The True Toll of the Trade War

Behind the escalating global conflict over trade and technology is a larger breakdown of the postwar rules-based order, which was based on a belief that any country's growth benefits all. Now that China is threatening to compete directly with the United States, support for the system that made that possible has disappeared.

Raghuram G. Rajan

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CHICAGO – Another day, another attack on trade. Why is it that every dispute – whether over intellectual property (IP), immigration, environmental damage, or war reparations – now produces new threats to trade?

For much of the last century, the United States managed and protected the rules-based trading system it created at the end of World War II. That system required a fundamentally new outlook, and a break from the pre-war environment of mutual suspicion between competing powers. The US urged others see that growth and development for one country could benefit all countries through increased trade and investment.

Under the new dispensation, rules were enacted to constrain selfish behavior and coercive threats by the economically powerful, and the US served as a benevolent hegemon, administering the occasional rap on the knuckles to those acting in bad faith. Meanwhile, the system’s multilateral institutions, particularly the International Monetary Fund, assumed the role of helping countries in need, provided they followed the rules and met the conditions.

For decades, America’s power over the global economic system stemmed in no small part from its control of votes and influence over other voting countries in these multilateral institutions. That arrangement was possible because most countries trusted the US not to misuse its power to advance its own national interests (at least not excessively so), and the US had little reason to betray that trust. No other country approached America in terms of economic productivity, and its only military rival, the Soviet Union, was largely absent from the global trading system.

The expansion of rules-based trade and investment opened up lucrative new markets for US firms. And because it could afford to be magnanimous, the US granted some countries access to its markets without demanding the same level of access to theirs. If policymakers from an emerging-market economy expressed concerns about the potential effects of more open trade on some of their workers, economists were quick to reassure them that any local pain would be outweighed by the long-term gains. All they needed to do was redistribute the gains from trade to the groups left behind. This would turn out to be easier said than done.

Still, in the world’s nascent democracies, protests by those left behind were regarded as an acceptable cost, given the overall benefits, and were easily contained. In fact, emerging-market economies became so good at capitalizing on new technologies and lower-cost transportation and communication that they managed to take over large swaths of manufacturing from the industrialized countries. This time, however, it was moderately educated workers within developed countries – particularly small towns – who bore the brunt of the pain, while higher-skilled workers in urban service-sector industries flourished.

But, unlike in emerging markets, where democracy had not yet sunk deep roots, disaffection among a growing cohort of these countries’ workers could not be ignored. Policymakers in advanced economies thus reacted to the backlash against trade in two ways. First, they tried to impose their labor and environmental standards on other countries through trade and financing agreements. Second, they pushed for far stricter enforcement of IP, much of which is owned by Western corporations.

Neither approach was particularly effective at slowing job losses, but it would take something much bigger to upset the old order: the rise of China. Like Japan and the East Asian tigers, China grew on the back of manufacturing exports. But, unlike those countries, it is now threatening to compete directly with the West in both services and frontier technologies.

Resisting outside pressure, China has adopted labor and environmental standards and expropriated IP according to its own needs. It is now close enough to the technological frontier in robotics, artificial intelligence, and other areas that its own scientists can probably close the gap in the event that it is denied access to inputs it now imports. Most alarming to the developed world, China’s burgeoning tech sector is enhancing its military prowess. And, unlike the Soviet Union, China is fully integrated into the world trading system.

But now, belief in the central premise of that system – that each country’s growth benefits all countries’ growth – is breaking down. Industrial countries are increasingly concerned that their own higher regulatory standards are putting them at a competitive disadvantage vis-à-vis relatively poor but efficient emerging markets.

At the same time, emerging-market governments are growing more resentful of developed countries’ attempts to impose standards – higher minimum wages, low-carbon energy – that they themselves did not follow when they were developing. These governments have also become less willing to open their domestic markets to developed countries, having observed Western multinational corporations hankering for unfettered access to the Chinese market.

But most problematic of all is that the old hegemon does not see China’s rise as an unmitigated blessing. With little incentive for the US to support a system that has allowed China to grow both economically and militarily, it is no wonder the post-war order is collapsing.

So where do we go from here? Given that China can be slowed, but not stopped, it is imperative that it be made to see the value of rules-based trade. For that to happen, it must have a say in making the rules. Otherwise, the world economy could end up divided between two or more mutually suspicious blocs. Ending the flows of people, production, and finance that currently integrate the world economy would be calamitous, not just economically but also in terms of global security, owing to the heightened possibility of a new military conflict.

Unfortunately, there can be no going back in time. Once broken, trust cannot be magically restored. The best we can hope for is that China and the US will avoid opening up any new fronts in the trade and technology war, while acknowledging the need for negotiations to create a new world order. Whatever form that order takes, it must both accommodate multiple independent powers or geopolitical blocs and include new rules to ensure that all countries – regardless of their political or economic system and state of development – behave responsibly.

Is any of this possible? One can only hope. But, given the current state of affairs, I am not holding my breath.


Raghuram G. Rajan, Governor of the Reserve Bank of India from 2013 to 2016, is Professor of Finance at the University of Chicago Booth School of Business and the author, most recently, of The Third Pillar: How Markets and the State Leave the Community Behind.

Big business, shareholders and society

What companies are for

Competition, not corporatism, is the answer to capitalism’s problems




ACROSS THE West, capitalism is not working as well as it should. Jobs are plentiful, but growth is sluggish, inequality is too high and the environment is suffering. You might hope that governments would enact reforms to deal with this, but politics in many places is gridlocked or unstable. Who, then, is going to ride to the rescue?

A growing number of people think the answer is to call on big business to help fix economic and social problems. Even America’s famously ruthless bosses agree. This week more than 180 of them, including the chiefs of Walmart and JPMorgan Chase, overturned three decades of orthodoxy to pledge that their firms’ purpose was no longer to serve their owners alone, but customers, staff, suppliers and communities, too.

The CEOs’ motives are partly tactical. They hope to pre-empt attacks on big business from the left of the Democratic Party.

But the shift is also part of an upheaval in attitudes towards business happening on both sides of the Atlantic. Younger staff want to work for firms that take a stand on the moral and political questions of the day. Politicians of various hues want firms to bring jobs and investment home.

However well-meaning, this new form of collective capitalism will end up doing more harm than good. It risks entrenching a class of unaccountable CEOs who lack legitimacy. And it is a threat to long-term prosperity, which is the basic condition for capitalism to succeed.

Ever since businesses were granted limited liability in Britain and France in the 19th century, there have been arguments about what society can expect in return. In the 1950s and 1960s America and Europe experimented with managerial capitalism, in which giant firms worked with the government and unions and offered workers job security and perks.

But after the stagnation of the 1970s shareholder value took hold, as firms sought to maximise the wealth of their owners and, in theory, thereby maximised efficiency. Unions declined, and shareholder value conquered America, then Europe and Japan, where it is still gaining ground.

Judged by profits, it has triumphed: in America they have risen from 5% of GDP in 1989 to 8% now.

It is this framework that is under assault. Part of the attack is about a perceived decline in business ethics, from bankers demanding bonuses and bail-outs both at the same time, to the sale of billions of opioid pills to addicts. But the main complaint is that shareholder value produces bad economic outcomes.

Publicly listed firms are accused of a list of sins, from obsessing about short-term earnings to neglecting investment, exploiting staff, depressing wages and failing to pay for the catastrophic externalities they create, in particular pollution.

Not all these criticisms are accurate. Investment in America is in line with historical levels relative to GDP, and higher than in the 1960s. The time-horizon of America’s stockmarket is as long as it has ever been, judged by the share of its value derived from long-term profits. Jam-tomorrow firms like Amazon and Netflix are all the rage. But some of the criticism rings true.

Workers’ share of the value firms create has indeed fallen. Consumers often get a lousy deal and social mobility has sunk.

Regardless, the popular and intellectual backlash against shareholder value is already altering corporate decision-making. Bosses are endorsing social causes that are popular with customers and staff. Firms are deploying capital for reasons other than efficiency: Microsoft is financing $500m of new housing in Seattle.

President Donald Trump boasts of jawboning bosses on where to build factories. Some politicians hope to go further. Elizabeth Warren, a Democratic contender for the White House, wants firms to be federally chartered so that, if they abuse the interests of staff, customers or communities, their licences can be revoked. All this portends a system in which big business sets and pursues broad social goals, not its narrow self-interest.

That sounds nice, but collective capitalism suffers from two pitfalls: a lack of accountability and a lack of dynamism. Consider accountability first. It is not clear how CEOs should know what “society” wants from their companies. The chances are that politicians, campaigning groups and the CEOs themselves will decide—and that ordinary people will not have a voice.

Over the past 20 years industry and finance have become dominated by large firms, so a small number of unrepresentative business leaders will end up with immense power to set goals for society that range far beyond the immediate interests of their company.

The second problem is dynamism. Collective capitalism leans away from change. In a dynamic system firms have to forsake at least some stakeholders: a number need to shrink in order to reallocate capital and workers from obsolete industries to new ones.

If, say, climate change is to be tackled, oil firms will face huge job cuts. Fans of the corporate giants of the managerial era in the 1960s often forget that AT&T ripped off consumers and that General Motors made out-of-date, unsafe cars. Both firms embodied social values that, even at the time, were uptight.

They were sheltered partly because they performed broader social goals, whether jobs-for-life, world-class science or supporting the fabric of Detroit.

The way to make capitalism work better for all is not to limit accountability and dynamism, but to enhance them both. This requires that the purpose of companies should be set by their owners, not executives or campaigners. Some may obsess about short-term targets and quarterly results but that is usually because they are badly run. Some may select charitable objectives, and good luck to them. But most owners and firms will opt to maximise long-term value, as that is good business.

It also requires firms to adapt to society’s changing preferences. If consumers want fair-trade coffee, they should get it. If university graduates shun unethical companies, employers will have to shape up. A good way of making firms more responsive and accountable would be to broaden ownership. The proportion of American households with exposure to the stockmarket (directly or through funds) is only 50%, and holdings are heavily skewed towards the rich.

The tax system ought to encourage more share ownership. The ultimate beneficiaries of pension schemes and investment funds should be able to vote in company elections; this power ought not to be outsourced to a few barons in the asset-management industry.

Accountability works only if there is competition. This lowers prices, boosts productivity and ensures that firms cannot long sustain abnormally high profits. Moreover it encourages companies to anticipate the changing preferences of customers, workers and regulators—for fear that a rival will get there first.

Unfortunately, since the 1990s, consolidation has left two-thirds of industries in America more concentrated. The digital economy, meanwhile, seems to tend towards monopoly. Were profits at historically normal levels, and private-sector workers to get the benefit, wages would be 6% higher. If you cast your eye down the list of the 180 American signatories this week, many are in industries that are oligopolies, including credit cards, cable TV, drug retailing and airlines, which overcharge consumers and have abysmal reputations for customer service.

Unsurprisingly, none is keen on lowering barriers to entry.

Of course a healthy, competitive economy requires an effective government—to enforce antitrust rules, to stamp out today’s excessive lobbying and cronyism, to tackle climate change.

That well-functioning polity does not exist today, but empowering the bosses of big businesses to act as an expedient substitute is not the answer. The Western world needs innovation, widely spread ownership and diverse firms that adapt fast to society’s needs. That is the really enlightened kind of capitalism.

‘Greater fool’ theory drives weird world of negative yields

Lending at a loss only makes sense if there are other buyers willing to risk bigger hits

Neil Collins


Jyske Bank is offering its customers 10-year euro mortgages at a rate of minus 0.5 per cent © Reuters



So, Mr Christiansen, how much would you like us to pay you for the privilege of lending you money? Would 0.5 per cent a year be enough? This is not fantasy. Jyske Bank, a highly respectable Danish financial institution, is offering its domestic customers 10-year euro mortgages at a rate of minus 0.5 per cent. It is paying them to take the money.

The German government knows all about this, as investors prepare to accept a guaranteed loss if they hold its paper to maturity. As markets journal Grant’s Interest Rate Observer notes: “One-quarter of corporate and sovereign bonds the world over is priced to deliver a yield of less than nothing.”

Welcome to the weird world of negative interest rates. It has been a profitable one, too, for earlier buyers. As Lex pointed out this week, German government debt has returned 30 per cent in the past year.

There may be more gains to come, but we are into “greater fool” theory here. We hear the arguments that insurance companies and pension funds need to match asset returns to future liabilities, but this only makes sense if those liabilities are going to shrink, which would be a novelty. Otherwise, lending at a guaranteed loss only makes sense if another buyer can be found who is prepared to risk a bigger guaranteed loss.

As for the banks, they have yet to come to terms with this brave new world. If they charge customers for looking after their money, we will keep the cash under the mattress instead. This shrinks the banks’ balance sheets just when they should be encouraged to expand their lending.

Mr Christiansen may be delighted that he is making money from his mortgage. His fellow Danes may be less pleased at the long-term impact on their economy.

Do they dare scrap HS2?

In contrast to our Mr Christiansen, the UK government is still having to pay interest on its debt, but the rate is below 1 per cent. This will help the advocates for the runaway financial train that is HS2 in the independent review, which the latest transport secretary launched this week.

The first rule of these reviews is to decide on the answer you want and pick the panellists to produce it. So the chairman is a former chairman of HS2 Ltd, and the nine members include the former chairman of the Rail Freight Group, the chairman of Network Rail and the chairman of Transport for the North.

The review is unlikely to conclude that the whole venture is a terrible mistake. More likely is some conjuring trick by which the projected cost can be made to look more palatable — perhaps by terminating the line inconveniently far from London.

To avoid looking like a whitewash, the review must also produce credible projections of ticket revenue and running costs, something the government has lacked the courage to do. The panel might even dare conclude that there is a price at which it makes sense to write off the £4bn already spent and invest instead in a network that desperately needs it.

Do you really need that electric car?

If you thought you were saving the planet by ditching your dirty diesel and going electric, here is a nasty shock. The UK parliament’s science and technology committee has concluded you should give up your car altogether. Widespread personal vehicle ownership, it says, “does not appear to be compatible with significant decarbonisation”.

This is another blow for the UK’s motor industry, gasping from poor sales and pinning its hopes on being saved by these “clean” vehicles. The demonisation of diesel was bad enough, but worse is the thought that the next generation does not aspire to a shiny new motor at all. It is no fun if you are always the designated driver.

The committee concludes that electric vehicles do not eliminate emissions, but merely displace them out of sight, whether through extraction of the raw materials needed for their batteries or to the power generators.

It is more fashionable than ever to fret about climate change, and more than half of UK citizens say they favour “net zero” emissions by 2050, according to an Ipsos Mori survey. Reports such as this one from parliament will show whether we are serious about the sacrifices needed to get there.

Righteous anger from the US will not win the tech war with China

Washington’s tech sanctions will not halt Beijing’s industrial advance

James Kynge




Political debate is often couched in terms of principle. But the strongest argument against the US fighting a technology war with China has little to do with right and wrong. It is simply that the US may well lose.

Washington, to be sure, has cause to feel aggrieved. It has signed several bilateral agreements with Beijing since the early 1990s to protect American intellectual property in China, only for each one to be violated in spectacular fashion by Chinese actors.

For decades, Chinese shopping malls did a roaring trade in fake Nike shoes, counterfeit Apple iPhones and other ripped-off US brands, while commercial and trade secrets were also stolen. The Commission on the Theft of American Intellectual Property estimated that in 2015 alone, US losses were worth up to $540bn — more than the entire US trade deficit with China.

But righteous indignation is not, by itself, a winning strategy. US President Donald Trump boasted this month that “the longer the trade war goes on, the weaker China gets and the stronger we get”. But others see the opposite dynamic in play: mounting losses for leading American corporations as the US and Chinese economies decouple after nearly 40 years of engagement.

The tech sanctions the US has imposed on China — restrictions on US exports to more than 140 Chinese companies on Washington’s “entity list” — were framed as punishment for wrongdoing. Beijing sees them as aggression born of fear that China will become the world’s technological leader.

A patriotic backlash in China has already begun. Cisco, the US networking equipment maker, is sounding the alarm. Chief executive Chuck Robbins said this month that Chinese state-owned companies are shutting their doors in Cisco’s face. “We’re being uninvited to bid,” he said. “We are not even being allowed to participate anymore.”

Qualcomm, a US chipmaker that gains 65 per cent of its revenues from China, faces similar headwinds. The company warned this month that revenues in the 2019 financial year will fall to a seven-year low, largely because of dwindling Chinese demand. Rival US chip companies Micron, Qorvo and Broadcom also derive about half of their global revenues from China.

“We know that US technology is often the best and we really do want to use it,” a senior Chinese tech executive said privately. “But when the supply from the US is so unreliable and so political, we are forced to find alternatives.”

These sentiments are reinforced by Chinese consumers. Huawei, the world’s largest telecoms equipment company, has seen its smartphone sales soar at home following Washington’s decision to blacklist the company in May. Meanwhile, Apple’s iPhone sales in China have slumped.

From a Chinese perspective, the US approach appears akin to the “ku rou ji”, or “bitter flesh strategy” — wounding yourself to gain advantage over an adversary. In Chinese folklore, such a desperate ruse works only if you end up inflicting greater injury on your rival.

So far, China is absorbing the pain. Its official figures show the trade surplus with the US has swollen this year in spite of tit-for-tat trade tariffs. Some US tech companies, including HP, Dell, Microsoft, Amazon and Apple, are considering shifting some production out of China. But neither this, nor the US blacklist has been able to arrest China’s tech advance.

Indeed, in several key areas, Chinese companies are already ahead. High-speed rail, high-voltage transmission lines, renewables, new energy vehicles, digital payments and 5G telecoms are just some of the industries in which Chinese companies are widely regarded as leading their US counterparts.

Opinions are divided on whether the US or China has the more vibrant start-up culture. A study by Chinese institutions in 2017 found that the country had 164 unicorns — or start-ups valued at more than $1bn — compared with 132 for the US. But Credit Suisse said in a March report that the US had 156 unicorns against China’s 93 — and China’s were of inferior quality.

Almost all sources agree that China is catching up fast — even in foundational disciplines such as artificial intelligence. “Despite China’s bold AI initiative, the United States leads in absolute terms,” the Information Technology and Innovation Foundation said this week. “This order could change in coming years as China appears to be making more rapid progress than either the United States or the European Union,” it added.

With dominance at stake, neither side appears ready to cede an inch. Dan Wang, a Beijing-based analyst at Gavekal, a research company, says that more Chinese companies are likely to be blacklisted by the US. Further steps could include limits on the export of broad categories of US-made technologies, he added.

Angry remarks by Mr Trump this week underline the risks of escalation. “Somebody had to take China on,” he said. “And it’s about time, whether it’s good for our country or bad for our country short-term.”

The problem for Washington is that such steps might indeed be bad for America — in the short term and in the longer term as well. US companies and their affiliates operating in China sell nine times more than their Chinese counterparts sell in the US, according to Gavekal. As the superpowers decouple, the US has more to lose.

Investing in Cryptocurrency Is Risky. This Fund Is Just a Bad Idea

By Lewis Braham


Photograph by Chris Ratcliffe/Bloomberg



The exchange-traded fund has made it easier for investors to buy and sell a multitude of illiquid assets. Sometimes, that’s a problem.

ETF investors are well-served by products like the SPDR Gold Trust (ticker: GLD) and iShares Gold Trust(IAU), which enable them to own the hard asset in an ETF, for instance. The crypto world, however, hasn’t proved to be nearly as sound.

Take the Grayscale Ethereum Trust(ETHE), launched on June 20. Its shares hit a peak of $526 on June 21, but in the two months since then have fallen 92%, to less than $40.

Etherium is not easy to explain, but let’s call it a programmable blockchain and a cryptocurrency. The Grayscale Ethereum Trust is also hard to explain—it’s not quite an exchange-traded, closed-end, or open-end mutual fund. It’s complicated enough that to purchase new shares, you need to be an accredited investor (with an income of more than $200,000 or a net worth or more than $1 million).

New shares are created for accredited investors at essentially Ethereum’s value. But when those accredited investors want to sell, they must do so on the over-the-counter market, without the oversight of an exchange. Who’s buying? Retail investors. The problem? Those OTC shares can trade at a premium or discount to the trust’s Ethereum-based NAV.

So far, Grayscale Ethereum shares have traded at huge premiums, an absurd 1,825% on June 21, meaning that people were paying 18 times the value of the underlying cryptocurrency. As the price collapsed, the premium shrunk to a still-ridiculous 119%, as of Aug. 21, so the shares are now double the value of the underlying assets.

During the same June-to-August span, Ethereum’s value as a cryptocurrency slid 39% because of overall securities markets’ volatility. For the currency to recover, it must gain 64%, while the trust’s shares must soar 1,232% to go back to $526.

There’s a similar, albeit less extreme, pattern with Grayscale’s older, more popular $2.4 billion Bitcoin Trust(GBTC). It had its highest premium of 142% in May 2015 near its initial public offering, its lowest premium of 0.1% on October 2015, and has averaged a 43% premium overall.

“There are probably quite a few things that affect the premium pricing in the market,” says Michael Sonnenshein, managing director at Grayscale Investments. “We ourselves do not trade the shares, and we’re not involved in the prices at which they end up being quoted each day.

They’re purely subject to market forces and market interest. They are the first and only publicly quoted securities that provide exposure to digital currency. So, there are potentially not enough shares out there to satisfy the demand.”

True, but any retail investor can open a cryptocurrency account at a “digital currency wallet” such as Coinbase without paying such premiums to buy Bitcoin and Ethereum. If you link your regular bank account to a Coinbase wallet, it charges 1.5% of the value of each cryptocurrency transaction. That’s not cheap, but it beats paying a large premium. Also, bear in mind that Grayscale’s trusts have their own internal transaction costs and charge annual asset-based “sponsor” fees of 2% for the Bitcoin one and 2.5% for Ethereum.

The only winners here are the accredited investors who want to liquidate their position. Some did so at an 1,825% premium. Even though Ethereum itself has fallen 39% since then, accredited Grayscale investors can still avoid losses by selling at the current 100%-plus premium. The Ethereum and Bitcoin trusts have never traded at discounts.

“It’s a little unfortunate that accredited investors can buy at [NAV], and retail investors are forced to buy at a variable premium rate,” says Matt Hougan, global head of research at Bitwise Asset Management, a rival cryptocurrency money manager. “That’s not ideal.”

“Not ideal” is one term for it. Unfair is another. Bitwise also offers cryptocurrency investment funds for accredited investors, but doesn’t list them on the public markets, allowing its investors to redeem their shares at the NAV price directly through Bitwise—with no premiums or discounts. It also has filed with the Securities and Exchange Commission to launch a regular publicly traded Bitcoin ETF. “No retail investors should be buying a product trading at a 100%-plus premium,” Hougan says. “It’s just too risky.”

There are only two reasons that retail investors would pay such exorbitant prices. One is ignorance; the other is that they want cryptocurrency in their retirement accounts. Normal IRAs and 401(k)s don’t allow direct cryptocurrency purchases. (Self-directed IRAs, do, but they are complicated.)

Indeed, Grayscale promotes its Bitcoin Trust to retail investors on its Drop Gold blog as an easy way to access crypto in retirement accounts.

For some retail investors, the Bitcoin Trust trade has probably still worked despite being overpriced, as Bitcoin has soared in recent years. According to Morningstar, Bitcoin Trust shares have a whopping 96% five-year annualized return. Then again, in 2018, they fell 82%, more than the underlying NAV’s 75%. Add the premium phenomenon to an already volatile underlying investment and you have two ways of getting whipsawed.