The Eternally Optimistic IMF

The International Monetary Fund believes that ringing alarm bells on global economic growth is not its job, especially with many observers spotting signs of improvement in the past few weeks. But with economic conditions set to worsen before they improve, complacency is likely to have a high cost.

Ashoka Mody

mody24_MANDEL NGANAFPGetty Images_imf

PRINCETON – In April 2018, the International Monetary Fund projected that the world economy would grow robustly, at just above 3.9% that year and into 2019. The global upswing, the Fund said, had become “broader and stronger.” That view quickly proved too rosy. In 2018, the world economy grew only by 3.6%. And in its just released update, the IMF recognizes that the ongoing slowdown will push global growth down to only 3.3% in 2019.

As always, the Fund blames the lower-than-forecast growth on temporary factors, the latest culprits being US-China trade tensions and Brexit-related uncertainties. So, the message is that growth will rebound to 3.6% next year. As Deutsche Bank points out, IMF forecasts imply that fewer countries will be in recession in 2020 than at any time in recent decades.

But the forces causing deceleration are still in place. Global growth this year will be closer to 3%, with rising financial tensions in Europe.

The IMF keeps getting forecasts wrong because it misses the big picture. The economically advanced countries – which still produce about three-fifths of global output – have been experiencing a long-term slowdown since about 1970. The reason, Northwestern University’s Robert Gordon says, is that despite the promise of modern technologies, ever-slower productivity growth has dragged down the growth potential of these rich economies.

As a result, China has come to play a dominant role in determining the pace of global growth. Besides its large size, the Chinese economy has extensive trade links that transmit its growth to the rest of the world. When China grows, it sucks in imports from other countries, giving the global economy a big boost. Rapid Chinese growth revved up the world economy between 2004 and 2006, in 2009-10, and in 2017.

But China’s once-heady growth rates have necessarily fallen as the country has become richer. By historical standards, an economy as rich as China today should be growing at 3-5% a year, rather than the 6% or more that the Chinese authorities are trying to achieve through fiscal and credit stimulus.

Pushing too hard for extra growth has increased China’s financial vulnerabilities to worrying levels. By standard measures of credit growth and asset-price inflation, the country should have had a financial crisis by now. The Chinese authorities have therefore played yin and yang, stimulating growth to prevent a rapid slowdown, but reining in the stimulus to contain financial risks.

The latest cycle has been no different. In 2017, Chinese policy stimulus spread through the world, leading to the celebration of a “synchronous upsurge.” The most significant beneficiary was Europe, which depends heavily on trade. European Central Bank president Mario Draghi patted himself on his back for deft “monetary policy measures,” which he said had supported “broad-based” momentum.

When China withdrew its stimulus in early 2018, the IMF, the ECB and other forecasters blissfully continued to project high growth rates, even as the global economy slowed rapidly. Soon enough, Europe swooned, sending Italy into a technical recession and Germany to the threshold of one. (Oddly, the United Kingdom’s economy, for all its Brexit-related troubles, is doing marginally better than both.)

In the past few months, China’s leaders, concerned about their economy’s slowdown, began a new round of stimulus. Although data are not yet available, world trade growth appears to have risen slightly since then. European growth rates have ticked up, although only enough to alleviate immediate recessionary risks.

For the world economy, the continuing problem is the short-lived nature of Chinese stimulus. The OECD has already warned that the latest stimulus will drive up the worryingly high volume of corporate debt, and that over-indebted local governments will borrow more to finance wasteful infrastructure. Faced with the choice of financial crisis or slower growth, the Chinese authorities – and the rest of the world – will once again prefer slower growth. Thus, China’s deceleration will resume in the coming months, dampening world growth yet again. For now, no other country is in a position to take China’s place.

Darkening the global outlook further, the US economy is coming off the “sugar high” of fiscal stimulus and corporate cash repatriation from overseas. In addition, Germany’s slowdown in 2018 and early 2019 may not only reflect its sensitivity to slower world trade growth. Its economy may be finally descending from its high pedestal as its vaunted diesel-engine-based car industry struggles to meet pollution standards and growing competition from electric cars.

The real risk, however, lies in Italy. Running down the checklist of crisis indicators, all of Italy’s are flashing red. The economy has zero – possibly negative – productivity growth, which makes it impossible to generate internal momentum to pull out of recession. The ECB has no room to help. Italy’s debt-to-GDP ratio is above 130%, and the European Union’s absurd budget rules, in any event, make fiscal stimulus nearly impossible. Tremors along the Italian fault line will spread quickly to France, which has only slightly better indicators and also little scope for an effective policy response to a serious downturn.

The IMF, always reluctant to ring alarm bells on the global economy, is especially unwilling to counter the recent upbeat sentiment. But with economic conditions set to worsen, complacency is likely to have a high cost.

Ashoka Mody is Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs at Princeton University. He is a former mission chief for Germany and Ireland at the International Monetary Fund. He is the author of EuroTragedy: A Drama in Nine Acts.

Trump, Tariffs and China Spell Trouble for American Steel

The vanishing levies on Canada and Mexico could be just the beginning of the industry’s problems

By Nathaniel Taplin

It was all just a fleeting, pleasant dream.

U.S. steelmakers woke last week to the brutal reality of evaporating tariffs on Canadian and Mexican steel. But an even greater problem is waiting in the wings: China may soon be tempted to ship more of its unwanted steel to foreign shores.

President Trump said Friday that the 25% tariffs he imposed on Canada and Mexico in mid-2018 would be lifted and that both countries would drop retaliatory levies. That removes a major hurdle to congressional approval for Mr. Trump’s revamped Nafta, the U.S.-Mexico-Canada Agreement.

U.S. steel companies will certainly take a hit, given that the tariffs boosted U.S. prices significantly above the global average for most of 2018, at the expense of steel-consuming industries like oil and autos. Even with the 25% tariff, imports of Canadian and Mexican hot-rolled coil steel are roughly 5% cheaper, according to Moody’s.

           Bad news is coming down the pipe for U.S. steelmakers. Photo: staff/Reuters

Meanwhile, Chinese steelmakers are raising output nearly as fast as property investment, the main source of steel demand, is growing. If that trend continues and Chinese mills send their excess production abroad as they did in 2014, it could sink global steel markets.

The big global steel rally that began in 2016 was made in China. The country’s stimulus pushed property investment sharply higher, while Chinese President Xi Jinping’s signature campaign to reduce excess factory capacity and pollution, launched in 2017, gave steel output a hard knock. Close to 10% annual growth in real-estate investment, paired with falling steel output, sent China’s monthly net steel product exports sliding about 60% between late 2015—when they ran to nearly 10 million metric tons—and late 2017.

Unfortunately, nothing lasts forever. Weakening economic growth in 2018 led to weaker controls on production. Property investment is still growing at about a 10% clip, but now steel output is too. Margins have narrowed, and net exports have begun to creep higher.

One cause for optimism is that regulators appear to be aware of the problem. China’s two biggest steel cities will extend seasonal winter production restrictions into June, Reuters has reported.

This is helpful, but it also puts the global steel market once again at the mercy of Chinese officials. April industrial growth was bad. If May doesn’t show a significant bump, or the Chinese job market keeps worsening, pollution restrictions might be watered down again.

Beijing doesn’t want domestic steel prices to collapse. Given the strained state of trade relations with Washington, sending more steel abroad look tempting. The U.S. steel industry needs to prepare for a bad day.

China’s Fake Numbers And The Risk They Pose For The Rest Of The World

Not so long ago, London Telegraph’s Ambrose Evans-Pritchard was one of the handful of must-read financial journalists. He probably still is, but since he disappeared behind the Telegraph’s pay wall his work is invisible to non-subscribers, only emerging when a free outlet runs one of his stories.

That happened this morning when the Sydney Morning Herald carried his analysis of the financial Ponzi scheme that is China.

After taking on more debt in a single decade than any other country ever — in the process helping to pull the US and Europe out of the Great Recession — China recently shifted into an even higher gear, creating a world record amount of credit in the most recent reporting month.

And – more important for headline writers and money managers – it reported exactly the right amount of GDP growth.

This brings to mind a long-ago interview in which economist Nouriel Roubini asserted that China just makes its numbers up, frequently reporting GDP immediately after the end of the period being measured, something that even the US can’t do.

But it’s one thing to for the rest of us to suspect and/or assert that China is just giving the markets what they want to hear, and another thing to understand the implications and explain them coherently. Evans-Pritchard does this in his latest article.

Maximum vulnerability: China (and the world) are still in big trouble
China’s majestic and elegantly-stable GDP figures are best seen as an instrument of political combat. 
Donald Trump says “trade wars are good and easy to win” if your foes depend on your market and you can break them under pressure. 
He proclaimed victory when the Shanghai equity index went into a swoon over the winter. This is Trumpian gamesmanship. 
It is in China’s urgent interest to puncture such claims as trade talks come to a head. Xi Jinping had to beat expectations with a crowd-pleaser in the first quarter. The number was duly produced: 6.4 per cent. Let us all sing the March of the Volunteers.
“Could it really be true?” asked Caixin magazine. This was a brave question in Uncle Xi’s evermore totalitarian regime. 
Of course it is not true. Japan’s manufacturing exports to China fell by 9.4 per cent in March (year on year). Singapore’s shipments dropped by 8.7 per cent to China, 22 per cent to Indonesia, and 27 per cent to Taiwan. Korea’s exports are down 8.2 per cent. 
The greater China sphere of east Asia is in the midst of an industrial recession. Nomura’s forward-looking index still points to a deepening downturn. “Those expecting a strong rebound in Asian export growth in coming months could be in for disappointment,” said the bank. 
China’s rebound is hard to square with its own internal data. Simon Ward from Janus Henderson said nominal GDP growth – trickier to manipulate – is still falling. It dropped to 7.4 per cent from 8.1 per cent in the last quarter on 2018. 
Household demand deposits fell by 1.1 per cent last month. This means that the growth rate of “true” M1 money is still at slump levels. It has ticked up a fraction but this is nothing like previous episodes of Chinese stimulus. It points towards stagnation into late 2019. “Hold the champagne,” he said. A paper last month by Wei Chen and Chang-Tai Tsieh for the Brookings Institution – “A Forensic Examination of China’s National Accounts” – concluded that GDP growth has been overstated by 1.7 per cent a year on average since 2006. They used satellite data to track night lights in manufacturing zones, railway cargo volume, and so forth. 
“Local officials are rewarded for meeting growth and investment targets,” they said.  
“Therefore, it is not surprising that local governments also have an incentive to skew the statistics.” 
Liaoning – a Spain-sized province in the north – recently corrected its figures after an anti-corruption crackdown exposed grotesque abuses. Estimated GDP was cut by 22 per cent. You get the picture. 
Bear in mind that if China’s economy is a fifth or a quarter smaller than claimed it implies that the total debt ratio is not 300 per cent of GDP (IIF data) but closer to 400 per cent. If China’s growth rate is 1.7 per cent lower – and falling every year – the country is less able to rely on nominal GDP expansion whittling away the liabilities. 
Debt dynamics take an ugly turn – just at a time when the working-age population is contracting by two million a year. The International Monetary Fund says China needs (true) growth of 5 per cent to prevent a rising ratio of bad loans in the banking system. 
China bulls in the West do not dispute most of this. But they say that what matters is the “direction” of the data, and this is looking better. Stimulus is flowing through. It gained traction in March with an 8.5 per cent bounce in industrial output – though sceptics suspect that VAT changes led to front-loading. Suddenly the words “green shoots” are on everybody’s lips. 
The thinking is that China will rescue Europe. Optimists are doubling down on another burst of global growth, clinched by the capitulation of the US Federal Reserve. It will be a repeat of the post-2016 recovery cycle. 
Personally, I don’t believe this happy narrative. But what I do respect after observing late-cycle psychology over four decades – and having turned bearish too early during the dotcom boom – is that investors latch onto good news with alacrity during the final phase of a long expansion. A filtering bias creeps in. 
So sticking my neck out, let me hazard that heady optimism will lead to a rally on asset markets until the economic damage below the waterline becomes clear. 
Let us concede that Beijing has opened its fiscal floodgates to some degree over recent weeks. Broad credit grew by $US430 billion ($601 billion) in March alone. Business tax cuts were another $US300 billion. Bond issuance by local governments was pulled forward for extra impact. But once you strip out the offsets, it is far from clear that the picture for 2019 has changed. 
Nor is it clear what can be achieved with more credit. The IMF said in its Fiscal Monitor that the country now needs 4.1 yuan of extra credit to generate one yuan of GDP growth, compared to 3.5 in 2015, and 2.5 in 2009. The “credit intensity ratio” has worsened dramatically. 
I stick to my view that the US will slump to stall speed before China recovers. Europe is on the thinnest of ice. It has a broken banking system. It is chronically incapable of generating its own internal growth or taking meaningful measures in self-defence. 
Momentum has fizzled out in all three blocs of the international system. We are entering the window of maximum vulnerability.

Lots of good data here – something notably lacking in most reporting on China’s “miracle.”

But the best — and scariest — single stat is the dramatic decline in the marginal productivity of debt.

China, like the US, is getting progressively less bang for each newly-borrowed buck. There’s a point at which new borrowing doesn’t just product less wealth but actually destroys it. The US and China are heading that way fast, while Europe might be there already.

As Evans-Pritchard, notes, the result is “maximum vulnerability.”

Britain is once again the sick man of Europe

If treachery becomes part of the debate, there can only be total victory or total defeat

Martin Wolf

David Cameron, the 'essay crisis' prime minister, resigns after losing the EU referendum in 2016 © Getty

When I was young, in the 1960s, the UK was known as the “sick man of Europe”, for its prolonged economic weakness. But after Margaret Thatcher’s time as prime minister, this grim epithet no longer seemed applicable. Yet now, once again, as I go abroad — and especially in continental Europe — people ask me, with a mixture of bewilderment, pity and Schadenfreude, “What is wrong with Britain?” I do not pretend to know the answer (or answers). But I can describe the symptoms: the UK is undergoing six crises at the same time.

The first and most important crisis is economic. The starting point was the shock of the 2008 financial crisis. But, today, the most important aspect of this is the stagnation in productivity. According to the Conference Board, output per hour in the UK rose by just 3.5 per cent between 2008 and 2018. Of all significant high-income countries, only Italy’s grew less. Yet that is not because the UK’s productivity is already high. On the contrary, output per hour in the UK lags behind that of Ireland, Belgium, the US, Denmark, Netherlands, Germany, France, Switzerland, Singapore, Sweden, Austria, Australia, Finland and Canada. High employment and low unemployment are good news. But stagnant productivity means stagnant real incomes per head. This means that one group can only get better off if another does worse. This does not make for happy politics. A long period of fiscal tightening has made it unhappier.

The second crisis is over whether national identity has to be exclusive. That question soon turns into one about loyalty. Many are comfortable with multiple identities. Others insist there must only be one. One way of looking at this division is as one between “people from somewhere” and “people from anywhere”, as David Goodhart defines it in his book, The Road to Somewhere. But, once politicised, this becomes far more bitter and divisive. It has been, in Brexit.

The third crisis, Brexit, has weaponised identity, turning those differences into accusations of treason. Normal democratic politics are subsumed within (and managed by) appeals to a higher shared loyalty. Once the idea of “treachery” becomes part of political debate, only total victory or total defeat are possible. Such perspectives are incompatible with the normal give-and-take of democratic life. And so, in fact, it has proved. The country is so evenly divided, and emotions are so intense, that resolution is at present impossible.

The fourth crisis is political. The existing parties, based historically on class divisions, do not fit the current identity divisions between those who are gladly both British and European and those who insist that being the former excludes the latter (at least if by “European” one means “citizen of the EU”). Both main parties are being destroyed in the process, but a new political configuration is yet to emerge.

The fifth crisis is constitutional (by which I mean that it relates to the rules of the political game). Membership of the EU is a constitutional question. Use of referendums as the device to resolve such constitutional questions is itself a constitutional question. If referendums should decide such things, what must be the role of parliament in interpreting and implementing that decision? What, for that matter, is a sensible decision-rule for a constitutional referendum? Should it be a simple majority or a supermajority? Why did we stumble into this mess, without asking ourselves any of these questions?

The sixth and perhaps most important crisis of all is of leadership. The UK has stumbled from the “essay crises” of David Cameron to the mulish obstinacy of Theresa May. Now it can see before it the prospect of a general election, with a Conservative party led by Boris Johnson confronting a Labour party led by Jeremy Corbyn. These two men do not have much in common. But they seem to me the least qualified potential prime ministers even in a country that is, after all, still a permanent member of the UN Security Council. One is an inveterate buffoon and the pied piper of Brexit. The other is a hardline socialist and a life-long supporter of leftwing despots. With such leaders, the mess can only worsen — and it surely will.

Why so many crises have befallen the country at the same time and how they all relate to one another are really important questions. Poor economic outcomes, in terms of real income growth, are surely related to the rise of national identity as a salient issue, though there are other factors, notably immigration. What matters, however, is not what caused all this, but that it is going to take a long time to sort all this out. The UK will, alas, remain sick for a while.

Banking on the Future of Cryptocurrencies

Charlie Lee is lauded in cryptocurrency circles as the creator of Litecoin, an alternative to Bitcoin he conceived in 2011 as a Google software engineer. Today, Litecoin is the sixth-largest crypto with a market cap of $5 billion. It bears many similarities to Bitcoin, but also has important differences: Transactions are confirmed 75% faster, it has greater liquidity with four times more coins in circulation, and it is more resistant to manipulation by miners holding 51% control of the network.

In 2017, Lee sold his entire stake in Litecoin and now serves as managing director of the Litecoin Foundation, which seeks to advance Litecoin and develop blockchain technologies for the social good. At the recently held second annual Penn Blockchain Conference, Lee sat down with Knowledge@Wharton to talk about the philosophy behind Litecoin’s creation, whether cryptos will replace hard currency and what’s next for him.

Knowledge@Wharton: I want to establish an origin story for Litecoin. Could you tell us what made you create this cryptocurrency in the first place?

Charlie Lee: Sure. In October of 2011, I was playing around with the Bitcoin code base, and I guess the short of it was that I was just trying to create … a fork of Bitcoin. It was mainly a fun side Project.

Before Litecoin, there were about a dozen other altcoins (alternative cryptocurrency) and most of them don’t exist today anymore. Most of them were created by founders who wanted to strike it rich. So they would do something called a pre-mine — they would mine a lot of coins for themselves before they launched it, right in the beginning. Then hopefully if it becomes successful, it would make them a lot of money.

A lot of people didn’t like how unfair these coins were compared to Bitcoin, which was launched very fairly. One push was to create a fairer version of a coin called Tenebrix. [There were improvements but still] Tenebrix was launched with 7 million coins for the founder. Then I helped create this coin called Fairbrix, which is basically Tenebrix without the pre-mine.

Fairbrix was attacked in the beginning. There were some bugs in the code because the Tenebrix code was not very well written, so it kind of failed. After that I decided to do it right, to actually fork from Bitcoin and to create Litecoin. So I did that and made it fair.

It is one of the stories that people don’t hear about Litecoin, which is how fair it was. I made sure to launch it as fairly as possible. The week before [the launch, I released] the source code and binary so people can actually run Litecoin before the actual launch to test the mining, to see if it works on their computer, to make sure everything is OK.

Then at the time of the launch, which was a time that was voted in by the community, I released two constants that people can just put into their config file, restart their client and would just start mining coins. When I launched it, thousands of people were mining from the start. It was pretty much as fair as I could possibly make it.

Knowledge@Wharton: Your whole point was to create a more egalitarian cryptocurrency. Do you feel that you have succeeded?

Lee: Yes. I think one of the reasons why Litecoin actually survived and became popular is because of the fair launch. Everyone, including myself, had equal access to mining the coins and also buying it from the exchange. I didn’t pre-mine. I didn’t have a lot of Litecoins. I didn’t just create Litecoins and give a lot to myself.

Even a coin like Ethereum has a huge pre-mine. They sold however millions of dollars worth in the beginning and gave a lot of Ethereum or ETH to themselves. Given how fair Litecoin was, it is one of the reasons why it survived where other coins didn’t, I think.

Knowledge@Wharton: One of the things that would give a lift to cryptocurrencies is mass adoption, and it has been said that merchant adoption specifically is the Holy Grail of altcoins. Do you agree with that, and how do we get there?as ever seen. If Bitcoin is a better form of gold, for example, it doesn’t have to be used daily.  People [store but] don’t spend gold, right?

And you can actually build on top of that.

With Bitcoin and Litecoin there are Layer 2 solutions. Lightning Network [that sits on top of the blockchain to enable faster executions] is probably a better form of a payment network than just on-chain Bitcoin or Litecoin. I see that happening where people will build on top of it.

While I wouldn’t say [mass adoption] is the Holy Grail, I think eventually you will be able to spend your Bitcoins or Litecoins [more widely] and it is going to happen eventually, but it is not something that is needed today.

Knowledge@Wharton: Do you think there will ever be a time when we will do away with central authorities of monetary systems in the world?

Lee: I don’t know if that will ever happen. I think for sure cryptocurrency will be one of the currencies that people will use; it will achieve mass adoption one day and people would treat it as real money. The volatility will come down and things will be priced in cryptocurrencies. I truly believe in that. Whether or not the current system of currencies will still be around, I don’t know.

Knowledge@Wharton: Do you see that maybe one iteration of that future is that central banks would issue some kind of cryptocurrency?

Lee: I don’t see the benefit of that, to be honest. Because for me the benefit of cryptocurrency is decentralization — the censorship-resistant part, where no one can prevent you from spending your own money. If the central banks or the governments actually create a cryptocurrency, they still have full control, so what is the point? It is effectively no different than a digital version of a U.S. dollar.

Knowledge@Wharton: Do you see a world where cryptocurrencies in blockchain applications will be ubiquitous, just like mobile phones are now widely used to pay for things instead of just making phone calls? Do you see blockchain and cryptos changing the daily lives of people, and in what way?

Lee: Yes. I think in the future you will be using cryptocurrencies in your daily lives, and you may not even realize it. If Bitcoin really does become as ubiquitous as money, it will have to be easy to use. It will be very different from what we are doing today. Who knows what devices we will be using, but you could be spending Bitcoin, buying stuff, and you wouldn’t even know it. You may not even call it Bitcoin. It might just be money.

Knowledge@Wharton: There are many cryptocurrencies out there, and by some counts more than 2,000. Do you think we will get to the point where maybe a few will emerge as dominant, or maybe just one? How many do you think the world can handle?

Lee: Definitely not thousands. I think there is going to be more than one — Bitcoin, Litecoin, maybe a few others. Maybe a handful that would actually represent real value. The beauty of it is eventually they’ll be very interchangeable, so you can send Litecoin and the recipient can send Bitcoin, and it will be converted automatically, instantly. And you wouldn’t even have to worry about it, you wouldn’t even have to know. I think that is going to happen.

The important thing is that the user experience will improve, and a lot of complicated things will have to be abstracted away from the end user. Just like what happens with what you use today. You don’t really care what happens when you make a phone call or when you swipe a Visa card. However many institutions that get contacted to approve this transaction, how the money moves — you don’t really care. All you care about is that you [can] buy this product. The same thing will happen with Bitcoin and cryptocurrencies: Things will get simpler, and that is when things will take off.

Knowledge@Wharton: In a Utopian universe for cryptos, technology is everything. But since we don’t live in that world, social behaviors are also very important. What do you think will drive mass human adoption to make people trust them? Because trust is really critical for cryptos to take off.

Lee: Trust is definitely very important. A lot of the things that are hindering adoption today is the lack of trust in terms of securing your Bitcoins. A lot of people aren’t tech savvy enough to protect and store their own coins, and they rely on third parties like exchanges. And then the exchanges get hacked. Pretty much every month there is a story of an exchange getting hacked and losing millions of dollars of customers’ funds. And that really hurts. It hurts the trust in this industry and also the people who actually lost money.

So it is very important for us to build out simple yet secure ways of helping people store their own funds. Whether that is mobile wallets that are secure or hardware wallets, like the Ledgers or Trezors, and improvements to those which would make them simple to use yet still secure.

It has always been a trade-off, right? Simplicity versus security. Putting money on an exchange like Coinbase is extremely simple, but you are relying on someone else to secure the coins for you. And then there’s putting things [away yourself], like I [did. I] previously had coins on paper wallets, where you print out a piece of paper with your private key and then you put that piece of paper in the bank safe, or you split it up somehow.
You store it, secure it yourself. [But it makes cryptos] really hard to use. It’s like for long-term storage; you can’t really spend it. The compromise [is something] in between. We just have to find a good way … that is both secure and simple. I think that is a very important thing to achieve.
Knowledge@Wharton: Where do you see cryptos in terms of being an investment asset? Is that a good idea? How do you even do a valuation of that?
Lee: As the industry grows, people, at least initially, will value it as more of an investment asset or a speculative asset. But eventually when it becomes more stable, and prices become less volatile, it will become less of an investment asset and more of just money that people would hold on to. I think it is fine right now [for people to consider it as an investment asset], but I don’t see that being the future.

Knowledge@Wharton: Where do you see cryptocurrencies going? What do you think is its next iteration or use case? Do you see any new trends coming?

Lee: My focus is on the monetary aspect of cryptocurrencies. With Litecoin, I want it to be used as money. My focus for that is merchant adoption, where more and more merchants or people are actually supporting Litecoin or using it or accepting it. One of the key things I am working on is to improve the fungibility of Litecoin.

What that means is right now when you spend Litecoin or even Bitcoin, transactions you make have a history attached to them. People can track back and see where you got those coins and how that person got his coins to send to you. You can track it all the way back to the beginning, so you can almost see if I used the coins to buy illicit goods or gambled with it.

You’ve heard stories of Coinbase banning people from using their service if they found out that the coins you received were sent from, say, a gambling website or from a dark marketplace. That makes the coins not very fungible, because you have to pick and choose which coins to send to someone if you don’t want them to see how much you got paid or what you used with it.

In contrast, if you walk to a store and you have two $20 bills in your wallet, for example, you don’t care which one you spend unless you care about how pretty one of them is. Like the U.S. dollar, fiat currency is very fungible. Bitcoin, Litecoin today are not. That is something that we need to improve.

One of the requirements of fungibility is privacy. If the coin is not private, then it is not fungible.

Fungibility and privacy go hand in hand, and it is something that I am really looking into right now.

Knowledge@Wharton: What else is next for you? Are you running for president, like so many are doing?

Lee: No, but it would be cool if an Asian-American becomes president. I am still focused on Litecoin. I am working full time with the Litecoin Foundation on just everything around Litecoin, including development. Also on issues like, for example, what I was talking about with privacy and fungibility. And adoption of Litecoin, partnering with various companies supporting Litecoin, merchants, merchant processors and just getting more exposure for Litecoin.

The US-China conflict challenges the world

Smaller countries should band together to sustain multilateral free trade

Martin Wolf

Where does deepening economic conflict between the US and China leave the rest of the world, especially historic allies of the US? In normal circumstances, the latter would stand beside it. The EU, after all, shares many of its concerns about Chinese behaviour. Yet these are not normal circumstances. Under Donald Trump, the US has become a rogue superpower, hostile, among many other things, to the fundamental norms of a trading system based on multilateral agreement and binding rules. Indeed, US allies, too, are a target of the wave of bilateral bullying.

So what are American allies to do as the US and China battle? This is not just about Mr Trump. His focus on bilateral trade balances may even be relatively manageable. Worse, a large proportion of Americans shares a deepening hostility not just to China’s behaviour, but to the fact of a rising China.

We are also seeing a big shift in conservative thinking. In 2005, Robert Zoellick, deputy secretary of state, argued that China should “become a responsible stakeholder” in the international system. Recently, Mike Pompeo, secretary of state, has indicated a different perspective. Foreign affairs specialist Walter Russell Mead describes Mr Pompeo’s animating idea as follows: “Where liberal internationalists believe the goal of American global engagement should be to promote the emergence of a world order in which international institutions increasingly supplant nation-states as the chief actors in global politics, conservative internationalists believe American engagement should be guided by a narrower focus on specific US interests.” In brief, the US no longer sees why it should be a “responsible stakeholder” in the international system. Its concept is, instead, that of 19th century power politics, in which the strong dictate to the weak.

This is relevant to trade, too. It is a canard that the trading system was based on the notion that international institutions should supplant nation states. The system was built on the twin ideas that states should make multilateral agreements with one another and that confidence in such agreements should be reinforced by a binding dispute settlement system. This would bring stability to the conditions of trade, on which international businesses rely.

All this is now at risk. The spread of the tariff war and the decision to limit the access to US technology of Huawei, China’s only world-leading advanced technology manufacturer, seem aimed at keeping China in permanent inferiority. That is certainly how the Chinese view it.

The trade war is also turning the US into a significantly protectionist country, with weighted-average tariffs possibly soon higher than India’s. A paper from the Peterson Institute for International Economics states, that “Trump is . . . threatening tariffs on China that are not far from the average level of duties the United States imposed with the Smoot-Hawley Tariff Act of 1930.” Tariffs may even stay this high, because the US’s negotiating demands are too humiliating for China to accept. These levies will also lead to diversion to other suppliers. Tariffs may then spread to the latter, too: bilateralism is often a contagious disease. Contrary to Mr Trump’s protestations, the costs are also being borne by Americans, especially consumers and farm exporters. Ironically, many of the worst hit counties are in Republican control. (See charts.)

Some might conclude that the high costs mean that the conflict cannot be sustained, particularly if stock markets are disrupted. An alternative and more plausible outcome is that Mr Trump and China’s Xi Jinping are “strongmen” leaders who cannot be seen to yield. The conflict will then either remain frozen or, more likely, worsen as relations between the two superpowers become increasingly poisoned.

Where does this leave US allies? They should not support American attempts to thwart China’s rise: that would be unconscionable. They should indicate where they agree with US objectives on trade and technology and, if possible, sustain a common position on these issues, notably between the EU and Japan. They should uphold the principles of a multilateral trading system, under the auspices of the World Trade Organization. If the US succeeds in rendering the dispute system inquorate, the other members could agree to abide by an informal mechanism instead.

Most significantly, it should be possible to sustain liberal trade, at the expense of the US and China. Anne Krueger, former first deputy managing director of the IMF, notes in a column that, by its own foolish decision to reject the Trans-Pacific Partnership, the US suffers from WTO legal discrimination against its exports to members of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, which replaced TPP. The EU also has free trade agreements with Canada and Japan.

This is good. But they can go further. Countries that see the benefits of a strong trading order should turn such FTAs into a “global FTA of the willing”, in which any country willing to accept the commitments could participate. One might even envisage a future in which participants in such a global FTA would defend its members against illegal trade assaults from non-members, via co-ordinated retaliation.

Hostility between the US and China is a threat to global peace and prosperity. Outsiders cannot halt this conflict. But they are not helpless. If the big powers stand outside the multilateral trading system, others can step in. They are, in aggregate, huge players. They should dare to act as such.

China battles the US in the artificial intelligence arms race

What counts is implementation not innovation, and here the Chinese have big advantages

Martin Wolf

In late March I attended the China Development Forum for the ninth time. The visit stimulated my recent observations on China’s economy and politics. But what makes the CDF most valuable is serendipity. This time that came in the shape of a meeting with Kai-Fu Lee, former president of Google China and now a leading venture capitalist in Chinese technology.

Mr Lee gave me a copy of his new book, AI Superpowers: China, Silicon Valley and the New World Order. This has a startling story to tell: for the first time since the industrial revolution, he argues, China will be at the forefront of a huge economic transformation — the revolution in artificial intelligence.

He starts his book by talking about China’s “Sputnik moment”, when Google DeepMind’s AlphaGo defeated Ke Jie, the world’s leading player of the ancient Chinese game of Go. This demonstrated the capacity of modern AI. But, by implication, Mr Lee’s book foresees another such moment, when the US realises it is no longer leader in the global application of AI. The original Sputnik moment occurred when the Soviet Union put the first satellite in orbit in 1957. This led to the space race of the 1960s, which the US duly won. What will the present “race” lead to?

Mr Lee does not claim that China will lead in fundamental innovation in this area. But that may not matter, since the big intellectual breakthroughs have already occurred. What matters most is implementation, not innovation. Here China has, he writes, many advantages.

First, the work of leading AI researchers is readily available online. The internet is, after all, a superlative engine for spreading intellectual breakthroughs, not least including those in AI.

Second, China’s hypercompetitive and entrepreneurial economy lives by Facebook founder Mark Zuckerberg’s notorious motto: “move fast and break things”. Mr Lee describes a world of cut-throat business activity and remorseless imitation, which has already allowed Chinese businesses to defeat leading western rivals in their home market. The ceaseless “trial and error” of the Chinese business model is, he argues, well suited to rolling out the fruits of AI across the economy. It could, for example, work far better in introducing autonomous vehicles than the west’s safety-conscious approach. China’s swarms may be inefficient, but they are effective. That is what matters.

Third, China’s dense urban settlements have created a huge demand for delivery and other services. “American start-ups like to stick to what they know: building clean digital platforms that facilitate information exchanges,” Mr Lee argues. But Chinese firms get their hands dirty in the real world. They integrate the online and offline worlds.

Fourth, China’s backwardness allowed businesses to leapfrog existing services. So China has been able to jump to universal digital payment systems, while western businesses still use outdated technology.

Fifth, China has scale. It has more internet users than the US and Europe combined. If data is indeed the fuel of the AI revolution, China simply has more of it than anybody else.Sixth, China has a supportive government. Mr Lee cites a speech by premier Li Keqiang in 2014 at the World Economic Forum’s “summer Davos”, calling for “mass entrepreneurship and mass innovation”. In his report “Deciphering China’s AI Dream”, Oxford university’s Jeffrey Ding points to the State Council’s national strategy for AI development. China’s government has ambitious goals and is willing to take risks to achieve them. One of the things China can do more easily than anywhere else is build complementary infrastructure.

Finally, writes Mr Lee, the Chinese public is far more relaxed about privacy than westerners.

Chinese leaders, it may be argued, see no justification for individual privacy at all (except for their own).
 So where is this supposed “race” between the US and China today? Mr Lee distinguishes four aspects of AI: “internet AI” — the AI that tracks what you do on the internet; “business AI” — the AI that allows businesses to exploit their data better; “perception AI” — the AI that sees the world around it; and “autonomous AI” — the AI that interacts with us in the real world. At present, he thinks China is equal to the US in the first, vastly behind in the second, a little ahead in the third, and, again, far behind in the fourth. But five years from now, he thinks, China might be a little ahead in the first, less far behind in the second, well ahead in the third and equal in the last. There are, to his mind, no other competitors.

Mr Ding analyses the drivers differently. He distinguishes hardware, data, research and the commercial ecosystem. China is far behind the US in production of semiconductors, ahead in the number of potential users and has about half the number of AI experts and roughly half the number of AI companies. All told, China’s potential is about half that of the US. Yet Mr Ding is looking at AI overall, while Mr Lee focuses on commercial applications.

Historical experience suggests that the rents created by a lead in an important technology are valuable, though often impermanent. So, which country will be ahead in the application of AI is indeed important. But the economic and social impact of AI is a bigger issue and one that is relevant to every country.

As Mr Lee stresses, advances in AI offer gains. This is not just in personal convenience, but in improving medical diagnostics, tailoring education to individual students, managing energy and transport systems, making courts fairer, and so on and so forth.

Yet AI also threatens huge upheavals, notably in labour markets. Many of the jobs (or tasks) that AI might do are today done by relatively educated people. It seems reasonable to fear that AI will accelerate the hollowing out of the middle of the earnings distribution, possibly even the upper middle, while increasing concentrations of private wealth and power at the top.

Yet perhaps the most important consequence will be in the intensity of influence and surveillance made possible by AI-monitored mobile devices and sensors. George Orwell’s Big Brother (or many big commercial brothers) might watch us all the time. Such perfect monitoring might be attractive to China’s state. It is horrible to me and, I hope, billions of others.

AI, Mr Lee insists, is not the same as artificial general intelligence: the true super brain is far away. Even so, the challenges this AI creates are huge. We will not stop it. But we may in the end conclude we have birthed a monster.

The Terrifying Truth About Negative Interest Rates

Pushing interest rates below zero is both an act of desperation and something that in theory should have a huge, immediate impact of the behavior of borrowers and savers. The fact that negative rates have become the new normal in big parts of the world but haven’t caused the expected behavior change should scare the hell out of everyone.

To understand why this is so, think of the rate of interest as the price of money. It’s what an individual or business has to pay to get credit with which to buy and invest. As with anything else, when the price of money is high, we tend to acquire less of it and when the price is low we acquire more. So making money not just cheap, not just free, but actually profitable to borrow, while making savings unprofitable to hold should, according to conventional Keynesian economics, create a scene in the credit markets reminiscent of those Black Friday Wal-Mart videos where fistfights break out over the last remaining Barbie Doll. Businesses in particular should be borrowing and investing like crazy, igniting an epic capital spending boom.

But that hasn’t happened. In Europe, for instance, negative rates have been in place for five years …

negative interest rates Europe

… and instead of a rip-roaring post-Great Recession recovery, the result has been the kind of anemic growth that conventional economics would predict for a tight-money environment.

Business capital spending, the engine that in theory should be propelling Europe’s economy, looks like the opposite of a boom.

Europe capital spending negative interest rates

This translates into seriously boring GDP growth:

Europe negative interest rates Europe

Why call such an uneventful situation terrifying? Because of what comes next.

Europe’s current sub-2% average growth rate is too slow to stop debt-to-GDP from rising. In other words, even with negative interest rates the Continent continues to dig itself ever-deeper into a financial hole. The same death spiral dynamic is in place in US, Japan and China.

To put the problem in more familiar terms, the world’s central banks have launched their version of tactical nukes at the problem of slow growth and soaring debt, and the dust has cleared to reveal the enemy unscathed and coming back for another go.

The next recession will begin with interest rates already at emergency levels, leaving central banks with no choice but to launch even bigger nukes. If interest rates are currently at -0.5%, then push them down to -5%. If buying up every investment-grade bond didn’t work last time around, then buy up junk bonds and equities, and maybe pay off everyone’s mortgage and student loans.

This will also fail, for reasons best explained by the unfortunately non-mainstream Austrian School of economics. The Austrians focus on a society’s balance sheet and observe that when low-quality (that is, speculative) debt exceeds certain levels, there’s nothing to be gained by encouraging more borrowing. So go ahead and cut interest rates to any crazy level you want.

The inevitable, necessary result of too much bad debt is a crash that wipes that debt out. Or a hyperinflation that destroys the currency with which desperate governments flood the market in an attempt to stave off the debt implosion.

This explains why today’s negative interest rates haven’t ignited a boom (there’s already too much bad paper circulating), and also why the next round of monetary experiments will fail even more spectacularly.

The US is seeking to constrain China’s rise

Ban on companies supplying Huawei is damaging and ill-conceived

The editorial board

However great the vulnerabilities in Huawei and the broader Chinese tech sector that they have revealed, the US steps may also ultimately fail © Reuters

Huawei is under siege. Google is restricting parts of its Android operating system to the Chinese telecoms tech giant. US chipmakers are poised to suspend supplies too. The US move to put the Chinese telecoms flagship on its so-called Entity List — requiring American companies to obtain a government licence to sell to it — is a pivotal moment for the global technology industry. It represents an opening salvo in an emerging new US-China cold war. It is also a serious miscalculation.

All countries have a right to protect national security interests — nowhere more than in 5G telecoms, nervous system of the future digital economy and the “internet of things”. The Trump administration’s moves last week, however, go far beyond what is needed to address security concerns. They also seem far more than an attempt to pressure Beijing into reaching a trade deal.

They amount to an effort to decouple the US and Chinese tech sectors, leading to a bifurcation of the global industry. This reflects a view reaching beyond the Trump White House and deep into the US security establishment that President Xi Jinping’s China is a malign actor, and that its technology is on course to outstrip America’s. Indeed, the US steps appear part of an attempt to constrain China’s rise.

Echoes of the Soviet era abound, but Soviet industry was never entwined with America’s in the way China’s is. The latest US moves seem designed to cripple or crush one of the first Chinese tech companies to become globally competitive — and one that relies on American suppliers in both mobile phones and network equipment.

Assuming the US administration sticks to its measures, despite heavy lobbying by US businesses, they will damage American and other western corporate interests. Allied capitals will resent the White House’s efforts to impose its writ.

However great the vulnerabilities in Huawei and the broader Chinese tech sector that they have revealed, the US steps may also ultimately fail. They are likely to spur a Beijing-led effort to address China’s weaknesses and develop a fully independent supply chain. A historical analogy might be China’s nuclear weapons programme: the departure of Soviet advisers in the late 1950s forced it to build its own A-bomb. The result could hasten a splintering of the internet and associated technologies to which China and Russia, which recently passed a law ensuring it can cut itself off the world wide web, have already contributed.

Indeed, while China is complaining bitterly about the US moves, Beijing must take a good share of the blame for the situation it is now in. China has blocked multiple foreign companies and websites, including Twitter, Facebook, and Google services including Gmail and YouTube. The number of European companies compelled to hand over technologies in exchange for market access in China has doubled in two years, a report showed on Monday. While western intelligence agencies disagree on the size of the security threat Huawei represents, all point to China as the biggest source of cyber attacks on security and industrial assets.

If China wishes to change its image as a malign force, it must rein in such attacks. Yet Washington’s coercive steps are misguided. The US and the west should not seek to block China’s rise but encourage it to co-operate in a rules-based system, by setting good examples themselves. Washington’s allies should be free to determine what steps they judge necessary to combat security threats from Huawei or others. The US has the right to take security steps too — but not to allow these to slide into destabilising protectionism.

Suddenly, There's Not A Lot To Like

by: The Heisenberg
- Over the past three weeks, the macro narrative has taken a decisive turn for the worst.

- The Huawei bombshell looks to have made negotiations between the US and China all but impossible in the near term and Beijing is circling the wagons.
- It wasn't clear that China's economy was out of the woods and the renewed trade tensions muddy the waters considerably.
- Meanwhile, things are going off the rails in Italy again ahead of the EU elections.
It took three business days from time the US effectively blacklisted Huawei for the Trump administration to offer a concession in the form of a temporary general license that permits some transactions with the company and its dozens of non-US affiliates.
Until August 19, Huawei is permitted to buy American goods necessary to ensure existing networks remain operational and to update software on existing Huawei devices.
The decision came on Monday evening, following what I described over on my site as a "mini-panic" across the global technology supply chain. Last week, in a post for this platform, I suggested the Huawei gamble was something of a "crossing the Rubicon" moment for markets. In that post, I flagged the SOX (SOXX), which, through Friday, was headed for its second-worst month since May of 2012. By the closing bell on Monday, semi stocks were on track for their worst month since the crisis.
You didn't have to be any kind of seer to know that some manner of intervention from the US Commerce Department was in the cards. Monday wasn't an especially bad day for global equities on the whole, but the rout in semis was disconcerting for what it telegraphed about how the market was interpreting the Huawei decision. Literally minutes before the temporary general license announcement was posted to Commerce's website, I said the following in a short little post called "When The Chips Are Down":
Presumably, the Commerce Department will be forced to adopt some kind of middle ground that ameliorates market concerns and helps cushion the blow. Otherwise, this is going to quickly erode confidence. Given that the weakness in the chip space is indicative of an actual, real-world bid to dismantle the global technology supply chain, it’s difficult to imagine how this doesn’t spill over and prompt an across-the-board rout at some point in the very near future unless the Trump administration comes forward with something definitive regarding how they plan to mitigate the fallout from last week’s decision.
If you looked out across the headlines on Tuesday evening, most financial media outlets attributed Wall Street's good day to the temporary, partial reprieve granted to Huawei. The SOX rallied more than 2% and the SPDR S&P Semiconductor ETF (XSD) bested the S&P ETF (SPY) after three consecutive days of grievous underperformance. The yellow, dashed lines in the following visual mark the day the Huawei ban was announced.
To be clear, a 90-day partial reprieve from Wilbur Ross isn't going to cut it when it comes to restoring confidence and convincing market participants that the US fully appreciates the gravity of this situation. You might think the rout in the chip space is over done, but the reality is that nobody knows where this is headed. "We would expect that many, if not most, semiconductor companies will need to lower estimates," Raymond James wrote Tuesday, in a note cited by Bloomberg for a piece aptly entitled "US Chipmakers Preparing for China Trade Fight Fear That All Will ‘Suffer’".
Beyond the ramifications for semis, investors should step back and try to appreciate the big picture. I've attempted to communicate why the Huawei story is so momentous in at least a half-dozen posts over the past four days in addition to the two linked above. This is China's crown jewel on the line. Huawei is Beijing's national champion. Although the rhetoric from Chinese state media was already pretty shrill following the Trump administration's move to more than double the tariff rate on $200 billion in Chinese goods, the tone became overtly hostile following the Huawei decision. In remarks cited by a widely-read piece in the South China Morning Post, Xi on Tuesday appeared to suggest that China is preparing for an indefinite war of attrition.
Also on Tuesday, Bloomberg said the Trump administration has "for months" held off on punishing Huawei for fear of undermining the trade talks. That might sound like an innocuous headline, but it's not. Since the arrest of Meng Wanzhou in December, US negotiators have been at pains to insist that trade talks are separate from national security concerns. Implicit in that insistence was a promise that Huawei and Meng wouldn't be used as leverage. The Bloomberg story (which cited unnamed sources) suggests the US always intended to play the Huawei ace in the event the terms of a prospective trade deal weren't deemed favorable enough for Washington.
Importantly, some of China's recent stimulus efforts have been inward-looking, seemingly designed to bolster domestic demand rather than rescue the global cycle. That could be due to worries that the monetary policy transmission channel is clogged by lackluster demand for credit, or it could just be that Beijing is taking a "China first" approach this time around when it comes to stimulus. Whatever it's attributable to, it's reasonable to assume that in an all-out trade war scenario, that tendency to focus inward will be redoubled. Consider this from Barclays:
China’s stimulus has failed to boost exports from trading partners like Korea and Taiwan implying that China’s stimulus is domestically oriented and that the improvement in fixed asset investment is driven by real estate/ infrastructure at the expense of manufacturing, thereby increasing the efficacy of the policy measures domestically and limiting the amount of pass-through of this stimulus to the rest of the world. We therefore see risks of a prolonged and soggier soft patch in the global economic recovery compared to 2016. 
When you throw in the fact that April activity and credit growth data missed estimates, you're left with somewhat vexing concerns about the outlook in an environment where the US is turning the screws as tight as they'll go.
With that in mind, remember that for the better part of a decade, China has been the engine of global growth and credit creation. That's a point that's been emphasized and reemphasized by analysts since 2015, when the yuan devaluation rattled markets and China concerns were top of mind.
"Following the Global Financial Crisis, Washington had too many problems to focus on China, plus the Chinese were the driving force behind global GDP and debt creation after 2008 in a world hungry for growth," Bank of America writes, in a note dated Monday, adding that "the European sovereign debt crises of 2011 and 2012 made Chinese economic activity an even more important pillar of the world economy."
The recovery from the crisis has been tepid, and although 2017 was characterized by synchronous global growth, "gangbusters" isn't a term you'll hear anyone use to describe the pace of economic expansion in developed economies. There will probably never be an "ideal" time to confront Beijing on trade, and it's true that fiscal stimulus in the US has given the Trump administration a growth cushion (so to speak) when it comes to pushing the envelope, but there is a certain sense in which undercutting China's economy amounts to cutting one's nose of to spite the face.
At the same time, the renewal of trade concerns is weighing heavily on emerging market equities which have now erased most of their gains for the year. Notably, recent underperformance has pushed the ratio of the iShares MSCI Emerging Markets ETF (EEM) to the S&P ETF below 2018's nadir (top pane).
Meanwhile, things are going off the rails in Italy again - perhaps you've heard. Matteo Salvini has ratcheted up his signature budget bombast ahead of the EU elections and there's rampant speculation he may attempt to capitalize on League's popularity by forcing a government shakeup.
The bickering between League and Five Star is becoming wholly untenable and it's doubtful that Salvini wants to wait too long to make a move lest the Italian economy should decelerate anew and/or Italian assets succumb to another bout of turmoil on par with what we saw last May. Amid the tension, Italian stocks are on track for their first losing month of the year (bottom pane in the visual above).
Here's a bit of color from Goldman that gives you some perspective on Italy in the context of the recent risk-off mood (this is from a note out Tuesday):
In order to assess how the deteriorating macro picture has influenced performance, we benchmarked cross-asset performance to the recent changes of our first three GS risk appetite indicator factors: global growth, monetary policy and the dollar. We found that cross-asset performances since beginning of month have been in line with their implied return, except the Banks sector which has underperformed materially. 
Note that the FTSE MIB (i.e., Italian stocks on the whole) have actually performed inline with their implied beta, which means that things could get a lot worse for Italian equities in the event decent earnings are no longer sufficient to offset concerns about the banking sector, where exposure to the sovereign is actually running near historical highs.
To be clear, monetary policymakers are on high alert and will do what they can. The RBA minutes and a speech from Philip Lowe on Tuesday telegraphed a rate cut and the market still expects Fed easing. Meaningful ECB and BoJ normalization is out of the question for the foreseeable future.
Whether central bank accommodation will be enough this time around is debatable.
In case it didn't come through in all of the above, my current view is that there's not a lot to like about the setup right now.
Take that for what it's worth.