December 2016 Newsletter
Glance Around the Globe
In This Month’s Issue
With so focus recently directed at the US election and domestic policy, it is easy to lose track of potentially market moving situations playing out in the rest of the world. With that in mind, we will review some of those events on the horizon for December and into the new year.
The lineup of major world events kicks off on December 4th, when the country of Italy will hold a public constitutional referendum. The proposal under consideration would introduce reforms to Italy’s legislative branch, reducing the size of their upper house (Senate) and limiting its powers. The Italian Prime Minister, Matteo Renzi, has said these reforms are necessary to stabilize the country’s political system and enact needed reforms to save the Italian financial system, currently awash in bad debts and mired in negotiations with the European Central Bank.
Renzi has said that he would resign if a “no” vote prevails, which would inject significant uncertainty into the bank rescue plans while the country is forced to form a transitional government and find a new Prime Minister. The world’s oldest bank, Monte dei Paschi di Siena is particularly at risk, which at one point this year held bad loans equivalent to almost 50 times its market capitalization, according to the Financial Times.
“Senior bankers and officials said that the worst-case scenario was where a failure of Monte Paschi’s complex 5 billion euro recapitalization and bad-debt restructuring demanded by regulators would translate into a wider failure of confidence in Italy and imperil a market solution for its ailing banks,” the FT says. At the time of writing, the polls indicate that the “No” vote is leading by six points. However, as we have seen all too often recently, polls may not be as accurate as once thought.
Figure 1 – Italy has Failed to Prosper from Eurozone Membership
Due in part to the design of Italy’s bicameral parliamentary system, in which the upper and lower houses wield equal legislative power, it has been very difficult for any government to push through the structural reforms necessary for Italy to compete and prosper within the Eurozone.
Austrian Presidential Election
Also on December 4th, Austria will go to the polls in a presidential election for the second time this year. Far-right Freedom Party candidate Nobert Hofer challenged the result of the first election in May and the constitutional court ruled in his favor, saying that there were counting irregularities in the results. While Hofer hasn’t explicitly campaigned for an Austrian exit of the EU, he has called for a referendum on membership if Turkey were to be admitted to the union or if Brussels sought to consolidate power. The Freedom party has led opinion polls for months and even if there is not an imminent threat of an EU referendum, a Hofer victory would be the latest in a cascade of protectionists and right-wing, anti-globalization politicians coming to power throughout the developed world.
Indian Currency Shock
One economic development that is not getting much coverage by the US media is the surprise move by India to render 86% of the country’s currency null and void by the end of the year. To accomplish this, the Indian government has declared the popular 500 and 1,000 rupee notes invalid, while introducing new 2,000 rupee notes (500 rupees is approximately $7.50 as of writing). The surprise move has been described as an effort to curtail rampant petty corruption, counterfeit currency, and illegal goods markets. While official statistics regarding corruption can be unreliable for obvious reasons, the recent Global Corruption Barometer survey reported that the number of respondents who have paid a bribe in the past year was 9% in China, compared with 54% in India.
However, many observers believe that the real motivation behind the demonetization is to force more Indians in to the formal economic structure. Up until this campaign, cash accounted for upwards of 95% of all monetary transactions in the country. Only 60% of Indians have bank accounts and up to 80% of employment is paid for in cash, according to Forbes. This system leaves the vast majority of financial transactions not tracked and a large proportion of taxes uncollected.
Figure 2 – Lion’s Share of Value Out of Circulation
With one stroke, the Indian government took 85+% of the currency value out of circulation. This graph brings home the magnitude of that change.
For the common Indian, the move has been quite disruptive to normal life. In the short run, consumption activity in the Indian economy is grinding to a virtual halt. Three weeks in to the program and long lines are still snaking out of banks, where people can only exchange the equivalent of $65 per day. According to Diego Maiorano from a quote in Forbes, “Street vendors and shops are unable to buy provisions, which is causing shortages (rumored or real) of basic goods in certain areas. Taxis, rickshaw drivers, barbers, maids, and doctors are all facing the difficult choice of either accepting the old notes, or providing their services on credit.”
An additional complication stems from the fact that many of those exchanging notes are only receiving the 2,000 rupee notes in return, which virtually no one is able to provide change for. While any immediate disruption appears to be contained to Indian citizens and tourists, the full implication of this change on the Indian economy has yet to be determined.
Bizarre Scandal in South Korea
For more than a month now, hundreds of thousands of South Koreans have taken to the streets each Saturday to protest President Park Geun-hye’s relationship with Choi Soon-sil, the daughter of a powerful deceased cult leader. Allegations claim that Choi, despite having no official government position, wielded immense power of the President and used her influence to bully companies into handing over tens of millions to businesses and foundations she controlled.
As the 11th largest economy in the world, a major US trading partner and home to thousands of US military personnel, this situation commands more attention than it is currently being given. As the country is still technically at war with North Korea, any instability in the US backed regime could potentially trigger a regional confrontation or conflict.
Brief Brexit Update
Figure 3 – U.K. Growth is Set to Cool, but Not as Much as Feared in September
GDP growth expectations for 2017 in the U.K. have been revised upwards from the immediate aftermath of the Brexit vote, indicating that at least for now, investors and businesses in the region are not pricing in the doomsday scenario that was predicted after the vote.
Chart of the Month
This chart shows the number of times from 1928-2015 that a particular month was the worst performing month of the year for the S&P 500. As is obvious from the chart, December has never been a “worst month of the year” over that time frame. Chart via CNBC.
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