If you want to understand asset prices, take the (very) long view

Today’s low-interest rate world only looks bizarre on an edited account of history

Gillian Tett
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Wall St in the 1890s. If the past 145 years are any guide to the future, it can be a dangerous mistake to assume that 'safe' assets will always be boring © Getty


Many asset managers are taking stock of the bizarre year that was 2017. If they are feeling broad-minded, some may also be pondering the story of the decade since the great financial crash.

However, if you want to get a truly thought-provoking perspective on portfolio performance — or just spark some conversation over the holiday — my advice would be to widen the lens even further, to the past 145 or so years.

Yes, you read that right. This week, a group of economists in America and Germany published the results of a massive and granular number-crunching exercise to track the performance of all the big investible asset classes (bonds, bills, equities and housing) in 16 advanced western economies from 1870 to 2015.

The authors of “The Rate of Return on Everything, 1870-2015” — Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alan Taylor — have not done this for narrow investment purposes. Instead, they hope to contribute to the academic debates which are now raging about whether secular stagnation — the long-term structural decline in aggregate demand identified by former US Treasury secretary Lawrence Summers and others — really exists, and whether the French economist Thomas Piketty is correct to argue that returns on capital always outstrip growth.

And in that respect, the conclusions are thought-provoking, albeit inconclusive. The data set shows that returns on assets do tend to outstrip growth in the long run, as Prof Piketty argues. However, there are some bafflingly volatile swings. In plain English, this means that rich people holding assets tend to get richer faster than the economy grows, fuelling inequality.

However, this pattern is so erratic that the economists suggest there is still a “conundrum” about why it exists.However, what most investors will find more interesting than the economic arguments is that this data set — which seems to be the largest of its kind ever assembled — also reveals at least three points about investible assets.

First, equities and housing have very different levels of correlation. From a (very) long-term perspective, both asset classes have produced similar returns since 1870, averaging out at about 7 per cent per annum across these 16 countries. But equity markets around the world have become tightly interlinked with each other: country co-movements rose from 0.4 in the middle of the previous century to 0.8 this decade.

Property markets, by contrast, are not correlated: country co-movements have stayed between zero and 0.2 in the past 50 years. Moreover, property is also only lightly correlated to business cycles and other asset classes. This suggests that if an investor wants truly to diversify their portfolio, they should look beyond securities; buying real estate everywhere from Manhattan to Mongolia was a better hedge in the 20th century.

A second fascinating implication is that today’s ultra-low interest rate world only looks bizarre if you take an edited vision of history. Yes, real rates are very low today compared with the peacetime years in the 20th century. But real returns on bonds and bills were much lower during the first and second world wars, tumbling to about minus 4 per cent (compared with 3 per cent for bonds in 2015, and zero for bills).

Returns on safe assets were also low in the aftermath of the two world wars, and they fell in the late 19th century, too. So, the authors suggest, instead of simply asking why real rates are so low today, maybe we need to ask “why the safe rate [was] so high in the mid-1980s”. The late 20th century might have been more of an aberration than today.

That highlights a third key point: the spread on returns between risky and safe assets has been surprisingly volatile in the past 145 years. However, this is not due to the behaviour of risky assets — these returns tend to move in fairly well-worn cycles. Instead, what is more notable is the behaviour of supposedly safe assets: although these returns are often stable, they periodically display unexpectedly massive swings (usually because war or financial shock has suddenly made “safe” assets seem anything but safe).

That last lesson is worth pondering now. This year, most investors have been mesmerised by the soaring price of risky assets, such as US equities. But the fact that supposedly safe bond prices have stayed so high is striking too, particularly given the stratospheric levels of debt and the turning US interest rate cycle.

There is a fair chance that this pattern will continue in 2018, unless central banks suddenly accelerate the tightening cycle. But if the past 145 years are any guide to the future, it can be a dangerous mistake to assume that “safe” assets will always be boring in the long term, let alone a reliable hedge against individual country risk. Investors forget that at their peril, particularly in a 21st-century world where geopolitical tensions are rising — along with the level of debt.


In search of lost sheep

Chileans will be a tough crowd for Pope Francis

Can a papal visit bring them back to the fold?






















WHEN a visit by Pope Francis to Chile was announced last June, the country’s devout Catholics no doubt hoped it would help bring lapsed ones back to the fold. But as Chileans await his arrival on January 15th for a three-day visit, followed by two days in Peru, the preparations have highlighted the increasing irrelevance of the Catholic church to many Chileans. Half of Chileans regard the visit as of little importance and a large majority disapprove of the government contributing 7bn pesos ($11m) towards security and logistics. “The money should be spent on the poor, above all on health,” fumes Sonia Meza, an evangelical who works as a maid, from La Florida, a suburb of Santiago.

The lack of enthusiasm contrasts with the ecstatic reception of John Paul II in 1987, during the 17-year dictatorship of Augusto Pinochet. Then, more than three-quarters of Chileans were Catholic. The church was respected for its staunch defence of human rights and the visit was used to rally opposition to Pinochet. A hymn written by locals for the occasion, “Messenger of life, pilgrim of peace”, followed John Paul wherever he went.

Over the three intervening decades, trust in the Catholic church has declined dramatically, according to surveys by Latinobarómetro, a pollster (see chart). Less than half of Chileans now call themselves Catholics, a figure that will shock many. An annual survey by the Catholic University’s Centre for Public Policy, which uses a slightly different methodology, comes up with a figure of close to 60% and shows Catholicism falling more slowly.



The Catholic church has been losing adherents across Latin America. But in other countries people are shifting mainly to evangelical churches. The same trend is visible among poorer and less educated Chileans. What marks Chile out is the behaviour of its richer and better-educated youngsters. Elsewhere in the region, they are staying with Catholicism; in Chile they are abandoning faith altogether. “There is an advanced and fairly rapid process of secularisation” in Chile, says Ignacio Irarrázaval of the Centre for Public Policy.

In part this is because Chile is the region’s richest country, and its most open economy. That has facilitated the spread of social trends from outside Latin America. It is also because of revelations about the sexual abuse of children by priests. The Latinobarómetro poll suggests that criminal cases filed against Fernando Karadima, the priest in charge of El Bosque, an upmarket parish in Santiago, triggered an exodus from the church. They came to public notice in 2010. Father Karadima had close connections to Chile’s elite, raising suspicions that powerful patrons had allowed him to act with impunity for many years. Francis’s appointment of Juan Barros, an associate of the disgraced priest, as bishop of the diocese of Osorno was seen by many Chileans as a disastrous mistake.

Trust in the Catholic church is now lower in Chile than in any other Latin American country, says Marta Lagos of Latinobarómetro. And the share of Chileans who say they have no religious belief is similar to that in Uruguay, which has a longer history of secularisation.

The church is also increasingly out of step with Chileans on matters of sexual morality. It campaigned against divorce, which became legal in 2004, and against last year’s relaxation of the strict abortion law. Church leaders seem more concerned by such matters than by injustice and inequality, says Fernando Montes, a Jesuit priest and former rector of Alberto Hurtado University in Santiago.

Some Catholics hope that young people will find Francis’s environmentalism, modest lifestyle and open manner attractive. His agenda emphasises matters of social justice. It includes a visit to a women’s prison, a meeting with a group of Mapuche, Chile’s most numerous indigenous people, and a celebration of immigrants.

No one doubts that hundreds of thousands will flock to see him. Three giant masses are planned, in Santiago, Temuco in the south and Iquique in the north. Hotels in Temuco expect hordes of Argentines to cross the border to see the first Argentine pope; Peruvians will swell the congregation in Iquique. Chileans who stay at home will be able to watch the pope’s progress around the clock. That does not mean they will follow him back to church.


As Economy Strengthens, Fed Ponders New Approach


By BINYAMIN APPELBAUM


Ben S. Bernanke, the former Federal Reserve chairman, and others have suggested the Fed should move away from a rigid inflation target of 2 percent annual growth. Credit Richard Drew/Associated Press        


WASHINGTON — In the wake of a deep economic crisis and a disappointingly slow recovery, a growing number of experts, including some Federal Reserve officials, say it is time for the Fed to consider a new approach to managing the economy.

Since the mid-1990s, the Fed has focused on keeping inflation slow and steady, at about 2 percent a year, in the belief that it was the best way to nurture economic growth and avoid painful downturns. Those pushing for a new approach do not agree on the best alternative — the ideas range from minor tweaks to tossing the current rule book — but there is broad agreement that the Fed should seize the moment now, before the next crisis hits.

“Monetary policy has not been as successful as we might like over the last decade,” Christina Romer, an economist at the University of California, Berkeley, said this weekend at the annual meeting of the American Economic Association in Philadelphia. “Now really is the time for every monetary economist to say, ‘Is there something better?’”

The stakes are high: The Fed pursues its goals by raising and lowering borrowing costs to influence economic growth and stability. Effective management allows the economy to prosper: Employment grows, wages rise and people enjoy better standards of living. Mistakes cause recessions.

The Fed has faced questions about its methods in the decade since the 2008 crisis, but in recent weeks, officials have shown a willingness to welcome the debate. John Williams, president of the Federal Reserve Bank of San Francisco, said it was time to talk about approach because the Fed is finally wrapping up its response to the last crisis, which entailed unprecedented steps to lower borrowing costs and get financial markets moving.

“The right timing of this debate is really now because the U.S. economy has fully recovered from this recession,” Mr. Williams said.

Patrick Harker, president of the Federal Reserve Bank of Philadelphia, told attendees at the economics gathering in Philadelphia that there was an urgent need for more and better research on the available alternatives.

“The most important issue on the table right now is that we need to consider the possibility of a new economic normal that forces us to re-evaluate our targets,” he said. “It is a question for the profession itself, and we do need people thinking about this.”

The Fed’s current approach is known as inflation targeting. It works in large part by training the public to expect a certain level of inflation, disciplining the pricing decisions of businesses and the wage demands of workers. It is, in other words, a self-fulfilling prophecy.

The Fed announced in January 2012 that it would seek to keep inflation at a 2 percent annual pace, formalizing its implicit target since the mid-1990s.

The rise of inflation targeting reflected a consensus among academics and policymakers that central banks did not have direct control over broader economic performance but did exercise direct control over inflation, and that keeping inflation low and stable was the best way to support growth.

Most central banks in developed nations similarly target a low rate of inflation, taking the view that unpredictable increases in prices are economically disruptive. The European Central Bank, for example, aims to keep inflation “below, but close to” 2 percent.

But the Fed’s focus on inflation in the real economy did not prevent asset prices like mortgage-backed bonds from soaring to unsustainable heights before 2008, and concern about keeping inflation low limited the scope of its post-crisis stimulus campaign.

Moreover, the combination of low inflation and modest growth has left the Fed with very little room to respond to future downturns by reducing interest rates. During past downturns, the Fed lowered rates by an average of five percentage points. But the Fed’s benchmark rate currently sits in a range between 1.25 percent and 1.5 percent. That would make cutting the rate a less effective tool than in previous firefights.

Janet L. Yellen, the Fed’s outgoing chairwoman, has emphasized that the Fed has other weapons in its arsenal. After 2008, the Fed bought large quantities of Treasuries and mortgage bonds and promised to keep interest rates low for years at a time, encouraging borrowing by businesses and consumers.

Ms. Yellen is expected to be succeeded by Jerome H. Powell, a Fed governor who is awaiting Senate confirmation as the next Fed chairman.

Some outside economists say the Fed is putting a brave face on a bad situation.

“We are living in a singularly brittle context in which we do not have a basis for assuming that monetary policy will be able as rapidly as possible to lift us out of the next recession,” said Lawrence H. Summers, a Harvard economist and former Treasury secretary.

The proposed alternatives to inflation targeting can be sorted into two categories. The first contains one simple idea: The Fed should permanently embrace higher inflation. The second is full of complicated ideas for temporarily embracing higher inflation during downturns.

Olivier Blanchard, a fellow at the Peterson Institute for International Economics who began his term as president of the American Economic Association at the Philadelphia meeting, said the choice of a 2 percent target had no particular economic logic to recommend it. Raising the target to 4 percent would give the Fed more room to operate without significantly larger economic costs, he said.

Many economists, however, are wary of the simple solution.

Ben S. Bernanke, the former Fed chairman, has warned that the costs of dropping a new anchor would be significant. On Monday, at a Brookings Institution conference convened to discuss alternatives to the 2 percent target, Mr. Bernanke dismissed a 4 percent target as politically untenable.

“The Fed is not going to adopt a 4 percent inflation target,” he said. “It’s just not going to happen.”

But Mr. Bernanke has added his name to the list of those seeking an alternative to the current system. Last year, he proposed that the Fed should announce that it would temporarily tolerate higher inflation during future economic recoveries.

A mechanized version of that idea, popular in some academic circles, would instruct the Fed to target an alternative economic measure, nominal gross domestic product, or N.G.D.P., which sums inflation and real economic growth. Under a 4 percent N.G.D.P. target, for example, the Fed would aim for a combination of inflation and growth that equaled 4 percent, such as 2 percent inflation and 2 percent growth. During a period of lower inflation, like the last decade, such a target would require the Fed to dictate more aggressive stimulus.

Some are skeptical that the Fed can improve the economy by trying harder. Atif Mian, an economist at Princeton University, has argued in his research that high levels of household debt are limiting the impact of monetary policy because many households cannot or will not continue borrow.

“There is this implicit assumption that things will have traction if you just push hard enough,” Mr. Mian said. “But what is the mechanism through which this will raise actual G.D.P.?”

Indeed, the Fed and other central banks have not even succeeded in hitting their 2 percent targets in recent years, for reasons that remain unclear. Inflation in the United States has been below that level for the last six years, although most Fed policymakers continue to predict that higher inflation is around the corner.

Ms. Romer said more ambitious targets might encourage central banks to try harder to stimulate inflation.

In practice, she said, the Fed could have purchased more Treasuries and mortgage bonds as part of its response to the crisis, or even engaged in direct lending to businesses.

“We should not just assume that what we’ve done for the last 25 years is right,” she said.


China’s Creditor Imperialism

Brahma Chellaney  

The newly-built Chinese-funded port in Hambantota


BERLIN – This month, Sri Lanka, unable to pay the onerous debt to China it has accumulated, formally handed over its strategically located Hambantota port to the Asian giant. It was a major acquisition for China’s Belt and Road Initiative (BRI) – which President Xi Jinping calls the “project of the century” – and proof of just how effective China’s debt-trap diplomacy can be.

Unlike International Monetary Fund and World Bank lending, Chinese loans are collateralized by strategically important natural assets with high long-term value (even if they lack short-term commercial viability). Hambantota, for example, straddles Indian Ocean trade routes linking Europe, Africa, and the Middle East to Asia. In exchange for financing and building the infrastructure that poorer countries need, China demands favorable access to their natural assets, from mineral resources to ports.

Moreover, as Sri Lanka’s experience starkly illustrates, Chinese financing can shackle its “partner” countries. Rather than offering grants or concessionary loans, China provides huge project-related loans at market-based rates, without transparency, much less environmental- or social-impact assessments. As US Secretary of State Rex Tillerson put it recently, with the BRI, China is aiming to define “its own rules and norms.”

To strengthen its position further, China has encouraged its companies to bid for outright purchase of strategic ports, where possible. The Mediterranean port of Piraeus, which a Chinese firm acquired for $436 million from cash-strapped Greece last year, will serve as the BRI’s “dragon head” in Europe.

By wielding its financial clout in this manner, China seeks to kill two birds with one stone. First, it wants to address overcapacity at home by boosting exports. And, second, it hopes to advance its strategic interests, including expanding its diplomatic influence, securing natural resources, promoting the international use of its currency, and gaining a relative advantage over other powers.

China’s predatory approach – and its gloating over securing Hambantota – is ironic, to say the least. In its relationships with smaller countries like Sri Lanka, China is replicating the practices used against it in the European-colonial period, which began with the 1839-1860 Opium Wars and ended with the 1949 communist takeover – a period that China bitterly refers to as its “century of humiliation.”

China portrayed the 1997 restoration of its sovereignty over Hong Kong, following more than a century of British administration, as righting a historic injustice. Yet, as Hambantota shows, China is now establishing its own Hong Kong-style neocolonial arrangements. Apparently Xi’s promise of the “great rejuvenation of the Chinese nation” is inextricable from the erosion of smaller states’ sovereignty.2

Just as European imperial powers employed gunboat diplomacy to open new markets and colonial outposts, China uses sovereign debt to bend other states to its will, without having to fire a single shot. Like the opium the British exported to China, the easy loans China offers are addictive. And, because China chooses its projects according to their long-term strategic value, they may yield short-term returns that are insufficient for countries to repay their debts. This gives China added leverage, which it can use, say, to force borrowers to swap debt for equity, thereby expanding China’s global footprint by trapping a growing number of countries in debt servitude.

Even the terms of the 99-year Hambantota port lease echo those used to force China to lease its own ports to Western colonial powers. Britain leased the New Territories from China for 99 years in 1898, causing Hong Kong’s landmass to expand by 90%. Yet the 99-year term was fixed merely to help China’s ethnic-Manchu Qing Dynasty save face; the reality was that all acquisitions were believed to be permanent.

Now, China is applying the imperial 99-year lease concept in distant lands. China’s lease agreement over Hambantota, concluded this summer, included a promise that China would shave $1.1 billion off Sri Lanka’s debt. In 2015, a Chinese firm took out a 99-year lease on Australia’s deep-water port of Darwin – home to more than 1,000 US Marines – for $388 million.

Similarly, after lending billions of dollars to heavily indebted Djibouti, China established its first overseas military base this year in that tiny but strategic state, just a few miles from a US naval base – the only permanent American military facility in Africa. Trapped in a debt crisis, Djibouti had no choice but to lease land to China for $20 million per year. China has also used its leverage over Turkmenistan to secure natural gas by pipeline largely on Chinese terms.

Several other countries, from Argentina to Namibia to Laos, have been ensnared in a Chinese debt trap, forcing them to confront agonizing choices in order to stave off default. Kenya’s crushing debt to China now threatens to turn its busy port of Mombasa – the gateway to East Africa – into another Hambantota.

These experiences should serve as a warning that the BRI is essentially an imperial project that aims to bring to fruition the mythical Middle Kingdom. States caught in debt bondage to China risk losing both their most valuable natural assets and their very sovereignty. The new imperial giant’s velvet glove cloaks an iron fist – one with the strength to squeeze the vitality out of smaller countries.


Brahma Chellaney, Professor of Strategic Studies at the New Delhi-based Center for Policy Research and Fellow at the Robert Bosch Academy in Berlin, is the author of nine books, including Asian Juggernaut, Water: Asia’s New Battleground, and Water, Peace, and War: Confronting the Global Water Crisis.


Getting Technical

There’s No More Gold in Gold

By Michael Kahn

Photo: Getty Images 



It’s understandable if reading the news these days makes you nervous. And when investors get nervous, they turn to hedging strategies, including moving some of their assets into precious metals. But no matter how we slice and dice them, the trends in gold, silver, and platinum are all still to the downside.

While gold is indeed up about 12% from its lows set a year ago, it is far from being in a bull market. The best we can say is that it remains in a sideways range since its 2013 plunge (see Chart 1).



There is a technical argument that the entire range is a bottoming formation. It’s not a very good argument, as the bottom lasted far longer than the bear market it is supposed to reverse.

The bad news is that the rising trend from last year broke down earlier this month (see Chart 2). It is possible to have both the short-term breakdown and the longer-term trading range co-exist, but it does delay any expectation that the faithful will get their wish with a breakout anytime soon.



Last week, gold bulls got very excited when the metal—and especially gold-mining stocks—jumped when the Federal Reserve made its expected move to raise interest rates for the third time in 2017. The key short-term rate moved higher by 25 basis points (one-quarter percentage point) to a range of 1.25% to 1.5%. That weakened the U.S. dollar and pushed gold prices up, and the VanEck Vectors Gold Miners exchange-traded fund (ticker: GDX) jumped more than 3%.

Even with that nice gain, mining stocks did not break their declining short-term trend, which remains to the downside, and the ETF trades well below its major moving averages (see Chart 3).



There isn’t much to like in the other precious metals—silver and platinum. Both are in downtrends in the short and long terms.

Some will argue that the dollar is holding all the metals down as dollar bears failed to capitalize on a major breakdown last August. The dollar index traded below a three-year support level but soon bounced back above it. In technical analysis, a failed breakdown is a bullish signal and a bullish dollar is generally bearish for gold.

Even if we take the dollar out of the equation, we see weakness in the yellow metal. Gold priced in euros, for example, is also weak. The chart of the SPDR Gold Shares ETF (GLD) divided by the CurrencyShares Euro Trust ETF (FXE) shows a breakdown below a four-year rising trend (see Chart 4).



At the same time, metals such as copper and palladium are in rising trends. Copper started to climb a year ago. Palladium now trades at 17-year highs, just a hair below its all-time high set in January 2001.

Even aluminum and nickel show some short-term strength, so we have to think that precious metals’ prices are soft for reasons unique to them.

The elephant in the room, when it comes to gold as a currency, is Bitcoin and the other cryptocurrencies. In the aftermath of the financial crisis, when governments around the world printed money out of thin air, the buzz was that gold would replace fiat currencies. Indeed, gold advertising on TV spiked just as gold itself reached its record high of $1,923.70 per ounce in 2011. (It traded at $1,265.60 Monday afternoon.)

Now, Bitcoin and the others have that same support from investors, and theoretically we can blame some of gold’s weakness on the rise of cryptocurrencies. Even so, according to a recent report from Goldman Sachs, gold’s market capitalization is $8.3 trillion. Bitcoin, the largest cryptocurrency, currently has a market cap of $388 billion.

Goldman also said there has been no discernible outflow of money from gold ETFs.

When it comes to the charts, all we can say is that the major trend in precious metals is flat, with minor trends pointing lower. Until we see some real bottoming action, we don’t believe there is any money to be made or portfolios to be saved with gold and its cousins.


Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.


The Limits of China’s Economic Power

George Friedman


The countries of East Asia are worried about the coercive power of Beijing’s pocketbook. And perhaps they should be. China is flush with money, and as it continues to pour massive amounts of aid and investment into the region, it’s only a matter of time before Beijing tries to cash in.

China’s overseas investments are being pushed, at least in part, for strategic reasons. This is evident in the high number of projects included in China’s One Belt, One Road initiative that make little commercial sense and fail to perform their stated purpose: to bypass chokepoints that a hostile power could use to asphyxiate the Chinese. In areas such as the Philippines, the primary goal appears to be the cultivation of political influence in foreign capitals or, more cynically, the creation of dependence on Chinese investment or consumers, which Beijing could someday exploit.

But China’s capacity for economic coercion has as many limitations as it does strengths, as the case of South Korea shows. Tensions between the two countries revolve around the deployment of the US Terminal High-Altitude Area Defense anti-missile system in South Korea. Fearing that the THAAD system’s powerful radar could penetrate deep into Chinese territory and threaten its ability to respond to missile attack, Beijing opposed the deployment. And it was compelled to do something about it.

What resulted was a set of informal retaliatory measures that amounted to sanctions in everything but name. For example, Lotte Group, a major conglomerate that owned the land where THAAD was deployed, saw a number of its superstores in China closed, ostensibly over fire safety concerns. Hundreds of other South Korean firms working in China claim to have been subjected to a surge in inspections, visa denials, and increased customs hurdles. Sales of South Korean automobiles in China dropped roughly 44%. Beijing also banned package tours to South Korea, leading to a 50% drop in Chinese visitors through the first 10 months of 2017 (compared to the same period a year earlier). The hit to tourism alone is expected to cost the South Korean economy more than $5 billion. All told, the THAAD issue dented South Korean gross domestic product by 0.4 percentage points this year, according to Bank of Korea estimates.

But for Beijing, the whole effort has been utterly fruitless… and possibly counterproductive. THAAD deployment was completed in September. As a result, last month, Beijing effectively surrendered its position and forged a face-saving agreement to normalize relations with Seoul. (Seoul, which has been diligently developing its own missile defense and anti-artillery systems to wean itself off US hardware anyway, conceded only vague promises to scale back its participation in the US ballistic missile defense network in East Asia.) China’s official position on THAAD has not changed, but Chinese tour groups have begun returning to South Korea. China’s hearty welcome of South Korean President Moon Jae-in's state visit last week essentially confirmed the return to the status quo.

So why were Beijing’s pressure tactics so ineffective? History shows that full-throated, multilateral sanctions efforts generally achieve their desired outcomes but only when the targeted government has strategic reasons to comply. And the strategic stakes for the country pushing the sanctions must be high enough that it will risk heavy diplomatic and economic blowback. In the case of THAAD, neither of these dynamics was at play.

Beijing’s concerns about the THAAD deployment never really matched the intensity of its protestations. China has good reasons to be wary of US defense systems on its doorstep, but THAAD itself does not jeopardize China’s nuclear deterrence capabilities as claimed.

Beijing’s economic retaliation therefore never really rose to a level that would inflict real pain on the South Korean economy, which is still expected to grow at a brisk 3.2% clip this year. In fact, China was unwilling to push measures that would require any amount of economic sacrifice on its own part—barring South Korean investment in China or withdrawing from an important currency swap agreement, for example. Retaliation was limited to areas in which Chinese firms and consumers had ample alternatives. (Chinese tourists, for example, could just as easily vacation somewhere else.)

Even if Beijing had been willing to go further, it’s doubtful that the Chinese could have implemented economic measures strong enough to outweigh Seoul’s immediate security imperatives or longer-term strategic considerations—namely, North Korea. The South is squarely within range of the North’s full —and expanding—ballistic missile arsenal. There is still a possibility that the crisis on the Korean Peninsula ends in war.

The notion that Seoul would weaken its missile defense to boost the prospects of its tourism sector isn’t one to be taken seriously. Beijing presumably never expected that it would, and realized that in its posturing it was backing itself into a diplomatic corner that threatened its credibility in the region. Thus, as soon as Seoul called Beijing’s bluff on THAAD, the Chinese took the first chance to move on.

The THAAD measures, moreover, were at odds with China’s much more important strategic goals—to weaken the US position in Northeast Asia—at a time when circumstances were ripening for progress. At issue is the divergence in the US’s and South Korea’s preferred plan for managing the North Korean nuclear threat. The US is more willing to deal with it militarily. South Korea would rather live with a nuclear North Korea than be obliterated by North Korean artillery, as may happen if the US goes to war with the North.

We don’t think the US is going to attack the North; doing so could destroy its alliance with the South. But the possibility of war is real enough that China is eager to drive a deeper wedge between Seoul and Washington. If the US ultimately decides to live with a nuclear North Korea, as we increasingly suspect it will, the resultant deterrence strategy may well create other opportunities for China to drive the same wedge. Either way, it makes little sense for China to undermine the narrative it has crafted as it has risen to power—that it is more willing and able to protect the region than the United States is.

Admittedly, the THAAD disagreement doesn’t tell us everything we need to know about how effective China will be in economically coercing its neighbors. But what it does tell us shouldn’t be particularly encouraging for Chinese strategic planners.

It’s one thing for Beijing to use overwhelming aid and investment to effectively buy the loyalty of a weaker regional state—say, Cambodia—where the strategic stakes are comparatively low. It’s another to try to bully into submission a wealthy US ally that’s staring down the barrel of mass destruction across its northern border.