The great Treasuries binge

Investors at home and abroad are piling into American government debt

Fiscal profligacy can continue for now, but is it economically sensible?



IN THE GOOD old days, America’s budget deficit yawned when the economy was weak and shrank when it was strong. It fell from 13% to 4% of GDP during Barack Obama’s presidency, as the economy recovered from the financial crisis of 2007-09. Today unemployment is at a 50-year low.

Yet borrowing is rising fast. Tax cuts in 2017 and higher government spending have widened the deficit to 5.5% of GDP, according to IMF data—the largest, by far, of any rich country.

It could soon widen even further. President Donald Trump is thought to want a pre-election giveaway. Fox News is awash with rumours of “Tax Cuts 2.0”. This month the Treasury announced it would issue a 20-year bond, which would lengthen the average maturity of its debt and lock in low interest rates for longer.

All this is quite a change for many Republicans, who once accused Mr Obama of profligacy, but now say that trillion-dollar deficits are no big deal. Democratic presidential candidates, meanwhile, are talking about Medicare for All and a Green New Deal. A new consensus on fiscal policy has descended on Washington. Can it hold?

Fiscal hawks worry that continued high levels of government borrowing will lead to economic chaos as the engine overheats. Many of them felt vindicated by the turmoil last year in the repo market, through which financial firms lend to each other. To buy Treasuries, investors must hand over money to the government. So rising bond issuance caused demand for cash reserves borrowed on repo markets to rise, sending rates soaring. The Federal Reserve was forced to step in to provide short-term funding.

Aside from that hiccup, however, markets have taken America’s debt binge in their stride. In recent months the yield on ten-year Treasuries has been below 2%. Interest repayments, as a share of GDP, are half the level of the early 1990s. That is despite there being a far higher stock of debt relative to GDP, a sign of investors’ voracious appetite for safe assets.

One source of this demand is investors at home. Much has been made of companies’ rising stock of debt. Yet America’s firms are now net suppliers of savings to the rest of the economy—probably because the money they have raised has been recycled to investors through dividends and share buy-backs. Those corporate savings have to be parked somewhere. Treasuries are an obvious destination.

Post-crisis reforms to the financial system have also played a role. Commercial banks, for instance, are now required to hold more high-quality liquid assets. Treasuries are an ideal candidate, points out David Andolfatto of the Federal Reserve Bank of St Louis. Meanwhile, a rule change in late 2016 has reduced the attractiveness of money-market funds that invest in corporate-debt securities. That, in turn, has increased demand for funds that invest solely in Treasuries.
Households have been saving more. When the financial crisis hit, families, fearing for their jobs and pay, began to stash money away. Despite the recovering economy they have not stopped, perhaps because of lingering economic uncertainty. The personal-savings rate is much higher than it was in the 2000s. In the past three years households’ holdings of public-debt securities have risen by 70%.

Domestic investors have soaked up two-thirds of the extra government borrowing since 2016. Foreigners have bought the rest, equivalent to $800bn-worth of Treasuries. As a consequence, America is now an even bigger net borrower from the rest of the world. Its current-account deficit has widened to around 2.5% of GDP.

It is no surprise that investors have an appetite for American debt. Policy uncertainty abounds, not least thanks to Mr Trump’s enthusiasm for threatening trade war. There are few other havens. Germany’s insistence on running super-tight fiscal policy means there is an undersupply of bunds, argues Brad Setser of the Council on Foreign Relations, a think-tank.

Traders moan that the market for Japan’s government bonds is illiquid.




Investors based in Europe appear to have been the most enthusiastic buyers (see chart). In part that reflects some countries’ large trade surpluses. In the past year Norway, a big oil exporter, has doubled its holdings. But that does not explain why Belgium, a country of 11m people, is one of the world’s biggest foreign buyers of Treasuries. Although official purchases by China look stable, some suspect that it is making some of its purchases through Belgian intermediaries.

Can America’s government deficit remain so wide for much longer? Some economists worry that loose fiscal policy at a time of low unemployment will cause the economy to overheat, rousing inflation.

That would force the Federal Reserve to raise interest rates, and push up government-borrowing costs. So far, though, there is little sign of that. Inflation is oddly soggy; the Fed cut rates three times last year.

America’s fiscal profligacy may be able to continue for now, especially if the Treasury borrows more at longer maturities. But whether it is economically sensible is a different matter. Despite all the loosening, long-term GDP growth is middling and productivity growth weak.

That may be because the splurge has been largely focused on tax giveaways, while federal investment spending has fallen as a share of government outlays. America’s fiscal policy may not be dangerous, but it may not end up doing much good.

Free Exchange

The costs of America’s lurch towards managed trade

China’s vow to buy more American goods carries the risk of waste and distortion




Standing before the global glitterati at the World Economic Forum in the Swiss mountain resort of Davos, President Donald Trump bragged of a “transformative change” to America’s trade policy. The newly inked “phase one” deal with China, he said on January 21st, would lower trade barriers and protect intellectual property.

He crowed about China’s promise to buy an extra $200bn of American services, energy, agricultural produce and manufactured goods over the next two years. He was not exaggerating. The agreement on a level of purchases, rather than on the rules of trade, does indeed mark a fundamental shift in American policy. But not one for the better.

America has embraced outcome-based rules in its trade relations before. Mercantilists like Mr Trump manage trade in two ways: either by restraining foreigners’ sales to America, or by encouraging them to buy more American goods.

In the 1980s American negotiators spent most of their efforts on the first, as they faced political pressure to contain a burgeoning trade deficit and became convinced that Japan’s trade practices were unfair. At their peak, these “voluntary” restraints affected around 12% of all exports to America, including cars, steel, machine tools, textile products and semiconductors.

Voluntary import expansions, where a trading partner agrees to import more, as China has, were less common. Most famously, Ronald Reagan’s administration negotiated a commitment from the Japanese government that 20% of its semiconductor market would be imported.

The aim was not so much to target the trade deficit directly, but to prise open what America thought was an unfairly closed market. The hope was that the intervention would jolt suppliers into investing in new economic relationships and lead to a sustained shift in trade patterns.

A generous interpretation of Mr Trump’s deal with China is that he is simply trying to do the same. He is not alone in feeling that China’s market shuts out outsiders, or that its policymakers do not always play fair. Veteran trade negotiators tell of haggling away one Chinese trade barrier, only for another to pop up elsewhere. (Economists recognise this problem as the difficulty of writing down a “complete contract” that covers every contingency.)

An outcome-based trade deal, tied to easily verifiable trade flows, should help to overcome distrust, and could force China to provide real market access. If it led to more investment in supply-chain infrastructure, then it could have lasting effects.

It could even be argued that managing trade with China would be easier than it was with Japan. Later attempts to repeat Reagan’s semiconductor tactic failed, as Japan’s government had grown tired of cajoling its private sector into changing its sourcing decisions.

It had no direct control over who bought the managed products, and had to resort to pleading letters to firms, as well as surveys asking about who they were buying from. By contrast, China’s government has the purchasing power of its state-owned enterprises at its disposal, and sway over the private sector too.




Dig into the details of Mr Trump’s new deal, though, and the risks of waste and distortion become clear. The agreed increase in sales to China is large and rapid.

According to an analysis by Chad Bown of the Peterson Institute for International Economics (with whom your columnist hosts a podcast), China has, in effect, pledged to increase its purchases of certain American agricultural products by 60%, and manufactured products by 65%, by the end of this year compared with levels in 2017 (see chart).

This must happen regardless of economic conditions in China. Whereas Japan agreed to increase the share of imported goods in domestic demand, China has signed up to buy fixed dollar amounts.

The risk is that China has promised to buy products that it either will not need or would rather get from elsewhere. State-owned enterprises could suck up American commodities and leave them to rot. American exporters, lured by higher prices to Chinese buyers, could switch from more sustainable relationships to ones that fizzle once their artificial advantage ends.

Or China could resort to logistical gymnastics to make it appear that it is buying American, such as by transporting goods from third countries through America. It could also have more American goods shipped directly to China, rather than through Hong Kong, so that they appear in the mainland’s trade figures.

Another danger is that China simply diverts trade from its other trading partners, prompting complaints that the biggest actors are carving up markets between themselves—and carving others out. Admittedly, members of the World Trade Organisation (WTO) are already allowed to agree on broad tariff cuts among themselves, which could lead to similar diversionary effects.

But trade deals are permitted, whereas discriminatory managed-trade arrangements are not.

And if, as Mr Bown warns, Brazilian and Argentine sellers of soyabeans or Russian and Canadian lobster-traders find themselves pushed out of China’s market, they are unlikely to react well.

Managed decline

If the deal sticks, it will threaten the world’s trading system. That system, ironically, is the result of America’s turning away from managing trade in the 1990s. Realising that it could not preach the virtues of free markets while itself practising something so different, America sought the creation of the WTO, as a shift towards a system based on rules rather than power.

Mr Trump’s presidency has consistently undermined those rules, and the deal with China again reinforces the idea that they do not matter. Now that he has won his share of the Chinese market, other countries may demand the same.

But the deal could also very easily fall apart, ushering in another round of hostilities. America is tightening its export controls, which could limit the goods available for China to buy. So, whatever the deal’s fate, disruption looks inevitable.

Whether Mr Trump will still be in office when that becomes clear remains to be seen. Official figures on whether China’s purchases have met this year’s target will not become available until early 2021, after the presidential election.

Basel derivative rules point to more pain for fund managers

Attempts at preventing ‘another Lehman’ will have limited upside for taxpayers

John Dizard

Christie’s employees walking into the auction rooms with the main sign from the Lehman Brothers office collection during a photo call at Christie’s in west London. PRESS ASSOCIATION Photo. Issue date: Wednesday September 29, 2010
Rules aimed at preventing ‘another Lehman’ threaten to freeze up capital flows and create an unintended systemic disaster © John Stillwell/PA Wire


Only a few days into the decade and finance people are being forced to confront another year of regulatory deadlines that will be impossible to achieve, in particular those imposed by Brexit, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions.

How about finding a way of not doing this to ourselves? 

On Brexit, we can only hope that each side is exhausted enough to abandon fantasies of a wealthy pirate ship or the bureaucratic destruction of London. Europeans need each other too much to indulge in revenge and domination. 

The Basel regulation mess should be easier to deal with than Brexit, as there seems to be less cultural and geopolitical noise intruding. But the post-financial crisis regulation has created a swamp of self-serving professionals masked as honest brokers, “fintech start-ups” and in-house profit centres. They do not want a solution for financial instability. They want career success for themselves. These are not the same thing.

There is a point in bureaucratic negotiations, as in war, where participants should realise that their maximalist demands and victory fantasies are pointless and destructive. For the Basel process, that would be now.

For the first years after the financial crisis, the global regulatory process was able to make real progress on reducing risk in banking and securities dealing. The rulemaking concentrated on major banks and dealers, as well as key pieces of financial market infrastructure. This made sense: those are the institutions that the public would be forced to bail out to save its own interest come the next crisis.

Also, the big banks, along with infrastructure bits such as the clearing houses, have the compliance bureaucracy and quasi-monopoly status that comes with their licensing. Top management of big banks can be reasonably expected to spend much of its time going to Basel, or mini-Basel, meetings on how banks should be regulated. 

But as the Basel regulatory process reached into asset management and operating companies, it has become self-defeating. By trying to turn every participant in the capital markets into a bank, Basel risks freezing up capital flows and creating an unintended systemic disaster.

I am thinking in particular of the uncleared margin rules (UMR) for derivatives transactions that are set to be imposed by next year on several thousand capital markets participants, most of them non-bank asset managers. The idea, easy to sell to the world’s politicians, is that we can avoid “another Lehman” by requiring a large number of investors to put up high quality liquid assets against their exposure to financial derivatives. 

Sounds good. Until you look at the details. Lehman was one of about a dozen key New York dealers, a bad apple at the centre of the dollar system. The Lehmans of the world are already covered by the Basel requirements intended to avoid another systemic disaster in derivatives markets.

According to the International Swaps and Derivatives Association (ISDA), the major institutions covered by the first phases of the UMR had already posted $170bn in two-way regulatory margin by the end of 2018. That margin comes in the form of high quality liquid assets that are segregated and unavailable for other purposes. 

But the planned extension of the UMR will cover not just top banks with taxpayer guarantees and a lot of staff, but many of their customers. BNY Mellon, the custodial bank, estimates the remaining phases of the Basel margin requirements will cover at least 640 institutions with more than 9,000 interconnecting relationships in the market. Based on my discussions with asset managers, there could be thousands of asset managers and companies that will be shocked to find out how many government bonds they have to put up as sterilised capital if they are to comply with the rules. 

Regulators already know this, as the UMR were originally intended to be in place by this September. Last July they were postponed until September of 2021. But that does not offer much relief, as counterparty banks and dealers will insist that a compliance process must be in place at least a year in advance.

The Basel compliance process favours banks and large dealers over asset managers and investors. For example, the mathematical model that ISDA endorses to calculate initial margin runs to 29 pages of equations. One of the effects of the “simplified” model, by the way, is to make it easier for banks to reduce the initial margin requirements that might otherwise burden their illiquid assets.

In other words, the Basel regulatory process has been partly captured by those it was intended to regulate. Asset managers and capital markets, which have taken away some of the banks’ capital allocation function, will now be burdened by higher technology and staff costs, and prospectively required to buy trillions of dollars in government debt.

This is not going to happen. Stop postponing initial margin rules — rethink the process in a realistic manner for non-banks.

The benefits are going to consultants, lawyers and therapists, not the tax paying public.

Banks labour under negative interest rates and ‘zombie’ loan threat

WEF assesses risk of corporate debt shock as fragile companies kept on life support

David Crow

FT Montage


When bank executives descended on Davos last year for the annual meeting of the world’s elite, they did so under a cloud. Just a day before the gathering began, UBS issued a profit warning after its predominantly rich clients pulled $13bn of assets from the bank.

Here was Switzerland’s largest bank and one of the top global wealth managers sending a distress signal from its own doorstep. The world’s wealthy had apparently turned bearish on the economy because of geopolitical tensions and sluggish growth.

It proved to be a sign of things to come. The outlook for global banks has since only deteriorated. In September, the European Central Bank cut rates further into negative territory, putting extra pressure on banks’ profit margins. The Federal Reserve cut US rates three times in 2019, reversing almost all of the increases implemented in 2018.

Moody’s, the rating agency, cited lower rates as one of the main factors behind its decision last month to change its outlook for global banks from stable to negative. Driving this are “rising global trade tensions [and] lower for longer or lowering interest rates, depending on the jurisdiction”, says Laurie Mayers, associate managing director at Moody’s.

Ms Mayers adds that banks are operating with “very high cost structures” that they are “struggling to bring down”.

Improving cost efficiency is particularly tough when banks are having to invest billions of dollars in new digital platforms to compete with fintech start-ups. The spectre also looms of Big Tech companies like Amazon and Google pushing further into financial services.

Other observers are less bearish. Analysts at Morgan Stanley recently turned positive on the European banking sector, though not because they predict a glorious period ahead, but rather because the worst might be over.

Magdalena Stoklosa, Morgan Stanley head of European banks research, notes that interest rates, in Europe at least, have probably reached their nadir. Few expect Christine Lagarde, the new ECB president, to implement further cuts.

“Yes, we are going to stay in this lower for longer structural backdrop and of course [profit] margins are going to be challenged,” Ms Stoklosa says. But she adds that, given the sense that rates may go no lower, “the confidence in earnings is much higher than it was a couple of months ago.”


Mandatory Credit: Photo by STEPHANIE LECOCQ/EPA-EFE/Shutterstock (10489796i) European Central Bank (ECB) President Christine Lagarde attends her first hearing by the European Parliament Committee on Economic and Monetary Affairs, a the European Parliament in Brussels, Belgium, 02 December 2019. European Central Bank President Christine Lagarde at European Parliament, Brussels, Belgium - 02 Dec 2019
New ECB president Christine Lagarde © Stephanie Lecocq/EPA-EFE/Shutterstock


Ms Stoklosa adds that in the third quarter of 2019, 80 per cent of eurozone banks managed to beat earnings expectations, albeit after they were revised lower by analysts. “Analysts have spent the last six months relentlessly cutting our earnings expectations for the banks, particularly for 2020. And I think we’re done, or we’re broadly there.”

Signs suggest that global regulators think that banks have enough capital, after a decade during which lenders were forced to build their buffers to prevent a repeat of the 2008 financial crash. The higher requirements have dragged on profitability, while crimping the amount of excess capital that banks can return to investors by way of dividends or buybacks.

The introduction of new global rules on capital — commonly known in the industry as Basel IV — had raised fears that the buffers would have to be built further when the standards are implemented from 2022. But Randy Quarles, the Fed governor in charge of financial regulation, last month told a congressional panel that overall capital levels at US banks did not need to rise. “We don’t believe that the aggregate level of loss absorbency needs to be increased,” he said.

The ECB is tweaking its rules to make it easier for banks to use debt rather than equity to meet the requirements, giving banks more leeway when deciding whether to return capital to shareholders. The Bank of England last month said it would consult on reforms that would “leave overall loss-absorbing capacity in the banking system broadly unchanged”.

“It looks like Basel IV will be the biggest non-event in the history of capital regulation,” says John Cronin, a banks analyst at Goodbody.

Even if some risks for banks do start to recede, however, there are new threats on the horizon.

They include a surge in loans to highly indebted companies that could quickly fall into difficulty in the event of a recession and struggle to make their repayments.

Last month, the Bank of England warned that the global stock of “leveraged loans” — which tend to be made to highly indebted companies, especially those owned by private equity — had reached more than $3tn, a 30 per cent increase since 2015.

The threats associated with leveraged loans have not escaped the attentions of the organisers of this year’s gathering in Davos. They have scheduled a session entitled “The Rise and Risk of Zombie Firms”. The programme asks: “With cheap money keeping fragile companies on life support, will a recession cause a reckoning in corporate debt?”

If the answer turns out to be an emphatic “yes”, bankers can count on more downbeat Davos gatherings to come.

Erdoğan Wades into the Libyan Quagmire

Turkey’s president, Recep Tayyip Erdoğan, is the epitome of today’s strongman political leader, but his decision to send Turkish troops to Libya may be a step too far. By the time his Libyan gamble sours, as it inevitably will, he will have run out of both luck and friends.

John Andrews

andrews7_Mustafa KamaciAnadolu Agency via Getty Images_erdogansarrijlibyaturkey


WINCHESTER, UK – Foreign critics of Turkish President Recep Tayyip Erdoğan deride him as a quasi-dictatorial megalomaniac. But Erdoğan – who was Turkey’s prime minister for 11 years before being elected president in 2014 – is now a reckless gambler, too.

In short order, Turkey will send troops to Libya at the request of the United Nations-backed Government of National Accord (GNA), which has been besieged in Tripoli for the last eight months by the advancing forces of Field Marshal Khalifa Haftar’s Libyan National Army (LNA).

This will be a military and diplomatic folly. Erdoğan already has the distressing example of the Syrian conflict on Turkey’s own doorstep. Does he really imagine that sending a few hundred – or even many thousand – Turkish troops to aid the beleaguered GNA will somehow resolve Libya’s tragic and bloody turmoil, itself the result of the 2011 intervention by foreign powers that toppled Colonel Muammar el-Qaddafi’s regime?

If Erdoğan expects either a GNA victory or an imminent peace settlement, he is deluding himself. Haftar’s well-equipped LNA has the support of Egypt, the United Arab Emirates, Saudi Arabia, Russia, and (at least covertly) France. With mercenaries from Russia and Sudan on his side, Haftar must feel rather more optimistic than Fayez al-Sarraj, the GNA’s prime minister. Support for the GNA from Turkey and Qatar, along with the fig leaf of UN recognition, weighs rather less in the military balance.

So, what explains Turkey’s entry into Libya’s dreadful conflict as yet another proxy warrior? One factor, often baffling to outsiders, is the ideological and political influence throughout the Middle East – or at least its Sunni Muslim parts – of the Muslim Brotherhood. Founded in Egypt almost a century ago, the Brotherhood favors a transition (peaceful, it has always maintained) to theocratic government. As its slogan proclaims, “Islam is the solution.”

That is a problem for the ruling families of Saudi Arabia, the UAE, and Bahrain, all of which regard the Brotherhood as a terrorist organization seeking to undermine their power. So, too, does the oppressive Egyptian regime led by President Abdel Fattah el-Sisi, who mounted the 2013 military coup that ended the Brotherhood’s disastrous year governing the Arab world’s most populous country.

Only Turkey – specifically, Erdoğan’s Justice and Development Party (AKP) – and tiny Qatar (very much at odds with neighboring Saudi Arabia) view the Brotherhood with enthusiasm rather than alarm. On the almost frivolous premise that my enemy’s enemy is my friend, the fact that Saudi Arabia, the UAE, and Egypt support Haftar is excuse enough for Turkey and Qatar to support Sarraj and the GNA.

The bigger reason for Erdoğan’s adventurism in Libya, though, is that it fits his desire for Turkey to play a determining role in its region for the first time since the demise of the Ottoman empire (of which Libya was once a part). On the surface, that ambition sounds reasonable enough.

Turkey has a population of more than 80 million, the second-largest military in NATO, and a relatively developed economy. It deserves to be treated with respect – which is why the European Union’s obvious reluctance to advance the country’s membership bid is a blow to Turkish pride.

But Turkey’s pursuit of its regional leadership ambition has come at a high cost. When the AKP came to power in Turkey almost two decades ago, Erdoğan’s mentor was Ahmet Davutoğlu, an academic who then became foreign minister and eventually prime minister. Davutoğlu was keen to expand Turkey’s influence abroad, but under the slogan “zero problems with our neighbors.”

How ironic, then, that Erdoğan has created problems with almost all of his neighbors. The EU cannot accept Turkey’s appalling record on human rights, especially following the military’s failed coup attempt of 2016. Israel cannot abide Turkey’s support for Hamas (which is aligned with the Muslim Brotherhood) in Gaza.

And virtually everyone is exasperated by Turkey’s policy in Syria, which features attacking the Kurds – the most effective fighters against the Islamic State – and ambivalence toward several jihadist groups. Significantly, Davutoğlu has broken with Erdoğan and formed a rival political party.

True, Erdoğan’s supporters can justifiably argue that Turkey has become a regional player to be reckoned with. The EU has to be financially generous, or else Turkey may let hundreds of thousands of Syrian and other refugees from war and poverty flood into Europe.

Russia and Iran, which both support Syrian President Bashar al-Assad’s regime, recognize that a settlement of the Syrian conflict will depend on Turkey’s acquiescence – hence the continuing three-party peace process that began three years ago in Astana, Kazakhstan.

Even the United States under President Donald Trump has had to eat a slice of humble pie: Turkey, regardless of NATO sensitivities and American economic threats, stands by its decision to buy a Russian air-defense system.

But the Libyan venture may be a step too far.

On December 5, the Turkish parliament ratified an agreement between Erdoğan and Sarraj that sets a maritime border between their two countries. The Turkish-Libyan deal ignores international law – as the EU, Cyprus, Greece, and Egypt have pointed out.

It also ignores geography, because the Greek island of Crete lies halfway between the two countries. And it threatens the January 2019 agreement between Egypt, Israel, Greece, Cyprus, Italy, Jordan, and the Palestinian Authority to exploit the gas reserves of the eastern Mediterranean.

Erdoğan is the epitome of today’s strongman political leader. But by the time his Libyan gamble sours, as it inevitably will, he will have run out of both luck and Friends.


John Andrews, a former editor and foreign correspondent for The Economist, is the author of The World in Conflict: Understanding the World’s Troublespots.