Anglo-Irish relations are a casualty of Brexit

The convergence of the two countries has been disrupted by the UK’s vote to leave the EU

Gideon Rachman

Over the past 50 years, the image of Ireland and the Irish has been transformed in Britain.

Thinking back to the 1970s, I cringe at the memory of the “Irish jokes” about “thick Paddies” that were a staple of my London school playground. When the Irish were not laughable, they were dangerous. The IRA bombing campaigns in the UK tarred the whole of Ireland as somehow linked to terrorism.

But in Britain today, Ireland is cool. The Irish are no longer the butt of jokes — they are the ones telling them. Entertainers such as Graham Norton and Dara O Briain are mainstays of BBC schedules. Dublin has the dubious privilege of being a favourite haunt for British stag weekends. And Anglo-Irish friendship is celebrated on the sporting field, with an Irishman, Eoin Morgan, captaining the England one-day cricket team.

The economic boom in Ireland and the passage of time have done a lot to bury old stereotypes. But so has joint membership of the EU. The danger now is that Brexit has reintroduced a dangerous strain of bitterness into Anglo-Irish relations, with the British and Irish once again harbouring resentment and anger towards each other.

Ireland and the UK joined the then European Economic Community together in 1973. Their joint membership helped to create a new kind of relationship, based on mutual respect and shared interests. European law also provided the legal framework for Dublin and London to work together on the Good Friday Agreement of 1998 that effectively ended the Troubles in Northern Ireland. In the European single market, a hard border could be erased and binary questions of citizenship — British or Irish — blurred.

Within the EU, the British and Irish discovered that they have a lot in common. In Brussels, they were allies in the struggle against “tax harmonisation”. When the UK stayed out of the Schengen border-free travel area within the EU, the Irish did the same — in favour of preserving the common travel area between the UK and the Republic of Ireland. Both countries have felt a pull from the US, with Mary Harney, former deputy prime minister of Ireland, once remarking that the Irish were spiritually “closer to Boston than Berlin”.

This vein of Euroscepticism led the Irish initially to vote against the ratification of the EU’s Nice and Lisbon treaties (referendum results that anticipated Britain’s 2016 vote for Brexit). In the Irish case, the initial referendums were later reversed in second votes.

But this convergence of Britain and Ireland has been radically disrupted by Brexit. Many Brexiters are enraged by the Irish insistence on a “backstop” to prevent a hard border between the Republic of Ireland and Northern Ireland, believing this to be a largely invented problem designed simply to thwart Brexit. Many Irish people are, in turn, outraged by what they perceive as Britain’s high-handed dismissal of their concerns, believing this to reflect old colonial attitudes. It is an uncomfortable coincidence that the Irish war of independence started a century ago, in 1919, culminating in the creation of the Irish Free State.

At the moment, the British and Irish governments are locked in a game of chicken over the backstop. Unless one of them swerves, there is a clear danger that Britain and Ireland will go over the no-deal cliff together on March 29.

Both countries would suffer badly. The British are already transfixed by no-deal horror stories, involving bureaucratic chaos and shortages of food and medicine. The Irish face an economic rupture with their second-largest export market, after the US.

The implications for Ireland’s crucial agricultural sector are particularly grim, given that the British government has announced that it will impose tariffs on food imports; in the event of no deal, Irish beef farmers would be particularly vulnerable. Last week, the Irish government published emergency legislation designed for a no-deal Brexit; an idea that Simon Coveney, deputy prime minister, described as a “lose, lose lose” proposition.

Even a more orderly Brexit will damage Anglo-Irish relations. Having felt humiliated by Ireland in the negotiations, some Brexiters will want to demonstrate that Britain can still push around its smaller neighbour. At the same time there will be continuing paranoia in Westminster that Ireland may enlist its bigger friends in Brussels, Berlin (or, God forbid, Washington), to once again get one over on the Brits.

Negotiating new relationships on trade and immigration and a host of other issues will be a constant irritant. And the question of Irish unity will also be back on the table. The thought of “losing” Northern Ireland will enrage British nationalists, many of whom are also strong Unionists. But the prospect of a united Ireland could also be a big problem for Dublin, with alarming financial and security implications.

Ireland might also find itself newly vulnerable within the EU. There is already grumbling from some of the other EU members that Ireland must repay the “solidarity” it has been extended over Brexit, by abandoning its insistence on setting its own (low) corporate tax rates.

As the process of Brexit unfolds, we are discovering how many pleasant aspects of modern life in Britain are closely linked to EU membership. A good relationship between Britain and Ireland should be added to that list.

How the shale revolution is reshaping world markets

The fast-growing industry in the US is proving doubters of its sustainability wrong

Nick Butler

A tanker docked at Cheniere Energy’s Texas terminal by the Sabine Pass in February 2016 to ship LNG to Brazil for the start of US shale exports © Bloomberg

The latest short-term outlook for US oil production published by the Energy Information Administration shows output rising to 13.2m barrels a day by the end of 2020. If this is achieved (and the EIA is traditionally cautious), the US will be the largest producer in the world, by a clear margin over Saudi Arabia and Russia.

Two-thirds of that production will come from “tight oil” — that produced by fracking shale rocks. Ten years after the shale business began, the revolution is as dynamic as ever.

Commentators who said shale was a marginal short-term phenomenon that would be killed off by falling prices, or rapid reservoir depletion, have been proved wrong. What began as a gas play now supplies the US with the bulk of its oil and gas needs.

Threatened by the downturn in prices after 2014, the shale industry has achieved a remarkable reduction in costs. The current outlook is for output to continue to rise until at least the mid 2020s even at current oil prices.

The impact on the global market and trade has been profound. The US is now a net exporter of both oil and gas, and recent figures from the International Energy Agency suggest that exports will continue to grow steadily.

That means US production growth is absorbing most of the annual increases in global oil demand (around 1m b/d), leaving Opec and Russia little or no scope to increase their own exports or revenue.

US export growth is the main reason why, despite the falls in production in Venezuela and Iran as a result of sanctions and social disintegration, the oil price at just over $60 for a barrel of Brent crude is below what it was 40 years ago in real terms.

US exports are also reshaping the world market for natural gas. The latest surge in gas exports, built on the growing volumes of that produced as a byproduct of oil extraction, is adding to a global glut. Prices can only fall further and expectations of a price surge in the early 2020s now look misplaced.

The past year has seen something of a pause in shale development because the infrastructure necessary to move additional volumes, particularly from the giant Permian field in Texas and New Mexico, had to be put in place. Nevertheless, US output rose by over 1m b/d last year.

Shale gas has taken market share from coal in the US and despite the best efforts of the Trump administration the gradual decline of coal will continue. Shale gas has also undermined the US nuclear business.

Oil from shale has removed the US dependence on oil imports. Last year only some 1.5m b/d of oil was traded into the US from the Middle East, clearly reducing the strategic importance of an area that was once a priority for American foreign policy.

The revolution is live but has not yet been exported. The potential exists. There are shale rocks in China, southern Africa, Russia and many other places around the world. But progress has been slow, not least because additional supplies are simply not needed in a saturated market.

Now, however, the situation is beginning to change. Shale development in Argentina and Canada is growing and the big energy companies, including BP and Chevron, are investing at a material level for the first time. The lesson of the US experience is that once a new industry is in place with the necessary skills and infrastructure, output from identified basins can grow beyond all initial expectations. The global shale revolution has barely begun, and the changes to the pattern of trade that we have seen so far are no more than a hint of the disruption to come.

The writer is an energy commentator for the FT and chair of the King’s Policy Institute at King’s College London

Whatever happened to the EM rally?

Strong positioning data suggest investors may have little appetite for more

Jonathan Wheatley

For emerging market investors, 2019 began promisingly. The US Federal Reserve has held back from adding to a run of interest rate rises that hurt EM assets last year, while fears of a more bruising trade war between the US and China have receded.

However, a January rally in the bonds and stocks of many developing economies has since fizzled.

Given the more benign backdrop delivered by a shift in policy from the Fed, the failure of EM markets to sustain their zip may lie in the fact that investors began the year with plenty of exposure to them, according to Robin Brooks at the Institute of International Finance, an industry association and gatherer of EM data.

The IIF examined balance of payments data from 23 emerging economies, broken down by cross-border flows and shifts in asset prices, to see how the value of foreign holdings of each countries’ securities, such as stocks and bonds, have changed.

Their research underlined that a decade of quantitative easing by western central banks triggered a flood of foreign money into EM assets.

Between 2010 and 2018, investors poured money into the majority of EM countries, with only Russia and Hungary missing out over the period. Although the effect of changes in the prices of EM assets was less uniform, the broad trend was that the value of foreign holdings of securities, as a share of total GDP, rose across EMs.

Mr Brooks and his colleagues also found that, despite last year’s rout in EM assets, most foreign investors took the hit to valuations without reducing their exposure. The IIF’s data suggest that flows were mildly negative, at most.

The analysis indicates that fund managers began the year with significant exposure to EM assets, putting a curb on their appetite for more. Until there are signs that global growth, and the Chinese economy in particular, can recover some momentum, the EM rally may well stay on hold.

Copper Prices Get Shanghaied

Prices of the metal, which have lost steam recently, bear more than a casual resemblance to trends in China’s rates and stock market.

By Nathaniel Taplin

Molten copper flowing at a smelter in Tongling, China, on Jan. 17.
Molten copper flowing at a smelter in Tongling, China, on Jan. 17. Photo: Qilai Shen/Bloomberg News

Students of global markets may have noticed that when it’s sunny in Shanghai, copper prices tend to gleam brighter, too.

The Shanghai Composite, China’s main stock benchmark, and global copper prices have risen in tandem since the start of the year, with the latter gaining 9% and the former up a full 23%. Recently both have lost steam.

Copper, the metal that supposedly has a doctorate in economics, is widely considered a reliable barometer of economic activity. The Shanghai Composite, filled with trend-chasing retail investors and heavily managed by the government, is not. What’s going on?

The man behind the curtain is, most likely, Chinese short-term borrowing costs. This latest run-up in Chinese stocks, like the last big bull market in 2015, was fueled by margin borrowing.

Early this year, China’s central bank was busy easing, too—a cut to the amount of cash banks must hold in reserve pushed short-term borrowing costs down near 2016 lows for much of January and February. That helped supercharge the stock rally, initially sparked by rising odds of a trade deal with the U.S. Meanwhile, speculators—watching the monster rally in Chinese stocks—probably concluded the worst was now over for the Chinese economy and bid up copper.

That now seems to have been premature. What ultimately matters for Chinese copper demand isn’t overnight borrowing costs, but how much companies that actually build things borrow and pay for loans. Corporate bank lending rates remain stubbornly high, and real credit growth has barely begun to recover. And China’s property market, the most important global copper demand source, is starting to look soggy.

Meantime, the People’s Bank of China, worried about a new stock bubble, has already mopped up much of the liquidity released in January. Short-term rates have moved back up, while margin borrowing has flatlined again, as have stocks and copper.

The Chinese economy is still slowing—just ask those real corporate borrowers and builders. That means more easing looms, which could spell a lot of volatility in short-term rates, stocks and metal prices in the months ahead while the central bank keeps trying to wrestle down long-term borrowing costs without pumping up a new stock bubble.

Short-end rates and shiny stock rallies are all very well. Investors looking for a clearer signal on metal prices should keep an eye on more-boring but reliable barometers, such as credit growth and weighted average bank lending rates.

Risky U.S. Loan Markets Lean Too Much on Japan

A single key source of funding has been a critical element in funding private-equity owned companies

By Paul J. Davies

Relying too much on one group of buyers is always dangerous: If they disappear, your business is toast.

The world of risky loans used to back private-equity deals is doing this twice over: Demand for loans is dominated by investment vehicles known as collateralized loan obligations (CLOs) and those vehicles, in turn, rely heavily on one group of investors, Japanese banks.

Japanese buyers haven’t stopped buying yet, but other investors see their appetite as a critical element in the funding of private-equity backed businesses. If they do stop, fewer loans will be available at a much higher cost and that would spell trouble.

CLOs buy portfolios of loans and get their funding by selling a mix of equity and debt. They currently buy more than 60% of all new leveraged loans issued in the U.S., a greater share than before the 2008 crisis.

As the CLO market has boomed, Japanese buyers have taken between 60% and 75% of all the most senior, AAA-rated debt, according to various market participants. One bank alone, Norinchukin, owns $62 billion of this debt, equivalent to owning nearly 10% of the entire CLO market.

The banks have rushed into CLOs in the hunt for higher yields than they can get on other safe debt. CLOs and the loans they hold also offer protection from rising interest rates because they pay a floating-rate coupon. They also proved resilient during the last crisis: While other vehicles exposed to subprime mortgages collapsed, no CLO defaulted on its senior debt.

This time around, though, the popularity of CLOs has helped to increase the average riskiness of leveraged loans. CLOs must stay full of loans and they need to earn a certain amount in order to pay bondholders and generate a return for equity investors.

A pedestrian walks past a stock board in Tokyo. The reliance on Japanese buyers is one of the threats to the loan market.
A pedestrian walks past a stock board in Tokyo. The reliance on Japanese buyers is one of the threats to the loan market. Photo: Natsuki Sakai/Zuma Press 

As loan yields have been squeezed, CLO managers have been forced to buy riskier loans to produce enough income for their investors. This has lifted demand for lower-rated loans: In the U.S., the share of the loan market rated B or B-minus has grown from less than 20% in 2011 to nearly 40% now, according to Barclays .CLO holdings are concentrated around B-ratings, according to Fitch Ratings, while their holdings of CCC-rated loans are also higher than in the past.

CLOs have limits on how many of the worst quality loans they are allowed to hold, raising concerns they could become forced sellers if loans suffer a spate of downgrades. However, it is more likely that CLO managers would simply stop investing and use income from their loans to pay down their debt.

This ratings issue and the reliance on Japanese buyers are twin threats to the loan market.

These threats are less about a wave of fire sales and more about a sudden stop to new funding.

That matters because private-equity backed businesses don’t tend to pay down their debt, but rely on repeated rounds of refinancing. If the taps are turned off, a rise in defaults will likely follow.

Carrying the weight

Should the world worry about America’s corporate-debt mountain?

It is not like the subprime crisis. But it could make the next recession worse

AMERICAN HOUSEHOLD debt set off the global financial crisis in 2007. But for much of the subsequent recovery America has looked like a paragon of creditworthiness. Its households have rebuilt their balance-sheets; its firms have made bumper profits; and its government goes on providing the world’s favourite safe assets. If people wanted to look for dodgy debt over the past decade they had to look elsewhere: to Europe, where the sovereign debt crisis dragged on; to China, where local governments and state-owned firms have gorged themselves on credit; and to emerging markets, where dollar-denominated debts are a perennial source of vulnerability.

Should they now look again at America? Household debt has been shrinking relative to the economy ever since it scuppered the financial system. But since 2012 corporate debt has been doing the opposite. According to the Federal Reserve the ratio of non-financial business debt to GDP has grown by eight percentage points in the past seven years, about the same amount as household debt has shrunk. It is now at a record high (see chart 1).

This is not bad in itself. The 2010s have been a rosier time for firms than for households; they can afford more debt, and a world of low interest rates makes doing so attractive. Moreover the firms are not borrowing the money for risky investments, as they did when a craze for railway investments brought about America’s worst ever corporate-debt crisis in the 1870s. In aggregate they have just given money back to shareholders. Through a combination of buy-backs and takeovers non-financial corporations have retired a net $2.9trn of equity since 2012—roughly the same amount as they have raised in new debt.

For all that, a heavy load of debt does leave companies fragile, and that can make markets jittery. In 2018 concerns about over-indebtedness began to show up in financial markets. The average junk-bond investor ended the year with less money than they had at the start of it (see chart 2)—only the second time this had happened since the financial crisis. In February Jerome Powell, the chair of the Fed, told Congress some corporate debt represented “a macroeconomic risk...particularly in the event of the economic downturn.” Might American firms have overdone it?

Thanks to low interest rates and high profits, American companies are on average well able to service their debts. The Economist has analysed the balance sheets of publicly traded American non-financial firms, which currently account for two-thirds of America’s $9.6trn gross corporate non-financial debt. Their combined earnings before interest and tax are big enough to pay the interest on this mountain of debt nearly six times over. This is despite the fact that the ratio of their debt, minus their cash holdings, to their earnings before interest, tax, depreciation and amortisation (EBITDA) has almost doubled since 2012.

But life is not lived on average. About $1trn of this debt is accounted for by firms with debts greater than four times EBITDA and interest bills that eat up at least half their pre-tax earnings. This pool of more risky debt has grown faster than the rest, roughly trebling in size since 2012. All told such debts are now roughly the same size as subprime mortgage debt was in 2007, both in absolute terms and as a share of the broader market in which it sits.

That a trillion dollars might be at risk is not in itself all that worrying. The S&P 500 can lose well over that in a bad month; it did so twice in 2018. The problem with that $1trn of subprime debt was not its mere size; it was the way in which it was financed. Mortgages of households about which little was known were chopped up and combined into securities few understood. Those securities were owned through obscure chains by highly leveraged banks. When ignoring the state of the underlying mortgages became impossible, credit markets froze up because lenders did not know where the losses would show up. Big publicly traded companies are much less inscrutable. They have to provide audited financial statements. Their bonds are traded in public markets. Their debt does not look remotely as worrying, even if some firms are overextended.

Give me your funny paper

But there is a second way to cut a subprime-sized chunk of worry out of the corporate-debt mountain. This is to focus on the market for so-called “leveraged loans”, borrowing which is usually arranged by a group of banks and then sold on to investors who trade them in a secondary marketplace. Borrowers in this market range from small unlisted firms to big public companies like American Airlines. The stock of these loans has grown sharply in America over recent years (see chart 3). They now rival junk bonds for market size, and seem to have prospered partly at their expense. Unlike bonds, which offer a fixed return, interest rates on leveraged loans typically float. They thus appeal to investors as a hedge against rising interest rates.

Europe has a leveraged-loan market, too, but at $1.2trn, according to the most commonly used estimate, America’s is about six times bigger. It is hard to judge the overlap between these leveraged loans and the debts of fragile public companies. But it exists.

The rapid growth of leveraged loans is what most worries people about the growth in corporate debt. The list of policymakers to have issued warnings about them, as Mr Powell has done, include: Janet Yellen, his predecessor at the Fed; Lael Brainard, another Fed policymaker; the IMF; the Bank of England; and the Bank for International Settlements, the banker for central banks. On March 7th the Financial Times reported that the Financial Stability Board, an international group of regulators, would investigate the market.

These worries are mostly based on three characteristics the growth in leveraged loans is held to share with the subprime-mortgage boom: securitisation, deteriorating quality of credit and insufficient regulatory oversight.

The 2000s saw an explosion in the bundling up of securitised mortgages into collateralised debt obligations (CDOs) which went on to play an infamous role in the credit crunch. In this context the collateralised loan obligations (CLOs) found in the leveraged-loan market immediately sound suspicious. The people who create these instruments typically combine loans in pools of 100 to 250 while issuing their own debt to banks, insurers and other investors. These debts are divided into tranches which face varying risks from default. According to the Bank of England, nearly $800bn of the leveraged loans outstanding around the world have been bundled into CLOs; the instruments soak up more than half of the issuance of leveraged loans in America, according to LCD, the leveraged-loan unit of S&P Global Market Intelligence.

For evidence of a deterioration in the quality of credit, the worriers point to the growing proportion of leveraged loans issued without “covenants”—agreements which require firms to keep their overall level of debt under control. So-called “covenant-light” loans have grown hand in hand with CLOs; today they make up around 85% of new issuance in America.

There are also worries about borrowers increasingly flattering their earnings using so-called “add-backs”. For instance, a firm issuing debt as part of a merger might include the projected efficiency gains in its earnings before those gains materialise. When Covenant Review, a credit research firm, looked at the 12 largest leveraged buy-outs of 2018 it found that when such adjustments were stripped out of the calculations the deals’ average leverage rose from 6.1 times EBITDA to 8.7.

Regulatory slippage completes the pessimistic picture. In 2013 American regulators issued guidance that banks should avoid making loans that would see companies’ debts exceed six times EBITDA. But this was thrown into legal limbo in 2017 when a review determined that the guidance was in fact a full-blown regulation, and therefore subject to congressional oversight. The guidance is now routinely ignored. The six-times earnings limit was breached in 30% of leveraged loans issued in 2018, according to LCD.

In 2014 regulators drew up a “skin in the game” rule for CLOs—a type of regulation created by the Dodd-Frank financial reform of 2010 that requires people passing on risk to bear at least some of it themselves. But a year ago the skin-in-the-game rule for CLOs was struck down by the DC Circuit Court of Appeals. The court held that, since CLOs raise money first and only then buy up loans on behalf of the investors, they never really take on credit risk themselves. Their skin is safe before the game begins.

In the middle of negotiations

Despite these three points of comparison, though, the leveraged-loan market does not really look like the subprime markets of the mid 2000s. CLOs have more in common with actively managed investment funds than with the vehicles that hoovered up mortgage debt indiscriminately during the mid-2000s. Those securities typically contained thousands of mortgages; those selling them on had little interest in scrutinising the details of their wares. The CLOs pool fewer debts, their issuers know more about the debtors and their analysts monitor the debts after they are bought. They need to protect their reputations.

Unlike the racy instruments of the housing boom, which included securitisations-of-securitisations, CLOs have long been the asset of choice for investors wanting exposure to leveraged loans. And they have a pretty solid record. According to Goldman Sachs, a bank, in 2009 10% of leveraged loans defaulted, but top-rated CLO securities suffered no losses. The securitisation protected senior investors from the underlying losses, as it is meant to.

And the rise in covenant-light lending “is not the same thing as credit quality deteriorating,” says Ruth Yang of LCD. It may just reflect the sort of investors now interested in the market. Leveraged loans are increasingly used as an alternative to junk bonds, and junk-bond investors think analysing credit risks for themselves beats getting a promise from the debtor. Ms Yang points out that loans that lack covenants almost always come with an agency credit rating, providing at least some degree of guaranteed oversight—if not, perhaps, enough for those badly burned by the failure of such ratings in the financial crisis.

Even if these points of difference amount to nothing more than whistling in the dark, the prognosis would still not be too bad. America’s banks are not disturbingly exposed to leveraged loans. The Bank of England estimates that they provide only about 20% of CLO funds, with American insurers providing another 14%. It also notes that the banks’ exposures are typically limited to the highest-quality securities. The junior tranches of CLO debt—those that would suffer losses should defaults rise—are mostly held by hedge funds, credit investors and the CLO managers themselves. Even if a lot of them went bust all at once access to credit for the economy at large would be unperturbed.

That said, defaults on loans are not the only way for corporate debt to upset the financial system. Take investment-grade corporate bonds. In 2012 about 40% of them, by value, were just one notch above junk status. Now around 50% are. Should these bonds be downgraded to junk—thus becoming “fallen angels”, in the parlance of debt markets—some investors, such as insurance firms, would be required by their mandates to dump them. One study from 2011 found that downgraded bonds which undergo such fire sales suffer median abnormal losses of almost 9% over the subsequent five weeks.

Another possible source of instability comes from retail investors, who have piled into corporate debt in the decade since the crisis. Mutual funds have more than doubled the amount they have invested in corporate debt in that time, according to the Fed. The $2trn of corporate debt which they own is thought to include around 10% of outstanding corporate bonds; the IMF estimates that they own about a fifth of all leveraged loans. Exchange-traded funds (ETFs), which are similar in some respects to mutual funds but traded on stock exchanges, own a small but rapidly growing share of the high-yield bond market.

In both sorts of fund investors are promised quick access to their money. And although investments in mutual funds are backed by assets, investors who know that the funds often pay departing investors out of their cash holdings have a destabilising incentive to be the first out of the door in a downturn. Some regulators fear that if ructions in the corporate-debt market spooked retail investors into sudden flight from these funds, the widespread need to sell off assets in relatively illiquid markets would force down prices, further tightening credit conditions. There is also a worry among some experts that the way in which middlemen, mostly banks, seek to profit from small differences in prices between ETFs and the securities underlying them could go haywire in a crisis.

Neither a widespread plummeting of angels nor a rush to the exit by investors would come out of nowhere. The system would only be tested if it began to look as if more corporate debt was likely to turn sour. There are two obvious threats which might bring that about: falling profit margins and rising interest rates.

Wipe that tear away

Until recently, interest rates looked like the bigger worry. One of the reasons markets sagged in late 2018 was that the Fed was expected to continue increasing rates steadily in 2019. Credit spreads—the difference between what corporations and the government must pay to borrow—rose to their highest since late 2016. Leveraged loans saw their largest quarterly drop in value since 2011 and a lot of money was pulled out of mutual funds which had invested in them. By December new issuance had ground to a halt.

But in January Mr Powell signalled that the central bank would put further rate rises on hold, and worries about indebtedness faded. Stocks recovered; credit spreads began falling, leveraged loans rallied strongly. In February CLO issuance exceeded its 12-month average, according to LCD. It no longer looks as if high interest rates will choke the supply of corporate credit in the near future.

The more significant threat is now falling profit margins. Corporate-tax cuts helped the earnings per share of S&P 500 firms grow by a bumper 22% in 2018. But this year profits are threatened by a combination of wages that are growing more quickly and a world economy that is growing more slowly. Profit forecasts have tumbled throughout the first quarter; many investors worry that margins have peaked. Should the world economy continue to deteriorate, the picture will get still worse as America’s fiscal stimulus wears off. The most indebted businesses will begin to run into trouble.

If the same growth in wages that squeezes profits leads the Fed to finally raise rates while the market is falling, the resulting economic squeeze would compress profit margins just as the cost of servicing debt rose. A wave of downgrades to junk status would spark a corporate-bond sell-off. The junior tranches of CLO debt would run into trouble; retail investors would yank their money from funds exposed to leveraged loans and corporate bonds. Bankruptcies would rise. Investment would drop, and so would the number of new jobs.

That worst-case scenario remains mild compared with the havoc wrought by CDOs a little over a decade ago. But it illustrates the fragilities that have been created by the credit boom, and that America could soon once again face a debt-driven turn in the business cycle that is home grown.

After all, though the current rise in corporate debt is not in itself a likely cause for a coming crash, the past suggests that it is an indicator both that a recession is on its way and of the damage it may do. Credit spreads have in general been shrinking, a quiet before the storm which tends to presage recession, though the link is far from certain. And recessions that come after borrowing rates have shot up tend to be worsened by that fact, perhaps because when people are lending a lot more they are, more or less by definition, being less choosy. In 2017 economists at the Bank of England studied 130 downturns in 26 advanced economies since the 1970s, and found that those immediately preceded by rapid private credit growth were both deeper and longer. That does not prove that the growth in purely corporate debt will be as damaging. But it is worth thinking on.

Will the US Capitulate to China?

The most important problem that a bilateral deal between the United States and China needs to resolve is Chinese theft of US firms’ technology. Unless the Chinese agree to stop stealing technology, and the two sides devise a way to enforce that agreement, the US will not have achieved anything useful from Trump's tariffs.

Martin Feldstein

us china trade negotiations

CAMBRIDGE – It’s beginning to look like US President Donald Trump will yield to the Chinese in America’s trade conflict with China. The United States threatened to increase tariffs on imports from China from 10% to 25% on March 2 if no agreement was reached. But Trump recently said that the date is flexible and may be postponed because of the progress being made in the ongoing bilateral talks.

Fair enough, but progress is in the eyes of the beholder. The most important problem that needs to be resolved is not America’s massive bilateral trade deficit with China. It is that the Chinese are stealing US firms’ technology and using it to help Chinese companies compete with those same firms in China and around the world.

The Chinese do this in two ways. First, US firms that want to do business in China are required to have a Chinese partner and to share their technology with that firm. That compulsory sharing of technology is explicitly forbidden by World Trade Organization rules. Since joining the WTO in 2001, the Chinese have ignored this rule and disingenuously claim that US firms voluntarily agree to share their technology because they want to be active in China.

Second, the Chinese use the Internet to enter the computer systems of US firms and steal technology and blueprints. Chinese President Xi Jinping agreed with then-President Barack Obama in 2015 that his government would stop doing this. But, after a temporary decline, such cyber theft has resumed, presumably because state-owned companies and others have the ability to reach into the computer systems of US firms.

Despite Trump’s upbeat talk about progress in the talks, there is no suggestion that the Chinese will agree to stop stealing technology. Instead, China’s chief negotiator, Vice Premier Liu He, has emphasized that the Chinese will reduce their large bilateral trade surplus by buying US soy beans and natural gas. A sharp reduction in the US trade deficit with China would enable Trump to claim victory and give him something to celebrate when Xi visits him at his home in Florida sometime in the next few months.

There are easy bragging rights in a dramatic reduction of the US trade deficit with China, which, year after year, has been the largest of America’s bilateral trade deficits. In 2017, the deficit with China was $375 billion, or two-thirds of the total US trade deficit. So the Chinese are clever to offer to buy enough US commodities to cut that very visible imbalance.

But while that would reduce the bilateral trade deficit with China, it would have no effect by itself on the total US trade deficit. As every student of economics knows, a trade deficit reflects the fact that a country chooses to consume more than it produces. And as long as a country consumes more than it produces, it must import the difference from the rest of the world.

If the Chinese do buy enough to reduce the bilateral trade deficit, the US would end up importing more from other countries or exporting less to other countries. The total US trade deficit will not decline unless the US reduces total demand by saving more. That is a matter for US policymakers; it is not something the Chinese can do for America.

US Treasury Secretary Steven Mnuchin has emphasized another largely irrelevant Chinese offer: a promise to prevent the value of the renminbi from declining relative to the dollar. While a stronger renminbi would make Chinese goods less attractive to US buyers, thereby reducing the bilateral trade deficit, it would not reduce America’s global trade imbalance.

Moreover, although the renminbi-dollar exchange rate does vary from year to year, the variations have been small. Today, a dollar buys CN¥6.7; a year ago, the dollar exchange rate was CN¥6.3, and two years ago it was CN¥6.9. A decade ago, in February 2009, a dollar bought CN¥6.8. In short, there is nothing to celebrate if the Chinese agree to stabilize the value of their currency relative to the dollar.

The key issue is technology theft. Unless the Chinese agree to stop stealing technology, and the two sides devise a way to enforce that agreement, the US will not have achieved anything useful from Trump’s tariffs.

Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research, chaired President Ronald Reagan’s Council of Economic Advisers from 1982 to 1984. In 2006, he was appointed to President Bush's Foreign Intelligence Advisory Board, and, in 2009, was appointed to President Obama's Economic Recovery Advisory Board. Currently, he is on the board of directors of the Council on Foreign Relations, the Trilateral Commission, and the Group of 30, a non-profit, international body that seeks greater understanding of global economic issues.

Reform the credit default swap market to rein in abuses

Windstream’s fight with Aurelius highlights complexities of ‘empty creditors’

Henry Hu

US securities regulators have called for a clean-up but need not wait for industry-wide changes. There are concrete steps individual companies, investors and judges can take to address the problem © Bloomberg

Credit default swaps are the banking equivalent of home insurance. Much as property owners buy coverage for fire and other disasters, banks, bondholders and other creditors purchase CDS protection against losses in case a corporate borrower runs into trouble.

But this valuable financial innovation is susceptible to opaque gaming and counterintuitive incentives. We badly need reforms, as was underscored when Aurelius Capital Management scored a court victory that may push telecoms company Windstream into bankruptcy.

When creditors are faced with an overstretched borrower, they often choose to work with them. They may waive breaches of contract or agree to out of court restructurings because they ultimately want the debt repaid.

But the CDS market has created a category of investors, which I dubbed “empty creditors” in 2007. In extreme cases, they stand to make more money on CDS if a company defaults than they would if it repaid its debts. These “net short” creditors are motivated to grease the skids to insolvency, even when bankruptcy makes no sense.

In the Windstream case, Aurelius owns some of the Arkansas-based company’s bonds, but it is widely believed to have a far larger investment in Windstream CDS. In September 2017, the hedge fund sent a formal notice to Windstream complaining that the telecoms group had breached a provision of a debt contract two years earlier — something no other creditor had complained of.

Windstream warned that if this breach counted as a default, it might have to declare bankruptcy. Aurelius pressed ahead. A judge, unpersuaded by the CDS issue, found for Aurelius on all counts. He ordered Windstream to pay a $310m judgment. The company’s share price fell by nearly two-thirds.

The case highlights another problem: CDS positions do not have to be disclosed. Debtor companies and investors must guess whether a net short creditor might be lurking.

The CDS market is also plagued by other gaming. In 2017, homebuilder Hovnanian agreed to intentionally default on an interest payment as part of a deal with Blackstone’s GSO arm, which had bought CDS protection on the company. GSO helped Hovnanian refinance up to $320m of its debt at a favourable interest rate in return for a missed payment that would have triggered a payout on the CDS. After a CDS seller sued, the manufactured default was called off.

US securities regulators have called for a clean-up, but we do not have to wait for regulatory changes or industry-wide changes. There are concrete steps individual companies, investors and judges can take to address this problem.

Publicity would help. As soon as a troubled company has a reasonable basis for believing that some of its creditors are motivated by their outsized CDS holdings, management should say so and present evidence for the claim.

Loan agreements and bond indentures could limit the rights of net short creditors, since they are motivated to cause firms to default. Limiting their ability to do so could benefit companies, normal creditors, shareholders, third parties such as CDS sellers, and overall market efficiency.

Judges can also rein in net short creditors, as they have started to do with shareholders. Net short shareholders benefit from falling share prices because their short positions outweigh their equity holdings. These “empty voters” with negative economic exposure have incentives to use their rights to destroy value, by, for example, voting to elect Mr Bean to the board.

In 2012, the hedge fund Mason Capital sought to block Canadian telecoms group Telus’s planned recapitalisation. Based partly on my affidavit, a judge in British Columbia found that Mason Capital’s likely status as an empty voter was relevant to considering its opposition. The court approved the Telus plan.

A judge faced with an empty creditor with negative economic exposure should consider doing the same. The world is already economically uncertain. There is no reason to allow CDS gaming and extreme empty creditors to make it more so.

The writer teaches at the University of Texas Law School and has written about the role of CDS in role of CDS in corporate defaults

A transatlantic front opens in the Brexit battle over derivatives

Britain is caught in the middle of a regulatory tussle between the US and the EU

Gillian Tett

A view of Bank underground station in view of the Bank of England. Splitting up the clearing business would be very costly for financial players, as Mark Carney, central bank governor, has pointed out © Bloomberg

Another week, another round of baffling Brexit political farce. But if you want a different perspective on these dramas, ponder a topic that (almost) no British politician ever bothers to discuss: the state of London’s gigantic derivatives market after leaving the EU.

For while this topic is arcane, it matters deeply — not just because derivatives have financial stability implications, but also because the issue is sparking some extraordinary behind-the-scenes battles, now with transatlantic consequences.

The issue at stake revolves around the clearing of derivatives trades. In recent years, the London Clearing House has dominated the swaps and futures sector, regularly clearing more than $3tn of trades each day, of which a quarter are euro-denominated and almost half in dollars.

Continental European politicians have always hated the fact that so much euro business sat in London. But they tolerated this because the UK was in the EU. And while American regulators were also uneasy about so much of the dollar market sitting outside their shores, they accepted it because the UK authorities gave the Commodity Futures Trading Commission sufficient oversight of the LCH dollar business.

No longer: European politicians have declared that if LCH wants to clear euros when (or if) Brexit occurs, that business must either move to continental Europe, or be regulated by the European Securities and Markets Authority, the Paris-based entity.

In one sense, that is no surprise. And what has come as a relief for the City — and banks — is that Esma declared last month that it will let London’s clearing houses perform these functions, even after a hard Brexit, as long as they accept Esma rules. This matters since splitting up the clearing business would be very costly for financial players, as Mark Carney, Bank of England governor, pointed out last month.

However, there is a trillion-dollar catch that sits completely outside the British parliament’s control: the US. The CFTC has told Europe that it will not accept Esma controlling London’s swaps business insofar as it impinges on dollar markets and US banks.

This is partly about national pride. But there is an ideological battle, too. British and US regulators tend to trust market forces, and believe private sector entities should be free to decide how much collateral market participants must post against trades, to cope with default risks. “We have almost two decades’ worth of experience working with the Bank of England and we rarely have any dust-up,” says Christopher Giancarlo, CFTC commissioner.

European regulators, however, do not like the idea of the market alone deciding when to demand more collateral for a transaction in a financial crisis. That is because during the 2011 euro crisis entities such as LCH (and others) imposed such “margin calls” on Spanish and Italian assets — European officials blame this for the dramas (never mind that this was admirably prudent risk management).

The net result, then, is that European regulators and politicians want to impose more intrusive controls. “We need to have a clear legal competence that, importantly, should cover both EU and third-country CCPs [central counterparties],” Benoît Coeuré, a member of the board of the European Central Bank, recently observed.

However, the Americans vehemently oppose this. And last autumn Mr Giancarlo warned — in an astonishingly tough speech — that if Esma meddles too much with the LCH dollar business, the Americans will consider “a range of readily available steps to protect US markets and market participants”. Privately, some US officials suggest this could include kicking European participants out of the Chicago Mercantile Exchange. Yes, really. This is very alarming stuff.

Is there a solution? Not obviously. Right now the protagonists are playing nice(ish) in public. After the EU recently outlined a broad political framework for handling European clearing, it promised to turn this into tangible rules by 2021. The CFTC and Brussels announced that the CFTC will take part in these preparations.

But the real battle is probably delayed, not resolved. Until the EU unveils its rules in 2021, it is unclear how far LCH will adhere to Esma’s principles for clearing when (or if) Brexit actually occurs. This uncertainty is not visible when markets are calm. It would be, however, if another crisis hits — and the volume of margin calls increases.

In the meantime, investors should draw two lessons from this saga. First, it shows the degree to which Brexit is not just a cross-channel affair — the fiendish logistics in finance affect transatlantic ties too. Second, it reveals London’s political weakness. The participants notably unable to throw their weight about in this drama are the British regulators. What happens next will be decided by the ideological and territorial fight between Washington and Brussels. So much for “taking back control”.

Putin, Khrushchev and the Lessons of the Cuban Missile Crisis

Putin has invoked the crisis to revive the perception of Russia as a superpower.

By George Friedman


In October 1964, Leonid Brezhnev, Alexei Kosygin and Nikolai Podgorny removed Soviet leader Nikita Khrushchev from office, supposedly because of Khrushchev’s “harebrained schemes.” Most have assumed that this referred to Khrushchev’s plan to turn Siberia into an agricultural heartland, but I have always believed it actually referred to his attempt to slip missiles into Cuba. Given how that plan ended, it would be a logical fit. It is therefore fascinating that Russian President Vladimir Putin announced last week that he’s ready for another Cuban missile crisis if the United States decides to deploy medium-range missiles in Europe. Given his comments, it’s important that we understand how the crisis unfolded and its relevance, if any, to what’s happening today.

During the 1960 presidential election, John F. Kennedy sought to discredit the Eisenhower administration by claiming that the Soviet Union’s missile capabilities exceeded those of the United States. The claim was a lie; the U.S. had a substantial lead in deployed missiles and was rapidly deploying nuclear submarines. The U.S. also had an enormous advantage in strategic bombers; the Soviets had only a small number of Bear strategic bombers, which were far inferior to the American B-52s.

Indeed, the U.S. would have an overwhelming advantage in a nuclear exchange. That, combined with its satellite imagery capabilities, meant the U.S. could theoretically launch a first strike on the Soviet Union’s relatively small missile force and render it useless. Theory and practice are very different things. Still, in the Soviets’ worst-case scenario, the U.S. might launch such an attack and force a Soviet surrender. The Soviet intercontinental ballistic missile capability was limited, and the Soviets needed an interim weapon that could guarantee a counterstrike against the U.S. regardless of how successful a U.S. first strike would be. The solution was to put intermediate-range nuclear weapons within range of the United States, and the only possible location was Cuba.

The whole strategy rested on smuggling the missiles in and making them operable before the U.S. could detect them. It was in many ways a harebrained scheme because not only was detection possible but the U.S. response was utterly unpredictable. The U.S. might determine that other installations existed and launch a sudden and powerful attack to destroy them. Moreover, the need for this deterrent was dubious. True, the U.S. had a strategic advantage over the Soviets, but using it in a first strike would be an enormous risk. Given the Bay of Pigs fiasco, Kennedy didn’t have much confidence in U.S. intelligence, and certainly not enough to bet the house on a first strike.

Robert F. Kennedy and others have portrayed the crisis as a showdown between two equal powers that was managed with diplomatic brilliance to avoid a disastrous end. However, transcripts of meetings held by the Executive Committee of the National Security Council, which advised John F. Kennedy during the crisis, tell a very different story (see Sheldon Stern’s “The Cuban Missile Crisis in American Memory” for more details). Certainly, it was a serious episode, but it did not put humanity in danger of nuclear annihilation.

In terms of the nuclear balance, the Soviets had a very weak hand. That’s why they tried to slip missiles into Cuba. The U.S. was running heel-and-toe surveillance on Cuba so the chances of the missiles not being detected by U-2s or human intelligence were low. Once detected, Khrushchev had to back down for the same reason he tried the maneuver in the first place: The Soviets were weak.

The Kennedy narrative of the crisis was that Khrushchev capitulated just before a U.S. invasion. In reality, both sides understood that, unless Khrushchev was nuts, the game was over the minute Kennedy announced the blockade of Cuba following the discovery of Soviet missiles. Indeed, Khrushchev did back down in return for a clever offer to withdraw obsolete U.S. missiles from Turkey and Italy (though the offer was only revealed at a later date). The fact was that Khrushchev had no choice but to capitulate.

Few have acknowledged, however, that Khrushchev won a huge point in his handling of the crisis. For the heroic narrative of the Kennedy brothers to work, they could not admit the truth – that U.S. nuclear capabilities far exceeded those of the Soviet Union. The Soviet Union had to be treated as a peer with enormous strength that was compelled to back down not by superior force but by the skills of the negotiators. If they acknowledged that there was no missile gap, and that the Soviets could not match U.S. nuclear power, then the crisis would no longer be seen as a stunning moment in history.

The Kennedy administration needed the heroic tale and therefore had to give something of extraordinary value to Khrushchev: the myth that the Soviet Union could stand toe to toe with the United States on nuclear capabilities. (The Soviets would become peers to the U.S. later on, but they were not in the 1960s.) The Soviets wanted this acknowledgment for three reasons. First, the American public would force caution on U.S. politicians. Second, other powers, especially those in Europe, would question the reliability of the U.S. security umbrella. Third, the Soviet public, enthralled by Sputnik and Yuri Gagarin, would believe they were witnessing another Soviet triumph. Yes, the Soviets conceded, but they could write that off as simple prudence. Every self-congratulatory memoir written by in the U.S. about the crisis reinforced the notion that the Soviet Union was a nuclear peer. Obviously, no one in his right might would risk nuclear annihilation over such trivia, but then no one actually did.


I do not know if this is what Khrushchev intended or if it was the result of unexpected political needs in the U.S., but I suspect the latter. Khrushchev likely wasn’t clever enough to have planned this scenario the way it played out. But regardless, Kennedy kept the missile gap story in place and conceded equality to the Soviets.

Which brings me to Putin’s recent comments on the Cuban missile crisis. At the moment, Russia is in no way a military challenge to the United States. Any U.S. medium-range missiles stationed in Europe would be meant as a deterrent or possibly used in case of a Russian incursion into Ukraine. It’s unlikely tensions there would escalate to the use of nuclear weapons. And that’s what makes it so attractive to Putin. Putin wants a showdown with the U.S. because it could end with the U.S. treating Russia as a dangerous peer and U.S. allies increasing their importance by maximizing the Russian risk. At a time when your own hand is weak, having your opponent declare you dangerous and powerful is a huge gift. The Soviets received this gift once before. Putin, faced with economic problems at home, a lackluster performance in Ukraine and a growing force to Russia’s west, may be looking to receive it again.

Khrushchev didn’t fully understand the game. But Putin does. He must take the world to an imaginary nuclear brink that will force a negotiation, if in nothing but appearance. The world will breathe a sigh of relief when it ends. And every deputy at the U.S. National Security Council will dine out for the rest of their life on how close the U.S. came to the abyss and how brilliantly the U.S. worked to avoid war with a fearsome superpower. And with that, the thing Putin has always decried, the geopolitical disaster of 1991, can be reversed. But considering that Khrushchev was ousted for such harebrained schemes, the downside could be political oblivion.

The future belongs to the left, not the right

For the time being, rightwingers are thriving, but their rise is self-limiting

Wolfgang Münchau

US congresswoman Alexandria Ocasio-Cortez has proposed a 70 per cent tax rate on high earners. Such a policy could cause collateral damage but from the perspective of the radical left, collateral damage is a promise, not a threat © Reuters

Matteo Renzi, Italy’s former prime minister, is getting ready to form his own centrist political movement, very much like French president Emmanuel Macron’s La République en Marche. A new centrist group in the UK has also brought excitement, albeit for different reasons. Liberal pro-Europeans are certainly not going down without a fight.

But the odds are not looking good for many of them. Liberal democracy is in decline for a reason. Liberal regimes have proved incapable of solving problems that arose directly from liberal policies like tax cuts, fiscal consolidation and deregulation: persistent financial instability and its economic consequences; a rise in insecurity among lower income earners, aggravated by technological change and open immigration policies; and policy co-ordination failures, for example in the crackdown on global tax avoidance.

When the financial crisis struck, continental European governments did not take full control of their banking systems, crack down hard enough on bonuses, or impose financial transaction taxes. They did not raise income and corporate taxes to counter-balance cuts in public sector spending. They did not tighten immigration policies.

The usual economic statistics do not capture how the lives of people on lower incomes have changed over the last two decades. Stagnating real disposable incomes matter, but so does lower job security and reduced access to credit markets and mortgages.

I expect the pushback against liberalism to come in stages. We are in stage one — the Trumpian anti-immigration phase. Immigration carries net economic benefits, especially over the long term. But there are losers from it, too, both actual and imagined. Chancellor Angela Merkel’s decision to open Germany’s borders to 1m refugees in 2015 was justified on ethical grounds, and I am sure will bring long-term benefits. But it turned into a crisis because she did not prepare her country politically.

The euro, too, was a liberal fair-weather construction. Once crisis struck, politicians did the minimum they needed to ensure its survival, but they failed to solve the underlying problems, which nowadays express themselves as imbalances that do not self-correct. Without a single safe asset and a genuine banking union, the eurozone will remain prone to financial crises.

Liberal democracy has been successful at breaking down trade barriers, protecting human rights and fostering open societies. But the inability to manage the social and economic consequences of such policies has rendered liberal regimes inherently unstable.

For now, the right is thriving on the anti-immigration backlash. But its rise is self-limiting for two reasons. First, rightwing policies are not succeeding even on their own narrow terms. A wall along the border with Mexico will not stem US immigration flows any more than the re-nationalisation of immigration policies would in Europe. And second, I suspect that immigration will soon be superseded by other issues — such as the impact of artificial intelligence on middle-class livelihoods; rising levels of poverty; and economic dislocation stemming from climate change.

This is a political environment that favours the radical left over the radical right. The right is not interested in poverty and its parties are full of climate-change deniers. Some of the rightwing populists may speak the language of the working classes, but the left is more likely to deliver.

The killer policy of the left will be the 70 per cent tax rate proposed by freshman US congresswoman Alexandria Ocasio-Cortez. It is not the number that matters, but the determination to reverse a 30-year trend towards lower taxation of very high incomes and profits. There would be collateral damage from such a policy for sure. But from the perspective of the radical left, collateral damage is a promise, not a threat.

What about the radical centre? Mr Macron has demonstrated that grassroots liberalism can succeed as an electoral strategy. But there are factors specific to the French electoral system that favoured Mr Macron’s victory in 2017. And it is too early to pass judgment on whether his actual policies will deliver what his voters wanted. Italy is also a candidate for a Macron-style revolution, but that could not by itself solve the country’s deep-rooted problems.

The economic and social impact of liberal policies varies across countries. Germany has so far avoided the downward spiral because of its unique position inside the eurozone and its still relatively strong industrial base. But wait until the irresistible force of the electric self-driving car hits the immovable object of diesel drivers.

We have entered an age that will favour radicalism over moderation, and the left over the right. It is not going to be the age of Donald Trump.

How the Upper Middle Class Is Really Doing

Is it more similar to the top 1 percent or the working class?

By David Leonhardt

Have upper-middle-class Americans been winners in the modern economy — or victims? That question has been the subject of a debate recently among economists, writers and others.

On one side are people who argue that the bourgeois professional class — essentially, households with incomes in the low-to-mid six figures but without major wealth — is not so different from the middle class and poor. All of these groups are grappling with slow-growing incomes, high medical costs, student debt and so on.

The only real winners in today’s economy are at the very top, according to this side of the debate. When Bernie Sanders talks about “the greed of billionaires” or Thomas Piketty writes about capital accumulation, they are making a version of this case.

On the opposing side are people who believe that the country’s defining class line is further down the economic ladder. To them, the upper middle class is on the happy side, enjoying rising incomes, longer lifespans, stable marriages and good schools. Richard Reeves’s recent book, “Dream Hoarders” made this case, as did Matthew Stewart’s well-titled Atlantic article: “The 9.9 Percent Is the New American Aristocracy.”

I think the chart above helps to resolve the debate. It shows that both sides have a point — but that it’s a mistake to divide the country into only two groups. To make grand pronouncements about the American economy, you need to talk about three groups.

The first is indeed the top 1 percent of earners, and especially the very richest. Their post-tax incomes (and wealth) have surged since 1980, rising at a much faster rate than economic growth. They are now capturing an even greater share of the economy’s bounty.

Then there are the bottom 90 percent of households, who are in the opposite position. The numbers here take into account taxes and government transfers, like Social Security, financial aid and anti-poverty benefits. Even so, the incomes of the bottom 90 percent have trailed G.D.P. Over time, their share of the economy’s bounty has shrunk.

Finally, there is the upper middle class, defined here as the 90th to 99th percentiles of the income distribution (making roughly $120,000 to $425,000 a year after tax). Their income path doesn’t look like that of either the first or second group. It’s not above the line or below it. It’s almost directly on top of it. Since 1980, the incomes of the upper middle class have been growing at almost the identical rate as the economy.

If you, dear reader, happen to be in this group, I’m not trying to dismiss your economic anxieties. I know that you may not feel rich. You probably have big mortgage payments, rising medical costs and perhaps eye-popping tuition bills.

But I’d ask you to spend a minute thinking about how much more challenging life is for the bottom 90 percent. These households aren't making six-figure incomes, and they have received only meager raises over the past few decades. They aren't receiving their fair share of the country's economic growth. No wonder so many feel frustrated.

And for too long, the country’s economic policy, even under Democrats, has blurred the distinction between the upper middle class and the actual middle class.

In the 2008 campaign, Barack Obama and Hillary Clinton both used $250,000 as the upper limit of the middle class. (Even in the New York area, $250,000 in pre-tax income puts a household in the top 10 percent.) Obama then delivered a tax cut for everyone below that cutoff. In the 2016 campaign, Clinton and Sanders used the same definition.

A better approach exists. Politicians should recognize that there are three broad income groups, not just two. The bottom 90 percent of Americans does deserve a tax cut, to lift its stagnant incomes. The top 1 percent deserves a substantial tax increase. The upper middle class deserves neither. Its taxes should remain roughly constant, just as its share of economic output has.

So here’s some good news: The 2020 Democratic candidates are moving in this direction.

Kamala Harris’s big tax cut applies only to families making less than $100,000. Elizabeth Warren’s child-care proposal delivers 99 percent of its benefits to the bottom 90 percent of earners, according to Moody’s Analytics. The housing plans from Harris and Cory Booker give all their benefits to the bottom 90 percent, according to the Center on Poverty and Social Policy. The tax cut from Sherrod Brown, who’s a potential candidate, is likewise focused on the middle class and poor.

Ro Khanna, a Silicon Valley congressman who co-wrote Brown’s tax plan, has a useful way of thinking about this. “Our priority has to be the working poor and those struggling to make it into the middle class,” Khanna told me. “What do the upper middle class care most about in my district? They want a pluralistic America that is engaged with the world and embraces technology and future industries. What they don’t want is a backlash to diversity, a backlash to globalization, a backlash to technology.”

The upper middle class doesn’t deserve the blame for our economic problems. But it doesn’t deserve much government help, either.