Thursday, December 04, 1997

Roping in the herd

We have frequently seen examples of how economies that permit total liberty for foreign investment flows, especially those that are in essence short-term investments, often must confront more difficulties than those that impose certain restrictions.

As so many things in life do, problems often have their roots in exaggeration. It is possible that on the one hand confidence and the magnitudes of the resulting flows become so great that they can actually hide problems or diminish the pressure brought to bear on local authorities to take corrective measures. On the other hand, absolute mass panic may set in, creating the medium for the type of accidents normally attributed to such a response (for example, the Mexican debacle and resulting “Tequila Effect”).

Since it is very difficult in most cases to identify a special event such as war, earthquakes, or the sudden death of an important leader as the trigger for a change in sentiment, and as we supposedly live in a world of virtual and perfect information, what could be the possible origin of the overly exaggerated reactions of fund managers?

Above all, I suspect that the financial roller-coaster rides we are subjected to have their origins in the traditional search for the type of security usually found in herds. This instinct predominates in most decision making. I refer specifically to the attitude “it doesn’t matter if things go well or not, as long as I’m in good company.”

As an example, I can go back to the period just after Venezuela abandoned exchange stability (February 1983). I watched with surprise as the treasurers of large multinational companies blithely signed contracts that insured future exchange rates at such incredible costs that they seemed outright irrational. The premium paid easily surpassed the possible exchange losses that would be caused by reasonably predictable devaluations.

When I tried to get to the bottom of this madness (frequently assisted in my investigation by offering a shot of whisky), I invariably would receive the following explanation: “We actually have two accounting registries. In the first we register the exchange earnings or losses per se. In the second we register the cost of the insurance premiums to cover exchange risks. Our head office has become so sensitive to exchange risk that it doesn’t combine both accounts to analyze the total net results. On the contrary, even if I save the company a fortune by not contracting this coverage, but incur in so much as one cent in exchange losses, I would be handed my pink slip in a flash.”

What, then, does this observation aim at? Simply that even when an individual or company is perfectly amicable, capable and basically worthy of an invitation to invest in our country, if his inclination as manager of funds is to follow the herd in stampede, the nation can simply not afford to allow him and his company to enter.

In this sense, we must ask why our monetary authorities have not managed to develop a coherent set of regulations to limit the inflow of international investment when this is obviously intended to be for irrationally short periods of time, in grossly large amounts, or both, instead of wasting time and money exchanging bonds and restructuring debt that matures in 20 years.

Countries like Chile, which have earned the confidence of international markets, limit the inflow of short-term investments. This limitation has definitely not resulted in damage. On the contrary, it has helped increase the confidence of exactly those foreign investors whom the country actually wishes to attract. They are not those that come on a 30-day visa, but rather those that come to invest for the long term.

It is important to remember that when a foreign investor risks his funds in a country in the long run, installing factories, developing projects, creating employment, and in general acquiring a real presence in the country, his interest in the future of the country becomes much more sincere and similar to that of the nation’s own population. Much more so than the interest of some fund manager sitting in New York or London.

When we speak of gaining the confidence of foreign investors, we must learn to discriminate among them.

PS. As you would want to know if those courting your daughters have serious intentions.

Published in Daily Journal, Caracas, December 4, 1997 and in "Voice and Noise" 2006.