredictable. So base basing our process of investment on you know in in in longterm uh uh structural shifts uh well has has a problem or how to trade that in the very short run. Yeah, makes sense. And I mean more generally for people who are interested in EM, people who are maybe early in their career or interested in being an EM macro investor, any advice or think obviously your policy experience has been very helpful, beneficial for you, but not everybody's going to get that for what what advice would you give to people if they want to get more proficient in EM debt, EM macro investing? Oh well, there's plenty of uh of uh material uh to study, you know, in international economics and and finance and plenty of authors that devoted uh uh their their careers uh to to study, you know, what happens in in EM. So uh from the early works of uh of uh Rudy Dorbush or Stanley Fisher um to you know Moraurice Optfeld or Ken Rogoff or Carmen Reinhardt or Gisher Malbo plenty plenty of uh of literature to you know uh to to study and to understand you know crisis and the way which this economies perform over time. >> Very good. Well, we um we've had uh uh Kenneet Rogoff on before and and and I'll be interviewing Morris uh Rob Obsfeld coming up soon. So, uh listeners listeners can stay tuned for that. >> That will be very very interesting, you know. >> Yeah. Very good. Well, Nicholas, very much appreciate you coming on today. It's been great to get your perspective on all things emerging markets. So, um uh obviously you're managing your uh tanic acid management so people can follow your progress there. Uh but uh thanks for coming on and and from all of us here at Top Traders Unplugged. Stay tuned um for more episodes coming up and we'll be back soon. >> Thanks Al. >> Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. 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