Currency intervention: how would the US do it, and would it work?

Washington’s FX policy has oscillated between heavy interventions and benign neglect

Eva Szalay in London

The Fed's recent dovish turn has made it easier for Donald Trump to push for interventions

The US dollar is near a multi-decade high, on a trade-weighted basis, and President Donald Trump is not happy about it. His increasingly blustery rhetoric, accusing other countries of manipulating their currencies lower to boost exports, could mean that the US Treasury Department intervenes in FX markets for the first time in years.

Since 1995, the US has stepped in three times — but on each occasion acted in concert with other big central banks to smooth excessive exchange rate fluctuations.

Could the US intervene on its own?

The short answer is yes.

America’s exchange-rate policy has oscillated from periods of large and frequent interventions to benign neglect under different administrations. In some cases, the view about exchange rates changed significantly under the same administration, flipping from viewing a strong dollar as a threat to making it an official policy — as in Bill Clinton’s two terms as president.

“What is remarkable about these fashions is how abruptly [policies] changed at times,” said Robin Winkler, a strategist at Deutsche Bank.

Following the breakdown in 1973 of the Bretton Woods exchange-rate system — in which the currencies of 44 countries were pegged to the value of the dollar, which, in turn, was pegged to the price of gold — big central banks regularly intervened to influence their currencies. In the US, President Richard Nixon had hoped that the end of the system would stabilise the dollar’s value but it did not, forcing the Treasury to step in frequently to buy dollars. Jimmy Carter’s administration also deployed significant resources to support the dollar in 1978 before interventionist policies briefly fell out of favour under Ronald Reagan.

The dollar appreciated more than 50 per cent under Reagan, with a 90 per cent rise against the Deutschemark in the five years to 1985. This led to a change of stance during Reagan’s second term, which ultimately led to the Plaza Accord of 1985, under which big central banks co-ordinated to weaken the greenback.

In the lead-up to the 1987 October stock market crash, the dollar gained ground again despite heavy intervention from the US. In late 1988 the currency saw another spurt, against the Japanese yen in particular, as the Federal Reserve raised interest rates. That led to the US intervening on an unprecedented scale in the first half of 1989, which caused clashes between the Treasury and the Fed’s rate-setting committee.

From that point, the Treasury “largely gave up on interventions, conceding that they had failed to have the desired impact”, said Mr Winkler.

How would intervention work this time?

Since 1934, the US Treasury has held responsibility for managing exchange rates, through the official vehicle for currency interventions — the Exchange Stabilisation Fund. The New York Fed acts as the official agent for the Treasury during interventions but the central bank also holds additional firepower to influence prices.

Historically, the Treasury and the Fed have acted together, shouldering intervention amounts equally, even when the central bank had reservations about the Treasury’s goals. If the Fed agreed to participate now, the administration’s war chest to buy other currencies would total about $200bn.

The Fed’s recent dovish turn has made it easier for Mr Trump to push for interventions, as the expected rate-cutting path aligns with the administration’s desire for a weaker dollar. But sensitivities around protecting the central bank’s independence will be more difficult to overcome and the Fed could resist calls to deploy its own firepower to help. If the Treasury decides to go it alone, the move could risk what Deutsche Bank calls an “institutional crisis”.

“Our interpretation is that the Fed would probably defer to the Treasury and go along even if it does not agree,” said Michael Cahill, an FX strategist at Goldman Sachs.

Does the US have broad support?

No, and without it, the results of an intervention could be mixed at best. While central banks have combined in the past to try to stabilise currencies — as in the aftermath of Japan’s biggest ever earthquake in 2011 — there is little evidence that peers such as the European Central Bank or the Bank of Japan would support the Treasury’s efforts.

Citigroup economists highlight that at the time of the Plaza Accord, every member of the G5 bloc was concerned about the strength of the dollar, but today only the US is complaining. “This is a one-sided Plaza at best,” said Citi.

That raises the prospect of tit-for-tat competitive devaluations. A unilateral US move “could harm severely the international monetary system”, said Mark Sobel, ex-Treasury official and US chairman of think-tank OMFIF.

Such a move would also make it hard for the Trump administration to label other countries as “manipulators”. Mr Cahill noted that the US would find it difficult to respond if China aggressively weakened the renminbi, for example.

And whatever shape intervention might take, intervening in the dollar may not be enough to offset factors that are pushing it higher. The US economy, for example, continues to outperform its peers. On that basis, Nomura strategist Craig Chan says the dollar could make gains in the second half — even if intervention causes some “short-term volatility and potentially a sharp fall”.

Who Will Win the Twenty-First Century?

For years, Europeans were lulled into thinking that the peace and prosperity of the immediate post-Cold War period would be self-sustaining. But, two decades into the twenty-first century, it is clear that the Old Continent miscalculated and now must catch up to the digital revolution.

Joschka Fischer


BERLIN – The first two decades of the twenty-first century are beginning to cast a long shadow over the Western world. We have come a long way since the turn of the century, when people everywhere, but particularly in Europe, indulgently embraced the “end of history.”

According to that illusory notion, the West’s victory in the Cold War – the last of the three great wars of the twentieth century – had given rise to a global order for which there could be no alternatives. Thenceforth, it was thought, world history would march steadily toward the universalization of Western-style democracy and the market economy. The new century would merely be a continuation of the previous one, with a triumphant West extending its dominion.

The world is wiser now. The web of alliances and institutions that sustained the West’s dominance is proving to be a product of the twentieth century, its future now in doubt. The global order is undergoing a fundamental change, as its center of gravity shifts from the North Atlantic to the Pacific and East Asia. China is on the threshold – economically, technologically, and politically – of becoming a world power and the sole challenger of the incumbent hegemon, the United States.

At the same time, the US is growing tired of its global leadership role. It began to step back under former President Barack Obama; but under Donald Trump, it has accelerated its withdrawal in a chaotic and dangerous manner. America’s abdication of leadership poses a threat to the very existence of the transatlantic West, which rests on a foundation of shared values and political institutions. In the absence of any reasonable alternatives, the structure is crumbling.

Russia, meanwhile, is confronting the future by looking to its twentieth-century past. Like the Soviet Union, it is placing its bets entirely on nuclear weapons. Yet in the twenty-first century, power will be determined not by one’s nuclear arsenal, but by a wider spectrum of technological capabilities based on digitization.

Those who aren’t at the forefront of artificial intelligence (AI) and Big Data will inexorably become dependent on, and ultimately controlled by, other powers. Data and technological sovereignty, not nuclear warheads, will determine the global distribution of power and wealth in this century. And in open societies, the same factors will also decide the future of democracy.

As for Europe, the Old Continent entered the new century in anything but optimal form. Living under the cozy post-historical illusion of everlasting peace, the European Union failed to complete the project of integration (though it did manage to expand eastward). The implicit withdrawal of the US security guarantee under Trump has struck Europe like a bolt from the blue.

The same could be said for the digital revolution. The first phase of digitization – consumer-facing platforms – has been led almost entirely by the US and China. There are no competitive European platform firms to speak of, nor are there any European cloud-computing companies capable of keeping up with the behemoths in Silicon Valley and China.

The most important issue facing the new European Commission, then, is Europe’s lack of digital sovereignty. Europe’s command of AI, Big Data, and related technologies will determine its overall competitiveness in the twenty-first century. But Europeans must decide who will own the data needed to achieve digital sovereignty, and what conditions should govern its collection and use.

These questions will determine the fate of democracy in Europe, and whether the Old Continent’s future will be one of prosperity or decline. As such, they must be decided at the European level, not by individual nation-states. Equally important, these questions must be answered now. Europe needs to get the digital ball rolling – or be run over by it.

In the years ahead, automotive design and manufacturing, mechanical engineering, medicine, defense, energy, and private households will all be disrupted by digital technologies. The data generated from these sectors will largely be processed through the cloud, which means that control of the cloud will be vital to countries’ long-term economic and strategic fortunes.

To safeguard its digital sovereignty, Europe will need to make massive investments in cloud-computing capacity and the other physical resources underpinning the digital revolution. Europe has been far too slow and indecisive in this respect. Its challenge now is to catch up to the US and China, lest it be left behind permanently.

Europeans should not harbor any illusions that the private sector will take care of things on its own. Europe’s competitive disadvantage calls for a fundamental change in strategy at the highest level. The EU institutions will have to lead on setting regulations and, together with the member states, on providing the necessary financing. But securing Europe’s digital sovereignty will require a much broader effort, involving businesses, researchers, and politicians.

Following the recent 50th anniversary of the first Moon landing, there has been much media discussion about a potential manned flight to Mars. For Europe, though, space travel can wait.

The top priority must be to establish and safeguard digital sovereignty, and to do whatever is necessary to arrest its own decline and protect democracy. For better or worse, the twenty-first century is well underway.

Joschka Fischer was German Foreign Minister and Vice Chancellor from 1998-2005, a term marked by Germany's strong support for NATO's intervention in Kosovo in 1999, followed by its opposition to the war in Iraq. Fischer entered electoral politics after participating in the anti-establishment protests of the 1960s and 1970s, and played a key role in founding Germany's Green Party, which he led for almost two decades.

Going to the Moon and Going to India

By George Friedman


Last weekend marked the 50th anniversary of the Apollo 11 mission, the first manned space flight to the moon. In endless articles, observers are asking why no attempts have been made to land men on the moon since the Apollo program.

In considering this, I think it’s useful to examine the U.S. and other space programs against a prior, comparable period of exploration – the European journey to the Western Hemisphere. The similarities and differences between the two will help us understand the issues behind that question.
The Race to India
The initial European explorations five centuries ago had similarities to the U.S. and Soviet space programs of the 1960s. First, both were extremely expensive and carefully planned. The two countries most competitive in these explorations, Portugal and Spain, spent a substantial proportion of their national budgets on the expeditions. The Portuguese trained captains and navigators and built ships that could sustain a crew for extended periods of time and survive dangerous conditions. They carried out a systematic program of exploration, with each voyage pushing farther south along the African coast in search of a passage to India. Meanwhile, Christopher Columbus had approached several countries, including France and England, soliciting funding for his own expeditions, but he was repeatedly turned down because of the program’s cost and improbability of success. Only Spain was willing to fund his journey, contributing both state funds and private investment.

Second, both programs were undertaken for reasons of national security and prestige. The Portuguese and Spaniards were bent on finding a route to India, the source of critical products for Europe. The traditional route from India to Europe had been disrupted by the Ottoman conquest of Turkey and the accompanying increases in tariffs. This shifted the economic process in Europe, and any nation that found another path to India would prosper enormously from the trade, with the added benefit of weakening the Ottomans.

Portugal’s program introduced new naval technologies and explored uncharted waters. It was Portugal that finally found the southern tip of Africa, navigating around it and through the Indian Ocean to India itself, landing in 1498. This frightened the Spaniards. They feared that Portugal would threaten them in Iberia and become the dominant power in Europe. The Spanish had only just expelled the last Muslim enclave in Spain in 1492, and the cost had crippled the national budget. But if Spain simply allowed Portugal to control the new route to India, Portugal would eventually control the oceans, and Portuguese power and prestige would dwarf Spain’s.

That’s why they were prepared to invest in Columbus’ risky voyage. The Portuguese navy dominated the southern route, and they had to find a different one. Columbus’ proposal to sail westward into unknown waters was risky. But it was the only practical chance for Spain to compete in the race to India. When Columbus reached what he thought was India, he found very little of value there.

In that sense, his voyages were a failure, and he returned to Spain to great criticism. But the Spanish doubled down, permitting additional journeys that also yielded little economic benefit, prompting Spain to suspend further explorations. The Portuguese, whose route to India had economic value and lent them national power, continued their voyages. The Spaniards slipped behind.

But in due course, with further exploration that was far less risky than Columbus’, the Spanish discovered the Incas in the Andes and the Aztecs in Mexico, both wealthy with gold and silver. The Spaniards conquered them (with disease as well as guns), took their wealth, and defeated Portugal in the race to wealth and power.

The Race to the Moon

The U.S. and Soviet space programs, like the European expeditions, were rooted in political and strategic considerations. Toward strategic ends, each country created and launched spy satellites to monitor the other’s military preparations. It was therefore critical that large sums be devoted to low Earth orbit spy satellites. Toward political ends, each sought prestige. The U.S. and the Soviet Union were making ideological claims concerning the effectiveness of their social and political systems, using demonstrations of technology to persuade other nations to come into their camps. The initial Soviet manned flights brought them political influence. Later, the moon landing lent that influence to the U.S. But there was a fundamental difference between the value of that influence and the cost of the space programs.

Manned flights did not persist, but space as a realm of military power did. And over time, the military power of space yielded economic benefits, from increased communication capabilities to GPS. Still, the economic benefits of manned missions to the moon simply did not compare to those that eventually accrued to Spain and Portugal.

Without clear economic value, Spain put a hold on exploration. Columbus’ journey yielded substantial scientific knowledge, but it could not support the cost of further exploration. Expeditions had to be justified by more immediate benefits. The same can be seen in the hiatus on U.S. manned moon missions. Having achieved its political and military ends, the U.S. continued the scientific dimension with limited unmanned explorations. Further manned trips to the moon were not economically viable.

That is changing now. As I argued in my recent piece on command of the seas, space is now the key to military power. And that means that space is now a potential battleground. Control of space will depend on strategic depth. If space is the key to military dominance, then nations will move beyond extremely vulnerable satellites – a few key satellites for GPS and communications control may not survive a major conflict.

The moon, then, becomes a strategic asset. Its military use is unclear at this point, but it is emerging. On the moon, it is possible to dig in and secure assets in ways that can’t be done in orbit. This means that a manned presence on the moon may well happen again, for the same reason that Spain continued its maritime exploration program: to build national power.

Still, the economic benefit of going to the moon is absent, and thus the cost of the military effort is not underwritten by economic gain, as was the case with the Iberian surge onto the oceans. This is the great weakness in a U.S. return to manned moon flights. I have written in the past that the value of space is unlimited solar power (which can be collected and returned to Earth as microwaves and then transferred into the electrical grid). Some argued that the platforms I envisioned would be vulnerable to attack, but that might be mitigated by lunar-based systems. Space-based solar power is much more efficient than Earth-based systems, which must deal with night and clouds. Beyond solar power, though, it is at present hard to imagine other economic uses of the moon.

One could say that space exploration is an end in itself. But except for limited efforts, this is empirically untrue. The Iberian exploration was driven by economics, military power and politics. The space exploration of the 1960s was driven by military power and political desire. The economic factor existed only where the technology developed could be spun off for commercial uses.

At present, commercial space companies are focused on supporting military and related efforts in space and on space tourism. The former would take place anyway, and the latter is a dubious indulgence. The commercial use of space remains the key for returning to the moon. And if my suggestion for space-based solar power is rejected, then some other must be found. Columbus did not come to America to build knowledge. He came for money, and Spain funded him for wealth and power.

Why Weak Corporate Earnings Don’t Signal a Weak Economy

Tepid results from multinationals don’t necessarily signal trouble at home

By Justin Lahart

The domestic economy is still solid, but the Federal Reserve’s beige book survey showed manufacturers continuing to worry about the uncertainty and costs associated with trade disputes. Photo: tim aeppel/Reuters

American companies are reporting second-quarter results, and the numbers so far have been nothing to write home about. Based on current estimates compiled by FactSet, earnings for companies in the S&P 500 will be down 1.9% from a year earlier. Actual results probably will be somewhat better given companies’ tendency to lower the bar and then clear it, but the final figures are unlikely to fit anyone’s definition of good.

It is tempting to hang earnings weakness on the domestic economy. Even though growth has moderated a bit, it is still solid. Macroeconomic Advisers estimates imply that final sales to domestic purchasers—a measure of underlying economic demand—was up 2.6% from a year earlier in the second quarter. That compares with a 2.9% gain in the second quarter of last year.

Outside the U.S., things aren’t looking so rosy, and that is a problem for many of the companies in the S&P 500, which conduct a substantial share of their business overseas. Paint maker PPG Industries ,for example, which generated more than half of its income outside the U.S. last year, highlighted weakness in the Chinese and European auto markets when it reported a 2.6% decline in second-quarter sales. The strength of the dollar compounds the problem: Industrial-equipment maker Dover said foreign exchange created a 2.6% headwind to sales.

Tariffs and trade tensions are another point of stress, particularly in the manufacturing sector.

The Federal Reserve’s beige book survey released Wednesday—a report of anecdotes drawn anonymously from business contacts around the country—showed manufacturers continuing to worry about the uncertainty and costs associated with the various trade disputes into which the U.S. has entered.

But trade counts as more of an issue for large public companies than for U.S. businesses at large. That isn’t just because of all the business they do overseas but also the kinds of companies they are. Some 190 of the 500 companies in the S&P 500—more than a third—are classified as manufacturers. Yet manufacturing jobs count for only 8% of U.S. employment.

Finally, companies are being confronted by rising labor costs and an inability to pass those costs on. It is part of why profit margins look to have slipped in the second quarter. But for most Americans, the combination of rising wage growth and low inflation probably counts as a good thing.

It is easy—and often makes sense—to view big U.S. companies as a barometer of the U.S. economy, but that is misleading at the moment. A measure of something isn’t the same as the thing itself.

The world economy

Markets are braced for a global downturn

The signals from bonds, currencies and commodities are increasingly alarming

LOOKING FOR meaning in financial markets is like looking for patterns in a violent sea. The information that emerges is the product of buying and selling by people, with all their contradictions. Prices reflect a mix of emotion, biases and cold-eyed calculation. Yet taken together markets express something about both the mood of investors and the temper of the times. The most commonly ascribed signal is complacency. Dangers are often ignored until too late. However, the dominant mood in markets today, as it has been for much of the past decade, is not complacency but anxiety. And it is deepening by the day.

It is most evident in the astounding appetite for the safest of assets: government bonds. In Germany, where figures this week showed that the economy is shrinking, interest rates are negative all the way from overnight deposits to 30-year bonds. Investors who buy and hold bonds to maturity will make a guaranteed cash loss.

In Switzerland negative yields extend all the way to 50-year bonds. Even in indebted and crisis-prone Italy, a ten-year bond gets you only 1.5%. In America, meanwhile, the curve is inverted—interest rates on ten-year bonds are lower than on three-month bills—a peculiar situation that is a harbinger of recession. Angst is evident elsewhere, too. The safe-haven dollar is up against many other currencies. Gold is at a six-year high. Copper prices, a proxy for industrial health, are down sharply. Despite Iran’s seizure of oil tankers in the Gulf, oil prices have sunk to $60 a barrel.

Plenty of people fear that these strange signals portend a global recession. The storm clouds are certainly gathering. This week China said that industrial production is growing at its most sluggish pace since 2002. America’s decade-long expansion is the oldest on record so, whatever economists say, a downturn feels overdue. With interest rates already so low, the capacity to fight one is depleted. Investors fear that the world is turning into Japan, with a torpid economy that struggles to vanquish deflation, and is hence prone to going backwards.

Yet a recession is so far a fear, not a reality. The world economy is still growing, albeit at a less healthy pace than in 2018. Its resilience rests on consumers, not least in America. Jobs are plentiful; wages are picking up; credit is still easy; and cheaper oil means there is more money to spend. What is more, there has been little sign of the heady exuberance that normally precedes a slump.

The boards of public companies and the shareholders they ostensibly serve have played it safe. Businesses in aggregate are net savers. Investors have favoured firms that generate cash without needing to splurge on fixed assets. You see this in the vastly contrasting fortunes of America’s high-flying stockmarket, dominated by capital-light internet and services firms that throw off profits, and Europe’s, groaning under banks and under carmakers with factories that eat up capital. And within Europe’s stockmarkets a defensive stock, such as Nestlé, is trading at a towering premium to an industrial one such as Daimler.

If there has been no boom and the world economy has not yet turned to bust, why then are markets so anxious? The best answer is that firms and markets are struggling to get to grips with uncertainty. This, not tariffs, is the greatest harm from the trade war between America and China. The boundaries of the dispute have stretched from imports of some industrial metals to broader categories of finished goods.

New fronts, including technology supply-chains and, this month, currencies, have opened up.

As Japan and South Korea let their historical differences spill over into trade, it is unclear who or what might be drawn in next. Because big investments are hard to reverse, firms are disinclined to press ahead with them.

A proxy measure from JPMorgan Chase suggests that global capital spending is now falling. Evidence that investment is being curtailed is reflected in surveys of plunging business sentiment, in stalling manufacturing output worldwide and in the stuttering performance of industry-led economies, not least Germany.

Central banks are anxious, too, and easing policy as a result. In July the Federal Reserve lowered interest rates for the first time in a decade as insurance against a downturn. It is likely to follow that with more cuts. Central banks in Brazil, India, New Zealand, Peru, the Philippines and Thailand have all reduced their benchmark interest rates since the Fed acted.

The European Central Bank is likely to resume its bond-buying programme.

Despite these efforts, anxiety could turn to alarm, and sluggish growth descend into recession.

Three warning signals are worth watching. First, the dollar, which is a barometer of risk appetite. The more investors reach for the safety of the greenback, the more they see danger ahead. Second come the trade negotiations between America and China. This week President Donald Trump unexpectedly delayed the tariffs announced on August 1st on some imports, raising hopes of a deal.

That ought to be in his interests, as a strong economy is critical to his prospects of re-election next year. But he may nevertheless be misjudging the odds of a downturn. Mr Trump may also find that China decides to drag its feet, in the hope of scuppering his chances of a second term and of getting a better deal (or one likelier to stick) with his Democratic successor.

The third thing to watch is corporate-bond yields in America. Financing costs remain remarkably low. But the spread—or extra yield—that investors require to hold risker corporate debt has begun to widen. If growing anxiety were to cause spreads to blow out, highly geared firms would find it costlier to roll over their debt. That could lead them to cut back on payrolls as well as investment in order to make their interest payments. The odds of a recession would then shorten.

When people look back, they will find plenty of inconsistencies in the configuration of today’s asset prices. The extreme anxiety in bond markets may come to look like a form of recklessness: how could markets square the rise in populism with a fear of deflation, for instance?

It is a strange thought that a sudden easing of today’s anxiety might lead to violent price changes—a surge in bond yields; a sideways crash in which high-priced defensive stocks slump and beaten-up cyclicals rally. Eventually there might even be too much exuberance. But just now, who worries about that?

Donald Trump is wrong — drags on Chinese growth are homegrown

Post-crisis stimulus has sent debt rising to levels that limit Beijing’s options

James Kynge

The US trade war is having a marginal impact on China’s economic slowdown, the real weakness is homemade © AFP

As usual, there was a lot to unpack in Donald Trump’s tweet. The US president claimed that American tariffs were having a “major effect” on the Chinese economy, which this week posted its lowest level of gross domestic product growth for nearly 30 years.

“China’s 2nd Quarter growth is the slowest it has been in more than 27 years. The United States Tariffs are having a major effect on companies wanting to leave China for non-tariffed countries. Thousands of companies are leaving,” Mr Trump tweeted.

Some of this is perhaps half true. Several companies — including US tech behemoths such as Apple — are indeed considering shifting part of their supply chain out of China. And, yes, this potential shift is driven partly by the US-China trade war.

But the overall message of Mr Trump’s tweet — that US tariffs are dragging China down — relies on a simplistic reading of what animates China’s economy. The reality is that China’s dynamism these days comes mostly from within, from investment and consumer spending. Trade has long since ceased to be more than a bit player in China’s growth story.

“The Trump tensions have contributed to slower growth in China, but the biggest impact has been on sentiment rather than directly from trade,” said Andy Rothman, investment strategist at Matthews Asia. “Remember that last year, net exports accounted for less than one per cent of China’s GDP.”

Thus, Mr Trump’s claim that US tariffs have had a “major effect” is overblown. Equally misleading is the idea that Chinese growth has taken a big hit. Economic expansion of 6.3 per cent in the first half of this year, down from 6.6 per cent over all of 2018, hardly constitutes a rout.

When such numbers are expressed in US dollars, the vacuity of Mr Trump’s words becomes clear. Last year, China added $1.45tn to its $13.6tn economy, making it by far the biggest national contributor to global GDP.

For context, the extra $1.45tn in economic output that China managed in 2018 is roughly equivalent to the size of the Spanish or Australian economies. Even if China manages only 6.3 per cent growth this year, it will have added another “Spain”.

Such comparisons help to put the importance of China’s economy into context. But they do not take account of the country’s manifold frailties, many of which lie intentionally obscured beneath upbeat official narratives.

The main structural drags on Chinese growth are homegrown. They are hangovers from blistering stimulus binges launched since the 2008 financial crisis that have sent debts skyrocketing to levels which now limit Beijing’s policy options.

Total debt in China stands at over $40tn, or close to 310 per cent of GDP, according to the Institute of International Finance. This represents an explosion from levels of just over 150 per cent in 2008, revealing that much of China’s golden decade was borrowed rather than bought.

The frailty has forced Beijing to temper its ambitions. Officials routinely warn over the risks that could erupt from a vast, unregulated shadow finance system. Local governments, meanwhile, are navigating what S&P analysts Gloria Lu and Laura Li call a “debt iceberg with titanic credit risks”. Households are also increasingly maxed out.

The upshot of all this is that Beijing no longer enjoys the luxury of being able to buy growth by deploying credit to spur unchecked asset price inflation. Such limitations help explain why Beijing appears set against a return to the go-go policies of 2009 and 2015. Several analysts think that if a stimulus is launched to stem ebbing growth later this year, it will be a limited, piecemeal affair.

Staying Beijing’s hand over the liquidity spigot is the knowledge that more credit will inflate housing prices further out of the reach of a swelling middle class. “History has proven that every country relying excessively on real estate for economic prosperity would eventually pay a heavy price,” warned Guo Shuqing, China’s banking regulator, in June.

Yet Chinese policymakers also know that when property prices ease, households feel poorer and rein in their spending, having an impact on the broader economy. So a balancing act results. When growth slips too much, tax cuts, rebates and judicious injections of liquidity are deployed. If things overheat, some goodies are withdrawn.

The only escape for China comes from boosting productivity. And it is this that gives Mr Trump his leverage. Although US trade tariffs have little power to injure China, the prospect of a full-blown economic rivalry with the US that restricts Chinese companies’ access to US tech looms as a potent threat.

Thus, says Mr Rothman, China is likely to favour a resolution with the US to the trade war.

Without one, Beijing will struggle over time to ascend the technology ladder, making productivity gains harder to attain.

The bonds that tie

Argentina faces the prospect of another default

An opposition triumph in primary elections prompts a vicious sell-off

THE ELECTION of Mauricio Macri in 2015 was supposed to usher in a new era in Argentina, a country with a reputation for toothsome steaks, rapid inflation and defaulting on its debts. Mr Macri promised to tame soaring prices with tight monetary policy, a problem Cristina Fernández de Kirchner, Argentina’s previous president, had tried to obfuscate by publishing dodgy macroeconomic data and imposing currency controls.

Mr Macri abolished these, allowing the peso to float freely, and removed export quotas and tariffs. Investors applauded. After resolving long-standing disputes with bond investors, Argentina was able to issue debt once more. In June 2017 Mr Macri even issued $2.7bn worth of 100-year bonds at a yield of 8%. They were almost four times oversubscribed.

Good fortune did not last. Unexpected changes to inflation targets and rapid debt issuance alarmed investors in 2017. These qualms mushroomed into a currency crisis last year. As the peso plunged, the central bank raised interest rates to 40%.

Mr Macri was forced to seek a $57bn loan from the IMF. In order to satisfy the terms of the bailout, he has cut public spending and raised the prices of utilities, such as gas and electricity, and public transport. The crisis has taken a heavy toll on the economy. Argentina has been in recession for the past year; inflation is over 50%. The poverty rate, as measured by the Catholic University of Argentina, has climbed from 27% in 2017 to 35% now.

Economic hardship has not played well with voters. “We voted last time for the president because we wanted a better life, especially for our children,” says Mercedes, a shop assistant in Buenos Aires. “But life was worse under him. We worked more to have less.”

On August 11th they voiced their discontent in primary elections for the presidency. The opposition, led by a veteran Peronist, Alberto Fernández, with the former president Ms Fernández (no relation) as his running mate, won 47% of the vote. Mr Macri’s coalition won just 32%.

The reaction of investors was swift and vicious. On August 12th they rushed to dump Argentine assets. Mr Macri may not have been a panacea for all Argentina’s ills, but his stewardship of the economy was far more sober than that of his predecessor, who now seems likely to be restored to high office. Argentina’s stockmarket, the Merval, fell by 37%. At one point in the day the peso was down by 30% before the central bank intervened and raised interest rates to 74%. It still closed 15% lower.

In dollar terms, the stockmarket’s collapse is the second-biggest one-day drop recorded anywhere in the world since at least 1950. The 100-year bonds that investors had clamoured for when Mr Macri issued them are now worth just 54 cents on the dollar, implying a default risk of 57%.

The rout in asset prices was severe, first, because the hope that Mr Macri can recover is small.

On August 11th nobody actually won or lost office: the vote was technically a primary and the main candidates were uncontested in their parties. But since all Argentines over the age of 16 were legally obliged to vote, it functioned as a full dress rehearsal for the real election, which will be held at the end of October. If the Fernándezes win more than 45% of the vote again in October, they will seize victory in the first round.

Second, investors are rightly fearful of the policies the pair may put in place. Ms Fernández’s spendthrift reputation precedes her. Mr Fernández warned in the final days of the campaign that devaluation of the peso was coming. He also promised to renegotiate the $57bn IMF loan, and said that he could in effect default on Argentine bonds.

In the aftermath of the vote, Mr Fernández tried to strike a more moderate tone. “We weren’t crazy in government before,” he declared. Reducing expectations, one of his advisers points out that if Mr Fernández wins, a weak peso will make the job of being president “that much tougher”. But it may already be too late. As The Economist went to press, the peso had fallen by 25% against the dollar since the election.

A weaker currency will push up the prices of imported goods, causing inflation to rise even further. It also has adverse implications for the country’s bonds. Argentina has defaulted on its sovereign debt eight times since independence in 1816, most recently in 2014 when Ms Fernández clashed with hedge funds. Government debt in Argentina is currently worth 88% of GDP. Three-quarters of it is denominated in foreign currency. A falling peso will push up the burden of servicing it. Economists at Bank of America now think the probability of a restructuring next year is high, and that the recovery value of Argentina’s debt could be as low as 40%.

Could the markets’ collapse persuade Argentines to change their minds by October? Some voters surely took the chance to punish Mr Macri in the primary vote, and will come back to him in the real thing. But few think it will be enough. Eduardo D’Alessio, of D’Alessio/Berensztein, a polling firm, says it would take “a huge, obvious mistake” by los Fernández before October to keep Mr Macri in office. Inside the president’s camp, the mood was doom-laden. “This is a catastrophe,” said one of his advisers. “It’s almost impossible to come back from this.”

Mr Macri has vowed to fight back. On August 14th he told voters: “I understand the anger.”

He has introduced a $740m stimulus package of tax cuts, price freezes and higher benefit payments.

Maybe it will help him claw back some votes.

But whoever gets the job after the vote in October, it has just become much harder.


Lots of investors bet on “factors”, such as size, value and momentum

But what if the crowd catches on?

THE FINAL of the European Football Championship in 1976 was settled by a penalty shoot-out. The winning kick, scored by Antonin Panenka of Czechoslovakia, was a thing of beauty. From Panenka’s long run-up and body shape, the West German goalkeeper, Sepp Maier, guessed that the kick would go hard to his left. He dived in anticipation. But Panenka did something novel. He calmly chipped the ball down the centre of the goal, which Maier had just vacated.

Armed with this story, we come scrambling back to the present to contemplate another game of fine margins: investment. Here too success often depends on the ability to outwit others. Indeed proponents of factor investing—buying baskets of stocks with characteristics that have been shown to beat the market averages—say it works by exploiting the enduring weaknesses of investors. If the dumb money keeps shooting for the corners, you profit by going down the middle. Just hold your nerve. 
This requires a faith that the future will be like the past. And where there is faith, there is always doubt. The world of investing evolves, just as football has. As more players adopted the Panenka, goalkeepers cottoned on. A new category emerged: the failed Panenka. A consideration of this begs a scary thought for factor investors: what if returns will be hurt by the ubiquity of the strategy itself?

The roots of factor investing go back at least as far as a canonical paper in 1992 by Eugene Fama, a Nobel-prizewinning economist, and Kenneth French. They found that listed companies that were relatively small, or whose stock price was low compared with the value of assets, had higher-than-average returns. They proposed that size and value were factors that justified a reward over and above that for bearing market risk, known as beta. Subsequent research identified other winning factors for companies with strong dividends (the yield factor) or high profitability (quality); or with share prices that have risen a lot (momentum) or that fluctuate only a little (low-volatility).

Investors took notice. Trillions of dollars are now invested in factor-based or “smart-beta” strategies. A new paper by James White and Victor Haghani of Elm Partners, a fund-management firm, sets out the reasons to be sceptical about their continued success. A first problem is the muddle over why factor premiums exist at all. One view says it is all about risk. Small or lowly valued firms are riskier because they might go bankrupt in a really deep downturn. You may buy that. But it is harder to dream up a compelling risk story about, say, momentum or low volatility.

The alternative view is that factors exist because of the shortcomings of others. So momentum works because investors in general tend to react too slowly to good news about a company’s prospects. Other factor premiums are put down to industry frictions. If, say, pension funds have demanding targets, but are not allowed to use leverage to boost returns, a second-best strategy is to tilt the portfolio towards high-volatility stocks. Low-volatility stocks are thus unduly cheap.

The big question is whether we should expect these quirks to endure. Once a way to make above-market returns is identified, it ought to be harder to exploit. “Large pools of opportunistic capital tend to move the market toward greater efficiency,” say Messrs White and Haghani. For all their flaws and behavioural quirks, people might be capable of learning from their costliest mistakes. The rapid growth of index funds, in which investors settle for an average return by holding all the market’s leading stocks, suggests as much.

Part of the appeal of index investing is that it is cheap. Factor investing, by contrast, involves a lot of churn—and thus expense. A detailed study by AQR Capital Management, one of the big beasts of factor investing, finds that trading costs were around 40% of gross factor returns. The costs are mostly down to the weight of money moving stock prices unfavourably. This figure is high enough to warrant concern, say the Elm duo. It may go higher as more money piles in. If factor premiums are also slimmer in future, trading costs will eat up a larger share of the extra returns.

What worked in the past cannot always be relied on to work in future. Penalty shoot-outs used to be seen as lotteries; they are now exercises in data-mining. Every goalkeeper and kicker knows what his opponent has done in the past. The best penalty-takers still hope to induce the goalkeeper to move first. But goalies are not as easily fooled. They can hold their nerve, too.

The Exploitation Time Bomb

Worsening economic inequality in recent years is largely the result of policy choices that reflect the political influence and lobbying power of the rich. There is now a self-reinforcing pattern of high profits, low investment, and rising inequality – posing a threat not only to economic growth, but also to democracy.

Jayati Ghosh


NEW DELHI – Since reducing inequality became an official goal of the international community, income disparities have widened. This trend, typically blamed on trade liberalization and technological advances that have weakened the bargaining power of labor vis-à-vis capital, has generated a political backlash in many countries, with voters blaming their economic plight on “others” rather than on national policies. And such sentiments of course merely aggravate social tensions without addressing the root causes of worsening inequality.

But in an important new article, University of Cambridge economist José Gabriel Palma argues that national income distributions are the result not of impersonal global forces, but rather of policy choices that reflect the control and lobbying power of the rich. In particular, Palma describes the significant recent increase in inequality in OECD countries, the former socialist economies of Central and Eastern Europe, and China and India, as a process of “reverse catching-up.” These countries, Palma says, increasingly resemble many unequal Latin American economies, with rent-oriented elites grabbing most of the fruits of growth.

In his earlier work, Palma showed how middle and upper-middle income groups’ share of total income has remained remarkably stable in most countries over time, at about one-half. Changes in aggregate income distribution, therefore, resulted largely from changes in the respective shares of the top 10% and the bottom 40% of the population (the ratio between these shares is now called the “Palma ratio”).

In other words, the huge variation in inequality across countries, and particularly between middle-income economies, is essentially the outcome of a fight for around one-half of national income involving one-half of the population. Only in cases of extreme inequality (such as South Africa) did the top 10% also manage to encroach on the income share of the middle.

It is misleading, therefore, to view rising per capita incomes in middle-income countries as indicating a general improvement in standard of living. In unequal middle-income economies such as those in Latin America, the incomes of the top 10% are already on par with those of their rich-country counterparts. The incomes of the bottom 40% are closer to the Sub-Saharan African average.

The driving force behind these trends is market inequality, meaning the income distribution before taxes and government transfers. Most OECD countries continually attempt to mitigate this through the tax and transfer system, resulting in much lower levels of inequality in terms of disposable income.

But fiscal policy is a complicated and increasingly inefficient way to reduce inequality, because today it relies less on progressive taxation and more on transfers that increase public debt. For example, European Union governments’ spending on social protection, health care, and education now accounts for two-thirds of public expenditure, but this is funded by tax policies that let off the rich and big corporations while heavily burdening the middle classes, and by adding to the stock of government debt. As Palma puts it, “in their new tax status, corporations and the very rich now prefer to part‐pay/part‐lend their taxes, and part‐pay/part‐lend their wages.”

In rich countries, middle-income groups have largely maintained their share of national income. But their living standards have fallen, owing to the rising costs of essential goods and services (such as housing, health care, and education), falling real pensions, regressive taxation, and rising personal debt. Most emerging-economy governments, meanwhile, are not implementing significant fiscal measures to reduce market inequality.

The dramatic increase in market inequality reflects the ability of the top 10% to extract more value created by others and to profit from existing assets – including those that should be public property, such as natural resources. Specifically, this increase in value extraction is the result of policies for which the rich have actively lobbied: privatization; deregulation of share buybacks that artificially inflate stock prices; patent laws that make drugs much more expensive; reduction or elimination of top marginal tax rates; and much else.

Giving the rich all this additional income has not resulted in higher investment rates in the OECD or in unequal middle-income countries. Instead, the rich are content to pluck the low-hanging fruit of rent extraction, market manipulation, and lobbying power. High profits therefore coexist with low investment and increasing market inequality, in a self-reinforcing pattern. This trend not only magnifies the risk of economic stagnation and market failures; political changes around the world suggest that it has also become a profound threat to democracy.

Addressing this dangerous state of affairs will require that governments use their power to tax and regulate to channel more private capital into productive spending and increase the amount of public investment financed by progressive taxation, along the lines of a Global Green New Deal. If policymakers fail to mount a response that is proportionate to the problem, the rich will continue to get richer, and the poor to get poorer, faster than ever. Who will address the problem then?

Jayati Ghosh is Professor of Economics at Jawaharlal Nehru University in New Delhi, Executive Secretary of International Development Economics Associates, and a member of the Independent Commission for the Reform of International Corporate Taxation.

The Walton family gets $100 million richer every single day

By Nicole Lyn Pesce

The family behind Walmart tops the Bloomberg list of the world’s wealthiest families

In the hour that it takes a new Walmart employee to earn the $11 starting wage, the family that owns the retail giant has banked $4 million.

In fact, the third-generation heirs of Walmart WMT, -1.52% founder Sam Walton have amassed a $191 billion fortune to top Bloomberg’s list of the richest families in the world. And that has grown by $39 billion since the Waltons topped the list last year.

The report breaks that out to the Walton fortune increasing by an eye-watering $70,000 per minute, $4 million per hour or $100 million per day.

Walmart rang up $514 billion in sales from more than 11,000 stores across the globe, Bloomberg added. And the family holding company Walton Enterprises owns a 50% stake in Walmart, which paid out $3 billion in dividends last year.

It’s been a good year for all 25 of wealthiest families in the world, however, who collectively control almost $1.4. trillion in total wealth, which is a 24% increase from last year.

And American dynasties took the top three places on the elite list. The candy-making clan behind Mars Inc. is in second place with $127 billion in wealth that was sweetened by $37 billion since last year. And the industrialists/politicians behind Koch Industries take third with $125 billion.

The Saudi royal family lands at No. 4, with Bloomberg estimating that the House of Saud is worth $100 billion — although the report notes this is a lowball figure drawn from cumulative payouts that royal family members are guessed to have taken over the last 50 yeas from the executive office of the king. The total wealth controlled by its 15,000 extended family members from its oil reserves, land deals and government contracts is probably much higher.

Family-owned fashion houses Chanel and Hermes, the beer makers at Anheuser-Busch InBev BUD, -1.62%, as well as Nutella-makers Ferrero also rank highly on the list.

Here are the top 10 richest families in the world, as reported by Bloomberg.

The Walton family, behind Walmart: $190.5 billion

The Mars family, behind Mars: $126.5 billion

The Koch family, behind Koch Industries: $124.5 billion

The Al Saud family: $100 billion

The Wertheimer, behind Chanel: $57.6 billion

The Hermes family, behind Hermes: $53.1 billion

The Van Damme, De Spoelberch and De Mevius families, behind Anheuser-Busch InBev: $52.9 billion

The Boehringer and Von Baumbach families, behind Boehringer Ingelheim: $51.9 billion

The Ambani family, behind Reliance Industries: $50.4 billion

The Cargill and MacMillan families, behind Cargill Inc.: $42.9 billion

Toward an Ever-Closer European Unión

The EU was designed for a world that no longer exists. To survive, it will have to reprogram itself.

By Jacob L. Shapiro    

The European Union is a victim of its own success. The challenges the EU faces today are a direct result of its achievement of the objectives with which it was charged by the Maastricht Treaty in 1992. The problem bedeviling the EU in recent years lies in the difficulty of reprogramming a living, breathing political entity after its creation. Bureaucracy has a way of creating its own objectives. Democratic virtues become vices when systemic overhaul is the primary item on the agenda. Reprogramming, however, is exactly what the incoming leaders of the EU’s institutions aim to do if their political experiment is to evolve.
Peace in Europe
When it was founded in 1992, the European Union was charged with five key objectives: monetary union, a common defense policy, European citizenship, cooperation on judicial and home affairs, and expansion of EU law. The EU never really had to generate a common defense policy – it already had NATO (though the atrophy of the alliance’s military mission in recent years has raised new questions in the EU about what a robust and independent defense policy for Europe might look like). On every other score, the European Union succeeded. The problems came with what should happen next. The EU was designed to be a broad institutional framework that respected the national identities of its member states, but bureaucratic manifest destiny turned the apparatchiks’ focus toward emphasizing European-ness rather than preserving the union.

This resulted in a deep disconnect – both within the European Union and within the member states themselves – which can be summed up by a single question: What is the proper relationship between European identity and national identity? The European Union has existed for 27 years – long enough for an entire generation of young people to come of age without knowledge of a pre-EU world, to travel with EU passports and to work almost anywhere on the Continent they please. Some of these young people – and plenty of older ones – genuinely identify as European. And yet there are others for whom such thinking is anathema – for whom the sacrifice of national sovereignty to Brussels is a perfidious betrayal. What is life without history, tradition and family – without national distinctiveness? What was the point of all that war if national sovereignty is to be ceded to an external power anyway?

The point, of course, was to bring peace to Europe. In that limited sense, the European Union hearkens back to the Concert of Europe. That informal 19th-century system was an attempt by Europe’s most powerful states to establish a stable balance of power. Their primary goal was twofold: weaken revolutionary forces like nationalism and communism, and prevent any single European power from dominating all the others. Reflecting the optimism of its time, the Maastricht Treaty imagined a European continent unshackled from over a century of almost constant war, never to find itself beset by such tragedy again. It aimed to accomplish this by tying the economic fate of Europe’s most powerful countries together to a historically unprecedented degree. The primary goals of the EU are still the same: dull revolutionary political forces and prevent any single European power from dominating the others.
European Obsolescence?
As it turned out, what European politicians failed to grasp in 1992 was the extent of Europe’s impending global obsolescence. Previous attempts to create European unity were designed for an era during which European states competed for global mastery, and the EU was modeled on these attempts. Today, European countries face a very different kind of challenge: to avoid being dominated by the very world they once ruled. A recent PwC study projected that, by 2050, there will not be a single EU country in the G-7 – the group comprised of the world’s seven largest developed economies. Already in terms of population, no EU country is in the world’s top 15 (Germany is 17th with a population of roughly 83 million). Previous attempts at European unity always failed because the geopolitics of the Continent resulted in perpetual, internecine conflict. In today’s world, the opposite is true. European unity is in the interest of EU countries because as individual states, their strength pales in comparison to the powers rising on the European periphery.

It is hard to overstate the novelty of this reversal. Europe’s internal dynamics always threatened to tear asunder the artificial chords that Maastricht wrought. Now, however, as a result of external challenges like the United States’ trade wars, China’s Belt and Road Initiative, Russia’s renewed assertiveness in its borderlands, an increasingly independent and powerful Turkey, and a rapidly changing demographic profile, the interests of EU countries are converging. The problem is that the European Union was not designed to manage a convergence of interests; it was designed to manage forces of divergence. At a time when the European Union might focus on marshaling the collective resources of all its 27 members – a force that when combined still ranks among the world’s most powerful, despite Britain’s impending departure – the EU has instead focused on rule of law issues in Poland and Hungary and on rapping Italy over the knuckles for irresponsible government spending. It is hard to fault the EU’s bureaucratic institutions for doing this – they are doing what they were created to do. The problem is that their design is obsolete.

Europe’s most powerful leaders (namely, French President Emmanuel Macron and German Chancellor Angela Merkel) know this. (It is a strange irony that the two countries that arguably played the biggest role in destroying Europe in the 20th century, and for whom the EU is supposed to function as a de facto cage, now must work together to save it.) It is not a coincidence that the recently elected new President of the European Commission, Ursula von der Leyen, is German, and that the presumptive next head of the European Central Bank, Christine Lagarde (who resigned from her post as head of the International Monetary Fund on Wednesday) is French. It is also not a coincidence that Macron and Merkel found a way to sideline the European Parliament’s choice of candidate – though this was made easy by the fact that the candidate could not carry the voters needed to win. Von der Leyen barely could herself, eking out 383 of 747 votes on Tuesday. If Germany and France are to achieve comprehensive EU reform, they will need plenty more of the past few weeks’ backroom wizardry: Getting 27 countries to agree to cede even more sovereignty to Brussels is as close to impossible as it gets in politics.

Complicating matters further is that not even France and Germany see eye to eye on the exact nature of those reforms. Macron has led the charge for reform since his election in 2017. He envisions a “two-speed” EU, where countries that want to pool their resources together to be governed by a stronger, more centralized authority can do so without fundamentally undermining the EU’s overall structure. Merkel, in part because of her domestic political weakness, has been less vocal about what reforms she thinks are necessary, but she has been conspicuously tepid on the specifics of Macron’s proposals. Von der Leyen will not have the luxury of silence – as her candidate’s speech for president of the European Commission made abundantly clear. To the chagrin of many of her more conservative supporters, von der Leyen spoke of a $1 trillion “Green Deal for Europe” that would cut carbon dioxide emissions in half by 2030, a capital markets union designed to strengthen Europe’s small and medium-sized enterprises, an EU unemployment benefit reinsurance scheme, and an undefined new “EU-wide rule of law mechanism” to defend “the cradle of European civilization.”

But not even these radical suggestions will be enough for Macron, who told Serbian President Aleksandar Vucic on Monday that the EU was too dysfunctional to consider further expansion in the Balkans, and who earlier this month characterized the horse-trading process of selecting new EU leaders as a “failure.” It may, however, be a place to start. And while the EU’s would-be reformers face a difficult situation, it’s not an impossible one. With the exception of Greece, popular sentiment toward the EU remains predominantly positive despite large and extremely vocal minorities of euroskeptics throughout the bloc. Now Germany and France have their handpicked candidates at the EU’s helm and can credibly push for a mandate to consider broad and deep-reaching EU reform – reform that must involve real French and German compromises if they are to be welcomed by other EU countries. Both Italy (minus the League party) and the Visegrad 4 (the Czech Republic, Hungary, Poland and Slovakia) reportedly supported von der Leyen’s appointment, a small sign that they at least like what they heard behind closed doors. As for von der Leyen, she, like Macron, understands that the EU has reached a “reform or die” moment. What is less clear is if she understands that, for the Herculean task ahead of her, a national interest-based pragmatism will be a far deeper well from which to draw than an unnecessarily ideological European-ism.