Strains in US government bond market rattle investors

Analysts and fund managers urge swift action from Federal Reserve and Treasury

Adam Samson, Robin Wigglesworth, Colby Smith and Joe Rennison



The US government bond market has come under strain during this week’s financial market tumult, prompting calls from analysts and fund managers for decisive action by the Federal Reserve to prevent a bigger calamity.

Banks and investors have said that trading conditions in Treasuries, the world’s biggest and deepest debt market, have deteriorated in the past few days.

The market became “overwhelmed by liquidity concerns” during a chaotic day on Wednesday, said Bank of America analysts in a note to clients.“[This] could stop the Treasury market from functioning. If that happens it is a national security issue.

It will limit the ability of the US government to respond to the coronavirus,” said Mark Cabana, a BofA strategist who authored Thursday’s report. Signs of dysfunction on Wednesday meant that during an ugly day for stocks, when haven Treasuries would typically be expected to rally, they actually fell.

In that environment, it becomes even harder for investors to shield themselves from losses, spreading volatility around the financial system.“The US Treasury market is the bedrock for all other financial markets; it is the world’s risk-free rate and allows the US government to fund itself,” BofA said in its report.

“If the US Treasury market experiences large-scale illiquidity it will be difficult for other markets to price effectively and could lead to large-scale position liquidations elsewhere.”

The bank warned that asset classes including stocks, corporate debt and mortgage-backed securities were all vulnerable. Global equity markets were under heavy pressure on Thursday, with Europe’s main benchmark down 8 per cent, and S&P 500 futures tumbling 5 per cent — the maximum allowed fall outside normal trading hours.

Several fund managers also raised alarm at the worsening health of the US government debt market and warned that, without decisive action, dysfunction could have a widespread impact on fragile financial markets.

“There’s a fundamental problem in the Treasury market. It’s just not functioning,” said Gregory Peters, a senior portfolio manager at PGIM Fixed Income.

“Liquidity is seizing up everywhere, but the [sovereign bond] market is the most messed up . . . It is freaking people out.” BofA said volatility, which has rivalled levels reached in the depths of the financial crisis in 2008, had begun affecting market participants.

It said dealers in the Treasury market had widened the spread in price at which they were willing to buy and sell US government debt at, a classic sign of diminishing liquidity.

The volatility also “limited their ability to transfer risk”.The Wall Street bank called on the Federal Reserve or Treasury to step in with a “rapid” and “large” response of a greater magnitude than they have deployed.

This sentiment was echoed by a fund manager who said markets were expecting “meaningful” action from the Fed and Treasury jointly in the coming days. On Wednesday, the New York arm of the central bank ramped up its intervention in short-term borrowing markets for the second time this week, unveiling larger and longer-term lending facilities to stem any dysfunction in funding markets.

BofA said that the additional measures were probably insufficient to shore up the repo market, where investors swap high-quality collateral such as Treasuries for cash.

“We are concerned that the size of this repo operation may not be large enough to stabilise the cheapening in US Treasury securities and materially improve Treasury market liquidity,” said BofA. “We believe it may take a more forceful action from the US Treasury or Federal Reserve to act as a ‘circuit breaker’ in these illiquid Treasury markets.”

The Fed, which cut rates last week by half a percentage point in the first reduction between meetings since 2008, is due to meet next week. Markets are currently pricing in a three-quarter point reduction in the main policy rate at that meeting, bringing the range down to between 0.25 per cent and 0.5 per cent. Some analysts have called for more, expecting the Fed to cut rates to zero.

“The market is crying out for policy help,” wrote Priya Misra, head of global rates strategy at TD Securities, in a recent note.

JPMorgan analysts say that the Treasury market’s functioning has been impaired in part because of the number of traders that now work from home to limit the spread of coronavirus, which it argued was the “most significant large-scale operation risk” facing Wall Street since the disruption caused by the 9/11 terrorist attacks in New York.

Partly as a result there were “signs of emergent stress already apparent”, such as the depth of the Treasury market, which by some measures is now the weakest since the nadir of the financial crisis.

Transaction costs have also surged.One fund manager said that the prevalence of work-from-home arrangements was also having a clear impact on banks and asset managers.

“The average trader on Wall Street is inexperienced, can’t take risk, and now can’t communicate with colleagues properly,” he said.

“They’re isolated at home in their sweatpants, and they’re not going to step in to provide liquidity.

Psychologically it’s a bad situation.”

Downturn, disrupted

Business and the next recession

When economies change, so do recessions. What will the next one look like?




Cast your mind back to 2007. Flashy types were showing off their first-generation iPhones.

Netflix sent dvds through the post for people who did not have the time to drop into a branch of Blockbuster.

The biggest firms in the world were old-economy stalwarts such as General Electric and Royal Dutch Shell. Myspace ruled online. That seemingly distant era was when America, followed by Europe and most of the rich world, last fell into recession.

Since then the way people buy products, entertain themselves, move around and borrow money has altered and in some cases been revolutionised by a mighty band of global technology titans.




“The composition of the economy has changed since 2007, and hence so will the nature of recessions,” says Douglas Elliott of Oliver Wyman, a consultancy.

Working out the impact of the next recession is important because one is on the way, sooner or later. Past recessions have been costly.

The Economist calculates that in the most recent downturn 11m people lost their jobs in rich economies and profits of big listed firms in Europe and America dropped by 51% and 30%, respectively.

Stockmarkets always take a battering when the economy turns (see chart 1). Recessions matter to governments and central banks, which must work out how to respond, and to firms and investors, because downturns sort the wheat from the chaff.

In the past three recessions the shares of American firms in the top quartile of each of ten sectors rose by 6% on average, while those in the bottom quartile fell by 44%.

In some important ways the corporate world looks similar to the picture in 2007. American firms are big earners, with corporate profits steady at 8.5% of gdp, and many industries are relatively highly concentrated.

In Europe profitability and concentration remain lower. As in 2007, Western firms remain highly globalised despite the trade war. Big listed firms in America make 31% of their sales outside their home market, while for large European companies the figure is 53%.

Much has also changed. First, the digital world is more dominant. An economic bounceback has fuelled the rise of global tech giants that have disrupted incumbents in retail, taxis, hotels and many other businesses.

The example of tech upstarts has seeped through to non-tech firms, which are now more asset-light. Managers have shifted it spending from buying servers to renting them through the cloud, for example.

The second change is that bosses may have less room to cut costs.

Third, some firms have heaped on debt and engaged in accounting puffery, increasing what John Kenneth Galbraith, an economist, called “the bezzle”: money no one is aware has gone missing. Boom times paper over cracks, for instance by allowing firms to delay writing down the value of misfiring acquisitions.

Start with the first change, the rise of digital technology. The most visible difference is in the nature of the largest firms: seven of the ten most valuable firms in the world are now tech outfits, up from two in 2010 (see chart 2).

In America the top five —Alphabet, Apple, Amazon, Facebook and Microsoft—account for 13% of the profits of s&p 500 firms. This is forecast to rise to about 20% in five years’ time.

At less than 5%, their share of s&p 500 employment is small but they have become America’s largest investors, ploughing $189bn into the economy last year (including research and development), equivalent to 17% of investment by big publicly listed companies.




How the tech giants weather a recession is thus of great importance. Investors may view these firms as impregnable, but they are heavily exposed to revenues that are cyclical (see chart 3), including advertising, consumer spending and business it spending, which were all sensitive to the economic mood in the pre-digital age.

Novel business models may offer some protection. Perhaps Facebook users will spend more time online if they lose their job? Maybe advertisers will slash spending on tv, newspaper and billboard advertising before taking the knife to digital spending.

There is evidence that the pain could be acute. In downturns in 2000-02 and 2007-08 sales growth at Amazon and Microsoft slowed sharply. Smartphone sales have already slowed. A recession may see consumers hanging on to devices for longer rather than trading up to the newest handset. Fortress balance-sheets offer a measure of safety: the big five tech firms have $270bn of net cash.

Beyond the giants, insurgents have emerged. Airbnb and Uber have turbocharged the matching of buyers and sellers. Financial innovators such as LendingClub and SoFi facilitate millions of loans by connecting people who need money with those with some to spare. Subscription offerings have flourished, delivering anything from ready-made meals to makeup. For many this will be their first downturn; for some it may be their last.

Not all will be hit as badly as might be expected. A recession in Brazil in 2015-16 hit demand for Uber rides hard, but higher unemployment meant more cash-strapped drivers were available, reducing costs and improving service.

Likewise a downturn could help Airbnb win market share from hotels if it means more people make their homes available for rent in search of cash. A crisis may not so much impact tech companies as accelerate the decline of the “old”, non-digital economy.

The tech darlings that look most vulnerable are those that offer “micro-luxuries”: discretionary spending consumers can quickly forgo. Expect Deliveroo (food delivery), Bird (electric-scooter rentals) and Peloton (subscription exercise bikes) to feel the pinch.

Those with high fixed costs will be especially exposed as demand falls. WeWork, a tech-tinged property firm, is committed to $47bn of lease payments over the next 15 years or so. Such firms may not be good at retreating. “If you’re a 30-year-old tech founder, who has never been through a recession, you think things grow forever. Cutting costs isn’t part of your playbook,” says Tom Holland of Bain, another consultancy.

While it is not Silicon Valley’s forte, ruthless cost-cutting has always been part of the playbook for companies outside the tech industry when the economy slumps. In the last recession the labour costs of American firms dropped by 7% in total as they laid off workers and squeezed wages to protect shareholders and avoid default.

The austerity game

Room for manoeuvre is now more limited. In some cases this is because cost structures have changed. Over $200bn of annual corporate it spending, for example, has shifted to cloud-computing providers such as aws and Microsoft. Costs that used to come in lumps (on a big server once a decade) now arrive as a quarterly bill for software-as-a-service. This could help.

If a firm is going bust it may find it easier to pay its cloud bill than to flog unwanted hardware.

But firms are losing flexibility to preserve cash by delaying capital spending.

Meanwhile the social context has shifted. In 2019 the heads of 181 of the largest firms in America said they shared a “fundamental commitment” not just to their owners but to their customers, employees, suppliers and communities, too. Many ceos privately regard these kinds of declarations as decorative fluff.

This will be tested in a downturn as laying off workers and outsourcing jobs abroad come under more political fire. “You don’t want to be seen firing people, especially if you’re still profitable,” says one European boss. “It will be more of a last resort. We may have to take a bit more pain before announcing lay-offs.”

The final change is that a long period without a downturn has encouraged bad habits that mean some firms are too indebted, or are hiding nasty secrets. Such problems are usually spotted once it is too late to fix them. The Asian crisis of 1997 featured crony-capitalists crippled by debt-currency mismatches; in 2000-01 it was imploding dotcom firms and frauds at Enron and WorldCom; and in 2007-09 banks built on rotten foundations crumbled.

Predicting these fiascos is hard but there are some general warning signs. After a long bout of dealmaking, goodwill (the difference between what the acquirer pays for a target and its book value) is at a record high of $3.6trn for s&p 500 firms.

This can indicate trouble. In 2000-01 and 2007-09 firms made huge goodwill write-offs as they confessed to dodgy deals.




In America 97% of firms in the S&P 500 in 2017 presented at least one metric of their performance in a way that was inconsistent with Generally Accepted Accounting Principles, or gaap, up from 76% before the last downturn, according to Audit Analytics, a consultancy.

The number of large American firms mentioning “adjustments” to profits has more than doubled since the last recession (see chart 4).

Over 60% of American mergers and acquisitions were financed last year with loans that include “add-backs”, a rapidly rising accounting phenomenon. These allow buyers to ignore inconvenient expenses more or less at will, for example by assuming merging firms will successfully cut costs once combined. Loan documents are drawn up using the fiddled profit figures as a baseline.

Often the losers are firms with too much debt. If a recession is triggered by rising interest rates they get hit just before the downturn begins and again once it is in full swing, as sales slide and they struggle to meet interest costs or refinance loans. Since 2007 overall corporate debt has risen.

In Europe non-financial corporate debt now stands at nearly 110% of gdp, compared with under 90% in 2007. In America businesses are now borrowing more than households for the first time since 1991.

Much of the money has gone to companies with far less ability to repay their current debts, let alone when a downturn strikes. In the rich world one in eight established companies makes too little profit to pay the interest on their loans, let alone the principal. That is up from one in 14 in 2007, according to the Bank for International Settlements.


A recession half as bad as the 2007-09 slump would result in $19trn of corporate debt—nearly 40% of the total—being owed by such straitened companies, according to the imf. Janet Yellen, a former chair of the Federal Reserve, has warned that “if we have a downturn in the economy, there are a lot of firms that will go bankrupt, I think, because of this debt. It would probably worsen a downturn.”

Optimists argue that the structure of debt has become more flexible. Banks are in better shape thanks to new (albeit largely untested) regulations enacted since 2008, and so should be able to keep lending if the economy sours.

Businesses have been able to secure loans with fewer strings attached, for example if they look like they may struggle to repay the money. In America, businesses now borrow increasingly from lenders outside the banking system, such as the private offices of rich families, or pension funds.

These, some say, can knock heads together quickly and help firms recover. It is best to take such statements with a pinch of salt. A mini-panic in late 2018 saw the price of many private-debt instruments plunge, suggesting the system is fragile.

Winners and losers

Who will be the winners?

Every recession has them. Warren Buffett picked up assets on the cheap in 2007-09, while JPMorgan Chase cemented its place as America’s leading bank as the industry retrenched.

Firms that thrive in downturns tend to have the clarity of purpose and financial muscle to keep investing and growing as others pull back, says Martin Reeves of the bcg Henderson Institute.

It is a test of management and culture but also requires strong balance-sheets: 15% of firms in the S&P 500 have more cash than debt, including Apple and Monster Beverage. Investors with money are watching and waiting.

The private-equity industry has some $2trn of cash. Mr Buffett sits on $128bn.

A recession will come, eventually. When it does it will batter companies that have been sustained only by low interest rates.

The churn as those businesses are sold, restructured or dissolved will extract an economic and human toll. Recriminations will fly, then abate. In time, the more productive firms that survived will think of ways to invest money profitably.

That will lead to new jobs, then economic growth, then exuberance—and the cycle will start all over again.

Carmakers struggle to plan for an autonomous future

The industry hopes a shift away from private ownership does not have to be a problem

Izabella Kaminska

An Uber drives down 34th Street in Manhattan, New York, U.S., on Thursday, August 9, 2018. John Taggart/Bloomberg
Network operators such as Uber and Lyft don’t necessarily want to own the vehicles they rent to the public © Bloomberg


Car manufacturers don’t just sell customers a transport solution. They sell an aspirational lifestyle.

So it should come as no surprise that many have started to worry about the impact autonomous driving technology will have on their profits, if and when those aspirations are made irrelevant.

Some industry practitioners believe that when travelling in autonomous vehicles becomes the norm, there will be little to no incentive to own a private car at all. Instead, fleet managers or ride-sharing networks will rent cars to the public as and when demand requires, undermining the opportunity for manufacturers to increase margins with bespoke extras.

The industry’s response is that the shift doesn’t have to be a problem for profitability. People will still need cars; business models will have to adjust. Rather than marketing cars to individuals, manufacturers will have to be better at marketing themselves to professional fleet networks or operators.

But this view ignores the role private car ownership plays in pricing vehicle transport more widely. Network operators such as Uber and Lyft don’t necessarily want to own the vehicles they rent to the public. Asset ownership can be burdensome and these businesses understand that tying balance sheets up in fixed assets can impede growth.

It can also expose owners to all sorts of inconvenient risks and costs, such as accident and damage liability, maintenance and fuelling expenses. For private owners, the utility and convenience drawn from exclusive ownership makes those costs and risks seem worthwhile.

This has sparked speculation that the sector might emulate the “opco-propco” model used in retail and hospitality. Companies are split into two entities, with the operational side engaging in a sale and leaseback with the property-owning entity in a way that improves the overall credit standing of the duo and lowers its funding costs. The “propco” might then be organised as a sort of investment trust, opening the door to low-risk mutualised ownership.

The problem is that investors in vehicle fleets would be exposed to a lot more risk than in conventional real estate investment trusts, because the depreciation rate of autonomous vehicles is an unknown variable in a world where private ownership has been upended.

In conventional vehicle securitisations, the cost-effectiveness of lease payments is tied to how well the cars keep their value in the second-hand market. If the market is expected to be strong, the collateral value of the car can be used to discount the effective rental costs.

Without private buyers for former fleet vehicles, however, it’s hard to imagine how residual values might be propped up. Resale value might have to be determined solely by scrap value, increasing leasing costs all round.

Here lies the paradox for the autonomous market. If private ownership becomes obsolete, fares will lose an important source of subsidy through the residual value channel. Ironically, rental rates could then rise to levels that made private ownership seem more compelling rather than less.

Some say the solution lies in collective autonomous membership schemes, where a one-off investment (less than the cost of buying a car outright) entitles a member to ride in any available vehicle. But the problem then becomes one of liquidity management and ensuring members don’t demand to use the scheme’s cars at the same time.

The only way to resolve that difficulty is to ensure a fleet has at least one vehicle per member on hand, making the cost of membership entirely substitutable with private ownership. The key benefit then becomes the capacity to summon a vehicle quickly, rather than having to wait for one’s personal car to arrive from half way across town.

Whatever the industry hopes, that benefit might not be enough to compensate for the burden of not being able to keep personal items at the ready in one’s boot. They may need to think again.

jueves, marzo 12, 2020

OIL PRICES / GEOPOLITICAL FUTURES

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Oil Prices

By: George Friedman


Since before World War I and throughout the 1970s, the people who controlled oil had a lever for controlling others. Since the 1980s, the equation has shifted; oil producers have become dependent on oil consumers. Demand was always there, and then it started to vary and the political stability of oil producers also varied.

Geopolitical Futures’ forecast for 2020 was that there would be a global economic slowdown, whose effects would be intensified by dynamics kicked off by the 2008 crisis. We saw the 2008 crisis as being an exporters’ crisis, in which countries dependent on exports, particularly China, had been badly hit by the decline of global demand for manufactured goods, and exporters of raw materials, particularly Russia and Saudi Arabia, were hurt by the decline of demand in manufacturing countries like China. Our view of 2020 was that a routine business cycle would resurrect those pressures.

We did not anticipate the coronavirus, nor the global panic, particularly the disruption of the Chinese economy. We predicted that the Chinese economy would be disrupted as a result of a decline in global demand, and this would be followed by a decline in oil prices. The result would be increased global political stress, particularly on oil producers. Energy accounts for 30 percent of Russia’s gross domestic product and 60 percent of Russia’s exports. It accounts for 50 percent of Saudi Arabia’s GDP and 70 percent of its exports.

The political consequences of the global slowdown, according to our forecast, would be most intensely felt by countries most dependent on energy production. The second tier of countries that would be most affected were those most dependent on exports, led by China and Germany, which relies on exports for nearly 50 percent of its GDP. These countries would face internal political turbulence as the decline affected internal economic systems, and social systems as a whole.

European countries have seen contractions in their economies, or declines in growth. China was under heavy economic pressure before the U.S. imposition of tariffs, and was facing instability in Hong Kong and Xinjiang. Russian President Vladimir Putin had imposed a radical new model for Russian governance and was obviously sensitive to weakness in oil prices, which could not return to the high prices that had previously fueled the Russian economy.

The United States is the strongest economy in the world, partly because among the major economies it is least dependent on exports, which account for about 13 percent of GDP, with nearly half going to Canada and Mexico. What is happening is in outline what we expected: China is staggering, triggering a decline in oil prices, and the U.S. is slowing but not going into crisis.

The question now is what the effects of the decline of oil prices will be on Saudi Arabia and, most important, Russia. The economic consequence has to be substantial. Russia has reserves, and it has claimed that the Russian system would continue to function well with oil as low as $40 per barrel. At the time of writing, the price is below that level, and reports of serious economic stringency, especially outside of Moscow and St. Petersburg, were rampant even before this crisis.

More important, when the Russians speak of reserves, they are speaking of their national budget. That budget is a vital part of their economy but far from all of it. The budget may have some buffering, but the rest of the economy is highly vulnerable to the impact of low oil prices.

Russia is a major power, and as with the Soviet Union, which was difficult to read until it collapsed, economic instability in Russia is significant globally. Many have argued that the Soviet Union collapsed because of low oil prices and high defense spending. I think these were contributing factors but not decisive.

We are seeing those forces at work now as well. This also explains why the Russians were not prepared to cut oil production when the Saudis demanded it. The Russians simply could not absorb the cost of stabilizing the price of oil. It is not clear that the Saudis can either, but their global significance, once massive, has declined greatly since the 1970s, and even Saudi Arabia’s regional power is limited.

Whether the Saudis miscalculated, acted out of domestic pressures, or now expect the Russians to limit the damage on them by aligning with the Saudis is unknown, but the damage to the global economy is intense and has been inevitable for some time. It is the speed that is unique and damaging.

There have been analyses arguing that the Russians engineered the decline in prices to hurt U.S. shale producers. Given that it was not Russia but Saudi Arabia that engineered the decline (Russia was resisting the Saudi price cut), this would be Russia cutting off an American finger while cutting its own throat.

The Russians are enormously more dependent on higher oil prices than the Americans are. Texas oil will be hurt, but that is a fairly small part of the American economy, and nowhere near the 30 percent of Russia’s economy.

The economic and political question surrounding the coronavirus is how long it will take to normalize its presence. The virus is new and frightening. It is likely not going to disappear. If it does not, it will be integrated into expectations around the world. As with other diseases, some people will get it and some will die.

Shutting down the movement of people and goods and slashing economic output will likely produce net negative results greater than the coronavirus. Unless it appears that it has the characteristics of the Black Death, it will become part of the panoply of diseases like tuberculosis, Lyme disease or malaria that the world lives with. The arrival of treatments and vaccines will of course speed this up.

The question then is what the economic damage will be, and therefore what the political damage will be. China is the fulcrum of the issue, and its problems go beyond the coronavirus. It is also the largest importer of oil in the world.

As its economy weakens, oil prices will decline. And with the decline of oil prices, oil exporters will face serious economic problems, and political tension as their economies weaken. The coronavirus did not cause this. It did, however, intensify the time frame dramatically.

US economy is dangerously dependent on Wall Street whims

The Federal Reserve faces pressure to keep cutting rates to keep asset prices high

Rana Foroohar

US Asset Bubble Economy
© Matt Kenyon


Watching the markets these days is like watching the seven stages of grief — shock, denial, anger, bargaining, depression, testing and, finally, acceptance. We clearly have not reached that last stage yet.

This isn’t really about coronavirus — that was simply a trigger for a correction I have long expected. The US is in the longest economic recovery cycle on record, with mounds of global debt, falling credit quality, and decades of low interest rates driving asset prices to unsustainable levels.

The reluctance of investors, politicians and central bankers to accept that is not just an example of the natural human tendency to put off pain. Rather it is something scarier and more factual.

The truth is that the US economy is now dependent on asset bubbles for survival.

This was sharply quantified in a recent edition of financial analyst Luke Gromen’s weekly newsletter “The Forest for the Trees”. About two-thirds of the US economy is consumer spending. But people’s spending patterns are not based on their income alone. Our personal consumption is also linked to our expectation of wealth held in assets like stocks and bonds.

What’s stunning is how utterly dependent American fortunes have become on the inflation of those asset prices. Mr Gromen has calculated that net capital gains plus taxable distributions from individual retirement accounts are equal to 200 per cent of year on year growth in US personal consumption expenditure.  
That does not necessarily mean that people are pulling money out of their retirement accounts to buy hand-sanitiser, bottled water and face masks. But Mr Gromen argues that it does mean that US gross domestic product “cannot mathematically rise if asset prices are falling”.
 
No wonder the US Federal Reserve cut rates by 50 basis points last week. The move came with a predictable risk of spooking the market — and it did so. The S&P 500 fell nearly 3 per cent that day. But the fundamental risk of inaction was deemed greater.
 
Central bankers are clever people. They know that they cannot fix pandemics or political dysfunction with monetary stimulus. But in the US more than anywhere, they have found themselves in an unenviable position: managing an economy that has, over the last several decades, and particularly since 2008, depended on low interest rates to push up asset prices.
 
That in turn has made it less obvious to consumers (and voters) that average real weekly earnings for the bottom 80 per cent are at about the level they were in 1974, and that the things that make people middle class — healthcare, education, and housing — have become unaffordable.
 
Seen in this light, President Donald Trump’s disingenuous attempts to equate the fortunes of Wall Street with those of the country at large make a kind of grim sense. The value of the S&P 500 is less a gauge of the broad health of US corporations or consumers than it is of the wealth of a few tech firms and value of the 2017 tax cuts. The latter accounted for two-thirds of the aggregate rise in corporate profits between 2012 and today.
 
But share price increases represent a disproportionate amount of the income tax paid by the top 5 per cent of earners, who pay 60 per cent of income tax receipts. Given the importance of asset price increases in both tax receipts and GDP growth, it is hard to imagine a world in which the Fed won’t keep cutting rates indefinitely. Live by the market, die by the market.
 
It did not have to be this way, and this situation did not develop overnight. The US built an economy that is dangerously dependent on the whims of Wall Street little by little, since the 1970s onwards. It is the result of policy changes driven by both Democrats and Republicans.
 
Among them was the 1982 rule that allowed share buybacks in specific conditions, even though this had once been considered market manipulation; and the decision to provide favourable tax treatment to stock options, which allowed already fortunate people to profit from the rising valuations of companies they worked for. The most fundamental change was the shift from defined benefit pensions to defined contribution 401(k) plans, which has linked the future of so many Americans, in a Faustian way, to the fickle fortunes of the market.
 
All of it was supported by the myth that share prices are the ultimate indicator of what was happening inside a company, and ultimately, an economy.
 
I don’t think that’s really been true for a long time, something underscored by last week’s death of former General Electric chief executive Jack Welch. He came to represent the rise, and ultimately, the fall of shareholder focused capitalism. After the 2008 crisis it became clear that GE’s share price under Welch had been artificially bolstered by debt and leverage.
 
Welch eventually rejected shareholder “value” as the “dumbest idea in the world”. I can only hope that this market downturn will force more people to come to the same conclusion. How much longer can we run an economy driven so disproportionately by financially engineered asset bubbles? The next few weeks and months may give us the answer.




Is a Strong Economy Enough to Re-Elect Trump?

The odds of an economic downturn in the US this year remain low, which means that US President Donald Trump's prospects for re-election in November are strong. But with an approval rating still below 50%, Trump will have to navigate a difficult field of swing states and cross his fingers that the Democrats are hobbled by infighting.

Michael J. Boskin

boskin68_JIM WATSONAFP via Getty Images_trumprally


STANFORD – With the US presidential primaries underway, everyone is wondering whether President Donald Trump will be re-elected in November. Opinion polls show that the ability to beat Trump ranks high among Democratic primary voters’ top priorities.

Following Trump’s acquittal in the Senate on impeachment charges and a State of the Union address in which he could tout America’s strengths – first and foremost, the economy – the president’s approval rating, at 49%, is the highest since he took office.

But Trump has reason for concern. The acquittal may offer merely a transitory bump, and his approval rating should be much higher than it is, given the state of the economy.

Consider the precedent of President George H.W. Bush, whose approval rating rose to 91% following the first Gulf War, which had received congressional approval, succeeded in expelling Saddam Hussein’s Iraqi forces from Kuwait, and was partly paid for by America’s allies (including Saudi Arabia, the United Arab Emirates, Germany, and Japan).

In an Oval Office meeting at the time, I tried to persuade the president’s political team that, despite his recent successes, he needed a better strategy for responding to a mild recession that had begun in the latter part of 1990. I reminded them that even Britain’s victory in World War II had not spared Winston Churchill defeat in an election held less than three months later.

In the event, Bush, anticipating that massive Democratic majorities in both houses of Congress would block any legislation he proposed, decided to postpone a bolder economic agenda until after the election. He hoped that a Republican revival would improve its chances in Congress. But, owing to a slow recovery and Ross Perot’s third-party candidacy, Bush was defeated by Bill Clinton.

For his part, Trump has escaped most of the blame for presiding over large budget deficits. But that is because the Democrats’ proposals would blow up the deficit even more. At the same time, Trump can tout an historically low unemployment rate, including among minorities, as well as solid wage gains, which have been strongest at lower income levels.

Trump can also point to trade deals like the US-Mexico-Canada Agreement, which will offset some of the damage from his tariffs. He has secured funding to rebuild the military, and appointed two conservative Supreme Court justices and many more federal district and appeals court judges. And he has signed bipartisan criminal justice reform legislation and a major tax-reform package, as well as rolled back some of the excessive regulations of the Obama era.

Political prediction models, based largely on economic conditions, suggest that Trump should win easily in November, as do betting markets, which give him a 60% chance – an increase since the pre-impeachment period. Trump’s problem, of course, is that he consistently steps on his own good news with his daily Twitter attacks, which have turned off some of the voters he needs.

Meanwhile, the leading Democratic contenders to have emerged are US Senator Bernie Sanders of Vermont and former New York City Mayor Michael Bloomberg. National polls suggest that any of the Democrats currently running would beat Trump. But those predictions could be misleading, because they do not account for Trump’s outperformance among actual voters in the states that he needs to win the Electoral College.

The biggest threat to Trump, then, is an economic downturn that reverses the recent job and wage gains and triggers a stock-market selloff; but forecasters see low odds for this scenario. Another issue will be the mood among voters in 8-10 swing states. Trump remains a sharply polarizing figure, and a re-election bid is a referendum on the incumbent.

Some of the states that carried Trump in 2016 swung to the Democrats in the 2018 midterm congressional elections. Trump narrowly won Pennsylvania, Michigan, Wisconsin, and Arizona in 2016, but he just narrowly lost in Minnesota and New Hampshire. Florida and Ohio, usually the most important swing states, are currently leaning his way, and a few other states that he previously won or lost by 3-5 points could conceivably come in to play.

Meanwhile, Bloomberg has already spent hundreds of millions of dollars on advertising – more than all the other candidates combined – and is willing to spend $1 billion to defeat Trump, even if he does not secure the Democratic nomination. If the Democrats are united and encourage strong turnout, especially among minorities and younger voters, they could win.

After complaints from the Sanders campaign that party rules unfairly favored Hillary Clinton in the 2016 primary contest, Democratic convention delegates will now be awarded proportionally to all candidates who receive at least 15% of the vote in a given state. Ironically, this means that Sanders may reach the summer convention in Milwaukee, Wisconsin, with a plurality but not the majority needed for nomination.

In that case, party officials, chosen without regard to primary results, will vote on a second ballot. Overall, more Democrats associate with the center-left than with the far-left. But if they come together to nominate a more moderate candidate, they risk alienating Sanders’s base, whose failure to turn out in November would tip the scales to Trump. Republicans, meanwhile, remain united behind Trump following his impeachment, which enraged his base and which most moderates viewed as unnecessary overreach.

As of now, Bloomberg is untested, Sanders’s odds are lower than they would be in the event of widespread economic distress, and Trump remains both his own best advocate and worst enemy. The outcome might come down to whether the 10-15% of persuadable voters in swing states – most of whom are satisfied with the condition of the country, the economy, and their personal finances – decide that they can tolerate another four years of Trump’s tweet storms.

Or, they might not “vote their pocketbooks.” They could decide that enough is enough, and accept a leftward policy lurch in exchange for a leader who foregoes the Twitter attacks.


Michael J. Boskin is Professor of Economics at Stanford University and Senior Fellow at the Hoover Institution. He was Chairman of George H. W. Bush’s Council of Economic Advisers from 1989 to 1993, and headed the so-called Boskin Commission, a congressional advisory body that highlighted errors in official US inflation estimates.

On Leadership, Virtue and Vice

By: George Friedman



Editor’s note: George is preparing for a book tour for his new book “The Storm Before the Calm,” which launches in a few days. He was unable to write a new Thought piece this week, so we hope you’ll bear with him and enjoy re-reading this piece we chose from June 2017.


Last week there was a fire in a high-rise building in London that killed dozens. British Prime Minister Theresa May was slow to issue a statement, and it was another day before she visited the scene – and then only to meet with members of the emergency services.

It was not until day three that she paid a visit to the survivors. Her explanation was that she was busy overseeing the management of the disaster and therefore couldn’t go sooner. She was met by a storm of criticism.

Two questions arise from this affair. First, why would anyone think an empty gesture like visiting the site of a fire – no matter how many died – to be important? Perhaps the prime minister ought to be doing something productive? Second, why did May answer that she was busy overseeing the crisis?

Exactly what was it about the disaster that she could oversee? She faced what seemed to be unreasonable condemnation and replied with a preposterous justification.

But it is the first question that I want to discuss because it raises another, more important question: that of leadership.

More Than Policy

The simple answer to the first question is that May ought to have visited the site of the fire because that’s what prime ministers do. They engage in gestures, and whatever they may privately feel or not feel, they show themselves to be grieving the dead.

A prime minister, a president, a king or a queen represents the country at moments such as these, and their responsibility is to convey to the country the gravity of the event, the sorrow they feel, and that the state – personified by them – is not indifferent to the suffering of its citizens.



Members of the emergency services work inside the charred remains of the Grenfell Tower block in Kensington, west London, on June 17, 2017, follwing the June 14 fire at the residential building. TOLGA AKMEN/AFP/Getty Images


Even if the grief is posed, there is value in it. The philosopher La Rochefoucauld wrote that hypocrisy is the tribute that vice pays to virtue. Many of us are incapable of feeling the emotion we ought to feel. The reason is that, in some way, we are corrupt. But in pretending to feel it, we are validating virtue.

A leader must represent the best of us. May is not the head bureaucrat; she is a political leader, and the exercise of leadership is meant to display the virtues the nation ought to have. This is so important that the U.K. has two such leaders – the prime minister and the queen – both of whom are required to show what is appropriate and what the state feels, even if they don’t themselves feel it.

A political leader must first lead, and in leading, gain the authority to make policy. A leader who wants to make policy and is indifferent to the task of leadership will fail. Policy is easy; leadership is hard.

The statue of Abraham Lincoln in Washington superbly grasps who we wanted Lincoln to be: a brooding, grieving figure who felt every death, on both sides, during the Civil War. Whether he actually felt that I don’t know. But he convinced the nation that he did. Otherwise, his statue would not have been built or honored. Lincoln understood that the country had to be healed, or the union, saved in battle, would be lost in peace.

To heal it, he had to project to the country that the war was not only a tragedy but also a necessity. He also knew that there had to be a reconciliation. And for this reconciliation, the Confederacy could not be absolved, but those who fought for it had to be. Its soldiers had to be treated with honor – not for their beliefs, but because they believed deeply enough to die.

This is the purpose of leadership. A leader understands what is necessary. He also understands that governing, properly done, is a work of art. A leader paints a picture of who he is by what he says, by the gestures he makes and by framing an abiding concern for the nation. It is a concern that ought to be natural but in the greatest of politicians is crafted, sometimes in opposition to their nature. In our age, this would be the crime of inauthenticity.

La Rochefoucauld would celebrate it since it is far harder to appear to be caring when you are not than it is to feel the things you ought to. But a leader who knows what is right and needed in spite of his nature does something much harder: He does what he should and not what he is inclined to do. And he does it in such a way that we can believe in his virtue, and through him, in our own.

A nation that does not feel itself as virtuous is wounded in its soul. When there is no leader who even goes to the trouble of appearing to understand what the virtue of a leader is, then the country itself loses its sense of virtue. When a leader cannot imagine leadership beyond expertise in policymaking, and sees the role of leadership as a trivial task, then we are in equal trouble.

The Art of Leadership

In focusing on the question of leadership, I am challenging one of the foundations of geopolitics. Geopolitics, as we interpret it, argues that nations are too vast to be ruled by any one person, particularly since no leader rules for very long compared to the life of a nation.

For us, the course of nations can be best understood by ignoring presidents and prime ministers, and all the lesser figures, and focusing on the impersonal forces that shape millions of people and cause the nation to act in certain and predictable ways.

If this is true, then Lincoln’s leadership would be a matter of indifference. The North, having defeated the South, would inevitably have unified the nation. In fact, with Lincoln dead, the victors imposed Reconstruction, a relatively harsh regime that told the South that it had lost and would pay the price. Despite the absence of Lincoln’s sensibility after the war, the union survived. From this, it could be said that Lincoln was irrelevant.

But that assumes that geopolitics, as important as it is for my understanding of the world, would be all there is to public life; there is what will be and what can’t be, and that determines the rise and fall of nations. This is what geopolitics is about, and it matters. But nations also have an aesthetic sense of themselves.

We live in a work of art crafted by the founders and leaders of the nation. It defines our sense of self, and without that sense, we rise and fall in a very squalid place. Lincoln crafted a picture of who Americans are, and it is not unfair to say it has been lost – by all factions of our polity.

Nothing worth having has replaced it. America is a great power, but one with a troubled and hungry soul.

I began this with a trivial moment, in Britain, where a prime minister did not present herself at a fire and show the nation that it is proper to grieve. She answered that she had no time to go because she was busy managing things.

She did not know that management is not the task of the prime minister – at least not until after she leads. And if she leads, management becomes easier.

Her predecessor, Winston Churchill, knew this.

Churchills come rarely into the world, and truth be known, he was a fairly poor manager. But he gave Britain the sense that the world was filled with evil, and that that evil had to be destroyed.

He also gave Britain the sense that it was not only worthy of the task, but that it should feel itself honored to be placed in the role. Britain might have been victorious without Churchill.

But Churchill not only made it far easier to win, but he gave the victory a meaning of transcendent importance. He made Britain into a work of art and lifted it among the prosaic and squalid business of just surviving.

He did not change history, but he imbued it with virtues that even the most wicked of people would have honored by their hypocrisy.