A sea of debt

Corporate bonds and loans are at the centre of a new financial scare

The pool of corporate lending has risen to $74trn




Over the past decade officials—and some bankers—have tried to redesign the financial system so that it acts as a buffer that absorbs economic shocks rather than as an amplifier that makes things worse. It faces a stern test from the covid-19 virus and the economic ruptures it has triggered, not least a Saudi-led oil-price war.

The locus of concern is in the world’s ocean of corporate debt, worth $74trn. On Wall Street the credit spreads of risky bonds have blown out, while in Italy, a bank-dominated economy that is already in lockdown, the share prices of the two biggest lenders, Intesa Sanpaolo and UniCredit, have dropped in the past month by 28% and 40% respectively.

The scare has four elements: a queasy long-term rise in borrowing; a looming cash crunch at firms as offices and factories are shut and quarantines imposed; the gumming-up of some credit markets; and doubts about the resilience of banks and debt funds that would bear any losses.

Take the borrowing first. Companies came out of the 2007-09 financial crisis in a relatively sober mood, but since then have let rip. Global corporate debt (excluding financial firms) has risen from 84% of gdp in 2009 to 92% in 2019, reckons the Institute of International Finance.

The ratio has risen in 33 of the 52 countries it tracks. In America non-financial corporate debt has climbed to 47% of gdp from 43% a decade ago, according to the Federal Reserve.




Underwriting standards have slipped. Two-thirds of non-financial corporate bonds in America are rated “junk” or “bbb”, the category just above junk. Outside America the figure is 39%.

Firms that you might think have rock-solid balance-sheets—AT&T—have seen their ratings slip, while others have been saddled with debts from buyouts.

Naughty habits have crept in: for example, using flattering measures of profit to calculate firms’ leverage.

All this leaves business more vulnerable to the second factor, the shock from covid-19 and the oil-price slump. Some 7% of non-financial corporate bonds globally are owed by industries being walloped by the virus, such as airlines and hotels.

With oil close to $35, America’s debt-addicted frackers and other oil firms are in trouble.

Energy is 8% of the bond market.

A far broader set of firms could face a cash crunch if temporary shutdowns and quarantines spread. In China over the past months, financial distress—and informal forbearance—has been widespread. One multinational says it has relaxed its payment terms with suppliers in China.

HNA, an outrageously indebted conglomerate than runs an airline, has been bailed out.

To get a sense of the potential damage in other countries The Economist has done a crude “cash-crunch stress-test” of 3,000-odd listed non-financial firms outside China. It assumes their sales slump by two-thirds and that they continue to pay running costs, such as interest and wages.

Within three months 13% of firms, accounting for 16% of total debt, exhaust their cash at hand. They would be forced to borrow, retrench or default on some of their combined $2trn of debt. If the freeze extended to six months, almost a quarter of all firms would run out of cash at hand.

The near-certainty of rating downgrades and defaults in the travel-related and oil industries, and the possibility of a broader crunch, is the third concern. Credit derivatives, the most actively traded part of the fixed-income markets, have recoiled. The cdx index, which reflects the cost of insuring against default on investment-grade debt, is at its highest level since 2016, as is the iTraxx crossover, which covers riskier European borrowers.

Out of the public eye, privately traded debt may now only change hands at heavily discounted prices. The issuance of new debt has “dried up”, says the head of a big fund manager. This could fast become a serious problem because firms need to refinance $1.9trn of debt worldwide in 2020, including $350bn in America.

Fractured markets mean the fourth element, the resilience of the institutions that make loans and buy bonds, is critical. A majority of American bonds are owned by pension funds, insurers and mutual funds that can cope with losses.

But some will be reluctant to buy more. And 10-20% of all American corporate debt (bonds and loans) is owned by more esoteric vehicles such as collateralised-loan obligations and exchange-traded funds. Such exposures have yet to be fully tested in an extended period of severe market stress.

Who, then, can act as a source of stability and fresh lending? Some big cash-rich firms such as Apple could grant more favourable payment terms to their supply chains. Private-equity firms have capital to burn. But in the end much will rest on the banks, who have the relationships and flexibility to extend credit to tide firms over.

America’s banks have their flaws—Goldman Sachs is sitting on $180bn of loans and lending commitments with ratings of bbb or below, for example. But broadly speaking they are in reasonable shape, with solid profits and capital positions.

Outside America the picture is less reassuring. Europe’s banks make puny profits, partly because interest rates are so low; Italian banks had a return on equity of just 5% last year. Since the virus struck, the cost of insuring their debt against default has flared up, hinting that they could yet become a source of contagion.

State-backed banks in China and India will do as directed by politicians. But they are already labouring under large bad debts.

Global business may need a giant “bridging loan” to get through a tough few months. And governments may need to intervene to make it happen: by flooding credit markets with liquidity; by cutting taxes to get cash to companies; and by prodding banks to lend and show forbearance.

The world’s financial system has not yet become a source of contagion in its own right. But neither has it shown it can spontaneously help firms and households absorb a nasty but transitory shock.

Why Sweden ditched its negative rate experiment

Results of the Riksbank’s 5-year trial are being scrutinised by the world’s leading central Banks

Richard Milne in Stockholm and Martin Arnold in Frankfurt


© Bloomberg; Getty Images | Stefan Ingves of the Swedish Riksbank argues that negative rates worked; Christine Lagarde of the ECB believes we should study the side effects


It is the biggest monetary policy experiment of modern times. One that has divided economists, central bankers and politicians. But now that Sweden has called a halt to its five-year trial with negative interest rates the serious work has begun on looking at whether it worked.

Sweden’s Riksbank, the world’s oldest central bank, was the first to take its main repurchase rate — at which commercial banks can both borrow or deposit money — negative in early 2015, to fend off deflation, only returning to zero in December.

The end of the Swedish experiment is being watched with intense fascination, not just by those central banks that still have negative rates such as the European Central Bank and Bank of Japan, but also by authorities and economists worldwide pondering how to respond to the next downturn with limited ammunition to stimulate the economy.

For many, it is still too early to judge whether negative rates have worked or caused lasting damage to the economy and finance sector. But, Jakob Carlsson, chief executive of the Swedish life insurer Lansforsakringar Liv, is in no doubt.

He calls sub-zero rates “a mistake”, arguing that they force people to save more and spend less.

“Sooner or later, we will have to pay the bill for this experiment of artificially created negative rates,” he says.

Stefan Ingves, governor of the Sveriges Riksbank, pauses during a news conference at the Swedish central bank headquarters in Stockholm, Sweden, on Thursday, Dec. 19, 2019. Sweden's central bank ended half a decade of subzero easing in a move that will provide relief to the finance industry and a test case for global counterparts experimenting with negative borrowing costs. Photographer: Mikael Sjoberg/Bloomberg
Stefan Ingves, governor of the Riksbank argues that negative rates were a success but accepts that had they continued indefinitely they would have had a detrimental impact © Mikael Sjobeg/Bloomberg


Eurozone banks say they have paid €25bn in negative rates to the ECB since it cut rates below zero in June 2014, eating into their already weak profits. Other areas of finance have also felt the strain — Dutch pension funds, only narrowly avoided cutting payouts to pensioners last year after the government intervened to loosen rules.

“The ECB, the US Federal Reserve and the entire central bank community are watching very closely what is happening in Sweden, it is an interesting empirical example,” says Guntram Wolff, director of the Bruegel think-tank in Brussels.

“The real question is whether a change in interest rates from negative to zero has an impact on inflation and economic growth.

Line chart of Central bank policy rates (%) showing The negative rates club


”Negative rates turn the principles of finance on their head by forcing commercial banks to pay to store money at the central bank rather than earn interest on it. At the same time, some countries and companies have been paid to borrow.

Most recently, some individuals across Europe have begun paying to deposit large sums of money in banks, while mortgage borrowers in Denmark have received money from their house loans rather than having to pay interest.

The idea behind the topsy-turvy policy is to encourage banks to lend more money instead of holding it at the central bank, thus stimulating the economy by also lowering financing costs for companies and households. Denmark, the eurozone, Japan and Switzerland still have negative rates but the evidence on whether they work — and with what side-effects — is still being collected.

The ECB, which last year cut its deposit rate to a new low of minus 0.5 per cent, argues that without its actions the eurozone economy would today be almost 3 per cent smaller and have 2m fewer jobs. “Clearly everybody is going to look at what conclusions are drawn from that monetary policy reversal . . . in Sweden, but I wouldn’t draw any conclusions as far as our policies are concerned,” Christine Lagarde, president of the ECB, said in February.

Ms Lagarde has, however, promised to study the side-effects of negative rates, as part of a strategic review of monetary policy. “The longer our accommodative measures remain in place, the greater the risk that side-effects will become more pronounced,” she told the European Parliament.


Stefan Ingves, governor of the Riksbank, argues that negative rates have been a success in Sweden. But he accepts that had they continued indefinitely they could have had a detrimental impact, raising questions about their future value to policymakers.

The Riksbank introduced sub-zero rates in 2015, not due to weak growth — gross domestic product increased that year by 4.4 per cent in the EU member state — but because of the risk of deflation. Inflation dipped briefly below zero in 2014 and only returned to the Riksbank’s 2 per cent target at the end of 2017 when Sweden’s repo rate stood at a record low of minus 0.5 per cent.




HANDOUT - 11 February 2020, France, Strasbourg: President of the European Central Bank (ECB) Christine Lagarde (L) speaks with European Parliament President David-Maria Sassoli during their meeting at European Parliament headquarters in Strasbourg. Photo: Daina Le Lardic/European Parliament/dpa - ATTENTION: editorial use only and only if the credit mentioned above is referenced in full
Christine Lagarde, president of the ECB, talks to David-Maria Sassoli, president of the European Parliament./ She has promised to study the side-effects of negative interest rates © Daina Le Lardic/European Parliament/dpa


“Inflation actually came back. So in that respect, going negative made the whole thing work,” Mr Ingves says, stressing that quantitative easing — government bond-buying — also helped.

“The issue for us hasn’t been to stay negative for longer than we needed to”.

The Riksbank has been here before. Its 2010-11 decision to raise interest rates after the financial crisis was closely scrutinised. On that occasion it reversed course and cut rates again soon afterwards, drawing charges of “sadomonetarism” from Nobel-prize winning economists and inspiring the Fed to slow its monetary tightening.

Now, there are questions being asked again after the Riksbank raised rates while the Swedish economy is slowing and inflation falling. Mr Ingves is clear that in a world wracked by economic uncertainty, “if the choice were to be at zero or slightly negative, to be at zero is a good place to be”. He argues that as Swedish growth has been stronger in recent years than the eurozone’s “it is not all that strange that we slightly distance ourselves from the eurozone”.

Yet, some economists argue that the Riksbank may be forced to return to negative territory if the economy weakens or the sharp drop in inflation — the annual rate fell from 1.7 per cent to 1.2 per cent in January on the back of low energy prices — intensifies.


Line chart of Annual % change in consumer prices showing Swedish inflation remains below target


After five years of running a negative rates policy the Riksbank governor identifies several areas where, he believes, they could cause long-term problems. Top of the list is the banking system, where critics claim negative rates could weaken already struggling institutions, discouraging lending and prompting savers and companies to hoard cash.

As a byproduct, Dietmar Schake, sales director of Burg-Wächter, says Germany’s largest safe manufacturer has benefited from a one-third increase in sales since the deposit rate at the ECB went below zero. “Customers prefer to keep their money at home rather than in their bank accounts, where negative interest rates are threatening,” he adds.

Mr Ingves says Sweden’s banks have coped better than those in the eurozone because a lack of bad loans and lower costs mean their return on equity has stayed relatively high. But even here there is now relief. Johan Torgeby, chief executive of one of Sweden’s largest banks SEB, says lenders involved in fixed income “struggled for years” and calls the end of sub-zero rates “good news”. He adds: “We have never really understood what effect negative yields have on [boosting] consumption.”

Chart showing Swedes face rising household debt


He is not alone. One of the reasons the Riksbank gave for its decision to end negative rates was that the public struggled to understand the policy and thought it “strange”.

Banks provide 80 per cent of loans to European companies and households, making them the main channel to transmit interest rate policy into the wider economy. The Association of German Banks said in a recent report that negative rates had cost eurozone lenders a total of €25bn since they were introduced. “This burden is depressing the profitability of the banks and will ultimately even constrain their lending capacity,” it warned.

Much of the debate about negative rates hinges on the idea of a “reversal rate” below which lending activity by banks is subdued and starts to fall.

Research published last year by Princeton University economists Markus Brunnermeier and Yann Koby found that many of the benefits of negative rates are front-loaded — such as gains in asset prices on bank balance sheets — while the corrosive side-effects last longer.

Bank lending in the eurozone was, however, shrinking when the ECB first cut rates below zero in 2014 and has since rebounded.

Household lending is up more than 12 per cent since negative rates started, while corporate lending has grown 3 per cent. The ECB has also taken action to soften the blow for the banking sector, including a “two-tier” deposit system that exempts some of the money it holds for banks from negative rates, while also offering them loans at sub-zero levels to stimulate lending.

Among the big losers have been savers. With more than $13tn of bonds trading at negative yields, a growing number of pension funds, insurance companies, and banks are struggling to generate sufficient returns, raising doubts over some business models.

Mr Ingves acknowledges that Swedish insurance companies are heavily exposed to stock markets, unlike many of their European rivals. While shares have gone up, that has been good news. “But if the stock market is down at some time in the future, then risks are going up, and that increases risk in the system as a whole,” he adds.

Chart showing global value of negative-yielding bonds ($ trillion)


Isabel Schnabel, a German economist who recently joined the ECB board, says that criticism of its monetary easing policies in her country “is all too often combined with claims and accusations that have no basis in fact”.

While the average German saver is €500 out of pocket because of negative rates, Ms Schnabel says an average borrower is €2,000 better off and the overall gains outweigh the losses, with Berlin saving billions of euros on interest payments.

Another risk from negative rates is that they inflate asset price bubbles, while also keeping alive zombie companies that without cheap money would collapse. In Sweden, the big concern has been the housing market, with Mr Ingves repeatedly issuing warnings about record levels of household debt.

A series of measures to make mortgages harder to access have eased Swedish fears. The Riksbank recently changed its outlook on rates. Even when they were in negative territory, it always forecast increases. But in December, it said rates would remain at zero for years until, in the words of Mr Ingves, “the fog lifts” and there is a clearer view of the global economy.



The headline on a Sveriges Riksbank news release reads "Repo rate raised to zero per cent" ahead of a news conference at the central bank headquarters in Stockholm, Sweden, on Thursday, Dec. 19, 2019. Sweden's central bank ended half a decade of subzero easing in a move that will provide relief to the finance industry and a test case for global counterparts experimenting with negative borrowing costs. Photographer: Mikael Sjoberg/Bloomberg
The Swedish Riksbank report on ending negative interest rates © Mikael Sjoberg/Bloomberg


Gabriel Blir, an estate agent in central Stockholm, talks of the struggle he had to sell a flat bought near the peak of the market in 2016 for SKr4.5m. Two earlier attempts failed when bids went no higher than SKr4.2m but this month, after the Riksbank’s comments on rates, the flat was snapped up for SKr4.45m (€420,000). “When you hear that interest rates will stay low for years, it is a big safety net for buyers,” he says.

Such anxieties feed into the larger debate over the efficacy of negative rates. “There is an increasing realisation that the negative side-effects of these policies are becoming more apparent . . . while the benefits in terms of raising inflation to central banks’ targets have not been achieved,” says Danae Kyriakopoulou, chief economist at central banking think-tank OMFIF.

Policymakers at the ECB seem committed to sub-zero rates in their quest to lift inflation. “The overall macroeconomic effect of unconventional measures remains positive . . . there may be diminishing returns from negative rates, though we are not yet close to the reversal rate,” says Olli Rehn, head of Finland’s central bank and a member of the ECB governing council. “If needed, we have capacity to cut further.”

Mr Ingves appears less sure of the use of negative rates in the future. He underscores that they could indeed go below zero in Sweden again if the economy deteriorates, but he stresses that in a sharp downturn additional policies would have to take more of the strain.

“I think there actually is a lower bound for the policy rate,” he says, adding that he finds it difficult to envisage a rate of, say, minus 5 per cent. Instead he argues the central bank would have to use its balance sheet more. So too would the government, whose debt is forecast to fall to close to 30 per cent of GDP this year, low by European standards.

His comments echo those of Ms Lagarde, who said in February: “Monetary policy cannot, and should not, be the only game in town”.

Central bankers are closely monitoring how Sweden fares in its move to zero rates as the outlook for growth and inflation both there and in the rest of the world remains uncertain.

“We look forward to a day when we can get out of negative rates,” says Philip Lane, chief economist of the ECB. “At some point, the comparison of benefits and costs is going to change .
 . . It is a lot easier to make that decision when inflation is closer to 2 per cent, as in Sweden, than when it is still too far away, as it is here [in the eurozone].”

The US-Philippine Alliance on the Rocks

By: Phillip Orchard


There’s an old joke in the Philippines – “Yankee go home … and take me with you” – that’s embodied the ambivalence inherent to the U.S.-Philippine alliance since the colonial era. With the election of Philippine President Rodrigo Duterte, a general unease swung turned into open antipathy.

He has nursed a personal disdain for the meddlesome and moralizing Americans but hasn’t had the institutional support to make good on his pledge to break off the relationship – until now. In late January, Duterte gave Washington a month to make amends for some seemingly minor political slights or else he’d terminate the Visiting Forces Agreement, an important bilateral military deal.

Two weeks later, he pulled the plug, giving the Americans six months to pack their things and go. President Donald Trump responded with a shrug, claiming that the withdrawal would save the U.S. some cash.

This may just be yet another case of a weaker state seeking to play the competition between its more powerful rivals to its benefit. But if the unhappy couple can’t patch things up before Aug. 9, the alliance – the United States’ oldest in Asia – would effectively be neutered.

Without the VFA, most of the more than 300 annual bilateral exercises would be scrapped, to say nothing of a landmark 2014 basing agreement that would have had the potential to become Washington’s biggest check on China’s expansion into the South China Sea. A divorce makes little strategic sense for either side. So could this really be the end?

Sovereignty and Strategy

Tension between sovereignty and strategic necessity is inevitable when any country hosts another’s military. But in the Philippines, a former U.S. colony where U.S. troops once waged a ruthless campaign against pro-independence guerrillas, tensions have ebbed and flowed since the country became nominally independent in 1946. (It had little choice but to sign the 1951 Mutual Defense Treaty and let U.S. troops stick around.) Various Philippine governments have stoked anti-imperialist sentiment in search of leverage with the U.S., leading to periodic ruptures in the alliance.

The most prominent example of which came in 1991, when the Philippine Senate narrowly rejected an extension of a 1947 agreement allowing the U.S. military to lease its two largest overseas facilities, Subic Bay Naval Base and Clark Air Base. Awash in post-Cold War optimism and anticipating cuts to the Pentagon’s budget, the George H.W. Bush administration put up only a half-hearted fight to stay. (Clark Air Base had also just been buried by a volcanic eruption, which was seen by some as a celestial nudge to the U.S. Air Force to move on.) U.S. troops were gone by the end of 1992, and shortly thereafter, so too was some $200 million in annual U.S. military aid, enough to cover about two-thirds of the Philippine military’s acquisition and maintenance outlays.

The power vacuum didn’t last long. China quickly began asserting its claims to South China Sea atolls like Scarborough Shoal, less than 200 kilometers (125 miles) from Subic Bay, and Mischief Reef, which the People’s Liberation Army seized in 1995 and promptly turned into a military outpost.

The Philippines also quickly proved ill-equipped to manage the growth of al-Qaida-linked groups in the restive southern island of Mindanao and the Sulu archipelago. So, under West Point-educated President Fidel Ramos, Manila cozied back up to its old frenemy, who had become aware of its own interest in curbing jihadism and Chinese expansion. The new VFA was ratified in 1999 and U.S. military aid surged after 9/11. And in 2014, two years after China seized Scarborough Shoal following a brief standoff with overmatched Philippine maritime forces, Manila and Washington inked the Enhanced Defense Cooperation Agreement, a landmark deal giving the U.S. rotational access to at least five Philippine bases.




What’s strange about this latest rupture is that, on the surface at least, the alliance has remained on solid political and strategic footing. There’s still a robust strain of anti-Americanism in the Philippines embodied by Duterte, and there’s still plenty of disenchantment among the president’s vast support base about Washington’s condemnation of his drug war.

And Chinese money has coopted enough Philippine elites to give Duterte some room to maneuver.

But the U.S. is still broadly popular among both the politically influential military and, particularly following the U.S.’ response to a catastrophic typhoon in 2013, the public. (Polls consistently show the population’s trust in the U.S. alliance exceeding 75 percent – generally the highest in the world.)

The jihadist uprising in Mindanao in 2017 heightened the sense in Philippine defense circles that only the U.S. and its allies – not China – are prepared to provide critical security assistance in a crisis. And China has become only more aggressive in the South China Sea such that Philippine fishermen and energy firms are effectively blocked from extracting resources within the country’s exclusive economic zone without Beijing’s permission.

As a result, while Duterte’s opposition to the U.S. initially had some tangible effects, the alliance appeared to be back on track. For example, the annual Balikatan exercises, the allies’ largest, were scaled down and reoriented away from maritime defense to appease China in 2017-18, but they returned to form last year.

And while Duterte delayed implementation of the EDCA for several years and narrowed it somewhat in scope, the first EDCA project was finally completed last year, and another dozen projects were subsequently approved. There are now around 500-600 U.S. troops in the country at any given time.

Yet, here we are. The grievances cited by Duterte as rationale for his move – the U.S.’ cancellation of the visa of a former police chief who led Duterte’s violent drug war, and the U.S. Senate resolution condemning Duterte’s drug war – are the sort you’d expect to be easily managed, given the stakes.

And Duterte's pitch to the AFP – that this will force the country to get serious about modernizing the military to allow it to stand on its own – isn’t being taken seriously, given Manila’s lack of resources and the yawning balance of power with China.

But the apparent nonchalance from both sides to save the VFA suggests the Philippines’ frustration with the U.S. had become more severe than realized – weakening the alliance to the point where the personal and political motives of the two countries’ leaders could truly threaten to bring about its undoing.

Sources of Discontent

While the U.S. and the Philippines are united on the common threat posed by China, they have starkly divergent views on how to manage it. The U.S. is basically content with the status quo in the South China Sea. To contain China on other fronts, it doesn’t really need to escalate matters there – by, say, attempting to forcefully evict Chinese forces from Philippine-claimed reefs in the Spratlys.

So long as the Chinese navy can’t challenge the U.S. Navy directly, the U.S. is content to be able to cripple China by choking its maritime traffic along the first island chain and around the Strait of Malacca. Keeping the Philippines on its side is critical to this effort. Ultimately, to blow a hole in the U.S. containment line, China needs one of the countries along the first island chain to flip fully into its camp – and given the Philippines’ weakness, it may be China’s best bet.



But the U.S. also doesn’t want to get dragged into a war with China, at least not one that wasn’t started on its terms, and so it doesn’t want to give the Philippines reason to think the U.S. will automatically have its back if it picks a fight it can’t win on its own. It has therefore kept the commitments outlined in the Mutual Defense Treaty vague. And it’s done very little to ensure the Philippines’ material interests by, say, intervening in spats among fishermen (even if Chinese fishing fleets are working hand in glove with the Chinese navy).

One problem for the U.S. is that this strategy gives the Philippines little choice but to do whatever it deems necessary to remain friendly with China. It’s a core reason that Duterte imposed limits on cooperation with the U.S. while allowing China to gradually expand its commercial and political influence in the country in ways that could come back to haunt the U.S. Another problem is that perceptions of U.S. indifference allow Duterte’s arguments to gain traction with the public. In other words, it limits the potential for resistance when the president can credibly argue this: If the U.S. is unwilling to protect Philippine resources and territory, what good is the alliance?

It evidently has also made some factions more wary that had long buffeted the alliance from political currents. Among Philippine military leaders, for example, the U.S. interest in avoiding moves that may trigger a conflict with China is reasonable. But less so is U.S. reluctance to do more to help the AFP look out for itself. Manila has received around $1.3 billion in military aid since 1998 – or 52 percent of U.S. aid to the Asia-Pacific region. This year’s Pentagon budget earmarks around $250 million for the Philippines.

This isn’t nothing, especially when combined with myriad benefits – mainly, ISR and the fact that China can’t really be sure that the U.S. will always remain on the sideline if it pushes too far – provided cost-free by the U.S. military's regional presence. But it betrays a level of U.S. aloofness that’s at odds with the Philippines’ strategic importance.

For example, in the State Department’s newly released fiscal year 2021 request for foreign military financing funds (which are invaluable given the relatively high cost of U.S. arms), the entire Asia-Pacific region would get just 1.5 percent, compared to 93 percent for the Middle East. Ukraine alone would get 2 percent; Jordan would get 9 percent.

This undermines U.S. claims that it’s serious about finally, for real this time, “pivoting” from the Middle East to the Indo-Pacific. It also fosters doubt about the U.S.’ long-term commitments to regional partners. And given China's growth in anti-access/area-denial capabilities, which substantially raise the potential costs of coming to the Philippines’ defense, such doubts are set to grow.

Most problematic, it’s forcing Manila to look elsewhere for arms help – including suppliers (like China and Russia, both of which began selling arms to Manila under Duterte) that would pose interoperability problems for U.S.-Philippine cooperation and that the U.S. would rather not see gain sway with the AFP. (Washington's response to Manila’s dissatisfaction with U.S. aid is basically: Then help us help you with things like EDCA.)

Ceding the South China Sea


Both sides have valid points. Yet those points hardly seem to justify the strategic costs of hollowing out the alliance. The U.S. may be an imperfect ally, but it is Manila’s most powerful and least coercive option. This suggests the latest feud is merely another iteration of the historical push and pull over the terms of the relationship that both sides are working furiously behind the scenes to resolve.

And there’s reason to believe that that is the case. The day before Duterte ordered the termination, a State Department official said Washington plans to discuss the VFA and discounts on U.S. arms at a previously scheduled meeting with Philippine officials in March. And Washington has been hinting that the U.S. Coast Guard will begin playing a bigger role in the region – something that would position the U.S. to do more than occasionally sailing warships by Chinese bases off Philippine shores.

If not, and if the VFA gets scrapped, the potential consequences aren’t trivial. Sure, if the historical pattern holds, Duterte’s successor may soon be cozying back up to the U.S. (Duterte is scheduled to leave office in 2022.) But this shouldn't be assumed. The politics of matters of national sovereignty can be fickle and fierce, and a new VFA would once again require ratification by the Philippine Senate.

It took the shock of China's Mischief Reef seizure to get a sufficient number of stakeholders in Manila on board with welcoming back U.S. troops last time. Despite everything that China has done since, the U.S. has given Manila reason to wonder if it’s really worth the trouble. It’s not clear what more China could realistically do that would shake Manila out of its ambivalence once again, except perhaps building on Scarborough Shoal, reportedly a red line set by the Obama administration.

Even if a new VFA were eventually inked, it would be tough to overcome the momentum lost on things such as the implementation of the EDCA. Indeed, the loss of Subic Bay in 1992 is still hurting the U.S. position in the region. The closest U.S. Navy “base" is in Singapore, and U.S. deployments there are limited to a single littoral combat ship at a time. The closest air base is in Okinawa.

The closest U.S. ground-based missile deployments are more than a thousand nautical miles away in Guam. The U.S. just scrapped the Intermediate-Range Nuclear Forces treaty, in part to be able to hold China at bay with ground-launched anti-ship missiles. As it stands, it has nowhere to put them. Without them, in a conflict scenario with China, the overstretched U.S. Navy would likely need to preserve its ammo for bigger priorities farther to the north, effectively ceding the South China Sea to Beijing.

Just how much the U.S. would benefit from a greater ability to project power inside the first island chain, particularly around the Spratlys, is a hot topic of debate. So long as Manila doesn’t allow the PLA to establish its own bases in the Philippines (which it insists it won’t), the U.S. threat of a blockade will remain credible enough to discourage China from attempting to expel the U.S. Navy.

Australia and Japan (which has held talks with Manila on its own VFA) would also do more to keep the Philippines from getting pulled firmly into the Chinese orbit. But the more China can dictate terms to regional states like the Philippines on what they can and cannot do in their littoral waters, the more likely they are to conclude that their best bet over the long term is to throw in with Beijing.

Utilities’ Message About Central Banks

Such companies have done better than growth stocks, which offers insight into what people think about interest rates

By Jon Sindreu



To catch a glimpse of the deep-rooted mechanisms of central bank policy and its linkages to economic growth, there is nothing like looking at utility stocks.

Utilities’ rally since the start of 2020 is on par with the red-hot Nasdaq-100 Index. As a result, the valuation of the S&P 500 Utilities index is near an all-time high, with shares trading at almost 24 times the earnings of those companies, compared with 21 times for the broader S&P 500.

On first glance, boring water or electricity providers like Essential Utilities, American Water Works and Entergyhave little in common with the excitement of the headline-grabbing technology giants. Yet all these companies now have dearer valuations than Apple, Alphabet, Microsoft and Facebook.



Since 2019, the valuation premium that investors place on utilities has been around its highest level ever. Part of last year’s bump was explained by a jittery market, which pushed up the shares of so-called defensive companies—those with stable earnings that aren’t as exposed to economic busts. But that trend unraveled after October.

Investors are now giddy about go-go growth stocks, despite momentary concerns about the Chinese coronavirus. And yet, utility stocks have found renewed vigor.

It likely has to do with central banks and how they address tectonic shifts in common wisdom.

Surveys by Bank of America Merrill Lynch show that fund managers have piled into assets that do well when inflation collapses, like bonds, tech stocks and emerging markets, while selling “value” sectors like banks and energy. Yet market expectations for prices remain very stable, showing no fears of a deflationary spiral like they did back in 2016. Instead, it is expectations of inflation-adjusted or “real” interest rates that have collapsed.

Before the 2008 financial crisis, this was a bad omen because real rates were seen as reflecting the economy’s growth potential. And yet, real rates have appeared to follow officials’ every attempt to lower them, rather than being governed by deep-seated economic forces.

At the same time, inflation has remained subdued across the Western world, suggesting that trends in consumer prices often have little to do with monetary policy, or even growth and employment.


In the new era of central banking, utilities are long-term winners. / Photo: seth herald/Agence France-Presse/Getty Images .


In short: Central banks’ power over markets has revealed itself as greater than previously believed, but their power over the economy as much less.

This has strong ramifications. For one, rates could stay low regardless of what the economy is doing.

Last year, the Federal Reserve slashed rates following an equity selloff even as the job market showed no signs of trouble. This supports the idea that, at the very least, getting ahead of inflation is a much less pressing concern for central banks than it once was.

If true, it makes sense to put a premium on both tech stocks, which are valued on expectations of higher future potential, and utility stocks, which are stable dividend-payers and thus basically track bond yields.

There are other factors such as the trend toward decarbonization, which has given a boost to firms like NextEra Energy,the world’s largest generator of solar and wind energy. That doesn’t mean valuations aren’t overstretched, however, just as Treasury yields seem a bit too low for current Fed policy.

Neither seems to offer a buying opportunity right now—but in the new era of central banking, utilities are long-term winners.




Relieving Libya’s Agony

The credibility of all external actors in the Libyan conflict is now at stake. The main domestic players will lower their maximalist pretensions only when their foreign supporters do the same, ending hypocrisy once and for all and making a sincere effort to find room for consensus.

Javier Solana

solana114_FADEL SENNAAFP via Getty Images_libyaprotestflag


MADRID – Over the last decade, Libya has become a failed state, descending from its own Arab Spring into the coldest of winters. The fall of Muammar el-Qaddafi’s authoritarian regime in 2011 did not lead to the social improvements that many had hoped for, but rather to misgovernment and misery.

Now, the civil war that has been ravaging the country for years is in danger of becoming chronic. And the world, for the most part, has been looking away.

But the international community cannot evade responsibility in the face of this tragic course of events. Libya is a failed state today largely because certain external actors adopted failed policies toward it. The consequences of these missteps have been so toxic that they have affected other conflicts around the world.

To understand the origin and magnitude of the Libyan debacle, we must go back to the beginning of 2011. It was then, with the fighting between Qaddafi’s forces and the rebels at its height, that the United Nations Security Council adopted its historic Resolution 1973 – the first time it had authorized a humanitarian intervention by “all necessary measures” against the wishes of a functioning state. The resolution was adopted because the two permanent members with the greatest reservations – China and Russia – decided to abstain.

Up to that point, the international reaction to the crisis in Libya had been consensual and timely. But the subsequent NATO-led armed intervention strained the resolution well beyond reasonable limits. Instead of concentrating on protecting the civilian population, the campaign’s main proponents became fixated on removing Qaddafi by force.

Moreover, as is often the case, no viable reconstruction plans were in place. So, once the rebels’ common enemy was eliminated, Libya soon fell victim to sectarianism. Then-US President Barack Obama later called this lack of foresight the worst mistake of his presidency.

The mistake lay not only in ignoring the predictable problems that would arise once Qaddafi had been ousted, but also in the methods and objectives of the military operation itself. The effects of these myopic policies transcended Libya’s borders. In particular, the misuse of Resolution 1973 gave both China and Russia a pretext to justify their vetoes of many humanitarian resolutions on Syria. The fragile consensus in the Security Council was shattered, to the distress of countless threatened and unprotected civilians.

Nor did the strategic blunders end there. Recall that at the beginning of the century, in the hope of improving his country’s relations with the West, Qaddafi gave up his embryonic nuclear-arms program. At that time, he could hardly have imagined the fatal destiny that awaited him a few years later.

So, when John Bolton – then-US President Donald Trump’s national security adviser – suggested in 2018 that the Libyan denuclearization model could be applied to North Korea, the Pyongyang regime’s angry reaction surprised no one. Qaddafi’s fate provided a lesson that the North Koreans won’t easily forget, and which will compromise international efforts to halt nuclear proliferation.

The United States seems to be learning, albeit stumblingly, its own lessons from what happened in Libya. Recognizing the enormous risks involved in interventionist excesses, first Obama and now Trump have shown themselves to be in favor of limiting America’s security involvement in the Middle East and North Africa, though there have been some contradictions.

The European Union, on the other hand, can never afford to exclude this region from its strategic priorities. For starters, Europe bears an historic responsibility for these countries and their peoples. Moreover, everything that occurs in our neighborhood affects us directly, as the 2015 refugee crisis demonstrated. Looking the other way is thus not an option.

From our shore of the Mediterranean, we Europeans can see Libya’s turmoil and decay. The UN-recognized government in Tripoli is besieged by the forces of General Khalifa Haftar, who is supported by the Tobruk-based parliament. Complicating matters further, Haftar is perceived as the main bulwark against the rise of radical Islamism in the country, including the militias affiliated with al-Qaeda and the Islamic State. He thus has garnered the support of countries such as Egypt, Saudi Arabia, and the United Arab Emirates, as well as some others that also see in his military expertise a possible way out of the Libyan mire.

In this clash of interests and claims to legitimacy, in which Libya’s abundant oil plays a central role, the EU has suffered from an evident lack of unity and strategic insight. The bloc’s paralyzing contradictions have allowed other countries to fill the gaps: Russia and Turkey have now established themselves as the two most influential foreign powers in the conflict.

Despite this, last month’s negotiations in Moscow – sponsored by Russian President Vladimir Putin and his Turkish counterpart Recep Tayyip Erdoğan – were derailed following Haftar’s refusal to sign a ceasefire agreement. Immediately after this, German Chancellor Angela Merkel exercised the leadership expected of EU countries by hosting new talks in Berlin, in coordination with the UN special representative for Libya, Ghassan Salamé.

This conference resulted in some notable progress, such as a commitment by the states present to refrain from interfering in the conflict and to respect the arms embargo approved by the Security Council in 2011. It also succeeded in drawing international attention to Libya again, which is no small achievement.

The credibility of all external actors in the Libyan conflict is now at stake. If the commitments made in Berlin come to nothing – and there are already signs that this may happen – then Libya’s people will once again pay the price. The main domestic players will lower their maximalist pretensions only when their foreign supporters do the same, ending hypocrisy once and for all and making a sincere effort to find room for consensus.

Since 2011, the international community has failed disastrously in Libya. A course correction is long overdue, in order to give the Libyan people the direction and hope they deserve.


Javier Solana, a former EU High Representative for Foreign Affairs and Security Policy, Secretary-General of NATO, and Foreign Minister of Spain, is currently President of the Esade Center for Global Economy and Geopolitics and Distinguished Fellow at the Brookings Institution.