Mon. Dec 6th, 2021

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Turkey and emerging markets

Recep Tayyip Erdogan thinks lowering interest rates will help stabilize the Turkish currency and control inflation. He’s wrong. Here is the lira against the dollar since 2014, the year he became Turkey’s president (this and the following charts use data from Bloomberg):

The red circle shows the latest Turkish currency crisis, which follows the central bank lower interest rates to 15 percent (that was 19 percent in September) and Erdogan gave a warring speech damning global finances on Tuesday.

Here’s how investors fared in Turkish equities, in lira and in dollars:

It is remarkable, given the devastation of the lira, that hard currency investors have lost only half of their money in Turkish shares. But for the nation, the situation is desperate, and something will have to be done. A statement Tuesday from the central bank suggests that the government may be intervening in foreign exchange markets to support the lira, but it does not have the reserves to do so on a meaningful scale.

Edward Glossop, emerging market economist at Abrdn, told me that the basic options at this point are rate hikes and capital controls, but that Erdogan’s belligerent tone indicates that rate hikes are unlikely. Soft touch capital controls, such as converting hard currency deposits into lira within a certain window, can be the next step. Edward Th-Hussainy of Columbia Threadneedle, on the other hand, argues that rate hikes are becoming more likely by the day.

The good news – for all but the Turks – is that the crisis was mainly caused by poor policies unique to Turkey, and that there are few channels to distribute it elsewhere. As Jonas Goltermann of Capital Economics sums up, Turkish imports worldwide are not significant enough that their collapse would cause much external damage; foreign investment in Turkey has shrunk to become a small part of even emerging market-focused portfolios; and the Turkey mess is unlikely to make investors fear the possibility of crises in other markets, because everyone knows how uniquely bad Ankara’s policy is and how uniquely vulnerable its currency is.

But that’s not quite the whole story, because the strengthening dollar and the prospect of tightening US monetary policy are making the situation worse. In the last decade, the value of EM assets (stocks, bonds and currencies) has become increasingly sensitive to capital flows from the developed world, and thus to the debauchery of developed world financial policies. Here are 10 years of the MSCI Emerging Markets stock index, charted against the Goldman Sachs US Financial Conditions Index, which tracks interest rates, dollar strength and stock market valuations:

This is a strong relationship. However, it is noteworthy that US financial conditions eased this year, and EM assets did not strengthen. This is due to two factors: inflation and the mess in China, which is about a third of the MSCI EM index. Here are the S&P 500, the MSCI EM index and the MSCI EM index with China that have been crossed out in the past year:

In the first half of this year, EM ex-China outperformed US equities; reflection, and the concomitant rise in commodity prices, provided a seemingly ideal environment. But in June, when inflation got really hot, the ex-China index began to follow sideways, and in the last month, as the dollar strengthened, US equities roared ahead.

Central banks in emerging markets can not afford to get as cute with inflation as the US can. They have to suffocate it quickly with growth-killing rate hikes, and outside Turkey most have done so.

The tightening of US monetary policy comes at a terrible time for Turkey – and a bad time for emerging markets in general. It is not surprising that EM assets underperform. What remains a slight mystery, however, is the behavior of risk assets in the developed world. They act, with the exception of a few super-speculative stocks, as if stricter policies would not harm them at all.

Bitcoin ETFs: a terrible product that does well, thank you

Unsecured is no fan of the bitcoin exchange traded funds. They are opaque and expensive. The Securities and Exchange Commission’s concern about fraud means that bitcoin ETFs are really bitcoin-future ETFs, which create heavy “turnaround” costs as futures contracts expire, sell and buy expensive new ones.

It did not take a genius to see it when the products made their debut, and it is now cruelly clear. As Steve Johnson which was reported in the FT on Monday, only three bitcoin futures ETFs actually launched, compared to the dozen or so filed with the SEC. Anna Paglia, head of Invesco ETF, said the following after Invesco pulled its own bitcoin offering:

“We performed a number of simulations and the cost of the role of the futures contracts caused a delay of 60-80 basis points. [a month]. We are talking about some large numbers, 5-10 percent annualized. It was not intended to be ordinary vanilla replication of the [bitcoin] index. ”

On the other side . . . who cares? Bitcoin! About $ 1.6 billion has flowed into the first three bitcoin ETFs – ProShares ($ 1.5 billion), Valkyrie ($ 57 million) and VanEck ($ 3 million):

We asked Leah Wald, CEO of Valkyrie, what’s going on. She told us the question comes from both institutional and retail investors, but for different reasons.

For institutions, an ETF provides tax-free bitcoin exposure through retirement accounts, where it is impossible to hold bitcoin yourself. The ETFs also help investors avoid dealing with annoying crypto-currency exchanges or custody issues. We think it’s bad – simplicity that hides risk – but it is logical.

When asked why retail investors should not just buy from Coinbase or Robinhood and avoid the switching costs, Wald pointed out the costs associated with the direct trading of crypto, including:

  • Potential tax events with each purchase or sale of a cryptocurrency (tax guidance is ambiguous here);

  • Blockchain transaction fees;

  • Exchange withdrawal and transaction fees;

  • Custody and / or wallet fees.

Some of these costs, according to Wald, are not transparent, and can be invisibly embedded in the spread on a bitcoin trade. So savvy bitcoin investors might reckon that the ETF route is actually more cost effective than buying spot bitcoin.

Even if you buy that line (we’m not sure), it’s hardly an affirmative note – it’s just an argument that owning physical bitcoin is also expensive. The success of bitcoin ETFs, if sustained, amounts to a nasty critique of bitcoin itself (Ethan Wu).

A good read

OK, OK maybe span permanently is right on inflation.

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