On the Great Expansion, an EM Crisis? and the Blue Zones of Longevity – Part 1!

From: aditya rana
Date: Sat, Sep 7, 2013 at 2:25 PM
Subject: On the Great Expansion, an EM Crisis? and the Blue Zones of Longevity – Part 1!

Hi!,

Global markets are entering a critical phase over the next two months, which have historically been the worst months in terms of onset of crises and negative asset returns. The most important issues currently facing markets are the impact of a Fed tapering (which is likely to be announced in about two weeks) and a brewing emerging markets crisis. Global liquidity flows have been the key driver behind the recovery in risk assets post-2008, and it is therefore important to get a handle on them and think through possible scenarios for global liquidity through the end of the year. Gavyn Davies, ex-chief economist at Goldman and currently Chairman of Fulcrum Asset Management, wrote an interesting note (http://blogs.ft.com/gavyndavies/2013/07/16/no-tapering-yet-for-global-central-banks/ ) which sheds some light on what to expect of global liquidity flows in the coming months and risks of a large monetary squeeze:

-Global central banks, first in the emerging markets and subsequently in the developed world, have over the past decade, embarked on an unprecedented expansion of balance sheets ("The Great Expansion"), which more than doubled from 14% to 32% of the world’s GDP since 2003.

-However, the Fed’s May announcement of its intention to start "tapering" down its asset purchases, has led to a sharp tightening in global monetary conditions with global bond yields rising by 70 basis points and emerging market assets falling sharply. This has taken place despite the Fed’s subsequent attempts to try and distinguish between "tapering" and "tightening".

-To analyse the impact of the Fed’s tapering on global liquidity, it is important to look at the balance sheets of the major central banks around the world, as there is considerable cross-border leakage of liquidity injections by central banks.

-The first phase of this expansion (see graph below) , prior to 2008, was driven by emerging market central banks with the objective initially of building-up foreign exchange reserves, and subsequently to prevent appreciation of their currencies (particularly in Asia). The reserves were used to buy developed economy government bonds and were therefore akin to quantitative easing (albeit with shorter maturities).

-The second phase commenced in 2008-2009, in response to the financial crisis and was driven by central banks around the world. This was the largest (and most intense) phase of the expansion, adding about 7% of GDP to the global aggregate within a few months (see graph below).

-The third phase took place during the 2011-2013 period, culminating with QE3, and was driven by central banks of the developed world with the objective of bringing down bond yields and pushing investors into other risk assets through the "portfolio rebalancing" effect. This phase added about 5% of GDP to the global aggregate (see graph below).

-The third phase of expansion began to slow down around mid-2012, driven mainly by the decline in the ECB’s balance sheet as the prospects of a Euro crisis receded, which largely offset the increase in the Fed’s balance sheet via QE3. With emerging markets increasing their balance sheets by negligible amounts as the upward pressure on their currencies subsided, the global aggregate had increased only marginally (see chart below).

-Projecting forward based on policy statements and the behaviour of central banks , even if the Fed starts to taper from September and totally stops purchases by mid-2014, it is likely that global liquidity will still increase at a pace of 1.5% of GDP, which would be an increase from the growth in recent months.

-It is likely that the ECB will stop reducing its balance sheet, and actually increase it in line with nominal GDP growth through LTRO operations. In addition, the BOJ is in the process of embarking on the most aggressive stage of its program, while the emerging bank central banks are assumed to stay at about zero growth.

-However, if we experience a major emerging market crisis, and assuming their central banks shrink their balance sheets by about 2-3% of GDP (like they did during the Asian crisis and briefly during 2009), then global liquidity will face a larger liquidity squeeze than any time since 2003 (see chart below).

An insightful note which focuses attention on the key driver behind the performance of risk assets over the last five years. While the Fed has more or less committed itself to a gradual tapering, the actions of the ECB will be critical going forward. If the ECB reverses its balance sheet reduction strategy over the last year, and starts purchasing assets through the LTRO (as is likely the case), then the Fed tapering will have minimal impact on markets going forward. So this should be supportive to risk assets as we head into year-end (after perhaps a further few months of volatility as the market comes to grips with this phenomenon). There then remains the critical issue of a full-blown EM crisis, a possible but unlikely event, as Paul Krugman observes in a recent note:

"The big question here is how serious this really is — is it the kind of thing that maybe causes mild recessions when central banks hike rates, or is it a potential economic catastrophe? It’s important to understand that this is not at all the same question as asking whether the economies in question have deep structural flaws, lousy infrastructure, inferior politicians etc.. You can have all that and still skirt serious recession; you can also have a wonderfully innovative and efficient economy and suffer business cycle disaster (see America, 1929).

My take is still that the risks of real disaster are low. Here’s why. Below is a chart showing Indonesia’s external debt as a share of gross national income (not exactly the same as GDP, but close enough):

Indexmundi Indonesia: External debt as % of GNI

You see fairly elevated levels in the mid-1990s, then the ratio soars in the crisis. That’s the infamous devaluation/balance sheet effect: Indonesia’s private sector had lots of debt in dollars, so when the markets turned and the rupiah plunged, that debt ballooned relative to income and assets, causing a severe real-side crisis.

But as you can also see, Indonesia has a much lower debt ratio now — about half what it was in the mid-90s. What about India? I’ve already noted that its external debt level is relatively low — lower than Indonesia now, let alone Indonesia in the 90s:

Now, it’s possible that I and everyone else who tried to understand what happened in the 90s has the wrong model. But given what we know, I’m relatively though not totally calm."

In addition, the sharp depreciation of the Indian rupee in recent months should be seen in light of the real exchange rate (after adjusting for the much higher inflation rate in India) which implies about a 10% depreciation rather than the 35% depreciation in the nominal rate. This will provide a boost to exports in the coming months, and early signs are already pointing in that direction with exports rising by 11.6% in July.

Sharply depreciating EM currencies may well prove to be a blessing in disguise – To quote Paul Krugman again: "The first thing you want to say about the 1997 Asian crisis is that all the crisis economies — even Indonesia, which had by far the worst time in the beginning — eventually bounced back strongly (despite the usual complaints about structural problems, corruption, weak leadership etc) : Well, two obvious reasons: Indonesia had a currency that it could devalue, and did, massively. This caused a lot of short-term financial stress, but paved the way for export-led growth. And the IMF, after initially pushing austerity policies in Asia, backed off and reversed course."

Total Economy Database

The Blue Zones of Longevity – Part 1 :

As I had mentioned last week, I read a fascinating book over the summer holidays – "Blue Zones: Lessons for Living Longer From the People Who’ve Lived the Longest" written by Dan Buettner, an internationally recognized explorer and educator. The Blue Zones are five specific towns or regions around the world, where people are up to three times more likely to live to be at least 100 years old, while remaining active, with a significantly lower rate of disease. The Blue Zones include the Barbagia region of Sardinia in Italy, Okinawa in Japan, the community of Loma Linda in California, the Nicoya Peninsula in Costa Rica, and the Greek island of Ikaria.

Here is the first part of a summary of the key parts of the book:

-The book is about discovering the world’s best practices in health and longevity. Most of us have more control on how long we live that we would like to think – experts say that by adopting the right lifestyles we could add an extra quality decade to our lives.

-In 1550, Italian Luigi Cornaro wrote one of the first books on longevity – The Art of Living Long, and said that life could be extended by living in moderation. The book was a best seller, was translated into many languages, and he lived well into his 90s.

-To identify the secrets of longevity, our team of demographers, medical scientists and journalists, went to the Blue Zones where people have a 3 times better chance of living to 100 years than we do.

-The team identified the lifestyle components that help explain the area’s longevity – what they ate, the amount of physical exercise they got, how they socialized, what traditional medicines they ate and so forth. They then looked at common denominators between these five regions and came up with list of best practices of health.

The Sardinian Blue Zone:

-In 1999, a demographer presented at an international longevity conference that he had traced the history of 1,000 centenarians in the mountainous Barbagia region of Sardinia which had an unusually high proportion of male centenarians. He had also found a village of 2,500 people which had seven centenarians, which is astonishingly high given that the ratio for centenarians in the U.S. is one per 5,000.

-The region was coloured in blue ink, giving rise to the term "Blue Zone" which has been adopted by demographers around the world. This Blue Zone was unusual in that the ratio of men to women centenarians was one to one compared to one to four in other parts of the world.

–In this Blue Zone, 47 men and 45 women had lived over 100 years out of a population of 17,865 born between 1880 -1900 – a rate of centenarians that exceeds that of the U.S. by about 30.

-Based on genetic studies, this Blue Zone is inhabited by a people which have largely been isolated from the outside world and has allowed them to maintain traditional social values. Barbagia was not like the rest of the Mediterranean as they did not eat a Mediterranean diet.

-Experts hold the view that the environment and lifestyle might be much more important factors than genetics to the explain the longevity of Sardinians.

-After having studying several centenarians, they found a common theme – they worked hard through their lives as farmers or shepherds (and walked five miles or more daily over rugged mountains) and lived their lives with a daily and seasonal routine. They raised children who later cared for them as elders were respected greatly. Families were considered to be the most important thing in their lives.

-Their traditional diets (before the advent of modern diets!) were extraordinarily simple and consisted of whole wheat bread, a bit of cheese for the wealthier families, vegetables, fruits and fava beans. Meat was eaten at most twice a month – on some Sundays and festivals and fish was consumed rarely. Sheep and goat milk products were also consumed and a glass or two of red wine was drunk daily.

-Sardinian men have a temperament which allows them to shed stress- they are at once grumpy and likeable and often joke at each other’s expense (the word sardonic has its roots in this island!). They have a strong will, high self-esteem and great stubbornness – allowing them survive in unfavourable circumstances.

To be continued!

Here’s to living a simple life in moderation!

Regards,

Aditya

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