Russia and the dead BRIC thesis: James Saft

March 4, 2014

March 4 (Reuters) – Sometimes it takes a slap in the face to
make you realize a long-cherished belief is long dead.

Russia’s power move in Ukraine is the slap and the so-called
BRICs (Brazil, Russia, India and China) as an investment concept
is the (now very much dead) belief.

That’s not because India will bomb Sri Lanka or Brazil
impose a ‘co-prosperity zone’ on Surinam. It is rather because
Russia’s move on Crimea demonstrates that history is not over,
that globalization is not inevitable, and that you as an
investor can very easily get worked over by this process.

You might, in other words, be better off keeping your money
at home, or at the very least imposing a much greater discount
on how cheap emerging market assets must get before they are
worth the risks.

So far the damage in market terms is radiating out from the
point of conflict, or aggression, with Russian assets hit very
badly. That makes sense, but to simply focus on this story as
being about the particular geopolitics of Russia and the rest is
to miss the larger point: geopolitics, largely a one-way bet for
investors since the cold war, don’t always have to be a
supporting factor.

BRIC enthusiasm was founded on two related concepts, both
now very much in doubt.

The first was that the fundamentals within emerging markets
were superior, for a set of reasons that almost smacked of
historical inevitability. Not only were these countries, the
argument went, lower in debt, but they represented the
demographic future, with growing populations, better prospective
economic growth and a massively expanding middle class.

Clearly demographics, never a Russian strong suit, are no
longer a great reason to buy China, which is close to reaching
its own demographic tipping point a good deal earlier than we
would have bet 10 years ago. And while growing wealth and a
growing middle class are a good thing, evidence this produces
superior returns for investors is extremely thin on the ground.


The second concept, and here we enter into the truly
delusional, was the Davos mindset that globalization will
continue its steady march and will always favor capital.

Investment in BRICs, and in emerging markets generally, was
supported by a world view which took for granted the idea that
because ‘everybody’ wants to maximize development and growth,
‘everybody’ will not just give investors a fair shake but play,
more or less, by the international rules.

A world in which countries like Russia are doing things like
they are in Crimea is one in which capital which ventures abroad
is going to be more cautious. More cautious capital requires
higher returns to entice it. Russia particularly is going to get
hit by this, but there is a good chance it applies generally to
emerging markets.

Russia’s aggression in Crimea doesn’t just undermine this by
itself, it does so through the very timid response it has thus
far generated internationally. German interests seem inclined to
block sanctions based on energy, while British ones seem wary of
anything, such as seizure of the Russian elite’s assets abroad,
which might threaten London’s banking franchise.

Now, to be clear, Russia is a very particular kind of bad
bet, and its markets, even before their 10.8 percent fall on
Monday, were priced that way.

We’ve seen other easy assumptions about how emerging markets
and global investment ‘works’ being challenged recently. Take
the Chinese yuan, the slow and steady appreciation of
which, under the watchful eye of the People’s Bank of China, has
been the closest thing to a sure bet in global markets in recent

Two weeks ago, unexpectedly, the yuan suddenly started to
fall in value, dealing some nasty blows to speculators who’ve
come to rely on its steady appreciation. There are reasons to
believe that China simply wants to introduce two-way risk into
the market, and that it is simply trying to create unfriendly
conditions for those who try to hitch a free ride on the yuan’s
usual slow rise.

That said, China also faces substantial difficulties in its
needed transition towards a more consumption-based economy,
something it needs to do while deleveraging in what may be a
painful way for many influential constituencies.

Letting the yuan weaken makes a lot of that a good bit
easier economically. It would also be very dangerous
internationally, inviting a round of begger-thy-trade-partner

Needless to say, it would also not be good for foreign
capital flows, just like Russia’s Ukraine gambit.

The bottom line, and Russia only underscores this:
globalization is reversible.

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