The US cannot halt China’s march to global tech supremacy

The Asian superpower’s record shows its ability to modernise and adapt

James Kynge



The moment may one day be glorified in propaganda art. As the mist rolled off the Yangtze river, Xi Jinping stood on top of the Three Gorges hydropower dam in Yichang, a proud symbol of engineering prowess, and proclaimed that China would blaze its own trail to become a technology superpower.

The Chinese president’s immediate audience in April was a group of smiling workers in blue overalls. But his remarks were directed at the White House, from which rumblings of a trade war on China were emanating.

“In the past, we tightened our belts, gritted our teeth and built the two bombs [atomic and hydrogen] and a satellite,” Mr Xi said. “In the next step of tackling technology, we must cast aside illusions and rely on ourselves.”

Such rhetoric from the most powerful Chinese leader since Mao Zedong carries crucial weight. But, as a visual metaphor, the Three Gorges dam is more revealing than Mr Xi was prepared to acknowledge. Although the dam walls were built by Chinese companies, the turbines that generate its electric power were supplied — at least initially — by foreign companies.

The contradiction encapsulates China’s dilemma as it ramps up a techno-nationalist agenda. Its official “ Made in China 2025” programme calls for global leadership in various technological sectors by 2025, but its progress up the value added ladder has — to a significant degree — relied upon foreign technologies and intellectual property.

Thus, China’s response to the trade war is set to be carefully calibrated. Chinese companies are being told by Beijing to cut reliance on US technology and intellectual property in their supply chains, replacing them where possible with alternatives from Europe, Japan, Korea, Taiwan and elsewhere.

“The US is fundamentally an unreliable economic partner,” said one senior official at the State Assets Supervision and Administration Commission, the Chinese state-holding company with combined revenues last year of Rmb26.4tn ($3.8tn). “It is just too risky to rely on them.”

Can China really live without America? The answer supplied by financial markets appears to be “no”, as reflected in the slide in the renminbi’s value against the dollar and a concurrent fall in Shanghai stock prices. But over the longer term, China looks likely to prevail in two important ways. It may be able to de-risk its supply chain by reducing reliance on US imports, notwithstanding difficulties in key areas such as semiconductors. It may also attain its goal of global excellence in tech sectors including artificial intelligence, 5G telecoms, the internet of things, self-driving cars and battery technology by 2025.

One point in China’s favour is that its de-risking activities may be applied only to imports from the US and not to components made by US companies in China. This is a significant factor: the value of products that US companies made and sold in China was about $250bn last year, almost double the $130bn in products imported from America.

The other consideration is the ready availability of alternatives to US tech products. Research by Haitong, a Chinese securities company, finds that in eight of 11 technology sectors the sales in Asia of products made in the EU, Japan, Korea and Taiwan outstrip those of products made in the US. The three sectors in which the US has clear dominance are semiconductors, semiconductor equipment and aerospace.

The semiconductor industry, therefore, is the lightning rod for US-China tech rivalry. China’s vulnerability was laid bare in April when the US banned ZTE Corp, a Chinese telecoms company, from buying American semiconductors and other technology for seven years. The sanction brought ZTE to its knees, before Washington offered a reprieve.

Yet semiconductors are also the area in which China’s ambitions are clearest. Of some $300bn committed to help deliver Made in China 2025, some $150bn is earmarked to upgrade China’s capacity in semiconductors, according to Dan Wang of the research group Gavekal.

And even in semiconductors, the US chokehold is far from total. If the sanctions on ZTE had been applied to its Chinese competitor, Huawei, the damage would have been easily contained. Huawei designs its own chips through a wholly owned subsidiary called HiSilicon, which ranks as the world’s seventh largest chip design company.

China’s record also underlines the foolishness of betting against its modernising verve. A decade ago, few would have predicted global dominance in smartphones. But last year, companies such as Huawei, Oppo and Vivo accounted for 43 per cent of global smartphone sales, eclipsing Apple in the US and Korea ’s Samsung.

It seems clear that, while US opposition will make its ascent up the technology ladder slower and more painful, China will continue its climb.

Perhaps the story of the Three Gorges dam does — after all — point the way. Although its first turbines were supplied by European and US power equipment groups, two Chinese manufacturers raised their game quickly enough to participate in the project’s later stages. Harbin Power Equipment and Dongfang Electrical Machinery are now taking business off their European and US rivals in other countries.


Buttonwood

Are you a stock or a bond?

Why the ideal portfolio depends on the business you are in



IMAGINE two college friends whose careers have taken different paths. Simon is an investment banker. He works long hours, especially when his bank is advising on a big merger. His pastimes include potholing and skydiving. Chris works as a senior civil servant. Early each evening the lights in his office dim to remind his colleagues of the importance of work-life balance. His spare time is spent on long country walks, playing golf and going to the theatre.

How should they invest their money? More specifically, how much of their savings should go to bonds and how much to shares? Textbook theory says it depends on how tolerant Simon and Chris are towards risk. If either can bear the sometimes violent ups-and-downs of stockmarkets, he should hold more shares, which have higher rewards to go with the extra risk. Should such price swings keep him awake at night with worry, he should tilt the mix of his investments towards safer government bonds.

A risk-lover such as Simon is happy to own mostly shares. If you think skydiving is fun, you probably will not lose sleep if the value of your portfolio goes down from time to time. By the same logic Chris, who prefers a quiet life, is content to hold a bigger slug of bonds than Simon. Yet on a broader reckoning, both friends would be better advised to go against their inclinations. Simon, the banker, should buy mostly bonds. Chris, the bureaucrat, should buy mostly stocks.

If that seems paradoxical, consider the nature of each friend’s line of work. Simon’s professional fortunes are tied to the stockmarket. When share prices are booming, the general appetite for business risk is high. Investment projects are approved. Deals are done. The demand for the services of investment banks is strong. Simon’s bank makes pots of money and his bonus surges. His fortunes are changeable, though. When the stockmarket is down, the bank’s profits plunge. So his returns are high, but also volatile—like a stock. To hedge against the stock-like returns of his occupation, Simon should own bonds. In contrast, Chris enjoys a bond-like career. His salary is lower but steadier. His job is not at risk in downturns. So he can afford to take bigger risks with his investments. He should own stocks.

Your job is your down-payment

This is not to say that preferences about risk do not matter to investment choices. They do. It is that wealth should be looked at in the round. A proper reckoning would include not only financial assets but human capital—a person’s knowledge, skills and talents. This has a big influence on earnings over a working life. Young people, with few savings and decades of employment ahead, have most of their lifetime wealth embedded in their human capital. It has a payoff, just like a stock or a bond. It makes sense to take account of that when deciding what to hold as financial wealth.

This way of thinking comes more naturally to people who work in finance. There are fund managers with most of their professional portfolio in stocks but all of their personal wealth in three-month bills. If the bets on stocks turn bad, they might find themselves out of a job. They do not want to put all their personal savings at risk as well.

But most people do not think like this. The available evidence suggests that households do not attempt to hedge their employment income. In fact, they typically “anti-hedge”, by holding a disproportionate fraction of their savings in the shares of their employer or of companies in the same industry or locality.

A paper, published in 2003, by James Poterba of the Massachusetts Institute of Technology discovered that an average of more than 40% of the value of the 20 largest company-pension plans in America was invested in the firm’s own shares. The dangers of such a strategy had recently become apparent. When Enron failed, its employees had over 60% of their retirement savings in company stock. Another study based on Swedish data by Massimo Massa, of INSEAD, and Andrei Simonov, now of Michigan State University, also found that households tend to invest in stocks that are closely related to their employment income.

People stick to what they know for understandable reasons. Investment can seem like an aggressive sport, the preserve of bulls and bears or Wall Street wolves. Yet it would be more helpful to think of investment as self-insurance. People save and invest to protect themselves from contingencies. The best way to guard against some sorts of risks is often to embrace a different kind. The kind of insurance you will need ultimately depends on who you are.


Is Indonesia the Next Emerging-Market Domino to Fall?

Indonesia looks healthier than the likes of Argentina and Turkey, but investors are right to be concerned

By Nathaniel Taplin

There are concrete reasons to refrain from bottom-fishing in Indonesia.
There are concrete reasons to refrain from bottom-fishing in Indonesia. Photo: beawiharta/Reuters


Investors who gorged themselves on Turkish delight and Argentine beef have had a rude awakening in 2018—the two countries are at the heart of a broadening crisis that has sent emerging-market currencies tumbling.

In Asia, one name keeps coming up: Indonesia, which also has a growing trade deficit—and lots of foreign debt. On paper, Indonesia has done everything right to reassure markets this summer, from raising interest rates to cutting spending and lifting import taxes.

Investors still aren’t convinced. The Indonesian rupiah has dropped 10% against the dollar this year, back to levels last seen during the Asian financial crisis of the late 1990s. Some of this can be attributed to contagion. But there are concrete reasons to refrain from bottom-fishing, even with benchmark Indonesian government bond yields looking attractive at about 8%.
On the surface, Indonesia looks healthier than the likes of Argentina. Public debt, at 29% of GDP at the end of last year, was well below normal levels in many developed countries. And Indonesia is still earning plenty of cash from exports to help pay off its foreign creditors. Short-term foreign debt was equivalent to 27% of the value of its exports in the year ended July, according to Nomura, compared with 141% for Argentina and 76% for Turkey.






The headline numbers don’t tell the full story. Indonesia, like China, relies heavily on state-owned enterprises for investment—and they aren’t in great financial shape. Its top state-owned infrastructure companies had aggregate earnings before interest, taxes, depreciation and amortization equivalent to less than four times their interest expense by late 2017, according to Trinh Nguyen and Gary Ng, economists at Natixis ,against a global median of eight times for the sector. The country’s low direct government debt looks less convincing in that context.

Indonesia also looks vulnerable because it is both a big coal exporter and a net oil importer. The former makes it susceptible to a China slowdown—prices for low-caloric value Indonesian coal have tumbled since June, while oil prices have remained high. The country’s monthly trade deficit in July was its largest since 2013, largely due to expensive energy imports.

Indonesia is no Turkey or Argentina, but investors are right to be concerned. Juicy bond yields notwithstanding, spelunking in Indonesia’s coal mines while broader emerging markets are filling up with water looks a risky business.


The Time Bomb Inside Public Pension Plans

Wharton's Olivia Mitchell and Leora Friedberg of the University of Virginia discuss the $4.4 trillion public sector pension shortfall.



Sanitation workers, firefighters, teachers and other state and local government employees have performed their duties in the public sector for decades with the understanding that their often lackluster salaries were propped up by excellent benefits, including an ironclad pension. But Moody’s Investors Service recently estimated that public pensions are underfunded by $4.4 trillion. That amount, which is equivalent to the economy of Germany, accounts for one-fifth of national debt. It’s a significant concern for public employees who were banking on a fully funded retirement to get them through their golden years.

But the issue has wider implications for all taxpayers, who likely will be tapped to make up the shortfall. The Knowledge@Wharton radio show, which airs on Wharton Business Radio on SiriusXM, asked two experts to explain how governments dug themselves into such a deep hole — and whether they can ever get out. Olivia Mitchell is a professor of business economics and public policy at Wharton. She’s also director of both the Pension Research Council and the Boettner Center on Pensions and Retirement Research at the school. Leora Friedberg is a professor of economics and public policy at the University of Virginia’s Frank Batten School of Leadership and Public Policy. The following are key points from their conversation.

Not Enough time, Not Enough Money 
There are plenty of reasons why state and municipal pensions are sorely underfunded, and those reasons sound unnervingly familiar. Mitchell and Friedberg ticked off a list of ingredients reminiscent of other financial stews, including the collapse of the housing market. Like that event, the pension problem has been simmering for decades. Government administrators believed their investment returns would be bigger, and they believed retired employees would die sooner. They used overly optimistic actuarial assumptions, and they thought the long-term nature of the investments could handle higher risk.






They were wrong.


“It seems like there’s enough blame to point to everyone,” Mitchell said. “All of those different approaches proved wrong, especially after the financial crisis where state and local pensions lost 35% to 40% of their money. It’s true that things have been doing a little bit better in terms of their investments, but still the fundamental flaw is that over the years employees were offered a future benefit that was not properly collateralized.”

Mitchell said the problem is worsening because state and local governments have neglected to take corrective action.

“Every year that goes by leads to more red ink and more concern because the state and local plans across the country have clearly not done what they should have done to contribute the right amounts, to invest their assets in their pension plans carefully and thoughtfully,” she said. “Older folks are living longer and needing more medical care, needing longer retirement benefits. It’s a series of challenges that, frankly, nobody is paying much attention to.” 
Friedberg said the problems with pensions are often inherent in the system, and they only compound.


“There aren’t strong incentives for the governments to actually take care of this … before it becomes a problem…,” she said. “After years of underfunding, some combination of taxpayers and state and local government workers bear the cost of that. We’ve already seen that going on for the last 10 years.”

In addition to the pension overhang, Friedberg noted, many states also face health insurance obligations that they aren’t adequately funding. Elected leaders are forced to increase taxes or cut spending to balance budgets thrown out of whack by pension debt, and the public workers are often vilified in the process.

“Politically, that ends up easier than dealing with the funding,” Friedberg said.

Money Problems Run Deep 
Mitchell and Friedberg warned that the pension hole will swallow public- and private-sector employees alike, because all income earners will pay for it. Mitchell ran a simple calculation to illustrate her point: If the shortfall were $5 trillion, divide that amount by the 158 million workers in the American labor force for an obligation of about $32,000 per worker.



“That gives you a concrete sense of the shortfall that we’re facing,” she said. “A lot of people don’t have $32,000 for their own retirement, much less to pay for state and local workers.”


Mitchell also said that governments are probably underestimating pension debt because they are allowed to use whatever actuarial assumptions “that they feel like without any oversight from the federal government.” While states and municipalities are reporting that they are 72% funded, the real rate is closer to 45%, she said.

Broaden that to the federal level, where the impending shortfall in Social Security is well-documented, and the scope of the problem grows. Instead of $32,000 per worker, it’s about $171,000, according to Mitchell.

“I think the problem is one of political non-transparency and also of population aging,” she said. “You keep running unfunded or underfunded plans as long as you have a growing workforce. Our workforce is not growing as quickly as it should be or could be. Our productivity is not what it could be, and what it means is we are going to be supporting more and more retirees on fewer and fewer workers. That gets very expensive quickly.”

Save Your Pennies

The professors have some advice for public-sector workers who are counting on a pension — don’t.
They said workers should take control of their own retirements by saving often and early.


“I think they need to be aware that the benefits they’ve been expecting may not be there,” Friedberg said. “It depends on those states and how tight those legal obligations are. In some states, it’s written into the constitution. In other states, it’s not. And it’s not legally protected by the federal government in any way as private-sector pensions are.”

Governments sometimes manage pension debt by cutting benefits, postponing cost-of-living adjustments or extending the vesting period. Many states are also starting to require employee contributions, similar to a 401k.

“There’s some advantage to that because it makes workers aware of their own savings and it familiarizes them with investment in the stock market,” she said. “But we know from the history of the private sector and moving away from defined benefit plans toward 401ks that voluntary contributions often fall well below what workers need to replace their recumbent retirement.”

Governments have turned to other coping mechanisms, including shedding employees before they are vested or not filling vacant positions.

“I think it is undercutting the competitiveness of the public sector as a place of employment,” Friedberg said. “It was already the case that pay was often lower for comparable jobs, especially for high-skilled workers. The promise of the pension benefit was supposed to make up for that. If that promise is no longer being fulfilled, talented people will certainly go elsewhere.”

Indeed, some cities and states have turned to outsourcing items once thought of as strictly in the public domain. Mitchell pointed to the privatization of prisons and emergency services as examples. Governments that outsource don’t have to deal with a pension payout at the end of a worker’s career.

But those measures still aren’t enough, Mitchell said.

“The bigger issue is the so-called hidden borrowing problem that, when folks that hired teachers and firefighters and so forth 30 years ago, they didn’t pay them the full amount that would make their salaries as well as their pensions robust,” she said. “Instead, they underfunded the plans, leaving today’s taxpayers to pay for services that were rendered 30 years ago.”

Start with Transparency

Mitchell and Friedberg strongly believe that governments need to be more open with employees, citizens and investors about how they handle their pension plans. In turn, those stakeholders need to engage.

“I think the place to start is to begin with transparency,” Mitchell said, citing federal regulations that require corporate plans to report their financial promises and set aside money to meet those obligations. But decentralization means the federal government has no power to compel states to report liabilities and assets or to follow similar protocols.

Mitchell reiterated the point that, ultimately, everyone will pay. She referred to a recent study that contended property owners will be held responsible for unfunded liability through what could be considered a “stealth tax.”

“Twenty percent of your property value is already going to be liable to be covering these state and local pension shortfalls,” Mitchell said. “So, you can sell and move out of Chicago or Detroit, but there’s already that capitalization of the underfunding in the value of your house.”

Friedberg said insolvency comes down to constitutional issues. Citizens need to start asking the right questions, because it’s easy for politicians to “pass the buck.”

Sharing a personal example, Friedberg noted that her home city of Charlottesville, Virginia, operates its own pension fund for police and municipal workers.

“There’s not much information about it, so it’s hard to know [how it’s performing],” she said. “I’d be happier if the city of Charlottesville didn’t have to do this very complicated financial operation of running a pension fund.”

The professors agree that many of the proposed solutions being floated are unlikely to fill the pension hole because the only way to get bigger investment returns is to take on greater risk. The stock market is just too volatile for that.

“There’s no magic investments that states can make here to recoup the money. Just like we saw with the financial crisis, high risk means that at some point there are going to be big declines and they won’t be able to pay their bills,” Friedberg said. “The other problem with bonds is it pushes the problem off to the future, then it makes it harder to understand what the future obligations are.”


It Was Meant to Be the Better Bitcoin. It’s Down Nearly 90%

By Alexander Osipovich, reporter





The bear market in cryptocurrencies has punished investors who bought bitcoin at the height of cryptomania last year. But losses have been even more brutal for those who invested in once-promising rivals of bitcoin.

Consider Bitcoin Cash, an offshoot of bitcoin that launched on Aug. 1, 2017 and moves independently of bitcoin itself. While bitcoin has fallen 68% from its record intraday high of $20,089 in December, Bitcoin Cash is down a crushing 88% from its peak of $4,355.62, according to CoinMarketCap.com. On Thursday, it traded at around $529.

Hundreds of other coins have also plummeted in value, but the underperformance of Bitcoin Cash is notable because it touches on a bigger theme: whether virtual currencies can really become a means of payment that would supplant traditional money.

Supporters of Bitcoin Cash conceived it as a way to fix problems they believed were impeding bitcoin from becoming a mainstream payment tool, akin to PayPal or Visa.

Boosters—including Roger Ver, a prominent crypto investor often called “Bitcoin Jesus”—argued that the original bitcoin network had gotten too slow, and that users were paying overly hefty fees for sending each other bitcoins. This faction argued that bitcoin’s clunkiness was causing people to treat it as a store of value, like gold, and not as a practical way to buy Big Macs or cappuccinos.

There’s still a lively debate over whether bitcoin is any good as a medium of exchange. Many bitcoin holders view it as a hedge against the collapse of government-backed currencies, but don’t often use it to pay for things.

After waging an unsuccessful campaign to change bitcoin from within, the rebels broke off and created Bitcoin Cash, in a so-called “fork” that bitterly split the virtual-currency community. The underlying technology of the new cryptocurrency was almost identical to that of bitcoin, except for tweaks aimed at speeding up transactions and lowering fees.
One year later, some research suggests the breakaway coin hasn’t lived up to its promises.

A study of activity by major cryptocurrency payment-processors—which help businesses accept payments in crypto—found that just $3.8 million worth of payments were made in Bitcoin Cash in May. That’s down from $10.5 million in March, according to Chainalysis, an analytics firm that carried out the study.

The market seems to be favoring bitcoin because it has the stronger brand, according to Martin Garcia, a managing director at Genesis Global Trading Inc., a digital-currency trading firm.

“Bitcoin is expressing itself as the more dominant token,” he said.