ACCUMULATING PERIPHERALS


Bankers and herd behavior by mattsteinglass
February 28, 2009, 8:34 pm
Filed under: Uncategorized

 

Wildebeest herd. Photo by wwarby under Creative Commons license.

Wildebeest herd. Photo by wwarby under Creative Commons license.

I think it was around April 2008 that I first became convinced that investment bankers and financial analysts might, while individually acute, be collectively just as dumb as the rest of us. It wasn’t because of housing in the US; it was because of inflation and currency tensions in Vietnam. In 2006 and 2007 Vietnam became an extremely hot investment destination as its export-driven economy took off; growth ran at over 7% from 2000 through 2008. Investment seminars heralded “the next China” and so forth, and there was a stock bubble with the VNIndex going from under 300 to about 1100 in the space of two years. FDI flooded into the country — over $6 billion disbursed in 2007 in what was then a $75 billion economy. Pledges of future FDI were far larger — over $20 billion in 2007, ultimately over $60 billion in 2008. As a result, credit growth exploded, with banks shoveling out money to people who used it to invest in assets. And inflation hit double-digit rates in early 2008, with many people predicting 30% inflation by year’s end.

This kind of inflation was the entirely predictable result of all that investment pouring in, unless Vietnam were to allow its currency to appreciate, which would have hurt exports — which were the reason for all the investment in the first place. One would have thought investment bankers might have figured this out and priced the inflation risk in before pouring in all that money in 2007. But no. Instead, by late spring 2008, foreign investors had gone apoplectic over Vietnam’s inflation rate and started demanding that the government depreciate the currency by 30%, to cope with an inflationary episode that had essentially been caused by…foreign investors. Vietnam went from being “hot investment destination #1” in summer 2007 to being the foreign currency community’s whipping boy in May 2008. If the government didn’t move to gradually depreciate the dong, foreign analysts said, it would face an abrupt currency collapse by the end of the year.

What struck me first was that the same people who had been trumpeting the glories of Vietnam as an investment destination in 2007 were warning of its collapse in 2008, for reasons stemming precisely from the very investor feeding frenzy they had whipped up in 2007. What was even more striking, as the year went on, was that the Vietnamese government beat off the warnings of a currency collapse by following policies that had nothing to do with the foreign analysts’ recommendations. They didn’t gradually depreciate the dong; instead they signaled their intention to defend it, and said they had the reserves to do so. They didn’t make it easier to convert the dong; instead they maintained the State Bank’s monopoly over dollar conversions. Meanwhile, they did pursue other macroeconomic steps recommended by foreign analysts — cracking down on easy credit, raising interest rates, and general anti-inflationary measures. And by the end of the year, it was clear the government had won. The dong is trading today just slightly lower than where it stood a year ago.

The herd behavior in developed country financial sectors that has led to the global financial crisis is vastly more complicated and has taken place on a much larger scale. But for me, the spectacle of foreign investors working each other into a frenzy to pour money into Vietnam in 2007, and then working each other into a panic over the exchange rate and inflationary consequences of their own actions a year later, was pretty instructive.

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