financial turmoil & the arab spring:factors influencing economic freedom

FINANCIAL TURMOIL & THE ARAB SPRING

Marshall L. Stocker MBA CFAwww.freedom-economics.com

Factors Influencing Economic Freedom

2

REMARKS

What Financial Turmoil ? Empirical Foundation Arab Spring: Economic Likelihoods Implications

“Prospects of stability and internal conflicts in the Arab world are still fundamental stumbling block to economic freedom.”

–Economic Freedom of the Arab World 2010

3

WHAT FINANCIAL TURMOIL?

4

4 OCTOBER 2011

Egypt 92% decline in FDILibya 87% declineSyria 65% decline

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4 OCTOBER 2011

“Some 218 investments were made by these regional private equity funds from 2004-09, out of which only 14 have reached exit…

‘Those GP’s will not raise new funds and will disappear’”

EGYPTIAN STOCK MARKET: 13 OCTOBER 2011

Tunisian President Ben Ali resigns (January 14, 2011)

Egyptian stock market down 44.1%

6

7

EGP TO US$ EXCHANGE RATE : CENTRAL BANK’S LOCAL ASSETS SKYROCKET

8

EGP TO US$ EXCHANGE RATE : 5-YEARSCENTRAL BANK’S LOCAL ASSETS SKYROCKET

9

EGP TO US$ EXCHANGE RATE : 5-YEARSCENTRAL BANK’S LOCAL ASSETS SKYROCKET

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HISTORY LESSON (?)

Brazil’s Central Bank used currency reserves to defend Real over two years 1997-98

Foreign currency reserves dropped 40% ($60 billion to $36 B)

Received IMF foreign currency loan ($41 billion = 8.7% of GDP)

Real peg broke (Jan. ‘99)

Announced 8% devaluation become 66%

=?

11

FINANCIAL TURMOIL SUMMARY

FDI plummets Private equity broken; no funding Public equity market crash Foreign currency reserves depleting

(Egypt)

Egyptian currency peg holding….

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FINANCIAL TURMOIL SUMMARY

“Its an off the record conversation, but am truly terrified now.

After my meeting at the ministry of finance, I would like to assure u all: we are humped. Totally, irrevocably, HUMPED!

Btw, the strikes are not why we are humped. We are for other reasons entirely.”

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EMPIRICAL FOUNDATIONS FOR IMPLICATIONS TO ECONOMIC FREEDOM

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EMPIRICAL FOUNDATIONS

(∆) Economic Freedom (∆) Financial Conditions

“Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005

“Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper

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EMPIRICAL FOUNDATIONSEqual Weighted Average Equity Returns (1970-2002)

Equity Returns & Economic Freedom

-9.45%

-3.75%

6.68% 7.51% 8.55%

-10%

-5%

0%

5%

10%

Bottom Fourth Third Second Top

% Change Economic Freedom Quintiles

Ave

rag

e A

nn

ual

ized

E

qu

ity

Mar

ket

Ret

urn

“Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005

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EMPIRICAL FOUNDATIONS: STOCKS REACT

Stock Index Price

∆ Economic Freedom 0.394**

∆ Size of Gov’t n.s.

∆ Legal System & Property Rights

0.229**

∆ Sound Money 0.158**

∆ Freedom to Trade Int’l 0.202**

∆ Regulation 0.438**

∆ Economic Freedom ∆ Stock Index Price

“Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005

17

EMPIRICAL FOUNDATIONS

“Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005

Annualized Percentage Currency Change vs. US$ by Economic Freedom Quintile

EMERGING MARKETS 1970-2004

-8.2% -8.1%

-2.2%

0.9%

3.0%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

Ann

uali

zed

Cur

renc

y R

etur

n

(LOWEST) Freedom Economic Freedom Quintile (HIGHEST Freedom)

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EMPIRICAL FOUNDATIONS10-Year Sovereign Bond Redemption Yield Spread

over 10-yr U.S. Treasury by Economic Freedom Quintile

1985-2004

0

20

40

60

80

100

120

140

Yie

ld S

prea

d (b

asis

poi

nts)

Yield Spread

Yield Spread w/o Japan

(LOWEST) Freedom Economic Freedom Quintile (HIGHEST Freedom)

“Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper

19

EMPIRICAL FOUNDATIONSAnnualized Percentage Currency Change vs. US$

by Economic Freedom Quintile ALL MARKETS

1970-2004

-6.3%

-1.1%

1.8%2.9%

3.9%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

Ann

uali

zed

Cur

renc

y R

etur

n

(LOWEST) Freedom Economic Freedom Quintile (HIGHEST Freedom)

“Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper

20

EMPIRICAL FOUNDATIONSCurrency Return OUTLIERS by Economic Freedom Score

ALL MARKETS 1970-2004

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

3 4 5 6 7 8 9 10

Ann

uali

zed

Cur

renc

y R

etur

n vs

. US

$

(LOWEST) Freedom Economic Freedom (HIGHEST Freedom)

“Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper

21

EMPIRICAL FOUNDATIONS SUMMARY

Change in Economic Freedom Equity Returns

Economic Freedom Government Debt Yields

Economic Freedom Currency Exchange Rate

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EMPIRICAL FOUNDATIONS SUMMARY: THEIRS

Equity Market Size as Percentage of GDP (Li 2002, LaPorta 1997)

Total Market Capitalization Increases after Capital Control Liberalization (Levine, Zervos 1998)

Privatization Effects Excess Market Returns (Perotti, van Oijen 2000)

Idiosyncratic Equity Market Liberalization leads to Excess Market Returns (Henry 2000)

GDP Growth, Investment & Productivity Rates (Gwartney, Lawson 2004)

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ARAB SPRING: FACTORS INFLUENCING ECONOMIC FREEDOM

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ECONOMIC FREEDOM OF THE ARAB WORLD

Current financial markets may indicate a current decrease in economic freedom.

Subsequent policy decisions that increase Economic Freedom may quickly appear in financial markets as financial euphoria.

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FINANCIAL TURMOIL & ARAB SPRING INFLUENCING (AREAS OF) ECONOMIC FREEDOM

Subsidies (expansion or rationalization) Capital controls Privatization: Nope; Entrepreneurship:

Yes IMF: Foreign Currency loans Transparency Monitor (yields, reserves, stock market)

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DON’T FORGET SECURITY

“The economic uncertainty has been exacerbated by deteriorating security …The …lack of efficient policing has brought higher crime levels, with armed gangs robbing motorists and attacking factories and warehouses.”

9 October 2011

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IMPLICATIONS FOR POLICY MAKERS & INVESTORS

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EGYPT’S CREDIT RATING DOWNGRADED (10-10-11)

Downgraded Egypt’s long-term default and currency ratings to “negative” as wavering political decisions continue to delay economic growth.

“Fitch has previously said it expected the sharp fall in foreign currency reserves…to start being reversed by external support in [quarter four;] the delays to the political transition are now causing concern, with reserves continuing to fall, and the global backdrop less supportive.”

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WHICH IS IT?

Over the past month, while affirming that the country is “committed to a free market” the interim government also banned three privatized companies; two of which were owned by foreign investors. -Daily News Egypt 10-10-11

FINANCIAL TURMOIL & THE ARAB SPRING

Marshall L. Stocker MBA CFAwww.freedom-economics.com

Factors Influencing Economic Freedom