Billionaires have never had it so good

Fortunes are created by technology and globalisation, as well as talent and enterprise

John Gapper

web_Wealth tax on billionaires
© Ingram Pinn/Financial Times


The world’s billionaires do not have everything their own way these days. They are still rich and powerful, but they are less feted for exceptional achievement and are under pressure to pay more tax.

Elizabeth Warren, the US presidential candidate, plans a wealth tax to denude the fortunes of those, such as Bill Gates, by tens of billions over decades. “I’m starting to do a little math about what I have left over,” Mr Gates joked last week. Jeremy Corbyn, the UK Labour leader, launched his general election campaign by promising to make billionaires pay a lot more tax.

Billionaires still have some friends. UBS last week sprung to their defence, arguing that its private banking clients merit their wealth. The “smart risk-taking, business focus and determination” of rich entrepreneurs give them the ability “to transform entire industries, to create large numbers of well-paid jobs, and to rally the world to find cures for diseases such as malaria.”

UBS says “the billionaire effect” enables companies controlled by their founders to take a long-term view and beat those with impatient shareholders. The 2,100 billionaires it counts have “an obsessive business focus, constantly scanning the world for new opportunities. And they are highly resilient, undeterred by failures and roadblocks.”

There is plenty of truth to this. Even if one sets aside the heirs and heiresses to fortunes, and the oligarchs who seized their wealth, it leaves many entrepreneurs who started their businesses from scratch among what Ms Warren calls “ultra-millionaires”.

Indeed, the world’s billionaire super league is more meritocratic than in past decades. As one study of the Forbes 400 list of richest US billionaires found, they “did not grow up nearly as advantaged as those in decades past”. There are more entrepreneurs from middle-class backgrounds who went to elite universities before making their fortunes.

But such success would have been less lucrative in the past — they might have been merely rich rather than super-rich. Before lionising or demonising elite entrepreneurs, consider how their personal talents are amplified.

First, the superstar effect. Globalisation and technology that allows businesses, such as Google and Facebook, to span markets, help the most successful entrepreneurs to profit faster and at greater scale. Successful founders can create superstar franchises, like some Hollywood stars in China.

The economist Sherwin Rosen once noted that “superstar economics” mean the returns to the winner in any category can be vastly higher than the returns to second place. These winners can, as the economist Alfred Marshall commented in 1890, “apply their constructive or speculative genius to undertakings vaster, and extending over a wider area, than ever before”.

Second, the security effect. One reason why the poor stay poor is that they cannot plan for the long-term. Abhijit Banerjee, Esther Duflo and Michael Kremer won this year’s Nobel economics prize for showing, among other things, that “the present takes up a great deal of [poor] people’s awareness, so they tend to delay investment decisions”.

The reverse is true of billionaires, who can finance ideas over decades and ride out failures and setbacks. UBS says that “the outperformance we call the ‘billionaire effect’ depends on the entrepreneur keeping control [of a company]”, but they may be advantaged by security as much as genius.

Third, the insider effect. People do not turn into billionaires without a keen sense of financial opportunity and the drive to make a series of good decisions. But once they achieve positions of power, they are reinforced by a network of advisers and brokers.

Billionaires do not leave their cash at banks; UBS or other private banks handle it. They have insider access, such as the opportunity to invest in private businesses, or initial public offerings of fast-growing companies. Wealth does not automatically beget wealth but moving in elite financial circles with enviable resources helps.

Fourth, the tax effect. Many countries tax income higher than capital, because it is simpler and they want to encourage entrepreneurs. But this leads to the rich paying less as a share of their wealth than those on average incomes.

Wealth is also mobile. Some billionaires reside in jurisdictions such as Monaco or (in the case of Sir Richard Branson) the British Virgin Islands. Even those who stay at home have scope through trust and offshore structures to shield some of their wealth.

These effects mean that entrepreneurs with great talents are in better positions to gain and sustain riches than in previous decades. Mr Gates dislikes Ms Warren’s plan to drain his wealth but he observed that “we are not close to the limit” in terms of raising taxes without damaging enterprise.

It is salutary that more of today’s super-wealthy built their own fortunes, but they are also lucky to live at an unusually helpful time in economic history. Mr Gates has acknowledged it by devoting tens of billions to philanthropy, as well as in prompting others to give back. Rather than getting too angry at Ms Warren’s wealth tax plan, it behoves others to recognise it too.

Smartphones fuel online shopping splurge as US marks Black Friday

Malls miss out as more Americans reach for mobiles

Alistair Gray in New York

Jayln Martin, left, and Dan Villegas stock items in preparation for a holiday sale at a Walmart Supercenter, Wednesday, Nov. 27, 2019, in Las Vegas. Black Friday once again kicks off the start of the holiday shopping season. But it will be the shortest season since 2013 because of Thanksgiving falling on the fourth Thursday in November, the latest possible date it can be. (AP Photo/John Locher)
Walmart employees prepare for Black Friday at a Las Vegas store. Big box US retailers such as Walmart and Target are faring well © AP


Millions of Americans were avoiding shopping malls and instead reaching for their smartphones to land Black Friday bargains, fuelling a boom in online orders over the extended Thanksgiving holiday.

Early data showed Amazon was on track to be a big beneficiary of the smartphone splurge as it grabbed an even larger share of consumer spending than last year, while weaker malls and department stores were set to miss out on the seasonal cheer.

“The lines aren’t what they used to be,” said Charlie O'Shea, lead retail analyst at Moody’s, who toured stores in suburban Philadelphia after doors opened on Thanksgiving. “People have more options.”

Hefty discounts were offered online long before Friday, reducing the need to rush to stores. TVs were being promoted heavily, with Amazon offering 50 per cent off some 4K models.

E-commerce spending totalled $57.5bn in the four weeks up to and including Thanksgiving, a like-for-like rise of about 16 per cent from a year ago, according to estimates from Adobe Analytics. It projected an additional $7.5bn for Black Friday.


$1.1tnUS retail sales in November-January period, according to Deloitte


Almost half the estimated $4.4bn worth of online purchases on Thanksgiving was made on mobile phones, Adobe said, compared with about a third last year.

Top selling items included children’s toys from the Disney movie Frozen II and LOL Surprise dolls.

Air fryers — kitchen gadgets — were selling well, as were Apple AirPods and Amazon Fire TVs. Popular video games included the music title Just Dance 2020 and basketball simulation NBA 2K20.

Initial figures pointed to Amazon increasing its lead over rivals online.

Of the top 10 digital vendors, Amazon captured a 61 per cent share in the week before Thanksgiving, according to figures from Edison Trends, compared with a 57 per cent share a year ago.

The company’s digital sales jumped 37 per cent in the period, Edison Trends figures showed. Only Walmart, which has a far smaller online business than Amazon, had a bigger rise, up 53 per cent.

In a sign that declining fortunes in stores is also translating to weakness online for some brands, digital spending at the department stores Kohl’s and JCPenney fell 6 per cent and 30 per cent, respectively, over the period.

Several forecasters predict total US consumer spending, which has been a source of resilience for the global economy, will remain strong over the holiday season despite concerns about trade tariffs.


Deloitte expects US retail sales to total $1.1tn over the November-January period, a rise of between 4.5 and 5 per cent from the same period a year ago. However, the season is threatening to widen the gulf between winners and losers in US retail.

Strong financial results released within the past two weeks have shown the big box retailers Walmart and Target, as well as discounters including TJX, are faring well. In stark contrast, several department stores and other mall-based companies posted sales declines.

Footfall overall at physical retailers in the run-up to the peak shopping season was weak, declining 5.5 per cent year-on-year in October, according to RetailNext.

Rod Sides, US retail practice leader at Deloitte, said consumers were even more willing to shop online over the Thanksgiving period than during the rest of the year. “Convenience is a big factor,” he said.

Retailers were set for a busy extended weekend online. Walmart on Friday unveiled discounts for Cyber Monday, including 45 per cent off Fruit of the Loom pyjamas, 35 per cent off a Ninja air fryer and 25 per cent off a Graco baby car seat.


In Central Asia, Can China Really Compete With Russia?

By: Ekaterina Zolotova


Chinese influence in Central Asia has increased markedly in recent years.

For Tajikistan, Kazakhstan, Uzbekistan, Kyrgyzstan and even the relatively more closed-off Turkmenistan, China is becoming not only a major supplier of loans and investment but also a key trading partner.

Some may interpret this as an indication that the influence of Central Asia’s historical benefactor, Russia, is diminishing.

It seems, however, that Russia isn’t too alarmed by China’s growing influence in the region.

That’s because, unlike China, Moscow’s interests in Central Asia are not just economic. Indeed, Russia has historical links to the region and security and political interests there, which will ensure that Moscow will be the dominant player in the region for years to come.

For Russia, maintaining influence in the post-Soviet Central Asian states is critical. These countries form a key buffer zone for Russia, separating the country from unstable areas of the Middle East and terrorist elements. Russia is concerned that terrorist and extremist influences could spread to its southern border and into the Caucasus through Central Asia and threaten to destabilize its southern and eastern regions.

Economic Influence

From an economic point of view, Russia looks at Central Asia as a region with potential. It sees Central Asia as a key route through which it could supply energy and other goods to growing markets like India, China and Pakistan, which, as they face increasing uncertainty from sanctions and the U.S. trade war, could become major consumers of Russian exports. But Moscow is facing increasing competition from Beijing in its historical sphere of influence.

After the 2008 global economic crisis, Beijing began to more actively invest in and trade with the countries of Central Asia. China’s foremost interests in Central Asia are economic; Beijing sees these countries as a growing market for Chinese products, critical trade routes for the Belt and Road Initiative, and a source of needed natural resources.

Chinese companies produce roughly 20 percent of Kazakh oil. More than 80 percent of Tajik gold deposits are operated by companies that receive Chinese capital, and more than 700 enterprises in Uzbekistan receive Chinese funding. China has also financed the development of Turkmenistan’s Galkynysh gas field and the construction of a gas pipeline through Kazakhstan. The estimated combined cost of these two projects exceeds $8 billion.

Trade With Russia and China as Share of Total Trade



Central Asian countries now owe billions of dollars in debt to China. Uzbekistan alone owes $3.4 billion (21 percent of the state’s external debt); Tajikistan owes $2.9 billion (48 percent of its external debt); and Kyrgyzstan owes $1.7 billion (42.5 percent of external debt).

This is raising concerns that Central Asian countries could become ensnared in so-called debt traps, compelling these states to agree to hefty political or economic concessions in order to pay off large loans they can no longer service.

In 2011, for example, Tajikistan agreed to lease 1 percent of its territory to China. And Turkmenistan has supplied gas to China at a price three times lower than the market rate.

Central Asia's Debt Owed to China



The growing Chinese economic influence here could challenge Russia’s historical role as the main benefactor for Central Asia. On economic grounds, Russia can’t really compete with China.

Moscow is, however, maintaining a degree of economic influence by strengthening integration with Central Asia, particularly through the Eurasian Economic Union, which includes an integrated single market and common policies on several industries.

Ultimately, the two countries are unlikely to engage in open confrontation in the short term for a couple of reasons. First, Russia can’t afford a confrontation with China.

After Russia’s annexation of Crimea in 2014, China became the only major power that was willing to increase bilateral trade and economic ties with Russia; Russian foreign policy, after all, has long been oriented toward the east.

Second, Russia has been a dominant economic force in Central Asia for decades. Its influence has been somewhat diminished as sanctions and economic troubles at home have eroded Russia’s ability to finance the region, but Central Asia and the Caucasus remain heavily dependent on Moscow in terms of both trade and remittances.

Strategic Interests

Moreover, although Russia continues to provide economic assistance to the region, this assistance stems from strategic interests rather than the promise of economic gain. Russia has written off hundreds of millions of dollars in Central Asian debt, including $240 million owed by Kyrgyzstan in 2017 and $900 million owed by Uzbekistan in 2016. For Moscow, developing good relations with these strategically located countries is more important than the potential economic benefit they could offer.

Central Asia



These countries form a key buffer zone for Russia, separating the country from unstable areas of the Middle East where terrorism and extremism are rife.

Russia has a sprawling border with Kazakhstan that’s difficult to protect, and the borders between the Central Asian states are not well defended.

The attack carried out by Islamic State militants on the Tajik-Uzbek border last week showed that terrorist organizations have already gained a foothold in the region. This is particularly concerning for Moscow because the militaries and security forces of Central Asian countries are highly dependent on Russia for equipment and training.

Since the formation of the Collective Security Treaty Organization in 1992, Russia has been the primary security guarantor for three Central Asian countries: Kazakhstan, Kyrgyzstan and Tajikistan. (Uzbekistan was also part of the CSTO but has withdrawn its membership.) Russia has military bases and facilities in Tajikistan and an air base in Kyrgyzstan, and is helping to strengthen these countries’ own military capabilities.


In October, it donated to Tajikistan 320 million rubles ($5 million) worth of military equipment and weapons including a radar station for monitoring airspace and modernized armored reconnaissance and BRDM-2M patrol vehicles. Also in October, the Central Military District’s press service announced the transfer of the S-300 Favorit anti-aircraft missile system to the Tajik-Afghan border. In addition, Uzbekistan has purchased from Russia Typhoon armored vehicles, delivery of which will begin sometime this year, as well as Russian-made BTR-82A armored personnel carriers, Tiger armored vehicles and a Sopka-2 radar station. Russia also plans to supply 12 Mi-35M transport and combat helicopters to Uzbekistan.

Though there has been much talk of China’s growing military presence in Tajikistan (it recently opened a new military base on the Tajik side of their shared border, for example, and held drills with the Tajik military in August), its security operations in Central Asia are mostly carried out within the framework of the Shanghai Cooperation Organization.

Whereas Russia wants to remain the dominant military player in the region, China is content to take a backseat and avoid competing with Moscow for regional supremacy. Moreover, Beijing shares many of Moscow’s security concerns in Central Asia and therefore doesn’t feel threatened by Russia’s willingness to support Central Asian countries. China actually has more reasons to cooperate than compete with Russia, at least in the short term.

Despite China’s growing economic and military power, Moscow and Beijing don’t see each other as direct rivals in Central Asia, at least for now. There is indirect competition between the two countries, but their current interests and priorities rarely overlap in such a way that would push them into direct competition. China’s interests in the region are mostly economic, so it will be involved there only inasmuch as it can benefit economically.

The deployment of Chinese troops in Tajikistan and the launch of counterterrorism drills with Tajik forces are connected to Chinese concerns over the security of its own investments in Central Asia and elsewhere. Russia, however, has deeper ties in Central Asia, and its interests are more strategic than economic. In tough economic times, it may see increasing competition for influence there, but no country has been able to match Russia’s presence and impact in the region.

Even With a Trade Deal, Copper Is No Sure Thing

Copper prices have risen in the past few months, but weakness in China’s construction sector could put an end to the rally

By Nataniel Taplin


China’s construction sector, the top source of global demand for copper, is losing steam. Photo: ruben sprich/Reuters


Things have been looking up for copper.

Prices for the red metal have risen about 4% since early September, after a dark and dreary stretch for it beginning in mid-2018.

Like many growth plays, copper has been buoyed by signs of warming relations between the U.S. and China, after a bruising trade conflict.

The latest headlines show even a limited deal between the two powers this winter is no sure thing.

But there are even more fundamental reasons to doubt the rally in copper—an important part of the investment case for mining stocks such as GlencorePLC or Freeport-McMoRan Inc. —has further to run.

That’s because Chinese construction, the top source of global demand, is losing steam after two strong years.

Monthly data Thursday showed property-investment growth, a good proxy for the construction of new homes, offices and other buildings, slowing to 8.8% on the year, down from 10.5% in both of the two months prior.





Growth in heavy industrial output and home prices has been slowing for months, and overall industrial growth also moderated in October.

Property investment is likely to droop further, along with industry and house prices, unless Beijing ramps up credit supply—which it has been unwilling to do.

There was some better news for metals in Thursday’s data: investment in power and utilities rose 1.9% in the first 10 months of 2019, compared with the same period a year earlier.

That beats the negative or near-zero growth of the last two years. Still, only far more substantial flows into the already overinvested power sector could offset the drag from property.

Last year, miner BHP estimated the construction sector accounted for 26% of China’s copper demand, versus 22% for power.

A trade deal would be marginally positive for copper.

But the real story for industrial metals is China’s construction cycle.

Investors should keep their attention focused there.

How the US should deal with China

Washington is in danger of throwing away the leverage its allies could have given it

Martin Wolf

Superpowers
                                                                                                                                  © James Ferguson


“It’s easy to win a race when you’re the only one who knows it has begun.

China is thus on the way to supplanting the US as the global hegemon, creating a different world as a result.

Yet it doesn’t have to end this way.”

This anxious view comes from The Hundred-Year Marathon by the Hudson Institute’s Michael Pillsbury.

Mr Pillsbury is one of the most influential American thinkers on US-China relations.

The book is more than a call to recognise reality: it is a call to arms.

On one central point Mr Pillsbury is certainly right: China’s rise is the great political event of our times.

Getting the response right is crucial. It is so easy to get it wrong.

Today, I fear, the US is getting it frighteningly wrong.

The starting point must be that, whether or not China has a plan for world economic domination by 2049 (the 100-year anniversary of the creation of the People’s Republic), that is a plausible, though not inevitable, outcome.

Other things being equal, population is decisive in determining the size of an economy.

The US is the most powerful high-income country because it has the biggest population, by far.

But the population of China is to the US’s, roughly what America’s is to Germany’s.

Nobody could now imagine a world in which Germany’s economy is comparable in size to that of the US.

Similarly, why should we imagine that the US economy will remain indefinitely comparable in size to that of China?

There can only be one answer to this question.

US output per head will remain far higher than China’s, permanently.

At market prices, China’s gross domestic product per head in 2018 was just 15 per cent of US levels.

That is very close to Turkey’s (and ranks 72nd in the world).

Imagine, however, that China achieves Spain’s output per head, relative to the US.

Its economy would then be twice the size of that of the US, at market prices (and close to three times as big in terms of purchasing power).



Is it plausible that China will, over the next three decades, achieve a GDP per head relative to the US comparable to that of Spain today?

Of course it is.

Does anybody doubt that the Chinese people are capable of this?

But what is plausible is not inevitable.

It is possible, instead, that Xi Jinping will be remembered as China’s Leonid Brezhnev.



Brezhnev closed down all thoughts of economic and political reform in the Soviet Union from 1964 to his death in 1982.

He emphasised communist orthodoxy and party discipline.

The result proved a disaster for the USSR.

His conservatism bore direct responsibility for the subsequent collapse.

It is conceivable that Mr Xi’s re-establishment of party discipline and the role of the state in economic life will have similar consequences for China.

But what is conceivable is not inevitable.

China also has a vigorous market economy and a studious bureaucracy.

It may avoid this trap.



In sum, what Mr Pillsbury views with horror is not just plausible, but natural.

What, short of war, could the US do to stop it?

The answer is: not much.

Yes, it could halt its imports from China and try to halt all transfers of technology, too.

Such actions would hit China’s development, but they are unlikely to halt it.

Only Chinese blunders, always possible, are likely to do that.



This is a cry not for defeatism, but for the realism Mr Pillsbury himself calls for.

China is likely to become the world’s greatest economic power because it is both big and competent.

Yet even if the US does not remain the world’s largest economy over the decades ahead, it should retain three significant assets: a law-governed democracy; a free-market economy; and economically powerful allies.

These are sources, respectively, of admiration, dynamism and strength.

Unfortunately, the US is trashing them all.

President Donald Trump seems ignorant of what a liberal democracy is.

The US economy is slowly morphing into rentier capitalism.

It has also become an unreliable and even outright hostile ally — ask the Germans.



The last might be the biggest blunder of all.

For military strength, the US has in truth to rely mainly upon itself.

But in economic policy or human rights, it does not.

The US’s allies bring enormous extra weight to the table (unlike Russia, China’s only potent ally).

Take trade: China’s exports to close US allies far exceed those to America alone.

Many of those allies also share US concerns over market access, poor protection of intellectual property and China’s demand to be treated as a developing country.

Yet the US has thrown away the leverage its allies could have given it.

If it had promoted a negotiation with China inside the World Trade Organization on these issues, in concert with its allies, it would have enjoyed both more leverage and the moral high ground.



It is, of course, not enough for the US to appreciate its resources.

It also has to know what to do with them.

It is not to make itself an enemy of the Chinese people’s legitimate desire for a better life.

Still less is it to dream of overthrowing China’s political system.

Such aims are neither reasonable nor achievable.

It is to stand up for an open and dynamic world economy, based on market principles, to defend freedom of speech and to challenge abuses of human rights in China itself.

But it is also to recognise that, if humanity is to achieve economic progress, maintain peace and preserve the global commons, a high degree of co-operation must also exist between the superpowers.

In dealing with China, the US and its allies need to confront, compete and co-operate across multiple domains.

Today, this seems inconceivable.

Instead, we are looking at a crumbling alliance and a fraught relationship between the US and China.

None of this augurs well for humanity’s future.

Remember: it could be so much better.

Inverse psychology

America’s yield curve is no longer inverted

So, no need to worry about recession? Hmm, maybe



WHAT DO YOU get when you subtract the yield on short-term government bonds from that on longer-dated ones?

A powerful economic omen, if recent history is any indicator.

Around a year before each of the past three recessions the yield curve—which shows the return on government bonds from very short durations to very long ones—inverted.

In July 2000, for instance, the yield on ten-year Treasury bonds dropped below that on three-month Treasury bills; by March 2001 the American economy had sunk into recession (see chart).

When the same thing happened in March this year, alarm bells rang across corporate boardrooms and political campaigns.

When the inversion deepened over the summer, traders and pundits began to speak of recession as a real possibility.



Now, however, the curve has righted itself.

From mid-October, long-term bond yields rose back above short ones (a move accompanied by other bullish financial-market signs, like rising stocks).

Market-watchers are asking: was that a false alarm?

Few economists think a yield curve inversion itself causes a slowdown.

The link between the two has more to do with the effect of monetary policy on both.

Short-term bond yields go up when the Federal Reserve raises its policy rate to keep the economy from overheating.

A drop in long-term yields often occurs when markets expect slower growth ahead: a sign that the Fed has tightened a step or two too many, hitting the brakes hard enough to drag the economy into recession.

This time around, the Fed seemed to take the omen seriously.

Over the course of 2019 it has first abandoned plans to keep raising rates (which had been going up since 2015), then cut its policy rate three times, reducing the effective rate from 2.4% or so to 1.55%.

The yield curve was not the only thing on the mind of its chairman, Jerome Powell: cuts were also a response to a deepening slump in manufacturing and a plateau in the growth rates of prices and wages.

But the central bank nonetheless responded faster and more fiercely to an inversion than it usually had.

If rate reductions have in fact spared the American economy from recession, then Mr Powell, by reacting promptly to the yield-curve omen, may have actually weakened its predictive power.

Few workers, or presidents, are likely to complain.

But the coast is not yet clear.

The Fed might yet seize defeat from the jaws of victory.

Rather than recognising its own success, it could interpret the un-inversion of the yield curve, and the absence (so far) of a downturn, as a sign that the original omen was a false alarm.

Were a new round of headwinds to threaten the American economy and re-invert the curve, the central bank might wrongly dismiss the signal and under-respond, thus bringing on the foretold recession.

It could also be that the slump that was predicted still looms ahead.

Less than a year has gone by since the yield curve first inverted.

Perhaps more important, each of the past three pre-recession inversions reversed themselves before the ensuing downturn began.

So while financial markets are celebrating a bullet dodged, the bullet may still be on its way.

Subzero Interest Rates Are Luring Insurers to Risk

Usually the most strait-laced of investors, insurance companies are letting loose to gain some income, drawing the attention of regulators.

By Jack Ewing



Credit...Yarek Waszul



MUNICH — It was a crisp fall morning, and Tom Wilson was contemplating the latest sign that the world of finance had turned upside down.

Greece had just sold bonds with a negative interest rate. It was the most recent example of how policies that revived growth after the last financial crisis have forced investors to effectively pay governments to assume custody of their money.

The amount of this kind of debt has soared in recent years, and now exceeds $17 trillion.

“Maybe I’m old school, but it just feels weird,” said Mr. Wilson, the chief risk officer of German insurer Allianz, in his office in Munich. “It feels bizarre to have negative interest rates.”

It’s more than bizarre. A growing number of economists, regulators and former central bankers are warning that European insurance companies — traditionally some of the most strait-laced of investors — are among the market players most at risk of a meltdown because of all the negative-interest-rate debt.

Insurers make money by investing the billions they collect in policymakers’ premiums. As they hunt for a return, any return, some companies are venturing into ever-riskier assets.

For the people who manage these billions, said Brian Coulton, chief economist of the debt ratings firm Fitch, “there has been a need to take on more risk.”

The so-called search for yield among investors has broad implications, creating demand and driving up prices for real estate, low-rated corporate debt and other risky assets; generating bubbles; and potentially setting the stage for the next financial crisis. Europe has more of this debt than any other region.

The impact on the insurance industry is drawing increasing concern. Last year, regulators conducted tests to see what would happen if rates spiked suddenly: Six of 42 large insurers would suffer losses large enough to drain their capital below legal thresholds, the tests found.

Insurers would probably be able to manage gradual increases in rates, said Dimitris Zafeiris, the top risk expert at Europe’s insurance regulator. But “if it happens quickly,” he added, “it raises questions about the impact on financial stability.”

Typically, insurers seek to earn a modest return while keeping the money safe in case it is needed to pay claims. European insurance companies were big buyers of bonds issued by countries like Germany or Switzerland that have impeccable credit histories.

But when the return on those super-safe bonds dwindled over the past decade, and then turned negative, insurers and other investors began buying riskier assets like corporate bonds rated BBB, or just above the level considered junk. A lot of money is at stake. Insurance companies in Europe collectively have assets of 11 trillion euros, or $12 trillion.

Recently regulators have become especially concerned that insurers have been loading up on a kind of investment known as collateralized debt obligations, or C.L.O.s for short. C.L.O.s are mortgages and other loans that have been packaged into securities. They bear ominous similarities to the securities that helped cause the 2008 financial crisis

Banks, pension funds and insurers may be underestimating the risk of C.L.O.s, the agencies that oversee those industries in Europe said in a joint report in August.

The Financial Stability Board, a group of central bankers and regulators from Europe, the United States, China and other countries, is also worried. The board said on Oct. 13 that it was scrutinizing whether C.L.O.s posed a risk to the global financial system.

The quandary for insurers is that fewer and fewer bonds — generally safe investments — pay a positive interest rate. A few weeks ago, even Greece sold short-term bonds with negative interest. In an auction, investors bid the rate down to negative 0.02 percent.

The bond sale was extraordinary considering that, less than a decade ago, investors in Greek government bonds were forced to take losses of 50 percent as part of a bailout plan.

Low and negative interest rates are no accident. They are the deliberate result of policies by the European Central Bank to deal with a debt crisis and chronic slow growth. The bank has purchased bonds on the open market to push down interest rates. And as a further inducement to lend, the E.C.B. charges a negative interest rate on deposits that commercial banks stash in the central bank’s coffers.

There is a growing backlash against these stimulus measures.

Low and negative interest rates have rippled through “the entire financial sector,” a group of former central bankers said in a letter to the European Central Bank in October. The scramble for higher rates has pushed up the price of riskier investments and “ultimately threatens to result in an abrupt market correction or even in a deep crisis.”

Whether to continue to encourage negative rates will probably be the key question confronting Christine Lagarde, who succeeded Mario Draghi as president of the European Central Bank bank on Nov. 1.

Mr. Draghi said last month that negative interest rates had “been a very positive experience,” stimulating growth and helping reduce unemployment. “The improvements in the economy have more than offset negative side effects from low rates,” he said.

At Allianz, Mr. Wilson’s job is to protect the company’s assets, which total €974 billion, or $1.1 trillion, of which €729 billion is invested in financial markets. That’s not counting €1.6 trillion that Allianz manages for other people through its fund management units, PIMCO and Allianz Global Investors.

Mr. Wilson said Allianz had avoided the C.L.O.s that so alarm regulators. But Allianz has about €150 billion of corporate debt rated just one notch above junk.

There has been an explosion in investor demand for these risky BBB bonds, because they offer better interest rates yet are still considered investment grade.

Regulators fear that a deep recession or other shock could force ratings agencies to downgrade BBB bonds en masse. That could cause a panic, because insurers or other institutional investors that are barred from holding debt less than investment grade would be forced to sell at fire-sale prices.

Mr. Wilson said Allianz’s holdings were diversified enough that it could cope with a rash of downgrades. He argued that insurance companies, despite their enormous presence in financial markets, were unlikely to be the cause of the next financial crisis. They are less interconnected than banks, he said, meaning that the problems of one insurance company would be unlikely to spread like a pandemic through the financial system.

And unlike banks, insurance companies are not dependent on a continuous supply of short-term credit, which can dry up suddenly if banks lose trust in one another. That is what happened in the 2008 financial crisis.

Others are not so sure insurance companies are benign, pointing out that a troubled insurer could create turmoil in bond markets that could easily spread to banks and create a broader crisis.

Some insurers “are as systemic as banks,” said Christoph Kaserer, a professor at the Technical University of Munich who has written about the industry.

The pressure on insurers to buy riskier assets is growing the longer interest rates stay low. Bonds that the companies bought years ago, when rates were higher, are continually maturing. The insurers must try to reinvest the proceeds in a way that earns a similar return.

“The longer the low interest rate environment prevails, the higher the impact of the reinvestment risk,” said Mr. Zafeiris, head of the risks and financial stability department at the European Insurance and Occupational Pensions Authority, Europe’s main insurance industry regulator.

Mr. Zafeiris said in an interview that, as a group, European insurers were healthy. But he added, “There are always outliers.” (Confidentiality rules do not allow him to name names.)

No big insurance company has failed because of negative interest rates, but the ratings agency Moody’s considers the outlook for the industry in Germany to be negative, in part because of negative interest rates.

Allianz has remained profitable, and the company’s share price is close to its 12-month high, an indication investors are not too worried.

The big question is what will happen if there is some kind of shock to the financial system that causes government and corporate debt to abruptly lose value. Mr. Wilson said he worried about that, too.

“I think the probability has gone up,” he said, citing risks such as trade war, conflicts in the Middle East or rising populism. “The number of triggers is manifold and increasing.”


Europe on a Geopolitical Fault Line

China has begun to build a parallel international order, centered on itself. If the European Union aids in its construction – even just by positioning itself on the fault line between China and the United States – it risks toppling key pillars of its own edifice and, eventually, collapsing altogether.

Ana Palacio

palacio101_Artur Debat Getty Images_earthspaceshadow


MADRID – Two months ago, in his address to the United Nations General Assembly, UN Secretary-General António Guterres expressed his fear that a “Great Fracture” could split the international order into two “separate and competing worlds,” one dominated by the United States and the other by China.

His fear is not only justified; the fissure he dreads has already formed, and it is getting wider.

After Deng Xiaoping launched his “reform and opening up” policy in 1978, the conventional wisdom in the West was that China’s integration into the global economy would naturally bring about domestic social and political change.

The end of the Cold War – an apparent victory for the US-led liberal international order – reinforced this belief, and the West largely pursued a policy of engagement with China.

After China became a member of the World Trade Organization in 2001, this process accelerated, with Western companies and investment pouring into the country, and cheap manufactured products flowing out of it.

As China’s role in global value chains grew, its problematic trade practices – from dumping excessively low-cost goods in Western markets to failing to protect intellectual-property rights – were increasingly distortionary.

Yet few so much as batted an eye.

No one, it seemed, wanted to jeopardize the profits brought by cheap Chinese manufacturing, or the promise of access to the massive Chinese market.

In any case, the thinking went, the problems would resolve themselves, because economic engagement and growth would soon produce a flourishing Chinese middle class that would propel domestic liberalization.

This was, it is now clear, magical thinking.

In fact, China has changed the international system much more than the system has changed China.

Today, the Communist Party of China is more powerful than ever, bolstered by a far-reaching artificial intelligence-driven surveillance apparatus and the enduring dominance of state-owned enterprises.

President Xi Jinping is set for a protracted – even lifelong – tenure.

And, as US President Donald Trump has learned during his ill-fated trade war, wringing concessions out of China is more difficult than ever.

Meanwhile, the rules-based international order limps along, without vitality or purpose.

Emerging and developing economies are frustrated by the lack of effort to bring institutional arrangements in line with new economic realities.

The advanced economies, for their part, are grappling with a backlash against globalization that has not only weakened their support for trade liberalization and international cooperation, but also shaken their democracies.

The US has gradually withdrawn from global leadership.

As a result, international relations have become largely transactional, with ad hoc deals replacing holistic cooperative solutions.

Institutions and agreements are becoming shallower and more informal.

Values, rules, and norms are increasingly regarded as quaint and impractical.

This has produced a golden opportunity for China to begin constructing a parallel system, centered on itself.

To that end, it has created institutions like the Asian Infrastructure Investment Bank and the New Development Bank, both of which mimic existing international structures.

And it has pursued the sprawling Belt and Road Initiative – an obvious attempt to position itself as a new Middle Kingdom.

Yet many, including in Europe, are not particularly concerned about the emergence of this parallel system.

So long as it brings ready access to project finance, it’s fine with them.

As Europe becomes increasingly alienated from the US, many Europeans also believe that they can improve their strategic position by situating themselves on the frontier between the two emerging worlds.

That strategy may offer some advantages, including opportunities for arbitrage.

But as anyone who lives on a fault line knows, there are also formidable risks: friction between the two sides is bound to shake the foundations of whatever is positioned atop the boundary.

This is especially true for the European Union, which is built on a commitment to cooperation, shared values, and the rule of law.

If the EU aids in building a parallel structure that contradicts its core values, particularly the centrality of individual rights, it risks severing its meta-political moorings – the beliefs to which its worldview is tethered.

A Europe adrift will eventually sink.

The solution is not for Europe simply to take America’s “side,” and turn its back on China. (That, too, would run counter to European values.)

Rather, the EU must heed Guterres’s call to “do everything possible to maintain a universal system” in which all actors, including China and the US, follow the same rules.

In this sense, the recent joint statement by Xi and French President Emmanuel Macron reaffirming their strong support for the Paris climate agreement is promising, as is Europe’s growing recognition that China is not only a partner or economic competitor, but also a “systemic rival.”

But this is only a start. Europe needs a robust China strategy that recognizes the profound, often subtle challenges that the country’s rise poses, mitigates the associated risks, and seizes relevant opportunities.

Achieving this will require perspective and discipline, neither of which comes naturally to the EU. But there is no other choice.

As soon as Europe stops defending the rule of law and democratic values, its identity – and its future – will begin to crumble.


Ana Palacio is former Minister of Foreign Affairs of Spain and former Senior Vice President and General Counsel of the World Bank Group. She is a visiting lecturer at Georgetown University.

China’s $1tn scramble for convertible bonds reflects hot market

Bidding for new deals including Shanghai Pudong Development Bank stuns investors

Hudson Lockett in Hong Kong


Chinese companies have issued a record $40bn in convertible bonds this year, according to Dealogic


New debt and equity offerings often draw a crowd.

But when investors last month placed more than $1tn worth of orders for a convertible bond issued by Shanghai Pudong Development Bank, about 140 times the $7bn raised, it was enough to shock even the most seasoned China investor.

That $1tn is almost as large as the entire stock-market capitalisation of Apple or Microsoft — two of the biggest companies in the world. “It was a ridiculous amount,” said Gerry Alfonso, head of research at Shenwan Hongyuan Securities in Shanghai.

As so often with runaway deals, the over-bidding in part reflects quirks in the way new debt and equity ends up in investors’ hands. But it also reflects a surge in issuance of these equity-linked instruments in China — a rise helped by an unusual embrace of the product by policymakers better known for cracking down on financial innovations to ensure stability.

So far this year, Chinese companies have issued a record $40bn in convertible bonds, up more than 80 per cent from the full-year total in 2018, according to Dealogic.

Convertible bonds typically carry a lower coupon payment than normal bonds but they offer investors the right to switch them for equity if a company’s shares rise to a certain price. For companies, convertibles offer a way to raise money more cheaply than by issuing regular debt and do not immediately dilute shareholders’ equity.

Ronald Wan, chief executive at Partners Capital in Hong Kong, said Chinese convertibles had become more attractive to investors thanks to this year’s stock rally, while the government was promoting the instruments as a way to rein in financing done off-balance sheet, or through a fragile shadow banking sector.

Chart showing the outstanding balance for a Suntak Technology convertible bond maturing in 2023 (in million Renminbi). Bond lists with face value of 800 million Renminbi, and redeemed with remaining balance of 4.7 million in October 2019. Another chart below shows share price and conversion price in the same time frame.


But Mr Wan cautioned that convertibles’ performance “depends on the quality of the issuer”, with investors typically favouring large banks and big blue-chip companies over small and mid-sized issuers.

Mr Alfonso eachoed that, warning that while large issuers such as Shanghai Pudong have seen ample liquidity in their convertibles after listing, investors in smaller issuers faced the prospect of taking heavy losses in the event of a sell-off.

“The liquidity is bad but there is liquidity,” he said. “The thing is, the price you’re going to get there is pretty horrendous.”

China’s first domestic convertible bond was issued in November 1992, two years after the Shanghai Stock Exchange opened. The bond, which never converted to stock, was the only onshore convertible issued for more than half a decade.

Today’s market is different, as Chinese convertibles carry special features that set them apart from those in the US or Europe. For one, conversion levels can be reset after a bond is issued, significantly increasing the chances it will switch into stock.

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Convertibles also tend to be looked on favourably by regulators because they are treated as debt until conversion, meaning investors have a better chance than equity shareholders of getting some form of repayment if the company goes bust. Chinese companies are normally required to wait at least 18 months between offerings of shares, which makes convertibles a useful way to gain access to new funds quickly.

“The process of [convertibles] approval still takes time — half a year or so — but it’s faster than an IPO or secondary offering,” said Yulia Wan, a senior analyst at Moody’s in Shanghai.

Ms Wan said that while the floor for conversion prices at issuance was determined by criteria including average trading price, it could be lowered if the shares traded well below the initial level for long enough. She added that because convertibles usually have a maturity of five to six years, a company’s shares have plenty of time to rise high enough for conversion.

The convertibles’ equity-like features mean they offer higher returns to investors than regular debt. But that alone does not explain the huge over-subscriptions common to the local market.

Mr Alfonso of Shenwan Hongyuan said some of the rush is down to scarcity. Because existing shareholders are entitled to a large chunk of any convertible bond that is issued, the number of lots a company can offer more broadly is limited.

In the open market, the highest bids naturally win out, but buyers know that they will get only a fraction of what they request. And because no money is required up front to make an offer, there is no reason not to bid as much as possible to maximise the odds of a successful purchase. “You put up as much as you can and hope for the best,”

Mr Alfonso said. Before regulators banned buyers from bidding through multiple accounts in March, it was not unusual for convertibles to be even more heavily over-subscribed. Prior to Shanghai Pudong’s latest convertible, the largest issuance on record of nearly $6bn, from China Citic Bank, was about 5,500 times oversubscribed, according to local media.

Fearing The Fearless Stock Market

by: Michael A. Gayed, CFA
 
 

Summary
 
- A bullish technical break has happened in the S&P 500.

- Cheap commodities point to an expensive market.

- Near-term bullishness remains, but fragilities are building.

      
But we have to ask ourselves, what's the purpose of the stock market? It's supposed to be a source of capital for growing business. It's lost that purpose.
- Mark Cuban
 
 
As we start the Thanksgiving week, it is worth discussing that complacency is the norm at this point in the year - expect new highs to come.
 
With no important economic releases scheduled this week and the market optimistic about the US-China trade deal, the S&P 500 looks poised to continue its march. The current bull run is nothing short of impressive - the cumulative S&P 500 total return exceeds all the previous bull markets after the second world war.
 
 
A comparison of the bull market run reveals longer consolidations in the current upside move than in the past.
 
It suggests a shake-up of weak hands on the move up and keeps the potential for even more gains alive.
 
One of the last Lead-Lag Reports I wrote mentioned that even with huge uncertainties, the VIX continues to drop.
 
Are market participants too lax?
 
 
 
Net short speculative positions in futures linked to the VIX hit a fresh record low of more than 218,000 contracts - the fear gauge falls silent.
 
 
Alarming signals do exist.
 
First, corporate debt keeps surging now at $10 trillion.
 
At the same time, the US national debt rose by 5.8% in the last year.
 
A healthy stock market and solid job creation drove tax revenues - a slowdown may complicate things moving forward.
 
 
 
Second, a growing gap between the riskiest junk and energy index reached a three-year high - downgrades in the speculative-grade debt market outpace upgrades at an alarming rate.
 
 
 
Third, gold to S&P 500 ratio after yield curve inversion points to weakness ahead - the two-year average performance following the inversion implies a stock market decline of almost 30%.
 
 
 
Finally, the S&P Commodity Index vs. the S&P 500 ratio tells us that commodities are cheap while stocks expensive.
 
This kind of chart makes even the most ardent bull a little uneasy.
 
 
Bulls have the record low VIX levels in their favor, while bears look at deteriorating conditions promising a decline. Is complacency justified under the current conditions?
 
The technical picture is bullish. Not only that the recent bull market evolved in a perfect rising channel - it recently broke above the upper edge, a further bullish sign signaling a change in the bull trend's dynamics fueling further gains.
 
 
 
Bulls would want to see the price remaining in the orange channel. It's not unusual for price to change dynamics again - a further break of the upper channel implies even more pain for bears.
 
On the other hand, a bearish case makes sense only on a break below 2,400. At that point, the series of higher lows and higher highs get invalidated.
 
Like it or not, the path of least resistance (especially during the Thanksgiving week) points to further gains, fueling the hopes of a Santa rally. Unless negative surprises from the trade war front occur, bulls have all the reasons in the world to be fearless.
 
Your Biggest Mistakes Are Often Invisible.
 
Sometimes, the biggest risks in your portfolio are just sitting there, waiting to surprise you.
 
That's why paying attention to the right data and insights is so important.
 
A few quick tips from an investment manager isn't enough: you need to dive deep into the signals that shake the market and move your portfolio.