Apple stock revisited

 

Apple is the most valuable publicly held company in the world, with a market capitalization of $652 billion as of today.  Its huge success is well deserved, as more than any consumer goods producer, AAPL offers products that combine high quality, style and ease of use.  Furthermore, AAPL has had the foresight to secure software and hardware design and ownership and to integrate services and devices as it famously did with iTunes.

There is no argument that Apple is a global success story and that the company has gone from success to success first with its Macs, then the iPods, iPhones and iPads.  The question is whether the stock is a buy at current levels.

As someone who bought the stocks years ago at $14 to sell it for a quick $10 gain a few months later, and who felt he had been very astute, I am not be the best judge of the company’s prospects.  But I do have a view, which is that the critical factor is the gross margin.

Most analysts argue that the stock is cheap because it sells at a p/e multiple of 16.2 times trailing 12 months earnings.  This p/e multiple is further lowered to 13.4 if we deduct from the market capitalization the value of the excess liquidity[1].  That is true, but this “cheapness” is due to a very high gross margin.  This margin reached 44.1% for the last trailing 12 months, vs. 40.5% in 2011 and 29.1% in 2006.

One could point to IBM which achieved an even higher gross margin of 46.9% in 2011.  The difference is that IBM’s business is more stable, being based mostly on services; IBM’s gross margin was 41.9% in 2006, not so different from today.

Unlike IBM, Apple relies essentially on one product, the iPhone, for about 65% of its gross profits with the Mac, the iPod and the iPad for roughly 12% each.  The iPad may bring some added diversification, but time will tell.

While Apple was a pioneer with the iPod, iPhone and iPad, competition is now heating up with giant electronics firms such as Samsung and Google invading its turf with ever more performing products.  This is not a setting conducive to fat margins.

Another factor to take into account is that Apple’s products are expensive; I suspect that the penetration of Apple’s products among the middle and upper socio-economic strata is pretty high.  Apple’s share of smart phones is estimated at 38% in North America, 26% in Western Europe, 25% in Japan and 20% in Asia[2].  One would think that to gain greater market share, Apple would have to target lower income buyers, which is not compatible with selling expensive, high margin products. 

So what if Apple’s gross margin were to revert to its 29.1% level of 2006, everything else being equal?  The p/e multiple would rise to 27.7, and 23 after deduction of excess liquidity.  Quite a different picture, although one that may be unrealistically bleak; after all, even if winning greater market share likely necessitates selling lower price and margin products, replacement devices for higher-end customers would probably remain very profitable.

Since I don’t know how long such a margin erosion might take nor its extent, and since, in any case, the future is always uncertain, I will take the average of current and estimated p/e multiples after deduction of excess liquidity.  I get 18.2.  This is not excessive, but neither a bargain nor a sure win.  This assumes that Apple’s excess liquidity of more than $110 billion will be either distributed to shareholders or wisely invested.  Finally, for reference sake, let us note that Samsung Electronics shares trade at a p/e multiple of 14.9 on the same 12 month trailing profits and ex-liquidity.

In sum, I think that investors who consider buying Apple shares shouldn’t focus on the low p/e multiple but on the high gross margin.

---

[1]  Defined as cash and bond holdings.  We consider that 2% of the average of sales for 2011 and estimated sales for 2012 is used in the business and therefore doesn’t qualify as excess liquidity.

[2]  Source: Gartner, JP Morgan.

Riding the TGV

I just returned from two weeks in France, visiting family and friends and enjoying the natural beauty of the Alps.  I also had plenty of opportunities to read local newspapers and watch news programs.  And yes, I took the famed TGV from Paris to Annecy, a 320 miles trip which took just 3 hours and 40 minutes. 

My tentative conclusion is that the French economy is not about to collapse, rather, it is starting a multi-year process of slow decay until it reaches a moment of truth which could be five to ten years in the future.  Although I am not expecting an impending crisis, I think that we should pay close attention, for as Mark Twain once said, history may not repeat itself but it does rhyme.

For the American tourist roaming the country and its capital, it is quite obvious that France is a very rich country.  In particular, its physical infrastructure is very impressive, and it is evident that much money has been invested there.  The above mentioned TGV now serves most large cities, is very comfortable and runs on time; the Air France terminal 2 at Roissy Charles de Gaulle is airy, its shopping gallery is magnificent and its bathrooms would make any New Yorker familiar with the old Pan Am terminal cry;  the RER (equivalent to our Metro North in New York) is likewise fast, efficient and well designed; finally, parkways are devoid of the craters, ridges and potholes that we regularly but unsuccessfully try to dodge on a daily basis.

To the economist, it is also clear that French households have less debt and more savings than us and that the country has many assets that could be sold to very willing foreign investors, witness the sales this year of Gevrey-Chambertin and Vosne-Romanée vineyards to Chinese investors.  Other assets are more intangible, such as leading technologies and a global outreach that goes back centuries.  Yes, France is a very rich country.

The problem is that the world has been changing faster than France; worse, France has moved in the opposite direction.  Historically, the wealth of France has been built on its large domestic market and later on importing riches from its colonies.  Today, in order to maintain its standard of living France must export more and compete with imports from foreign producers.  Yet, instead of strengthening its private sector, it protects a bloated public sector which accounts for well over half of its GDP.

As I wrote in previous notes, French governments have had little understanding of, or use for, the markets.  So long is the tradition of government intervention, from Colbert’s reforms to de Gaulle’s Five Year Plans to Mitterand’s nationalizations, that they believe that markets are either easily willed to toe the official line or to be held in high distrust.  This was evident even under President Sarkozy and crystal-clear under President Hollande. 

Since he took office, President Hollande has studiously complied with promises he made during his election campaign, such as lowering retirement age, raising the minimum salary, raising taxes on the rich, lowering gasoline prices and hiring more teachers.  It is good to keep one’s promises, but even if they are detrimental to the future of the country?  His supporters will argue that the pension adjustment covered only a fraction of the retiring population (true), that the raise in minimum salary and the drop in gasoline prices were small (also true).  But the problem is that the opposite decisions were called for, such as progressively raising the retirement age, lowering effective labor costs and leaving gasoline prices for the markets to settle.

The proposed tax increases on the rich included elements of utter farce:  taxing individual revenues in excess of 1 million euros at a 75% rate but excluding artists and professional athletes from that; including stocks and ownership in one’s business for purposes of levying taxes on net worth but excluding works of art.  As one commentator noted, it is as if the government wanted an elite of soccer players and collectors of Louis XIV dressers.  The government now says that it will introduce these taxes “intelligently”; this reminds me of the French minister who told a New York audience in 2000 that the 35 hour week law had plenty of leeway to defang it.

The point is that the current government seems unaware of the gravity of the financial and economic problems that France faces, yet comforted by the wealth of the country; accordingly, it seems to believe that gentle policy adjustments are sufficient, that so long as private companies make a profit their taxes can be raised, and that high revenues and corporate profits are evidence of profound social injustice.

Essentially, France like most countries is bound by its culture, and as we all know, national cultures change little and only over extensive period of time (witness A. de Tocqueville and A. de Custine’s enduring relevance to the US and Russia respectively).  I don’t think that the Hollande government can or wants to significantly correct its initial choices and orientation, nor that the French people want it to.  I think that even if a flash crisis strikes Greece, Spain or Italy, France will not budge appreciably and that fundamental reforms a la Schroeder will have to wait until 2016 at the earliest.

Why should we care?  Because history rhymes.  What we are witnessing in France reminds me of what has happened to another very rich and sophisticated country, Argentina.  Despite occasional bouts of recovery, Argentina has not returned to its economic glory days of the 30s and 40s.  This last decade, this country has successfully “picked the pockets” of its foreign creditors, its retirees and companies operating on its territory to fund its populist policies; price controls have distorted its energy sector, crime is rampant, inflation is well into double digits and now foreign exchange controls are used as a last attempt to stem capital flight.  Many Porteños say that Buenos Aires is the Paris of South America; that is true, and more than they know.

 

I am not saying that France will end up where Argentina is today, what I am saying is that there are enough cultural and other similarities for France to watch out and try to get off the Argentine-like track on which it is now engaged.

The US are different from France culturally, historically and geographically.  It is unlikely that much of the population will shift away from traditional American values at the same time.  Its immigration provides an energy and a source of renewal that is unique in the world.  Yet we have been very reluctant to admit that a major effort is required from everybody to get out of our predicament.  As in France, the Obama administration has hesitated to tackle public spending and has played the “tax the rich card”.  Had it stated that taxes would be raised on all Americans to make up for any shortfall in public cuts, we would be more advanced on the path to recovery.  There still is time, and there is a far more vigorous public debate in this country than in France or Argentina as to how to regain our economic health and achieve better social harmony.  But the clock is ticking and the dangers of failing to act are in plain sight for all to see.

The Standard Chartered Bank plc saga, part I

I will not be alone in saying that the Standard Chartered Bank’s compliance problems with the New York State banking regulator (Department of Financial Services - DFS) caught me by surprise. 

I have been following this bank for several years, as it seemed to provide straight forward banking services internationally and made a good return in so doing.  Management seemed quite competent.  Finally, the fact that it had acquired what remained of American Express Bank Ltd. where I spent the first 16 years of my professional career added to my interest.  Actually, I was looking for a good entry point to invest in its stock.

However, the misdeeds that it allegedly committed and apparently did not contest as well as what has transpired so far about its senior management’s conduct have led me to suspend any investment attempt.

Essentially, the bank was accused of willingly defying US regulations forbidding banks to channel money of sanctioned countries such as Iran through the US.  The DFS accused it of laundering more than $250 billion over several years through its US banking operations, of falsifying internal records to prevent regulators from tracing the identity of its Iranian clients and of filing untrue reports.  That a major bank decide, in a very big way, to defy the laws of its host country is simply baffling.

The reaction of senior and top management in this whole affair further raised alarm bells in my mind.  There was of course the now infamous email exchange between the Head of US operations and his superior in which the former clearly outlined the dangers of the bank’s course of action and the latter replied “who these f*** Americans think they are to tell us what to do”.  There was also the truculent initial response to the DFS action stating that only $14 million of transfers had been mishandled and that the bank was contemplating countersuing for damage to its reputation!  This from a bank that had been under Federal oversight from 2004 to 2007 for money laundering.  Then, in short order, the bank agreed to settle with the DFS, paying $340 million and accepting renewed oversight.  As Butch Cassidy asked the Sundance Kid in the eponymous movie, “Who are these guys”? 

What is worrying in this case is that this is not an instance where a low level trader decides to go rogue.  It is likely that the decision to continue doing business with Iran was vetted by the very top management; the Board of Directors was probably at least aware of the decision/policy, and if it was not, then more serious questions must be asked.  What management decides to choose Iran over the US?  What kind of senior manager blurts out the f*** word when referring to the Congress of a host country?  So far, I find no reassuring answers.  Either we are dealing with a culture or a strategic problem. 

The cultural hypothesis is that the top echelons of the bank include throwbacks to the Indian days of the British Empire, except that New York is not a remote outpost in the bush.  When a senior manager not only refuses to listen to his country manager’s cogent alert and advice but also responds with unrestrained fury, when the corporation lets it be known of its intent to counter sue its regulator for damage to its reputation, under the circumstances, I, for one, wonder about the culture of the place.

The strategic hypothesis is that the bank’s main focus is emerging markets, many of which, by definition, are less closely regulated than developed ones, often condone business practices which would be frown upon elsewhere, and in some cases are governed by regimes which are not models of good behavior.  New York is important to the bank for providing access to the US dollar system, but the Americas-Europe-UK segment accounted for only 10% of Standard’s operating income in 2011.  In that sense, and in my view, the bank probably has a higher risk profile than generally acknowledged.

Bottom line, the US regulatory and judicial process is not over by a long shot as the Federal Reserve, Treasury and the Justice Department are still to conclude their own enforcement actions.  I am among those who applaud the DFS decision to go public and break the apparently stalled multi-party negotiations.  I found the allegations against the bank shocking (called me an old-fashioned banker). 

Finally, having myself spent most of my banking and investing careers in emerging markets, I have come to the conclusion that the Standard Chartered business model is riskier than previously thought, and more importantly, that such higher risk profile is unlikely to be easily reduced. 

At some point under the right circumstances and at the right price, the bank may become an interesting investment or trading idea.  

Swimming interlude: Perfidious Albion

As far as I can remember, we the French have had a trust issue with the Brits.  Perhaps centuries of national conflicts, armed or diplomatic, explain that.  This gap extends to the sports arena.  I remember in particular a famous Irish rugby referee in the 60s who was renowned for applying the advantage rule so as to improve the flow of the game, except that to us French it seemed to flow only one way, against us.  But now, as an American citizen, I have the feeling that perfid Albion may reach over the Atlantic Ocean.

I am talking about the debate as to whether Michael Phelps is the greatest Olympian ever.  Please note that the term of reference is Olympian, not athlete.  It is very difficult to compare athletic achievements across the ages and across disciplines.  But it seems to me that Phelps may well be the One, and if he is not, is as likely to be as anyone else.

I was therefore surprised by the reaction of two famous British athletes who perhaps thought they should be considered as candidates for the title.  Sebastian Coe, one of the great middle distance runners of the 1980s with two Olympic gold medals in the 1500m and two silver in the 800m, declared that, in his view, Phelps probably was not the greatest.  He mentioned sprinter Jesse Owens, rower Steve Redgrave, decathlete Daley Thompson and gymnast Nadia Comaneci as candidates for such title, and, tongue in cheek (?) stopped short of perhaps nominating himself.  Lord Coe is the Chairman of the London Olympics Organizing Committee.  There is no question that each one his nominees had extraordinary Olympic achievements, but why they should be considered and Phelps shouldn’t is a mystery to me.

Steve Redgrave realized the "massive" feat of winning a gold medal in rowing in five consecutive Olympics.  This has to rank right up there among the greatest Olympic achievements.  As one who did varsity crew in college and rowed for the Bataillon de Joinville, I have particular respect for the fact that three of these gold medals were won in coxless pair, the most technically challenging boat of all. But when Sir Steve muses, with typical British slyness (Frenchly speaking) that Phelps’ feat would have been more impressive if he achieved it over six or seven Games, one is not sure how to react.  Yes, rowing is brutal.  Having done both sports, there is no doubt in my mind that a 2000m rowing race is more draining than even a 400m medley or a 1500m free swim.  You can’t therefore row multiple events. 

But training to swim middle distances, not to mention different strokes, is far harder mentally, and perhaps physically, than training in crew.  While Olympic level rowers can take some time off and remain competitive, swimmers can’t, witness Phelps’ difficulties in 2010 and 2012.  This is why no swimmer can remain at the top over a twenty year period.  Physiologically, it is also impossible for a 40 year old middle distance swimmer to beat 20 year olds, unlike in rowing.  Witness Janet Evans’ attempt to qualify in the 400m and 800m free this year.  Dara Torres’ swimming career did span 24 years and at 41 she came within 1/100 of a second of winning gold, an extraordinary feat.  But that was in the 50m free.  Dawn Fraser, the all-time great Australian sprinter, could have won gold in four consecutive Olympics had the Australian Swimming Union not banned her for 10 years for pulling  a prank at the 1964 Games.  Even then, I doubt she could done it again in ’72.

As Lord Coe noted, who is the greatest will be debated in pubs for a long time.  As this argument is starting, it is striking, although perhaps not so surprising, that great athletes, such as Sebastian Coe and Steve Redgrave, have big egos; after all, you have to believe in yourself to succeed.  I think that Michael Phelps has a very good chance to be the best Olympian (so far), as he combines durability with domination, eclectism with the sheer number of medals won (mostly gold).  But he also has a quality which is necessary in order to be considered an all time great Olympian, and that is class.

Swimming interlude

As you may have realized from several past notes, swimming is my second passion.  As you may also imagine, my loyalties were somewhat divided yesterday night when the time came for the 4x100 freestyle men final.

Because of the d*** time delay which NBC and its advertisers impose on TV viewers, I tried to follow the race online, but even there, the sites that provided “live timing” were also experiencing delays and other quirks.  So when my iPad’s screen finally showed the results, I was both stunned and elated.

Once again, life shows that forecasts and predictions are just that, extrapolations of the past which are as likely to pan out as to fail.  As in economics, sport experts find it very difficult to model human factors, either at the individual or group level.

Australia was the overwhelming favorite, the US was expected to be a worthy second with no hope of winning, and the French didn’t register on anybody’s radar (I believe the British bookmakers put the odds of a French victory at 7:1).  Contrarians anywhere?

After having styled themselves as the Weapons of Mass Destruction who would not just beat but annihilate the rest of the field, the Australians felt the overwhelming pressure to deliver and they faltered.  Indeed, faltered is perhaps too tame a word; they collapsed, finishing fourth behind Russia.

The US team had a very good race; indeed, it performed better than most expected.  Nathan Adrian touched first with a very fast and personal best of 47.89.  Michael Phelps kept the lead with a 47.15 split, probably a personal best and unexpected after his disappointing 400 IM performance.  Cullen Jones retained the lead in a solid 47.70.  Ryan Lochte fought very hard in 47.74, a good time for him.  This was the best line-up the US could offer.  Matt Greevers is intrinsically faster than Lochte but he had just finished swimming his 100 backstroke semi-final; under the circumstances, he might have matched Lochte’s time, but that would not have been enough to win.

The French, no longer under the microscope, swam very well too, and as the US in 2008, won thanks to an exceptional anchor who simply defeated models and extrapolations.  Amaury Leveaux, the team’s “mental stabilizer”, was a close third in 48.13 in the first leg.  Fabien Gilot, another survivor from the 2008 relay, advanced his team to second place in a strong 47.67.  Perhaps the first surprise performance was Clement Lefert, a 200 free specialist, who clocked a 47.39, surely a personal best when adjusted for the relay start.  Despite swimming the heats and semi-finals of the 200 free earlier in the day, Yannick Agnel blew the field with a blistering 46.74, exactly one second faster than Lochte.

Paraphrasing Yogi Berra, 95% of swimming is half mental.  The 4x100 relay, once again, proved it.  For France, after losing a “sure” gold medal in 2008, winning the gold at the world short course in Dubai and the silver at the European long course championships in Budapest, this London victory was sweet.

What about the losers?  Before we write off the Australian Missile, James Magnusson, let us not forget that Alain Bernard, after losing the anchor fight to Jason Lezak in 2008, came back to win the 100 free gold medal.  The mental pressures of a relay are different from those of an individual race.  Not all individual swimmers are good at relays and vice versa.

For the Americans, I think that it may be a good time to reflect on two issues.  First, it is generally accepted that relays give a good picture of an overall program.  In this regard, it is uncomfortable to think that Ryan Lochte, an extraordinary swimmer but not a sprinter, was the best available choice to complete the US relay.  It is also worth studying why France, not a traditional swimming world power, has come to be competitive with the US in sprint.  It started its ascent when a number of French swimmers came to study and swim at Auburn, but it has accelerated since then with less input from the top US swimming meccas.

Second, there is excessive pressure on the top US swimmers to sign up for as many events as they can.  As the rest of the world catches up and 200m events now incorporate semifinals, this can trigger adverse chain reactions: excessive physical stress, insufficient recovery intervals, disappointing results, self doubt, etc.  This hasn’t happened yet in these London Games, but it did in the past and could again in coming days.

Nelson at Trafalgar

On October 21^st, 1805, HMS Victory, Admiral Nelson’s flagship, sent out to its fleet the most famous naval message in history: “England expects that everyman will do its duty”.  Unfortunately for us French they did, and we lost the battle of Trafalgar.

The British navy was better trained and, at that time, enjoyed better command.  Nelson’s fleet was also under unified command while its adversary was a mix of French and Spanish task forces.  Nevertheless, the French and Spanish ships had huge firepower, and the British knew that they had to go all out to win.

Suppose however, that Nelson’s message had been different, such as:

-          “I know some of you men haven’t slept well these last few days.  Those who want to take the day off are excused from combat”, or

-          “Officers, because you receive a higher pay, I expect you to fight real hard.  As for you men, you can duck any time you feel like it”, or

-          “I have decided that one man on each battery will act as an observer in order to spot areas warranting future improvement”, or

-          “I have a plan to win this one without suffering any casualty”.

With less than an all out effort from all of his crews, Nelson could very well have lost the battle, and for sure British casualties would have been far higher.  Instead, he won everlasting fame, yet his example seems to have been lost of most future politicians.

Consider the cases of France and the US, where enormous adjustments must be made to correct structural economic and financial imbalances that threaten the future of these countries;  one would think that their political leaders would call for an all out effort, where every man and woman would be expected to contribute to national revival.  Not really.

What we have seen instead is a reluctance to acknowledge the gravity of the challenge and the inevitability of sacrifices and hardship in order to prevail.  We have also seen an effort to divide society, between rich and poor, young and old, entrepreneurs and salaried workers. 

 There is no question that the rich will need to pay more taxes, but there is also no question that almost half of the active population can’t continue paying no income taxes.  As Prime Minister Monti declared early in his mandate, the burden needs to be fairly shared among all.  Politicians should stress solidarity and fairness, not privilege or clientelism.  It is human nature that if Peter is asked to make an effort from which Paul is exempted, Peter will look for every way to wiggle out. 

We are at a time of crisis; the economies of most of the world are unstable, growth is negative to anemic, debts are ballooning while money is printed with abandon; trust in politicians, and therefore implicitly in democracy, is at an all time low; in the eyes of many, capitalism has failed to provide progress and stability for all (even when its critics have had a hand in its excesses).  Put it another way, we are in a state of unstable equilibrium the consequences of which could be very dire.  As at Trafalgar, it is time for a call, expressed succinctly and clearly, for each one of us to take our fair share of pain and to do our best to pull the country through.

Nowhere man (homo economicus)

Like all career generals, top economists prepare themselves for the day when their theories can be put to the test of reality (or is it the other way around?).  Certainly, the so-called Great Recession that has hit the US since 2008, then morphed into an existentialist crisis for Europe, and now challenges China’s investment driven growth is such a opportunity.  And indeed, we have seen a wide array of economists make the case for their deeply felt diagnoses and attending cures.  Yet they have little to show so far.

He’s a nowhere Man,

Sitting in his Nowhere Land
Making all his nowhere plans
For nobody.

Traditionalists have thundered against the wasteful ways of the consumer society and its propensity to spend itself to exhaustion, mostly with money borrowed from any willing lender, investor or speculator.  The cure is simple: let them fail, lance the boil and wait for nature to heal itself.  Unfortunately, and as we have seen when applied in some places, this triggers economic collapse, societal tensions and political instability.  But not recovery.

Doesn’t have a point of view,

Knows not where he’s going to,
Isn’t he a bit like you and me?

Others, who quote Keynes, have argued that the state should step up to make up for the reduced demand from the private sector and thus avoid an economic depression.  Some have also argued that such boost would also result in some degree of inflation which would help reduce the excessive indebtedness of both private and public borrowers.  We haven’t seen much inflation in the US where this approach was tried; on the contrary, prices have been stable but public debt has surged and little of that fiscal stimulus has found its way into worthy investment projects for a variety of reasons.

Nowhere Man, please listen,

You don’t know what you’re missing,
Nowhere man the world is at your command.

A variant of the Keynesian school of thought is epitomized by the Japanese economist Richard Koo who has made the persuasive argument that the current crisis of excessive private sector indebtedness doesn’t respond to traditional monetary policy as debtors focus on reducing their debt outstanding, even if interest rates are at rock-bottom.  In his view, the state had to crank up spending and go on as long as necessary;  in most wealthy countries, funding this fiscal effort should be doable as private sector savings would generally equal public sector borrowings.  While his reasoning is powerful, the example of Japan, which, by and large, has followed his prescription, is not: twenty years after its real estate bubble burst, Japan is still doing poorly while its public debt is soaring.

He’s as blind as he can be,

Just sees what he wants to see,
Nowhere Man can you see me at all?

Yet another group put its hopes on reforms, sometimes stated vaguely, or extravagantly.  By definition, reforms will change the way people work and live, will produce some winners and losers and can cast a pall of uncertainty that will last for several years, for reforms take years to be debated, agreed and implemented.  Successful reformers have been able to fine-tune the process so that change took place while stability was preserved and expectations were not let to run wild, with fear or overexcitement.  But reforms alone didn’t work. 

Doesn’t have a point of view,

Knows not where he’s going to,
Isn’t he a bit like you and me?

There is no lack of example of countries overcoming deep financial or economic crisis; there were no magical wands, excessive debts were not transmuted into savings, orthodox measures such as public spending cuts were combined with currency devaluation and strong foreign direct investments; and yes, there also were some policies that were “unorthodox” in their days such as privatizations, tax cuts and private pension reforms.  But what these countries also had was strong political leadership, capable and willing to carry out painful recoveries and to rally their nations behind the effort.

Nowhere Man, don’t worry,

Take your time, don’t hurry,
Leave it all ‘till somebody else
Lends you a hand.

Chile was engulfed in 1982 by the Latin American debt crisis despite having carried out wider economic reforms than the rest of the region.  Its downfall however was precipitated by an overvalued peso and excessive US dollar borrowings.  Because it was governed by the Pinochet-led military junta, Chile, unlike its neighbors, received no international financial help and was left to solve its problems on its own.  It did so by first nationalizing the banks (closing a few unviable ones), devaluing the peso, controlling public spending and restructuring its private and public debt in a way that was both fair and conducive to stabilizing and even raising foreign productive investments.  It has often been argued that having an authoritarian government helped Chile carry out unpopular policies.  This is true to some extent only; there were times in 1984 and 1985 when the position of the government was precarious; besides there have been many examples of authoritarian governments that were miserable economic failures. 

But Chile’s success in handling its crisis can be attributed to other important factors as well: unlike other countries, Chile cleaned up the financials of public companies before it privatized them; it insured that many ordinary Chileans could benefit from large privatizations thanks to its so called capitalism popular; from the beginning, it promoted free markets and private investments.  Finally, Chile offered a number of intangibles which are generally overlooked yet were of critical importance, such as a fair and predictable legal system, a very competent core administration where corruption was absent.  To this day, this remains one of the best turn-around stories.

He’s a nowhere Man,

Sitting in his Nowhere Land
Making all his nowhere plans
For nobody.

Brazil had been an intractable basket case for two decades, with endemic hyperinflation and spiraling public debt when F. H. Cardoso, then minister of Finance, launched the Plano Real in 1994.  The plan’s insight was to break the vicious cycle of expected inflation and general indexation without imposing price controls.  It did so by creating a money of reference (the Unidade Real de Valor- URV which was in effect indexed to the US dollar, not to domestic inflation) alongside the money of exchange (the cruzeiro), and setting it initially at a high level.  After confidence in the URV was won, the URV became the new money of exchange, the Real.  The strength of the Real was preserved by setting positive interest rates, by controlling public sector spending at times via financial negotiations with Brazilian states and by large scale privatizations.  FHC’s credibility helped him carry out his key policies, although former allies reproached him his free market initiatives which he nevertheless had the courage to see through.

Some elements are common to these turnaround examples: currency devaluation (delayed in the case of Brazil as the key problem was internal debt and lack of faith in the currency), public spending cuts, free market emphasis for greater efficiency and accountability, generally, policies that are consistent and understandable for the public, and leaders who are competent, honest and unafraid.

Homo economicus has a lot of ideas, and while there is always room for new policies, abolishing "no pain no gain" is not one of them.  In the end, he is only as good as the homo politicus to whom he reports and from whom he should get support.