The Growing Economic Sandpile
By John Mauldin
“Two ways. Gradually, then suddenly.”
Ernest Hemingway, The Sun Also Rises
Ubiquity, Complexity Theory, and Sandpiles
John Mauldin
Chairman, Mauldin Economics |
The Growing Economic Sandpile
By John Mauldin
John Mauldin
Chairman, Mauldin Economics |
Trump’s tariffs prove tougher obstacle than China expected
Beijing leaders weigh likely effects of retaliation on domestic economy
Tom Mitchell in Beijing
Xi Jinping’s administration has sought to stabilise China’s domestic economy, currency and stock markets, while also appealing to people’s patriotism © AFP
As China’s top leaders huddled on their annual summer retreat on August 3, US President Donald Trump loomed large over their deliberations.
Just two days earlier, Trump administration officials had said they were considering taxing Chinese exports worth $200bn at 25 per cent — compared to a previously announced tariff of 10 per cent. The world’s two largest economies had formally started trade hostilities in July, when they slapped punitive duties on $34bn of each other’s exports.
Chinese officials hoped their unwanted trade war with the US would pause there, at least for the summer. “Everyone has been surprised by Trump,” said one Chinese economist who is close to Beijing policymakers. “Most Chinese officials assumed that Trump was just trying to push the boundary but would eventually back off.”
Mr Trump has instead pressed ahead with his efforts to turn up the heat on Chinese President Xi Jinping. Next week, the US will impose already announced tariffs on another $16bn in Chinese exports, which will be matched by Beijing.
In the face of this unprecedented economic and geopolitical challenge, Mr Xi’s administration has sought to stabilise China’s domestic economy, currency and stock markets, while also appealing to people’s patriotism.
In its most recent meeting on July 31, the Chinese Communist party’s politburo — comprising its 25 most senior officials — called for “stable employment, stable finance, stable foreign trade, stable foreign investment, stable investment and stable expectation”.
Days later at Beidaihe, a seaside resort near the Chinese capital, politburo member Chen Xi urged a group of the country’s leading scientists to “keep a patriotic heart” and help China “independently control core technologies”.
During the two months before the Politburo’s appeal for economic stability, the renminbi had fallen more than 6 per cent against the dollar to a low of 6.85 — a huge move for the carefully controlled currency. Since the Politburo’s statement, the renminbi has traded sideways.
The country’s stock markets, which Mr Trump gleefully noted on August 4 had dropped more than 20 per cent this year, gained ground last week.
China’s central bank also guided interbank lending rates to their lowest levels since the country’s stock markets crashed three years ago. In addition, it reimposed rules that make it more expensive to bet against the renminbi.
Chinese officials must strike a balance between their determination to reduce financial risks and ensuring that economic growth does not slow too sharply in the face of Mr Trump’s onslaught. “The authorities have not given up on [reducing] risk, but they also want to support the real economy,” said Andrew Polk at Trivium, a Beijing consultancy. “The two may not be compatible.”
Keeping the currency at less than Rmb7 to the dollar, which one prominent central bank adviser last week called an important “psychological barrier”, could prove expensive.
“In an environment where growth continues slowing down and the China-US relationship doesn’t improve, holding at seven would just raise a lot of other issues,” said one currency strategist. “You would have to burn reserves, tighten capital controls and tighten monetary conditions, which runs against your current monetary policy.”
In its quest for stability on all fronts, the Chinese government has had to calibrate its response to Mr Trump’s escalating tariff threats. “Beijing is de-emphasising ‘retaliation equal in intensity and scale’ because that is difficult to execute without unacceptable pain to the Chinese economy,” said Yanmei Xie, a China political analyst at Gavekal Dragonomics.
When Mr Trump’s second round of tariffs takes effect on August 23, only 10 per cent of China’s exports to the US — or 2.2 per cent of its total exports — will have been affected. As the official China Daily newspaper said in a commentary, “the two countries’ trade conflict is merely push and shove at the moment”.
But if the Trump administration follows through on its most recent threat against an additional $200bn worth of Chinese exports, bringing the total value of affected goods to $250bn, about half of China’s exports to its largest trading partner — and 11 per cent of its total exports — will be taxed at 25 per cent. Last year China exported goods worth $505bn to the US.
In contrast China, which imported US goods worth $130bn last year, has already taxed — or threatened to tax — US exports worth $110bn.
In its response to Mr Trump’s latest 25 per cent tariff threat, China’s commerce ministry said it would respond with duties ranging between five and 25 per cent. Products that are harder to source from countries other than the US will be taxed at lower rates. Chinese officials have, for now, have exempted US oil exports from retaliation.
Having hoped in vain for the best, they are also now girding themselves for the worst. “Some people are loath to see a lion awaken or a dragon take off, feeling uncomfortable with a population of more than 1.3bn living a better life,” the Communist party’s flagship newspaper, People’s Daily, said in a commentary on Thursday. “We will stand firm.”
Argentina raises taxes in attempt to stem peso crisis
President Macri admits ‘emergency’ after collapse of investor confidence
Benedict Mander in Buenos Aires and Robin Wigglesworth in New York
Argentina’s president Mauricio Macri has unveiled austerity measures as he admitted the country faced an “emergency” in the wake of market panic after the peso’s collapse.
In an impassioned address to the nation from the presidential palace, Mr Macri said Buenos Aires needed to act quickly to restore investor confidence following his request last week for an accelerated $50bn IMF rescue package.
“We believed with excessive optimism that we could go along fixing things bit by bit. But reality shows us that we have to move faster,” said Mr Macri. “The world has told us that we are living beyond our means.”
Nicolás Dujovne, the economy minister, signalled he would quickly try to tighten control of spending, saying the government would next year eliminate its primary fiscal deficit: the gap between spending and income before taking debt servicing into account.
Argentina is to raise taxes and slash its bureaucracy to try to hit the target, which is much more aggressive than a previous plan to lower the deficit to 1.3 per cent next year.
The country has been lashed by a global storm in emerging markets since the peso plunged last week to it lowest level against the dollar, taking its depreciation this year to more than 50 per cent.
The elimination of the fiscal deficit will in part be financed by increasing export taxes, with Mr Macri saying the country needed help from “those who have most capacity to contribute”.
Taxes on exports have been highly contentious for Argentina’s powerful farming sector and Mr Macri had promised this year to continue to reduce taxes on exports of soya. But on Monday Argentina’s president said the crisis was forcing him to implement measures he would prefer to avoid.
“We know that it is a bad tax and it goes against what we want to encourage, but this is an emergency and we need your help,” he said, attributing much of Argentina’s economic problems to external factors, including rising US interest rates and oil prices, the US-China trade war, problems in Turkey and Brazil and the worst drought in almost half a century.
Mr Macri also announced that he would reduce the number of ministries by more than half in an attempt to cut spending, folding more than 10 ministries into others and in effect demoting more than half of his ministers. He described the currency crisis, which erupted in late April, as “the worst five months of my life” after his kidnapping 27 years ago.
Mr Macri said last week he would ask the IMF to speed up disbursement of a planned $50bn support programme to try to protect the country’s finances.
Investors have been looking for the Argentine government to ditch its policy of “gradualism” in reducing its spending, and are likely to welcome the promise to eliminate the primary budget deficit by next year.
“This is the only way they will arrest this crisis,” Federico Kaune, head of emerging market debt at UBS Asset Management, said ahead of Mr Dujovne’s announcement. “They need to show that the strategy has changed from gradualism to a more orthodox fiscal tightening.”
However, fund managers say that, after a series of mis-steps and a worsening crisis that has burnt many investors who kept faith with the government, markets will need to see tangible evidence and hard commitments before they dip back into the country.
The peso fell another 3.6 per cent against the dollar on Monday to trade back near the record lows touched last week, despite the government’s announcements.
And Then, The Fall
by: The Heisenberg
Volatility among the most popular stocks and low net leverage in a rising market have weighed on recent hedge fund returns. Despite outperforming earlier this year, our Hedge Fund VIP basket of the most popular long positions has lagged the S&P 500 by 118 bp YTD (7% vs. 8%).
Nearly 100 hedge funds owned Facebook as a top 10 portfolio position at the start of 3Q, keeping it atop our Hedge Fund VIP list and weighing on fund returns as the stock tumbled in July. Our VIP list of the most popular long positions has suffered large performance swings this year, lagging the S&P 500 by 500 bp since June.
Declining net leverage as the equity market rebounded and outperformance of concentrated short positions have also worked against hedge fund returns.
Globalization with Chinese Characteristics
Barry Eichengreen
BERKELEY – US President Donald Trump’s erratic unilateralism represents nothing less than abdication of global economic and political leadership. Trump’s withdrawal from the Paris climate agreement, his rejection of the Iran nuclear deal, his tariff war, and his frequent attacks on allies and embrace of adversaries have rapidly turned the United States into an unreliable partner in upholding the international order.
But the administration’s “America First” policies have done more than disqualify the US from global leadership. They have also created space for other countries to re-shape the international system to their liking. The influence of China, in particular, is likely to be enhanced.
Consider, for example, that if the European Union perceives the US as an unreliable trade partner, it will have a correspondingly stronger incentive to negotiate a trade deal with China on terms acceptable to President Xi Jinping’s government. More generally, if the US turns its back on the global order, China will be well positioned to take the lead on reforming the rules of international trade and investment.
So the key question facing the world is this: what does China want? What kind of international economic order do its leaders have in mind?
To start, China is likely to remain a proponent of export-led growth. As Xi put it at Davos in 2017, China is committed “to growing an open global economy.” Xi and his circle obviously will not want to dismantle the global trading system.
But in other respects, globalization with Chinese characteristics will differ from globalization as we know it. Compared to standard post-World War II practice, China relies more on bilateral and regional trade agreements and less on multilateral negotiating rounds.
In 2002, China signed the Framework Agreement on Comprehensive Economic Cooperation with the Association of Southeast Asian Nations. It has subsequently negotiated bilateral free-trade agreements with 12 additional countries. Insofar as China continues to emphasize bilateral agreements over multilateral negotiations, its approach implies a diminished role for the World Trade Organization (WTO).
The Chinese State Council has called for a trade strategy that is “based in China’s periphery, radiates along the Belt and Road, and faces the world.” This suggests that Chinese leaders have in mind a hub-and-spoke system, with China the hub and countries on its periphery the spokes.
Others foresee the emergence of hub-and-spoke trading systems centered on China and also possibly on Europe and the United States – a scenario that becomes more likely as China begins to re-shape the global trading system.
The government may then elaborate other China-centered institutional arrangements to complement its trade strategy. That process has already begun. The authorities have established the Asian Infrastructure Investment Bank, headed by Jin Liqun, as a regional alternative to the World Bank. The People’s Bank of China has made $500 billion of swap lines available to more than 30 central banks, challenging the role of the International Monetary Fund. Illustrating China’s leverage, in 2016 the state-run China Development Bank and Industrial and Commercial Bank of China provided $900 million of emergency assistance to Pakistan, helping its government avoid, or at least delay, recourse to the IMF.
A China-shaped international system will also attach less weight to intellectual property rights.
While one can imagine the Chinese government’s attitude changing as the country becomes a developer of new technology, the sanctity of private property has always been limited in China’s state socialist system. Hence intellectual property protections are likely to be weaker than in a US-led international regime.
China’s government seeks to shape its economy through subsidies and directives to state-owned enterprises and others. Its Made in China 2025 plan to promote the country’s high-tech capabilities is only the latest incarnation of this approach. The WTO has rules intended to limit subsidies. A China-shaped trading system would, at a minimum, loosen such constraints.
A China-led international regime would also be less open to inflows of foreign direct investment. In 2017, China ranked behind only the Philippines, Saudi Arabia, and Indonesia among the 60-plus countries rated by the OECD according to the restrictiveness of their inward FDI regimes.
These restrictions are yet another device designed to give Chinese companies space to develop their technological capabilities. The government would presumably favor a system that authorizes other countries to use such policies. In this world, US multinationals seeking to operate abroad would face new hurdles.
Finally, China continues to exercise tight control over its financial system, as well as maintaining restrictions on capital inflows and outflows. While the IMF has recently evinced more sympathy for such controls, a China-led international regime would be even more accommodating of their use. The result would be additional barriers to US financial institutions seeking to do business internationally.
In sum, while a China-led global economy will remain open to trade, it will be less respectful of US intellectual property, less receptive to US foreign investment, and less accommodating of US exporters and multinationals seeking a level playing field. This is the opposite of what the Trump administration says it wants. But it is the system that the administration’s own policies are likely to beget.
Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.
Fidelity Tries Luring Investors With 2 No-Fee Funds. So What’s the Catch?
By Tara Siegel Bernard
CreditMinh Uong/The New York Times
Investing just became even cheaper — free, actually.
Fidelity introduced two new index mutual funds last week that have no fees whatsoever, taking the democratization of investing to a whole new level. Consumers now have access to domestic and international stock markets without any hurdles, including no required minimum investment amount.
The move continues an industry trend toward lower-cost investing, with several giant firms — Fidelity, Schwab and Vanguard among them — all but daring one another to push their already rock-bottom fees even lower.
But when companies start to dangle free offers, one can’t help but ask: What’s the catch?
It’s simple, analysts said. If Fidelity can lure investors in with a promise of no fees, it is in a position to sell other products and services — a money-market account, say, or financial advice — that offer fatter profit margins. And given its size, the company can afford to sell no-fee funds below cost.
“They’re bait,” Jeffrey Ptak, an analyst with Morningstar, said of the new funds.
The good news is that the bait — Fidelity Zero Total Market Index Fund and Fidelity Zero International Index Fund — is as advertised: There are no hidden fees, and costs are not simply waived temporarily. (The funds track indexes created by Fidelity.)
“It is not a rebate, it is not temporary, it is not a promotional offer,” Kathy Murphy, president of Fidelity’s personal investing business, said. “It is permanent.”
Beyond the free funds, Fidelity has introduced other changes that make it easier and cheaper to invest. It has eliminated its minimum investment requirements for opening brokerage accounts (previously $2,500), 529 college savings plans and the vast majority of its indexed mutual funds when bought through Fidelity.
The company has also cut prices on nearly two dozen existing stock and bond index funds, so that all investors now have access to its lowest-priced class of fund shares. For people already invested in these funds, according to Fidelity, that translates to a reduction of roughly 35 percent, with some funds costing as little as 0.015 percent of assets, or a penny and a half for every $100 invested.
Fidelity’s latest changes come after another consumer-friendly move: The company significantly expanded the number of commission-free exchange-traded funds available on its platform, to 265 from 95. (Generally speaking, E.T.F.s are similar to index funds but trade like stocks on an exchange, meaning investors must pay commissions whenever they buy or sell shares, which also carry underlying investment fees). Vanguard also recently expanded its stable of commission-free E.T.F.s.
Lowering costs and easing access to investing is a universal good for consumers. But analysts and others who work in the industry said they expected Fidelity would try to sell more of its other wares — at least one of them probably in the form of advice. That is, the company may try to get investors to pay a separate fee to manage their money or perhaps try to entice them aboard its digital-investing platform, Fidelity Go, which charges 0.35 percent of assets total, including investment costs.
None of that is necessarily bad, if the advice is needed, the financial adviser is truly acting in the investor’s best interest (not, for example, motivated by a push to meet sales goals) and any fees are reasonable. But as some costs come down, the possibility of a sales pitch in other areas is something to watch for.
Investors have flocked to lower-cost index funds, which generally focus on a selection of investments that track the stock or bond markets (or segments of them). Over time, index funds tend to outperform actively managed mutual funds that hold investments handpicked by humans, in part because the active funds often cost significantly more.
The average index fund costs 0.52 percent of assets, compared with .87 percent of assets for actively managed mutual funds, according to a Morningstar analysis, which excluded funds that carry sales charges in addition to the underlying cost of the investment.
Fidelity introduced its latest price cuts as it grapples with broader challenges to its mutual fund business. Investors have been fleeing its actively managed funds in favor of cheaper index funds.
The company crows on its website that its index funds are now cheaper than Vanguard’s — “There’s no match for Fidelity in index investing — not even Vanguard.” Vanguard, the indexing pioneer, has long been heralded as the lowest-cost provider, and Morningstar says that, over all, it still holds the crown when comparing its universe of actively managed and index funds with Fidelity’s total collection of funds.
But Fidelity’s index funds are now a few pennies cheaper than Vanguard’s when looking at only passive investments, according to a Morningstar analysis: Investors are paying 0.04 percent of assets on average at Fidelity versus 0.07 at Vanguard.
Whether others will try to match Fidelity’s no-fee funds is unclear. The company’s move does not only put pressure on other index-fund providers, analysts said. It also has implications for actively managed funds, which may need to do even more to justify their much higher fees.
BlackRock, which has a huge E.T.F. business under the iShares name that competes in part with retail index funds, offers an E.T.F. that tracks the domestic stock market at a cost of 0.03 percent of assets. Martin Small, who leads BlackRock’s iShares business in the United States and Canada, said the firm had “zero plans” for a zero-fee E.T.F.
A Schwab spokeswoman declined to say whether the firm would make further changes to its prices. “Any time costs go down, investors win,” the spokeswoman said in a statement. She said Schwab was “laser focused” on straightforward, low-cost products that could be sold broadly to many investors “so we can continue to pass the benefits of our scale” to them.
Vanguard, whose mutual fund shareholders effectively own the company, said it was structured to lower the cost and complexity of investing in all of its funds, indexed and actively managed, for all of its customers.
“This is now a game of inches, with firms trying to gain supremacy one basis point at a time,” Mr. Ptak of Morningstar said.
The difference can be counted in pennies. Fidelity’s free domestic fund, for example, competes with Schwab’s Total Stock Market Index fund, which charges just 0.03 percent of assets, or 3 cents for every $100 invested; Vanguard’s Total Stock Market Fund, which, depending on the amount invested, ranges from 0.02 percent of assets, or 2 cents per $100, to 0.14 percent of assets.
“If you examine the recent history, we’ve had Schwab, Vanguard and Fidelity all make moves to try to gain an edge by removing fees and barriers,” Mr. Ptak added. “We’re now at a point of diminishing returns, so these firms will have to find other ways to differentiate, but it’s shaping up as a slugfest, with these firms trading blows.”
For now, consumers appear to be winning that fight.