Weak Link

Doug Nolan

Last week from The Institute of International Finance (IIF) (a summary from a members-only report): “Global debt has topped $250 billion – 320% of GDP: emerging market debt hits a new record of $71.4 trillion (220% of GDP); With limited room for further easing, debt service costs will be an increasing constraint on fiscal policy… USD hovering at record highs despite Fed rate cuts this year: persistent growth in demand for U.S. liquidity as dollar debt across EM and mature markets hits record highs. Non-U.S. banks are increasingly reliant on USD funding.”

The IIF estimated that global debt would end the year at $255 TN – “nearly $32,500 for each of the 7.7 billion people on planet” (as noted by Reuters’ Marc Jones). Global debt expanded $7.5 TN during the first half of the year, led by China and the U.S. From Reuters (Marc Jones): “Separate analysis from Bank of America Merrill Lynch… calculated that since the collapse of U.S. investment bank Lehman Brothers, governments have borrowed $30 trillion, companies have taken on $25 trillion, households $9 trillion and banks $2 trillion.”

Looking back, total U.S. Non-Financial Debt expanded 8.16% in 2007, strong growth that few found alarming. It was, after all, down from 2006’s 8.53%, 2005’s 8.77% and 2004’s 9.15%. Conventional thinking had it that the Fed was successfully orchestrating a “soft landing.”

Yields were said to remain relatively low in the face of booming Credit demand because of the so-called “global saving glut.”

Financial Sector debt growth at the time was signaling something momentous, though most conventional analysts at the time chose to disregard financial sector expansion (arguing that such analysis would be “double-counting” Credit already included in household, corporate and government sector tabulations). Financial Sector borrowings expanded at a 13.66% pace in 2007, up from 2006’s 10.35% and 2005’s 9.01%.

I have in previous CBBs highlighted the two-year $1.114 TN, or 27%, increase in (Z.1 category) “Fed Funds and Repurchase Agreements” that culminated with a $319 billion jump during Q1 2008. This data series was emblematic of the extreme speculative leveraging that had taken hold during mortgage finance Bubble “Terminal Phase” excess.

While conventional retrospective focuses on risky mortgage lending and housing market excess, the epicenter of the Bubble was in “repo” finance and myriad instruments (CDO’s, ABS, special purpose vehicles, derivatives and such) financed directly and indirectly in short-term market-based lending markets. It was the Bubble in speculative leverage that kept mortgage rates low in the face of historic borrowing demand.

The decade-old “global government finance Bubble” has notable differences - as well as clear similarities - to the previous Bubble. I have posited that global sovereign debt and central bank Credit have been the key sources of Bubble excess (as opposed to U.S. mortgage Credit). In general, interest rates (along with market yields) have been held at historically low levels, a dynamic that has trimmed overall rates of debt expansion.

This cycle has experienced unprecedented growth in central bank balance sheets that analytically should be viewed similarly to financial sector leveraging from the previous cycle.

Moreover, I would argue securities finance and speculative leveraging have evolved from a U.S. phenomenon to now comprise “repo” funding markets spanning the globe – “developed” markets, “developing” and, certainly, the “off-shore financial centers.”

The rapid expansions in global “Non-Bank Financial Institutions” and “off-shore” Credit indicate extreme speculative leveraging (akin to U.S. “repos” in 2007). Overall global Credit continues to outpace GDP growth, this despite historically low market yields that significantly reduced debt service costs. Indeed, the unrelenting rapid expansion of debt (and speculative leveraging) in the face of waning global growth dynamics portends difficult times ahead.

From the Bank for International Settlement’s “Statistical Release: BIS International Banking Statistics at end-June 2019.”

Under the headline, “Lending to [Non-Bank Financial Institutions] (NBFI) Continued to Lead Growth in Cross-Border Claims:” “The BIS locational banking statistics show that global cross-border bank claims rose by $365 billion during the second quarter of 2019, to reach $31 trillion by end-June. Their annual growth rate, which averaged around 0% since the Great Financial Crisis, reached a post-crisis high of 6%... Growth in lending to all major sectors increased. Claims on non-bank financial institutions continued to expand the most rapidly (13% year over year).”

Global cross-border bank claims (lending) surged $1.735 TN during the first half, the strongest six-month growth since pre-crisis Q4 ’07 to Q1 ’08. This compares to first-half growth of $324 billion during 2018 and $341 billion in 2017. Over two years, cross-border bank claims surged $2.520 TN, or 9%, to $30.98 TN. The second quarter’s 13% growth in lending to Non-Bank Financial Institutions was the strongest in the five-year history of the data. Notably, growth accelerated from Q1’s 11.7%, Q4 18’s 8.2% and Q3 18’s 6.4% pace.

BIS: “Reporting banks’ cross-border claims on all major sectors expanded during Q2 2019. The $190 billion expansion in claims on non-banks accounted for more than a half of the overall quarterly increase in global cross-border claims. This, in turn, was mostly driven by claims on non-bank financial institutions (NBFIs include entities such as insurance companies, pension funds, hedge funds and money market funds), which increased by $172 billion, resulting in an annual growth rate of 13%. The majority of this new lending to NBFIs was directed towards a few financial centres, such as the Cayman Islands ($37 billion), the United Kingdom ($34 billion) and Luxembourg ($24 billion).”

The $172 billion increase in lending to Non-Bank Financial Institutions followed Q1’s (record for the series) $468 billion surge, putting first-half growth at $641 billion.
BIS: “The latest increase in lending to NBFIs is part of a longer trend. Over the past five years, cross-border claims on that sector have grown at an average annual pace of 7% (compared with 1% for claims on all sectors), reaching $7 trillion at mid-2019.”

BIS: “Lending to offshore financial centres (OFCs) remained strong. It grew at 6% year over year and stood at $5 trillion as of end-June 2019, mostly to the benefit of NBFIs. Banks reported large increases in their claims on the Cayman Islands (+$45 billion), Jersey (+$9 billion) and Hong Kong SAR (+$8 billion).”

The surge in the “offshore financial centers” began in 2013, concurrent with the ramp up of global QE following the European bond crisis. After ending Q2 2013 at $3.5 TN, the “offshore financial centers” over six years surged $1.5 TN, or 43%, to $5.0 TN. I’ll assume this data capture only a segment of bubbling global markets funding financial speculation.

I also presume this surge in lending has been instrumental in the global collapse in sovereign yields (in the face of massive issuance) that has fueled broad-based inflation in real and financial assets around the world.

We won’t know all the crazy leverage and derivative strategies spawned during this period until the next big de-risking/deleveraging period. If recent articles pointing to the unwind of hedge funds trades as responsible for a jump in Japanese bond yields are accurate, we can assume at this point virtually everything is levered up. Who would have ever thought of leveraging negative-yielding bonds?

BIS: “…Cross-border lending to borrowers in developing Asia-Pacific rose by $27 billion, bringing the annual growth rate to 4%. Claims on China, up by $25 billion, accounted for almost the whole increase. Those claims have grown from a recent low of $699 billion (at end-March 2016) to $990 billion (at end-June 2019).”

Clearly, the Cayman Islands, the UK and Luxembourg are major sources of cheap finance for the global leveraged speculating community. But I ponder how much speculative finance during this cycle has emanated out of the likes of Hong Kong and Singapore - and flowed freely into higher-yielding Chinese Credit instruments.

After all, the world has never seen such a Bubble in “subprime” Credit. I have argued China is the great global Credit Bubble’s Weak Link. But, at this point, perhaps it’s Asian finance more generally.

The backdrop is increasingly conducive to heightened currency market instability.

Is the global economy about to rebound?

Evidence suggests the downturn is ending but recovery is expected to be weak

Valentina Romei and Chris Giles in London

OAKLAND, CALIFORNIA - NOVEMBER 18: A truck drives past stacks of shipping containers at the Port of Oakland on November 18, 2019 in Oakland, California. The World Trade Organization (WTO) says that global flows of goods across borders is on track to fall to the lowest level in ten years as tariffs and trade tensions continue to impact imports and exports. (Photo by Justin Sullivan/Getty Images)
Shipping containers at the Port of Oakland, California.. US-China trade tensions appear to b easing © Getty

Financial markets have been riding high this month, signalling rising optimism about the global economy only a few weeks after the IMF described it as “precarious”.

With 2019 looking certain to post the worst global economic performance for a decade — reflecting rising US-China trade tensions and their dampening impact on exports and industrial production — investors see possible green shoots of recovery next year and do not want to miss out on potential gains.

Some of this is not surprising. The IMF and other forecasters expect 2020 to be better than 2019, but the market moves in recent weeks raise the question now as to whether the outlook is much improved.

Investors’ enthusiasm may be overblown. So far the evidence suggests the slide in the global economy is coming to an end, but the pace of recovery is still expected to be weak.

Markets anticipate broad upturn

Financial markets pride themselves on being forward-looking, catching on to trends before they are obvious in the economic data. Markets have certainly been pointing towards a broad recovery.

With many equity markets close to all-time highs, investors believe the prospects for corporate profitability have improved sharply since the start of the fourth quarter. Government bond yields, a good indicator of economic optimism, have risen across advanced economies, suggesting central banks will not have to work hard to stimulate economic growth and inflation.

A graphic with no description

“As 2019 draws to a close, the market is pricing in economic recovery, with equities in the US hitting new highs and long yields well off the recent lows,” said Ric Deverell, economist at investment bank Macquarie.

Global trade shows signs of stabilisation

Much of the fear regarding the global economy in October stemmed from the real possibility that the global trade wars would intensify. In the past month, the news has been positive.

The chance of a disruptive no-deal Brexit as the UK looks to leave the EU have dropped sharply after prime minister Boris Johnson withdrew objections to a customs border in the Irish Sea. Tensions also eased between the US and China, and Donald Trump did not impose tariffs on European cars by his mid-November deadline.

Line chart of Purchasing manager index, composite new export sub-index, below 50= a majority of businesses reporting a contraction showing The deterioration in global new export orders has eased

These trends have become visible in trade data, with global goods trade volumes growing in the most recent two months of data from July and August. This month, investment bank J.P. Morgan’s export order element — which tracks companies’ orders of foreign goods and services — of its global purchasing managers’ index for October improved by the largest amount in four years — albeit from a low base.

GDP growth forecasts for 2020 stop falling

While the improvement in the trade outlook has buoyed financial markets, it has not yet found its way into economic forecasts. The outlook for 2020 growth has stopped getting worse, but upticks in forecasts remain tiny according to data from Consensus Economics, which averages forecasts from major independent economists.

After watching the “slide in the global economy” over the past 18 months, Peter Hooper, global head of Economic Research at Deutsche Bank, noted that in recent weeks there were “tentative signs of an easing” in the downward trends.

Line chart of By date of forecast, annual % change showing GDP growth revision for 2020

Though the signs are still nascent, some are celebrating the end of ever more gloom in forecasts. “There are definite signs among global activity indicators that the worst of the slowdown is behind us,” said Innes McFee, managing director of macro and investor services at the consultancy Oxford Economics.

Europe industrial output beats expectations

Although many survey indicators have continued to deteriorate, such as the regular forward-looking economic sentiment indicator from the European Commission, others are now showing more positive signs.

The PMI indices for manufacturing in October, released this month, improved for the majority of the countries in the world, including big industrial powers such as Germany, the US and South Korea.

In Europe, data on industrial production increased for the most recent two consecutive months, interrupting a period of steep contraction. Even Germany — which has suffered the most in the region from the industrial downturn — reported stronger than expected export growth and industrial orders in September.

Line chart of Annual % change, excluding construction showing The contraction in the eurozone Industrial production has eased

The improvement in the eurozone’s powerhouse is important. “German indicators are highly correlated with global trade dynamics,” said Katharina Utermöhl, senior economist at insurer Allianz.

Despite these increases, however, the outlook is still muted. Eurozone industrial production is still contracting on an annual basis and German manufacturing output was down 5 per cent in September compared to the same month last year.

But still no clarity for end of the year

The modest uptick in data does not yet provide convincing evidence for a broad-based global recovery. Monthly data remain volatile and many of the more positive industrial indicators represent only small proportions of the world economy.

When economists allowed a computer algorithm to evaluate the data, for instance, the outlook does not seem to have changed as much. According to analysis by Now-casting.com, a macroeconomic monitor, recent data releases from around the world have been mixed and do not point clearly to an improved outlook for the fourth quarter of this year. Improvements in the eurozone are offset by weaker data in the US, Canada and Japan.

Bar chart of % points change forecast made in October 13 and November 17 showing GDP growth revisions for Q4 2019

“We expect global growth to edge up over the course of 2020, but the pace of recovery will be weak by past standards,” said Neil Shearing, the group chief economist at Capital Economics.

“Policy will have to remain accommodative.”

There still needs to be a lot more movement in the data before economists will join financial markets in believing the worst of the global economic slowdown is over.

Modi must position India as a real alternative to China

Labour laws make it hard to attract global companies relocating in the wake of trade tensions

Duvvuri Subbarao

In this photograph taken on October 13, 2019, workers pack firecrackers in boxes at a manufacturing unit involved in the production of different varieties of firecrackers ahead of the Hindu festival of Diwali, in Sivakasi. - With thousands of workers painstakingly making by hand vast volumes of firecrackers, Sivakasi is usually at full tilt before Diwali. But with efforts to curb air pollution, India's $800-million pyrotechnics epicentre is fizzling out. (Photo by ARUN SANKAR / AFP) / TO GO WITH: INDIA-FESTIVAL-RELIGION-DIWALI-ECONOMY by Bhuvan BAGGA (Photo by ARUN SANKAR/AFP via Getty Images)
Manufacturing wages in India are a fraction of what they are in China. But this is neutralised by India’s low productivity © Arun Sankar/AFP/Getty

On her visit to Washington last month, India’s finance minister Nirmala Sitharaman said she was designing a policy to woo multinationals looking beyond China. For a country not known for its agility or opportunism in pursuing foreign investment, this is a significant initiative.

India missed out on being a part of the China-led global value chains that have powered the region’s export boom over the past two decades mainly because of the difficulty of doing business there. But, as the global companies that set up shop in China reposition their supply chains in the face of US-China trade tensions, the favoured alternative destinations have been Vietnam, Thailand and South Korea. Most multinationals seem not to consider India as an option. Might the country lose out a second time?

If this fate is to be avoided, certain steps must be taken. The government will hope the sharp reduction in corporate tax it implemented from October is a game-changer. Coming as it did in the midst of severe fiscal difficulties, the tax cut was a bold move but, while it puts India on the radar, potential investors may yet be unwilling to take the plunge unless further reforms are taken on.

At the top of the list are land reforms. Investors have been frustrated by India’s excruciatingly cumbersome land acquisition laws that result in heavy cost and time overruns. Taking action has been politically challenging as successive governments struggled to strike a balance between ensuring farmers are not cheated out of fair compensation and streamlining the process for investors. In his first term as prime minister, Narendra Modi tried to tweak the balance in favour of investors, but gave up quickly in the face of political backlash.

Equally important is to reform complex labour laws that make it difficult for companies above a minimum size to fire workers. Corporates have typically chosen to stay small to avoid legal hassles. This is not a position from which India can attract investment relocating from China, where economies of scale have been forged by employing thousands of workers in gigantic factories.

India’s poor infrastructure is another major barrier to investment. The problem here has been one of funding. The public-private partnerships the government hoped would be the answer proved an unhappy experience. With the gradual easing of the bad debt problem that has weighed down India’s financial sector, it should be possible to encourage private investment back.

Like its regional peers bidding for manufacturing capacity leaving China, India hopes to leverage its wage advantage. The average monthly manufacturing wage in India is a fraction of what it is in China. But this is neutralised by India’s low productivity owing to a poor skill endowment. The government has launched a programme to improve skills across both blue- and white-collar sectors. Here, even small improvements can yield big dividends.

In winning the battle for investment, India also has to fight misperceptions. The country ranked 63rd in the World Bank’s latest ease-of-doing-business rankings, a big jump from 142nd place, when Mr Modi took power in 2014. But the stereotype of an indifferent, corrupt, venal bureaucracy persists. A new narrative is needed, highlighting success stories such as Apple electronics manufacturer Foxconn’s decision to locate production capacity in India.

Mr Modi rode to office promising jobs for a burgeoning labour force. Not delivering on that promise is his single biggest failure. There can be no jobs without investment; no investment without reforms. Will he bite the bullet?

Jean-Claude Juncker, the outgoing president of the European Commission, admitted, “We a
ll know what to do, we just don’t know how to get re-elected after we’ve done it.” Mr Modi now has the challenge and opportunity of proving Mr Juncker wrong.

The writer, a former governor of the Reserve Bank of India, is currently a visiting fellow at the University of Pennsylvania.

Catching fire

Hong Kong stares into the abyss amid growing violence

A generation shapes its identity on the anvil of Xi Jinping’s intolerance

Since the middle of November, Hong Kong has been staring into the abyss. The violence attending its nearly six-month-old protest movement—both its participants, approvingly, and China’s central government, furiously, brand it a revolution—has stepped up a gear. Police have increased their use of tear-gas, rubber bullets and water cannon.

Protesters who once carried nothing more offensive than an umbrella now wield bows and specialise in petrol bombs. Vigilante violence has flourished. The first deaths—a student who fell running from the police and a street-cleaner hit by a brick apparently thrown by a protester—have been recorded.

On November 17th, in the most dramatic stand-off yet, the police began moving against protesters at the Hong Kong Polytechnic University (PolyU) who were mass-producing Molotov cocktails. The protesters barricaded themselves in. Riot police tasked with getting them out threatened to use lethal force in doing so.

The fears which that provoked have waned. International calls for the police to stay their hand may have contributed to a decision to wait for the protesters to emerge—as many have, cold, tired, hungry and frightened. Thanks to mediation by social workers and a few local politicians, 300 protesters under the age of 18 were allowed to leave, though their personal details were carefully taken down. Others have made dramatic escapes.

But as The Economist went to press 60 or so remained behind the barricades. Before making his own escape Mok, a 23-year-old graduate, told our correspondent that, “Even if we are dying on the campus or in the underground tunnels, we are not going to surrender.” With the language of martyrdom abroad, the risk of a bloody ending remains.

The violence of the Hong Kong protests, and of the response to them, is hardly remarkable by international standards. Much worse has happened in Baghdad, Beirut, Santiago and Tehran over the past months. But by the standards of both Hong Kong and China’s Communist Party, these events are shocking. No one would have predicted in May that a proposed change to the territory’s extradition laws could lead to a sustained rebellion lit by burning vehicles.

For one thing, China seldom treats rebellion with anything less than dire repression. For another, Hong Kongers tend not to see themselves as revolutionaries. But that, it seems, is changing. The protesters are willing to use violence in the service of decency and their way of life—to burn universities in order to save them.

Catching fire

Hong Kong has never been a democracy. But in the later years of British rule its Legislative Council (Legco) gradually became more representative of the people. The territory’s courts enjoyed genuine independence, and its citizens a free press. As well as boasting one of the world’s most vigorous economies, the territory bore most of the hallmarks of a free society.

Today, Hong Kong’s local district councils, for which elections are due to be held on November 24th, are the only tier of government chosen entirely through universal suffrage. But when China reclaimed the territory in 1997 it agreed that its form of government, courts, free press, trade relations, financial system and way of life should remain unchanged for 50 years: “one country, two systems”, in the phrase of Deng Xiaoping, then China’s leader.

Though some of the territory’s autonomy was eroded in the 2000s, China largely kept to the deal, its concerns over excessive freedoms offset by a thriving economy and, to some extent, the opprobrium it would face should it break its word.

But around the time that Xi Jinping, China’s current leader, came to power in 2012, the rate of erosion quickened. The government in Beijing pushed for a highly unpopular programme of “patriotic education” at schools to engender loyalty—a push that did not succeed, but still self-defeatingly contributed to the radicalisation of some of the territory’s young people. Proposed reforms that would have let Hong Kongers choose their chief executive, but in effect restricted the choice to a slate picked by Beijing, led to the Occupy Central protests of late 2014.

This year the issue originally at stake was a bill which would have allowed anyone in Hong Kong accused of a crime in mainland China to be tried there—which is to say, in a system Beijing controls. Outrage at this new erosion brought 1m people on to the streets. Carrie Lam, the territory’s chief executive, ignored them.

Her intransigence led to even larger protests. Organisers claim that a demonstration on June 16th brought 2m on to the streets—a turnout almost ten times larger than Martin Luther King’s March on Washington provided by a population less than a twentieth that of America in 1963. Civil servants, church groups, executives and the staff of Hong Kong’s biggest employers all joined in, as did teenagers, children and babes in arms.

The heart of the protests, though, was to be found among young, well-educated Hong Kongers fighting for their city’s democratic autonomy. For most of them that fight was, to begin with, metaphorical. For some—those now known as the frontliners—it was not. They looked back on the non-violent protests of Occupy Central when, as Joshua Wong, one of Occupy’s leaders, put it, the police had arrested “anyone with a megaphone” and learned their lesson: they would be leaderless, anonymous and comfortable with violence.

In “Longstreet”, a 1970s television programme, Bruce Lee tells his student “to be formless, shapeless—like water”; to take whatever form the circumstances require; to flow, creep, drip or crash. “Be water” became the movement’s watchword, votes on encrypted messaging apps its leaderless model of co-ordination.

The frontliners’ early forays beyond previous norms—blocking roads with pavement railings and shouting taunts at the police—now seem, by their own admission, almost quaint. Direct clashes were few. The storming of Legco on July 1st, and the subsequent daubing of its chamber with slogans, shocked the authorities and some of the populace. But the writing on the walls was in paint, not blood.

Boiling point

Other symbolic gestures were more aesthetically pleasing. A remarkably catchy, crowdsourced Cantonese anthem, “Glory to Hong Kong”, first heard at rallies, ended up sung by flash mobs of office workers during lunch breaks. A moment when a young girl and boy, forming a human chain, found themselves too shy to hold hands and instead gripped the two ends of a biro took flight on social media; within a day it had been mashed up with Michaelangelo into memes showing the spark of life, or freedom, flowing from one to the other.

The “Goddess of Democracy” who graced the Tiananmen Square protests—herself a repurposing of the Statue of Liberty—appeared again, now known as “Lady Liberty” and kitted out with the practical but now also iconic appurtenances of protest: hard hat, gas mask and umbrella.

The police met the water’s rising tide with what in retrospect seems like tolerance. When, three weeks after the storming of Legco, the frontliners painted slogans on the Liaison Office, symbol of the Chinese Communist Party’s authority over Hong Kong, the police were furious at having been outwitted. Yet when The Economist asked one officer what he and his colleagues near the office intended to do in the face of protesters barricading the road, he replied, with a wry smile: “Wait till the mtr [the underground system] closes and protesters take the last train home.”

Elsewhere on the mtr, though, that night saw a decisive escalation. Men with triad links and metal staffs entered the Yuen Long station in the New Territories looking for democracy protesters on trains. They laid into passengers indiscriminately; local police, apparently turning a blind eye, failed to respond. That incident did more than any other to discredit a police force that used to be called “Asia’s finest”. Today, only Mrs Lam uses the phrase.

Since then protesters have vandalised (or, in protest slang, “renovated”) state banks, Hong Kong’s biggest bookseller (which is owned by the Liaison Office) and restaurants with sympathies assumed to lie with the Communist Party. Rioters now set fires not only on the streets but inside buildings. On November 6th a pro-establishment politician with known links to the triads in Yuen Long was stabbed in broad daylight.

People fear being attacked simply on the basis of being Mandarin-speaking mainland Chinese. Nihilism is trumping romanticism: “If we burn, you burn with us”, a rebel slogan from the climax of the Hunger Games saga, has gained currency. Earlier this month it was given awful form when a bystander confronting protesters was doused with something flammable and set on fire (he survived).

Police commanders express bewilderment that the mass of ordinary, peace-loving Hong Kongers are not repelled by such scenes on the streets. Many are. But they are repelled yet more by the police. A survey published on November 15th by the Hong Kong Public Opinion Research Institute found that 83% blame the government, and especially the police, for the increase in violence. In a separate poll, 51.5% reported zero trust in the police force, up from just 6.5% before the protests began.

Hong Kongers are appalled that police have lined uniformed schoolchildren against walls for random searches and have arrested 11-year-olds. Reports are growing of physical mistreatment in detention. Rules of engagement that in July were consistent with best international practice—rubber bullets fired only below waist height, tear-gas used to disperse not to kettle—have been thrown out of the window.

Beatings at the time of arrest have become commonplace, sometimes escalating to frenzy. On November 11th an unarmed protester was shot in the stomach at point-blank range. And all this with impunity. Officially, only one officer out of over 30,000 has as yet been suspended for any action against a protester.

It is possible to see a terrible symmetry at work, with frontline ninjas in helmets with camera mounts uncannily resembling the black-clad police of the rapid-action unit known as the Raptors. Each side’s epithets dehumanise the other—“dogs” for the police, “cockroaches” for the protesters.

The litanies of brutality they recite match each other crime for crime. But a large part of the public, from taxi drivers to secretaries, sees no such balance. On October 1st, China’s national day, residents of high rises in Wanchai concealed hundreds of protesters suddenly cornered by riot police. Crowds scream at riot police in shopping malls and housing estates. Asia’s finest have become haak ging—“black police”.

Police commanders blame Mrs Lam and her administration for forcing them to deal with the ever-worse symptoms of a problem which can only be sorted out politically. But Dennis Kwok, who represents the legal profession in Legco, says the police now take direct orders from central-government officials.

Chris Tang Ping-keung, who was installed as police commissioner on November 19th, immediately changed the force’s motto from serving with “Pride and Care”—which aligned it with the citizens to whom it is nominally accountable—to serving with “Duty and Loyalty”. That will play well in Beijing.

Swirling Waters

China’s official narrative about Hong Kong is that Western “black hands” are training, organising and even paying protesters to destroy Hong Kong—part of a larger plot to hold down a rising China.

When America’s Senate passed a bill supportive of the protesters on November 20th Beijing reacted with a fury that grew out of and fed that narrative. Many mainlanders, bombarded by state media with images of protesters insulting China or waving foreign flags, long to see the protests crushed.

The Chinese government is clear that it wants things sorted. But it has held back from sending in the People’s Liberation Army (pla) and paramilitary police to quell the disturbances—indeed, though one can never know what a secretive leadership is planning, it may never seriously have been considered. In leaked comments from a private meeting with businessmen, Mrs Lam implied that China’s threats had been so much bluster.

One of her advisers says that, although the protests represent a big loss of face to China’s leadership, the loss of face that would come with abandoning all semblance of “one country, two systems” would be worse.

For a government that makes much of its decisiveness under the brilliant leadership of Xi Jinping, the absence of anything resembling a strategy to sort out Hong Kong is striking. The best spin that officials can put on it is that their leaders are playing a long game, waiting for popular sentiment to turn against the protesters and reconcile itself to something like the status quo ante.

This seems unlikely—but possibly looks more plausible if you sincerely believe, as hardliners say they do, that Hong Kong opinion polls cannot be trusted because they are conducted by universities and think-tanks that are hotbeds of Western liberalism, and if your view of the territory has long been coloured by reports from Liaison Office officials who tell you what you want to hear.

A deeper problem is that the government in Beijing has pre-emptively undercut the possibility of a satisfactory settlement. As the Hong Kong police argue in private, the unrest needs a political solution. But the Communist Party has systematically constrained the space in which the give and take of Hong Kong politics can take place.

Those constraints created the dissatisfaction that led to the protests; coming to some accommodation would require setting some of them aside. But China’s leadership is unwilling to countenance such action. An example: when Hong Kong’s high court overturned a ban on face coverings imposed by Mrs Lam, the National People’s Congress in Beijing made its disapproval clear.

If expecting politics to work in a place where they have tried to remove that possibility fails, China’s leaders “have no Plan B,” according to a senior adviser to Mrs Lam with close links to Beijing. And so things are left in the hands of Mrs Lam and her paralysed, incompetent government.

Mrs Lam is showing the same intransigence in the face of calls for an independent investigation into the causes of the unrest and into police behaviour as she originally did over the extradition bill. When in an unaccustomed fit of good sense she acknowledged the need to reach out to young people, she did so at a youth camp organised by the reviled pla—and in the Mandarin of the overlord rather than Cantonese.

Going with the Flow

With no one in power taking the initiative and violence ratcheting up, the outlook appears grim. But the district-council elections set for November 24th could possibly help move the action away from the streets. These elections, mostly concerned with rubbish collection and the management of public housing estates, have never previously been a big deal. This time democrats see them as an opportunity to show that the energy of the streets can be channelled into the ballot box.

With a democrat contesting every council seat and 386,000 (mainly young) new voters, the poll offers the chance for a symbolic coup de théâtre and, indirectly, a shift in the composition of Legco. Half of the committee’s 70 members are directly elected—six of the others come from the district councils. The election results will also affect the make-up of the committees, tightly circumscribed by Beijing, which every five years choose the chief executive.

It might seem strange, in the current circumstances, that the elections are going ahead. But both sides want them. Mok, the protester behind the barricades at PolyU, says that though he views the elections as part of the tainted system he is fighting, he and his comrades are determined to vote. The government, for its part, desperately wants to show that some things are carrying on as normal.

And for the elections to go ahead, it says it needs calm. This puts democratic leaders in something of a spot. They need the frontliners to leave the barricades—yet saying so out loud would risk splitting the protest movement.

When his pupil in “Longstreet” worries that wateriness does not sound like the way to beat his fearsome opponent, Bruce Lee upbraids him: “You want to learn the way to win, but never accept the way to lose.” The Hong Kong protesters know that they are not going to win a liberal democracy any time soon. But nor do they necessarily need to follow Lee’s last advice: that the pupil must learn the art of dying.

Some in Beijing acknowledge that a fundamental change has taken place in Hong Kong, and suggest that the central government will be “very cautious” about its next steps. In response to the suggestion that the Communist Party had lost the hearts and minds of a whole generation in Hong Kong, one thoughtful person in the capital said: “Oh, two.”

That is the case for giving Hong Kong the political space to start sorting out the mess itself. It is not a case Mr Xi is likely to take to. But some waters flow slowly.

A History of the Intermarium: Or, Poland’s Place in the World

By: Jacek Bartosiak

The Baltic Sea is responsible for Poland’s place in the world.

It turns near the mouths of the Vistula and Niemen rivers, following the path where the Black Sea, that most distant outlet of the Mediterranean Sea, extends to its northernmost point.

The Baltic-Black Sea bridge, which we call the Intermarium, is located here.

The Poles of centuries past rightly understood the Intermarium to be the most geopolitically influential region in Europe, but as an organizing principle of statehood, it is an entirely different matter.

It is a region of transition between Western Europe and Eastern Europe, two starkly different regions with starkly different political geographies. Western Europe has been under the influence of the world’s oceans throughout its history. From the sea came the influence of the Goths, the Angles and the Saxons, the Arabs and the Vikings, the English and the Spaniards, and in the 20th century, even the Americans. Similarly, Western Europeans created world empires by accessing and exploiting the oceans at their disposal.

But the rest of Europe, the part that starts at the eastern edge of the Intermarium, has always had a more continental character, influenced as it has been from the seemingly endless lands of Eurasia. The Black Sea is its only reprieve. The continental spaces of this region have determined the political and economic development of the region and, to a large extent, its status and political anchoring. It is continental, sure, yet it is also between-the-seas, creating a peculiar bloc with three frontiers in Asia.

The Modern Intermarium

Its peculiarity is perhaps best illustrated by the contrast in river systems between Eastern and Western Europe. Whereas Eastern Europe was cut off from the oceans and the great routes of economic and social ideas of the world, Western Europe boasts a different geographical layout, a different outline of shorelines and surfaces, different road systems and water communication networks that formed the political history of the region – this bizarre mosaic of nationalities, cultures, religions, political tendencies and social temperaments.
Major Roadways along the Oder Basin

River systems in Western Europe are more or less symmetrical, and the main rivers – the Rhine, the Seine and others – sport similarly sized basins on either side. However, starting at the Oder to the east, this symmetry clearly ceases. There are many more right tributaries, including the Vistula, the Niemen and the Dzwina basins, that are longer than the left ones. (Farther east, the basins become symmetrical again.)

The water divisions herein are usually very low and narrow and thus easy to cross. This means Intermarium rivers are an excellent communication network that can be easily connected by canals with very short relocations. The valleys they created also naturally gave way to easily traversed land routes.

Poland's Strategic Geography

So the historical significance of the river network, especially in the Intermarium, was enormous. This can be explained in large part by the natural expansion of the Polish people to the east. (Credit is also due to the Moravian Gate, in western Poland, which discouraged north-south migration.) But it also explains why these liminal lands that constitute the Intermarium were subject to invasions from both directions that meant to subordinate or destroy all their political organs or, at the very least, prevent the creation of a unified political entity – after all, the Intermarium covers an area of about 1 million square kilometers (roughly 400,000 square miles).

This area was for a time a military training ground for more powerful enemies, whose campaigns frequently ran from west to east and from east to west. Mongol power and Tatar-Turkish expansion spilled into it. Fights took place between Western and Eastern Europe, and the routes of Napoleon, the Swedes, the Russians, the Germans and the Soviets led through it.

The front of World War I stopped on it. Operation Barbarossa in 1941 and Napoleon’s strike against Moscow in 1812 emerged from the narrowest place of the Intermarium between the Carpathians and the Baltics. Russia’s expansion and the political influence of Western Europe stopped there. In short, no war for domination in Europe spared the Intermairum.

Succeeding Where Others Failed

Outside dominion over the Intermarium began in earnest in the 8th century. Strong eastward pressure and geopolitical and demographic expansion created several German states in colonized areas, the most important of which were, eventually, Prussia and Austria. But before those great kingdoms came to be, the Mongols, who had recently finished taming China, came through, devastating the powerful Kievan Rus in far eastern Europe.

The only answer the rulers of the Intermarium could muster was the integration of the “Old State,” the polity that existed before partition in 1795. Polish King Casimir the Great annexed Red Ruthenia, located in what is now the easternmost stretches of Russia, and attempted to bring Hungary into the fold.

The Union of Krewo, which brought Poland and Lithuania together as one in the late 14th century, finally succeeded where these other attempts had not. It established Great Lithuania, the anchor of the Intermarium, and thus stabilized the region for about 400 years. (It also arguably created an opportunity for the European rimlands to develop more peacefully because it eased pressure on them emanating from Asia Minor.)

The alliance was made formal in the 16th century, resulting in the Polish-Lithuanian Commonwealth, which brought Poland, Lithuania, the Principality of Polotsk (Belarus) and Kievan Ruthenia (Ukraine) under one banner. The promise of the Intermarium as an organizational principle had finally been achieved.

Both neighboring powers – German and Muscovite – understood the danger that this union presented and so made every attempt to chip away at the commonwealth’s power and absorb as much of its land as they could. And so the Intermarium was partitioned toward the end of the 18th century. The fall of Poland led to the complete liquidation of the geopolitical system the nation-states here had created. At the same time, the geopolitical buffer protecting the western rimlands from Russia ceased to exist.

This, along with the Napoleonic Wars and the Congress of Vienna, created a provisional line of demarcation between Europe and Russia that would last about 100 years.

The 1918 Treaty of Brest-Litovsk gave temporary control over the Intermarium, including all of Ukraine up to the Don River, which was once considered the border between Europe and Asia, to Germany. The Russians lost all their holdings; no Intermarium nation wanted to be on Russia’s side in World War I.

But the late 1910s were, of course, a time of great upheaval. After the war, the Russian Revolution, Brest-Litovsk and the Treaty of Versailles, chaos engulfed the region, only to be calmed by the Treaty of Riga, which ended hostilities between Poland and the Soviet Union in 1921.

Throughout the interwar years, there were various attempts to promote the Intermarium, as an organizing principle, and the activities of the Promethean movement, aimed at dividing the Soviets by separating nations that did not want to be under the power of Moscow, incusing in the Caucasus.

They all shared the desire to reclaim geopolitical influence under the guidance of the Intermarium as a way to counterbalance the Soviet Union and Germany. But these attempts, like those before it, failed. In 1939, the Soviets and the Germans came to an agreement on the division of spoils in the Intermarium, concluding in the Molotov-Ribbentrop Pact that Polish statehood should be abolished, thus disrupting the balance of power in Europe.

And since the Soviet Union was on the side that won World War II, it imposed its will by curbing Polish autonomy, thus crushing any hope for a formal Intermarium until 1991, when the Soviet Union collapsed.

What the West Tends to Forget

At the end of the 1950s, two Poles – Juliusz Mieroszewski and Jerzy Giedroyc – formed a geopolitical doctrine that contained a simple maxim: “There can be no independent Poland without a free Lithuania, Belarus and Ukraine.”

The editor-in-chief of the Paris-based emigre magazine Kultura called for the recognition of the independence of the Belarusians, Ukrainians and Lithuanians to help them regain autonomy regardless of whether they would be loyal to Poland in the future. He argued that the very existence of independent neighbors would mitigate the risk of clashing with Russia again.

Put simply, the concept was based on the assumption that Russia would not be able to threaten Poland if they were separated by the independent countries of the eastern part of the Intermarium at that time – i.e. the Soviet republics.

Poland’s primary foreign policy objective since the 1990s was therefore to support the independence of these countries and to promote bilateral relations with them so that they wouldn’t fall back into Russia’s orbit. Implicit to this policy, of course, was the renunciation of all revanchist claims to Intermarium territories.

Warsaw complemented this policy toward the East with focus on the West, represented by the U.S. military presence in Europe, the auspice of NATO, and the ability of Washington to organize and helm the economic world order that had been in place since Bretton Woods, with particular interest in Western European economic cooperation with the European community.

The biggest change Poland now faces is the fact that China and Russia are acting outside the world order the U.S. helped to build. If the U.S. no longer has unquestioned primacy, then Poland may need to reassess its options. At the very least, it requires Warsaw to better understand what its place in the world is. This, in turn, will result in an understanding of Poland's interests, and from a proper understanding of this might come a Polish grand strategy.

While much is made of the memory and possible resuscitation of other empires, the West has largely forgotten about the Polish land empire, and how it held the balance of power in Europe for centuries, creating a separate core area in a pivotal part of Europe and Eurasia, shaping a separate civilization and the strategic culture serving it.

Western strategists tend to ignore Poland’s strategic dilemmas, treating the country as a member of a Western camp (after 1991) or a hostile one (before 1991), and not an independent entity entering the 21st century with growing potential and superbly located in a strategic area of Eurasia. China, for its part, is beginning to understand as much, insofar as it pertains to the Belt and Road Initiative.

For the countries of the Intermarium, geography is a blessing and a curse. Being suspended between the world’s oceans and the Eurasian landmass gives it a lot of leverage, even as it imperils it from multiple directions. Western powers simply cannot influence the situation in the Intermarium – that is, the areas just east of Poland – without Poland itself. It’s up to Warsaw to figure out if it can capitalize on its leverage, especially when the world order is in flux.

The lives of the 0.0001%

Have billionaires accumulated their wealth illegitimately?

The economics of billionaires

BILLIONAIRES HAVE never exactly been popular with the radical left. But with a member of the nine-zero club sitting in the White House, and a decade of slow growth in living standards, some Democrats have taken to attacking billionaires to draw attention to their argument for root-and-branch economic reform.

“Billionaires should not exist,” says Bernie Sanders, a presidential candidate. Plutocrat-bashing has become part of the debate in Britain, too, where an election will be held on December 12th.

At the Labour Party’s campaign opener Jeremy Corbyn, its far-left leader, attacked the Duke of Westminster, one of Britain’s wealthiest landowners, and Rupert Murdoch, a media mogul.

Socialists argue that anyone who has become fantastically rich has profited from a rigged system. “Every billionaire is a policy failure,” goes the memorable phrase.

To assess this claim The Economist has drawn on data from Forbes, a business magazine, on billionaires in the rich world, updating an index of crony capitalism that we first put together in 2014 (see chart).

In the past decade the wealth of the world’s 2,200-odd plutocrats (which puts them inside the world’s top 0.0001%) has risen much faster than global GDP.

Still, most of the world’s billionaire wealth has been earned fair and square. Oprah Winfrey, for instance, has a fortune of about $3bn.

It is one thing to feel that having so much money is distasteful.

It is quite another to argue that these people have accumulated their wealth illegitimately and should be stripped of it.

But some billionaires are less upstanding, indulging in what economists call “rent-seeking”.

This takes place when the owners of an input of production—labour, machines, intellectual property, capital—extract more profit than they would get in a competitive market.

Such activity may or may not be illegal, and often involves cartels and lobbying for rules that benefit a firm at the expense of competitors and customers.

Our analysis identifies industries where rent-seeking is common, including mining, defence, construction and casinos.

This time it also includes the largest tech companies, since many of them have engaged in anticompetitive practices.

Three-quarters of billionaires’ wealth in advanced economies was fairly acquired. Still, rentier wealth has risen relative to GDP.

Some countries are more cronyfied than others. Sweden and Germany less so.

But in America rent-seeking industries made one in five billionaires and explain a third of total billionaire wealth.

What should be done?

Governments could do more to expose oligopolies to competition.

Another option would be higher taxes on wealth transfers (according to a separate analysis, one-third of global billionaire wealth is inherited).

Making the economy more competitive would do more for ordinary folk than tarring all plutocrats with the same brush.

The Rise of Nationalism After the Fall of the Berlin Wall

Following the fall of the Berlin Wall in November 1989, open societies were triumphant and international cooperation became the dominant creed. Thirty years later, however, nationalism has turned out to be much more powerful and disruptive than internationalism.

George Soros


BERLIN – The fall of the Berlin Wall on the night of November 8, 1989 dramatically and suddenly accelerated the collapse of communism in Europe. The end of travel restrictions between East and West Germany dealt a death blow to the closed society of the Soviet Union.

By the same token, it marked a high point for the rise of open societies.

I had become involved in what I call my political philanthropy a decade earlier. I became an advocate of the concept of open society that had been imbued in me by Karl Popper, my mentor at the London School of Economics.

Popper had taught me that perfect knowledge was not attainable, and that totalitarian ideologies, which claimed to be in possession of the ultimate truth, could prevail only by repressive means.

In the 1980s, I supported dissidents throughout the Soviet empire, and in 1984 I was able to set up a foundation in my native Hungary. It provided financial support to any activity that was not initiated by the one-party state.

The idea was that by encouraging non-party activities, people would become aware of the falsehood of the official dogma – and it worked like a charm. With an annual budget of $3 million, the foundation became stronger than the Ministry of Culture.

I became hooked on political philanthropy, and, as the Soviet empire collapsed, I established foundations in one country after another. My annual budget jumped from $3 million to $300 million in just a few years. Those were heady days. Open societies were in the ascendant and international cooperation was the dominant creed.

Thirty years later, the situation is very different. International cooperation has hit serious roadblocks, and nationalism became the dominant creed. So far, nationalism has turned out to be much more powerful and disruptive than internationalism.

This was not an inevitable outcome. After the collapse of the Soviet Union in 1991, the United States emerged as the sole surviving superpower, but it failed to live up to the responsibilities that its position conferred. The US was more interested in enjoying the fruits of its Cold War victory. It failed to extend a helping hand to former Soviet bloc countries, which were in dire straits. Thereby, it adhered to the prescriptions of the neoliberal Washington Consensus.

That is when China embarked on its amazing journey of economic growth, enabled by its accession – with US support – to the World Trade Organization and the international financial institutions. Eventually, China replaced the Soviet Union as a potential rival to the US.

The Washington Consensus assumed that financial markets are capable of correcting their own excesses, and if they did not, central banks would take care of failing institutions by merging them into bigger ones. That was a false belief, as the global financial crisis of 2007-08 demonstrated.

The crash of 2008 ended the unquestioned global dominance of the US and greatly boosted the rise of nationalism.

It also turned the tide against open societies. The protection they received from the US was always indirect and sometimes insufficient, but its absence left them vulnerable to the threat of nationalism. It took me some time to realize this, but the evidence was incontrovertible. Open societies were forced onto the defensive worldwide.

I should like to think that the nadir was reached in 2016, with the United Kingdom’s Brexit referendum and the election of US President Donald Trump, but the jury is out. The outlook for open societies is aggravated by the exceptionally rapid development of artificial intelligence.

It can produce instruments of social control that can help repressive regimes but pose a mortal danger for open societies.

For example, Chinese President Xi Jinping has embarked on creating a so-called social credit system. If he succeeded in completing it, the state would gain total control over its citizens. Disturbingly, the Chinese public finds the social credit system attractive, because it provides them with services they previously lacked, promises to persecute criminals, and offers citizens a guide on how to stay out of trouble. Even more disturbingly, China could sell the social credit system worldwide to would-be dictators, who would then become politically dependent on China.

Fortunately, Xi’s China has an Achilles heel: it depends on the US to supply it with microprocessors that 5G companies, like Huawei and ZTE, need. Unfortunately, however, Trump has shown that he puts his personal interests ahead of the national interests, and 5G is no exception. Both he and Xi are in political trouble at home, and in the trade negotiations with Xi, he has put Huawei on the table: he has converted microchips into bargaining chips.

The outcome is unpredictable, because it depends on a number of decisions that have not yet been taken.

We live in revolutionary times, when the range of possibilities is much wider than usual and the outcome is even more uncertain than in normal times.

All we can depend on is our convictions.

I am committed to the goals pursued by open societies, win or lose.

That is the difference between working for a foundation and trying to make money in the stock market.

George Soros is Chairman of Soros Fund Management and the Open Society Foundations. A pioneer of the hedge-fund industry, he is the author of many books, including The Alchemy of Finance, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means, and The Tragedy of the European Union: Disintegration or Revival? His most recent book is In Defense of Open Society (Public Affairs, 2019).