The invisible hand

Why Argentina needs free trade more than ever  |  There is little doubt that Argentina needs a miracle, or at least a helping hand. No, this is not another reference to football: just a simple statement of fact.

It has until the 30th July to find USD 1.3bn in order to avoid default. Argentina’s trade performance has suffered as a result of poor economic and trade tariff management since 2011. Trade declined in 2012 by over 4% and while it grew in 2013 and is expected to return to growth of around 7% this year, this will only take it back to the levels of exports last seen in the middle of 2011. Policy makers have focused instead on attracting inward investment to develop the large shale gas reserves, taking their eye of the trade ball. Yet even this policy has stalled: Delta Economics is forecasting that Foreign Direct Investment levels will increase in 2014 but this will again only take them just above the 2011 levels. Put simply: if Argentina is to stave off the permanent threat of default and encourage enduring FDI, it will have to bring the invisible hand back into its trade markets.

At first glance, it does not appear that trade matters unduly to the Argentinian economy. It still runs a trade surplus, although not as substantial as it was and this is reflected in its positive terms of trade (the value of exports in relation to the price of imports). Yet there appears to be very little correlation (-0.37) between its terms of trade and the value of the Argentinian Peso (ARS), as illustrated in Figure 1.


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Figure 1  |  Argentina’s terms of trade vs ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


This matters in so far as countries with high correlations between trade and their currency values are less prone to speculative attacks on their currency. The Peso has weakened by around 50% since the financial crisis: the last time the deterioration in its value was as substantial, Argentina was gripped by its last sovereign debt crisis. While the decline in value has been over a longer period of time, it does suggest that traders are speculating against Argentina being able to re-pay its debt.

If this is the case, then it is more than worrying. Argentina needs to default on its debt a bit like its football team needs the Netherlands to score 2 goals in the first fifteen minutes of the game on Wednesday. If it defaults, then it will find it very difficult to raise the external capital/inward investment that it needs to begin the process of extracting shale gas. But as Figure 2 shows, Argentina is no longer a net exporter of oil and gas, so, in order to restore its self-sufficiency urgently needs this inward investment.


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Figure 2  |  Value of Argentina’s oil and gas trade (USDm) versus ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


The Peso is barely correlated with oil and gas exports (-0.42), although it is correlated with its imports (0.72) suggesting that as the currency weakens (values are in Peso per USD), it is more likely to import oil which is worrying because it suggests that oil imports are plugging a structural weakness in Argentina rather than a response to imported oil being proportionately cheaper. And as the correlation with exports is so weak, it reinforces the view that the currency is more closely correlated with its economic condition than with its trade position.

So what is the scale of the challenge ahead? What does the Argentinian government need to do if it is indeed to create substantial economic growth through the inward-investment associated with shale gas production? Figure 3 presents the specific six-digit subsectors within natural gas that represent shale.


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Figure 3  |  Value of Argentina’s natural gas imports and exports (USDm), 2001-2026 (forecast)

Source  |  DeltaMetrics 2014


Other things being equal, that is, if inward investment continues at the pace we are currently seeing it and if policy and the economic climate remain unchanged, then the picture is not rosy for Argentina’s shale gas revolution. Our model suggests that imports are already outstripping exports and that trend will continue to grow over time. The chance of a trade surplus is remote, as is the chance of self-sufficiency in gas.

It is not the intention to enter a debate on shale in Argentina, still less to suggest that this is the only way out of the current crisis. Instead, just take a look at where policy really can have an influence: trade. Argentina’s openness, in other words its trade as a proportion of GDP has grown from just under 30% in 2001 to over 60% now. The economy is more dependent on trade as a result since it is so important in relation to GDP.

Yet oil and gas is not the sector, arguably, where it should be focusing in the short term. There are two reasons for this. First, the normalised revealed comparative advantage of oil and gas has deteriorated from a position where it was competitive in 2001 (0.39) to a position where it is uncompetitive now (-0.51). We are expecting its position to deteriorate still further to -0.60 by 2020. In contrast, Automotives were uncompetitive in 2001 (-0.12) but are competitive now (0.32) and will be more so by 2020 (0.38).

Second, there appears to be a much stronger correlation between automotive trade and the value of the currency suggesting that some of the speculation may dissipate if the manufacturing side of the economy can be allowed to flourish as Figure 4 shows.


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Figure 4  |  Value of Argentina’s automotive exports overall and to Brazil (USDm) vs ARS per USD, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


If Argentina can grow its manufacturing sector then it stands a chance of creating real export-led growth, particularly if it focuses on the regional automotive supply chain to Brazil since the correlation between it and its currency is particularly high for that trade route. As the currency has weakened, this has strengthened the position of Argentina’s automotive sector in relation to Brazil and has provided a platform for growth.

This is where policy makers should focus to address the challenges of growth and currency stability in the long run and to provide a clear message to markets and arguably the US Supreme Court to stave off default in the short run. Trade suffered between 2001 and 2012 when tariffs were first imposed and Argentina can in no sense afford to make this mistake again. Free trade is as key – otherwise the “hand of God” may well start to look like an Argentina own goal.



Born in the USA

Why America’s trade policy matters  |  Last week it was announced that US GDP failed to grow at the rate in Q1 analysts were expecting. To add insult to injury, Gazprom decided it was going to conduct its trade with China in Yuan or Roubles rather than US Dollars. The market reaction was decidedly muted. Does this mean that traders are just so buoyed by sentiment that they are no longer betting on macro indicators at all? Or has the rise of the Yuan already been priced in?

Neither answer seems particularly satisfactory. The clue may rest in the reason why the annualised drop of 2.9% in GDP was so large. The cold winter and health care costs were a significant part of it, but, more importantly, some two-thirds of the drop was accounted for by weaker-than-expected trade performance. Trade, as we might conclude from Obama’s erratic attention to key trade agreements such as TPP with Asia and TTIP with Europe, is apparently less important to the US economy than assets prices, such as housing. A temporary drop in trade won’t do as much damage as a drop in sentiment that might stop people buying things; the US is not returning to recession. So, that’s alright then.

This is an ill-advised, if not downright illogical thought process. Make no mistake about it, trade matters to the US economy. Exports will be worth USD 1.6tn to the US economy in 2014 and imports some USD 2.3tn. Compared to 2001, the US’s trade openness (exports + imports as a percentage of GDP) has grown from 16% to nearly 28%. Delta Economics is forecasting that by 2020, trade will be 36% of GDP on current trends. More than this, as Figure 1 illustrates, trade is also highly correlated with the value of the S&P 500.



Figure 1  |  Value of US trade (USDm) versus S&P 500, Last Price Monthly, June 2001-May 2014

Source  |  DeltaMetrics 2014, Bloomberg


So while traders themselves may not react to macroeconomic or trade-related news, the correlation of above 70% suggests that there are reasons why they should watch trade more closely. And in fact, the correlation with imports is slightly higher, at 71%, not least because of the size of the trade deficit that the US runs.

Much of that trade deficit is with China in particular and Asia-Pacific in general. In fact, the trade with the key global regions where US trade policy has currently stalled constitute 56% of US trade and Asia-Pacific is the most important of these in value terms.



Figure 2  |  Value of US trade (USDm) with key trading regions: the EU28, ASEAN and Asia-Pacific

Source  |  DeltaMetrics 2014


Figure 2 shows clearly is that although trade with Asia-Pacific has grown by 4.5% in the last 12 months, the trajectory for the rest of the year is relatively flat for all regions. Much of this growth was in Q2 2013 for all three regions and year on year 2013-14 growth is likely to be much lower at under 2% for Europe and just above 3% for ASEAN and Asia-Pacific.

Admittedly US exports are growing relatively quickly at above 3% while imports are forecast to fall in 2014 by nearly 1%. But as the S&P 500 is more correlated with imports than it is with exports, this should give policy makers pause for thought: might it be that markets are perhaps more interested in the activities of US-based global supply chains in Asia that import into the US, than they are in the re-shoring of US jobs evidenced through higher levels of export activity?


2014-06-30_bornInTheUSA_fig03Figure 3  |  Why US Policy needs to think about Asia

Source  |  DeltaMetrics 2014


Figure 3 shows that the US terms of trade (the price of export in terms of the price of imports) are not especially correlated with the value of the Dollar against the Euro but are with the value of the Dollar against the Yen. More than this, although trade with Europe is strongly correlated with the value of the Dollar against the Euro, this may well be because the Euro is a trade currency rather than a speculative currency. What is quite apparent from Figure 3 is that the correlations across the board: with the S&P 500 acting as a proxy for US assets and sentiment more generally, and with the USD versus the Yen are significant with both Europe and Asia, but strongest of all with Asia, reinforcing the view that the TPP and the TTIP talks are vital to US trade, if not directly to US GDP.

Yet China will be excluded from TPP talks. As the US’s third largest export partner and largest import partner this seems odd, and with a trade deficit that the US runs with China is forecast to be some USD 370bn a reminder that actually the US cannot afford to be overly protectionist in its relations with China. The US terms of trade with China are 84% correlated with the S&P 500 underlining the importance of the fact that US companies have strong interests in supply chains that run into and out of China across the Asia-Pacific region.



Figure 4  |  US terms of trade with China vs Yen per USD, June 2001-May 2014

Source  |  DeltaMetrics 2014, Bloomberg


Nowhere is the importance of supply-chain dependency more clear than in the trade competitiveness of US electronics. In 2001, the US had a Normalised Revealed Comparative Advantage (NRCA) in exports of Computers of 0.11 and in semi-conductors of 0.14. By 2006 in the case of computers and 2010 in the case of semi-conductors this comparative advantage had turned into disadvantage of -0.01 and -0.1 respectively. By 2014 the equivalent figures were -0.2 for both sectors. In fact, it is only the US’s increasing self-sufficiency in oil and natural gas that is improving the outlook for US exports with a near 50% improvement in the Revealed Comparative Advantage of mineral fuel exports by 2020. Even if the NRCA figure is still forecast to be mildly negative, this is a vast shift on its 2001 value of -0.62.

The wonder is why anyone should be surprised. From the mid-1990s onwards the globalisation strategy of large US multinationals was to outsource to China (and now the rest of Asia), the automated processes within semi-conductor and computer manufacture that could be done more cheaply but equally as effectively there. That process, now so established across more sectors, is hard to turn around once it has started and explains, to a large extent why US markets are so correlated with both imports and trade with Asia.

The problem was, as the song goes, Born in the USA. Maybe markets should be looking to Springsteen’s lyrics to predict what happens next:

“….Come back home to the refinery,
Hiring man says, “Son if was up to me….”