Gone missing

As the global economy picks up, inflation is oddly quiescent

But central banks are beginning to raise interest rates anyway




A FEW years ago, the news about the euro-zone economy was uniformly bad to the point of tedium.

These days, it is the humdrum diet of benign data that prompts a yawn. Figures this week show that GDP rose by 0.6% in the three months to the end of September (an annualised rate of 2.4%). The European Commission’s economic-sentiment index rose to its highest level in almost 17 years. Yet when the European Central Bank’s governing council gathered on October 26th, it decided to keep interest rates unchanged, at close to zero, and to extend its bond-buying programme (known as quantitative easing, or QE) for a further nine months.

The central bank said it would slow down the pace of bond purchases each month, to €30bn ($35bn) from January. But Mario Draghi, the bank’s boss, declined to set an end-date for QE.

A hefty dose of easy money will be necessary, he argued, until inflation durably converges on the ECB’s target of just below 2%. It shows few signs of doing so, despite the economy’s strength. Underlying, or core, inflation, which excludes the volatile prices of food and energy, fell from 1.1% to 0.9% in October, according to data published a few days after the ECB meeting. The euro zone’s miseries of 2010-12 were unique. But in its present, happier state of vigorous activity, low inflation and easy monetary policy, it is like many other big economies (see chart).

After a decade of interest rates at record lows, those central banks that are inclined to tighten policy naturally attract attention. The Bank of England’s monetary-policy committee raised its benchmark interest rate from 0.25% to 0.5% on November 2nd, the first increase since 2007.

On the same day, the Czech National Bank raised interest rates for the second time this year.

The Federal Reserve kept interest rates unchanged this week, having raised them in March and June, but a further increase is expected in December.

In Turkey, perhaps the only big economy that is obviously overheating, the central bank—which has been browbeaten by the president, Recep Tayyip Erdogan, who believes high interest rates cause inflation—opted on October 26th to keep interest rates on hold. Yet in most biggish economies, underlying inflation is below target (see chart) and monetary policy is being relaxed. Brazil’s central bank cut interest rates on October 25th from 8.25% to 7.5%. Two days later, Russia’s central bank trimmed its main interest rate, to 8.25%. This week the Bank of Japan voted to keep rates unchanged and to continue buying assets at a pace of around ¥80trn ($700bn) a year. These economies are gathering strength. It is a puzzle that, in such circumstances, global inflation is stubbornly low.



To figure out why, consider the model that modern central banks use to explain inflation. It has three elements: the price of imports; the public’s expectations; and capacity pressures (or “slack”) in the domestic economy. Start with imported inflation, which is determined by the balance of supply and demand in globally traded goods, such as commodities, as well as shifts in exchange rates. Commodity prices have picked up smartly from their nadir in early 2016. The oil price, which fell below $30 a barrel then, has risen above $60.

This has put upward pressure on headline inflation: in the euro zone it is 1.4%, half a percentage point higher than the core rate. Where inflation is noticeably high, it is generally in countries, such as Argentina (where it is 24%) or Egypt (32%), that have withdrawn costly price subsidies and whose currencies have fallen sharply in value, making imported goods dearer. In Britain, rising import prices linked to a weaker pound have added around 0.75 percentage points to inflation, which is 3%.

A second influence on inflation is the public’s expectations. Businesses will be more inclined to push up their prices and employees to bid for fatter pay packets if they believe inflation will rise. How these expectations are formed is not well understood. The measures that are available are broadly consistent with the central bank’s inflation target in most rich economies. Japan is something of an outlier. It has struggled to meet its 2% inflation target in large part because firms and employees have become conditioned to expect a lower rate of inflation. Japan’s prime minister, Shinzo Abe, recently called for companies to raise wages by 3% in next spring’s wage round to kick-start inflation.

Leave aside the transient effects of import prices, and inflation becomes a tug-of-war between expectations and a third big influence, the amount of slack in the economy. The unemployment rate, a measure of labour-market slack, is the most-used gauge. As the economy approaches full employment, the scarcity of workers ought to put upward pressure on wages, which companies then pass on in higher prices. On some measures, Japan’s labour market is as tight as it has been since the 1970s. America’s jobless rate, at 4.2%, is the lowest for over 16 years. Inflation has nevertheless been surprisingly weak.

In other words, the trade-off between unemployment and inflation, known as the Phillips curve, has become less steep. A paper last year by Olivier Blanchard, of the Peterson Institute for International Economics, found that a drop in the unemployment rate in America has less than a third as much power to raise inflation as it did in the mid-1970s.

The central banks that see a need for tighter monetary policy are worried about diminishing slack. There are tentative signs of stronger pay pressures in Britain and America, and firm evidence of them in the Czech Republic, where wage growth is above 7%. Even so, with inflation expectations so steady, the flatter Phillips curve suggests that the cost for central banks in higher inflation of delaying interest-rate rises is rather low. The ECB is quite a way from such considerations. The unemployment rate is falling quickly, but remains high, at 8.9%.

There is still room for the euro-zone economy to grow quickly without stoking inflation. The dull routine of good news is likely to continue.


China’s soft power comes with a very hard edge

Even ‘panda diplomacy’ is not nearly as warm and cuddly as it seems




No animal in the world is more adored than the giant panda. There is a reason: the panda’s proportions — short fat limbs, oversized heads and big eyepatches — trigger the same neural reaction in us as the sight of human babies.

Anyone who has worked closely with these animals will, however, tell you they can be vicious.

Almost every year there are reports of panda attacks in the small area of south-west China where they still exist in the wild.

The panda has become a symbol of China, abetted by the ruling Communist Party’s practice of “panda diplomacy”. Since the 1950s, China has sent scores of the bears to dozens of countries.

From North Korea and the Soviet Union, to Nixon’s America and Angela Merkel’s Germany, China has gifted or loaned the animals to governments it wants to befriend or reward.

The pandas come with hidden costs. China charges countries $1m a year for a pair of pandas and reserves the right to repatriate any offspring if it is displeased by the host country.

President Xi Jinping signs off on every panda loan, but not until recipient countries have jumped through hoops and endured years of negotiations. China-based foreign diplomats complain about how skilful Beijing has become at manipulating governments and constituents in their home countries to increase demand for panda loans.

The Chinese government’s focus on breeding captive pandas to show in zoos and loan to foreign countries has come at the expense of efforts to protect the fragile forests in south-west China, where some 2,000 bears still survive in the wild. The recent success of panda breeding has even led some in China to question the value of protecting the species in the wild.

A tragedy looms if the Chinese government does not redouble its efforts to protect the panda’s habitat, home to numerous other rare species as well.Soft power is about the organic cultivation of mutual advantage and trust.

All of this, of course, has the marking of a rather obvious — but nonetheless very apt — metaphor. China’s efforts to build soft power outside its borders goes far beyond pandas — and in these areas, too, the People’s Republic needs to tread more lightly, and take a more reciprocal and less authoritarian approach.

China is entitled, as is any significant power, to bolster its soft power around the world. That Beijing should do so is particularly understandable. It is not part of the western club of nations.

Its history, ideology, and economic system are all very different and so it needs to work hard to win acceptance from the group of countries that have held sway since the second world war.

But what China should realise is that while western powers — and indeed the world — may well be prepared to accept its rising influence, they will not be amenable to outright interference.

There are many examples of intrusive uses of soft power by China. The forcing of publishers to censor their publications, the use of the United Front Work Department to infiltrate overseas Chinese groups in countries around the world, and the co-opting of Chinese student groups in Australia and elsewhere to protest against free speech are just a few. Companies are caught up, too. When South Korea’s government got on Beijing’s bad side for deploying a missile-defence shield, the South Korean chain Lotte saw its stores in China hit with fire-code violations. A government-backed boycott kept Chinese tourists out of South Korea, too.

Soft power is about the organic cultivation of mutual advantage and trust. In too many cases, China prefers to bully instead. There are not enough pandas left in China to obscure the difference between the two.


Big Tech Meets Big Government

MOHAMED A. EL-ERIAN

Facebook, Google and Twitter executives testify before congress

SINGAPORE – Impressive quarterly results from the biggest technology companies show that they are nowhere near saturating their consumer markets, exhausting their innovation cycles, or reaching growth maturation. Dig a little deeper, and those reports also illustrate the sector’s substantial and growing systemic importance. Yet, for the tech sector, there is a distinct downside to this development.

With increased systemic importance often comes greater scrutiny. And, indeed, today’s prosperous and innovative tech giants now face the prospect of redoubled efforts to regulate and tax their activities. The longer it takes for these companies to recognize their systemic importance, the greater the likelihood of a more powerful backlash by governments and the public, hurting the companies and undermining their ability to continue producing innovations that genuinely boost consumers’ wellbeing.

When the tech sector began its evolution toward systemic importance, it comprised a collection of hungry start-ups possessing breakthrough technologies. Beyond disrupting existing economic sectors and activities, these technologies ended up producing new demand for the altogether new goods and services that they enabled.

Tech companies’ track record – time and again proving their capacity for exceptional growth – enables them to attract massive investment. They are thus able not only to strengthen their market position in their core activities, but also to develop innovative capabilities in new areas, by taking over smaller competitors, whether actual or prospective. And some are even able to self-disrupt repeatedly – and thus consistently to remain at the technological frontier.

Fueling Big Tech’s remarkable growth further, many of these companies’ services are ostensibly free, facilitating quick adoption by consumers. It helps that these services often can be provided as seamlessly abroad as they are within their country of origin, to the point that the very concept of “abroad” has become rather elastic.

Over time, the major tech companies’ rapid accumulation of market power has led to the rise of oligopolies in some sectors, and monopoly players in a few. Their social, economic, and even political influence has soared in some cases. Facebook and Twitter, for example, played a pivotal role in galvanizing protesters during the Arab Spring uprisings of 2011.

This raises serious risks: as beneficial as Big Tech’s innovations are, they can also serve as important channels for state or non-state actors to bring about their own disruptions. In the run-up to last year’s presidential election in the United States, some social media platforms inadvertently enabled the spread of disinformation. More menacing, extremists like the Islamic State have relied on social media for recruitment and propaganda purposes.

It should come as no surprise that Big Tech firms tend to move much faster than governments and regulators. As such, what began as a laissez-faire attitude of benign neglect– largely a result of ignorance and inattention – is evolving into something more forceful. As tech firms reach systemic importance, attitudes toward them change markedly.

This shift has become increasingly apparent in recent years, as major tech firms have faced intensifying scrutiny of their competitive practices, tax behavior, data uses, and privacy policies. Broader questions about their contributions to labor displacement and effects on wage growth have also arisen, even as societies increasingly recognize that technological disruption implies the need for education reform and improvements in skills acquisition and retraining.

Yet the tech sector itself still seems to underestimate its growing systemic importance. As a result, firms can lag in recognizing the need to update their operations, resources, and mindsets to reflect their shift from small disruptor to powerful incumbent. That means building more comprehensive and integrated business models, informed by experienced talent with expertise in a broader array of areas, in order to move beyond these companies’ laser focus on innovation.

The longer this process takes, the greater the risk that tech firms will lose control of the narrative.

Beyond fueling a rise in outside monitoring, regulation, and supervision, there is the risk of a consumer backlash – or even the further exploitation of innovations by malicious actors.

In an ideal world, major tech companies would recognize and adjust to their changing role in step with external actors, including governments and consumers, thereby striking the right balance between innovation, consumer benefits and protection, and national security. But this is not an ideal world. And, so far, internal and external forces have been out of sync, in terms of perceptions, capabilities, and actions. Add to that conscious and unconscious biases and considerable temptation for political manipulation, and the risks become only more profound.

Big Tech can and should play a larger role in helping the entire economy to evolve in an orderly and mutually beneficial manner. This will require, first and foremost, that they internalize their own systemic importance, and adjust their perspectives and behaviors accordingly. But it will also demand far better communication, with firms’ objectives and operations becoming much more transparent.

And, finally, it will call for a commitment to enhanced monitoring both of themselves and of their peers, together with more effective collective action, as appropriate.

If the tech sector fails to make such changes, government oversight and regulation will inevitably intensify. And it is far from certain that the net result will be positive for society, much less for business.


Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.


Doug Casey: How I Learned to Love Bitcoin, Part II

by Doug Casey



In all of Africa, most of South America, and a great part of Asia, fiat currencies issued by governments are a joke. They’re extremely unreliable within those countries. And they’re totally worthless outside the physical borders of the country. That’s why those people now want dollars. But those are physical paper dollars. And governments everywhere are trying to eliminate physical currency.

I think, therefore, that the Third World will adopt Bitcoin in a huge way.

That’s not just because people who own cryptocurrencies are currently making money. They’re saving an appreciating asset rather than a depreciating asset. You’re on a Sisyphean treadmill if you try to save a Third World currency—but three-fourths of humanity has no alternative.

Nobody in these backward places wants to save the worthless local currency—but, by law, that’s typically their only option. Billions will try to get into Bitcoin.

These coins are also private. They can transfer wealth outside of the country, which is very helpful. Kwachas, pulas, pesos, and such are worthless outside of the countries that issue them.

Of course, governments hate that, and this will present a big problem down the road. Governments hate Bitcoin. It gives their subjects a huge measure of extra freedom.

The whole Third World is going to go to these cryptocurrencies. They all have smartphones in these countries. A phone is the first thing they buy after food, shelter, and clothing. Bitcoin will become their savings vehicle.

Sure, it’s a bubbly market. But soon billions more people will be participating in it. So, it’s going to get more bubbly. That’s my argument for the bubble getting bigger, and the prices of quality cryptos going higher.

But like I’ve said, cryptocurrencies are just the first application of blockchain technology. I think they have staying power simply because government fiat currencies are bad, and will be getting worse. They’re not going away. But I view them mainly as a speculative opportunity right now.

How high is Bitcoin going to go? Bitcoin is kind of the numeraire. It’s the gold standard, as it were, of cryptocurrencies. John McAfee, who founded the cyber security giant McAfee, Inc., thinks it’s headed much higher. He thinks Bitcoin’s going to $50,000.

That sounds outrageous, but it’s entirely possible. Another 10-1 in a manic market is possible—although it brings up thoughts of tulip bulbs, of course.

Remember, Central Banks all over the world are printing up fiat currencies by the trillions, desperately trying to put off a collapse of the world economy. Many will issue their own cryptos—they’re trying to totally abolish paper cash as we speak. And they won’t want competition from private currencies like Bitcoin. Governments may well try to outlaw peer-to-peer cryptos.

That’s a topic worth exploring. Governments are going to get into these currencies in a big way. But only their own versions, probably making private cryptos like Bitcoin illegal. With paper cash no longer available, they’ll then be able to track absolutely everything that’s bought and sold.

At that stage—which is in the near future—the blockchain tech will have gone from one of the biggest pro-freedom innovations to one of the most repressive. Like gunpowder—first a liberator for the average man, then a means to suppress him. That said, technology, in the long run, is eventually always a liberating force.

And there’s one more factor that few are considering in the crypto revolution. They’re very good for gold. That’s because they’re drawing attention to the nature of the monetary system. Something few people think about. At all.

When people buy these cryptocurrencies, even if they know nothing about hard money, economics, or monetary theory, they implicitly ask themselves, “Hmm, Bitcoin or the dollar?” They’re both currencies. Then they naturally start asking questions about the nature of the dollar… the nature of inflation… and whether the dollar has any real value, and what’s going to happen to it, and why.

Figuring out the differences between currencies—as opposed to just accepting the dollar and central banking as if they were constants in the firmament, which almost everyone does now—is part of a monetary revolution.

People are going to start asking themselves these questions—which wouldn’t have otherwise occurred to them. They’re going to see that only a certain number of Bitcoin will ever be issued, while dollars can be created by the trillions, by the hundreds of trillions.

That’s going to make them very suspicious of the dollar. It’s going to get a lot of people thinking about money and economics in a way that they never thought about it before. And this is inevitably going to lead them to gold.

So, the Bitcoin and cryptocurrency revolution will prove extremely positive for gold. It’s going to draw the attention of millions, or hundreds of millions of people, to gold as the real alternative to the dollar and other currencies, after Bitcoin.

Plus, I suspect future versions of Bitcoin, or Bitcoin 2.0, will be easily redeemable in gold grams.

This is actually a big deal that most people aren’t looking at.


Buttonwood

Investors call the end of the government-bond bull market (again)

It is the corporate-bond market they should worry about



FOR the umpteenth time in the past decade, a great turning-point has been declared in the government-bond market. Bond yields have risen across the world, including in China, where the yield on the ten-year bond has come close to 4% for the first time since 2014. The ten-year Treasury-bond yield, the most important benchmark, has risen from 2.05% in early September to 2.37%, though that is still below its level of early March (see chart).

Investors have been expecting bond yields to rise for a while. A survey by JPMorgan Chase found that a record 70% of its clients with speculative accounts had “short” positions in Treasury bonds—ie, betting that prices would fall and that yields would rise. Meanwhile a poll of global fund managers by Bank of America Merrill Lynch (BAML) in October found that a net 85% thought bonds overvalued. In addition, 82% of the managers expected short-term interest rates to rise over the next 12 months—something that tends to push bond yields higher.

In part, this reflects greater optimism about the global economy. For the first time since 2014, America has managed two consecutive quarters of annualised growth of 3% or more. Forecasts for European growth have also been revised higher. Commodity prices, including oil, have been rising since June, which may be a sign of improving demand.

The BAML survey found that, for the first time in six years, more managers believe in a “Goldilocks” economy (in which growth is strong and inflation is low) than in a “secular stagnation” outlook (in which both growth and inflation are below trend). If those views turn out to be correct, then it might be expected that bond yields would move a bit closer to more “normal” levels. Until the crisis of 2008, the ten-year Treasury-bond yield had been above 5% for most of the previous four decades.

Investors also expect that, eventually, some kind of fiscal stimulus will be passed in Washington, DC. Of the fund managers polled by BAML, 61% expect tax cuts in the first quarter of next year. Such a package may increase the deficit and induce more economic growth; both factors would push bond yields higher.

Another factor behind the upturn in yields is a shift in central-bank policy. The Federal Reserve has started to wind down its balance-sheet, by not reinvesting the proceeds when bonds mature. The European Central Bank will soon cut the amount of bonds it buys every month by half, to €30bn ($35bn). The private sector will have to absorb the bonds that central banks are no longer purchasing.

Whether this will trigger the long-prophesied collapse of the bull market in bonds is another matter. Globally, there are no signs of a sustained surge in inflation (see previous article).
PIMCO, a fund-management group, thinks that global economic conditions may now be “as good as it gets”. The momentum of growth may already have reached its peak.

Central banks also know that higher bond yields can act as a brake on economic growth. In G20 advanced economies, the combined debt of households, governments and the non-financial corporate sector has been rising steadily and stands at 260% of GDP. Every debt is also a creditor’s asset, but higher borrowing costs can create awkward adjustments; in America, for example, 30-year mortgage rates are around half a percentage point higher than they were a year ago. So the pace of tightening will be very slow. And if the economy shows any sign of wobbling, central banks will probably relent.

Perhaps the real area of worry should be the corporate-bond market. Low government-bond yields have pushed investors in search of a higher income into taking more risk. American mutual funds now own 30% of the high-yield bond market, up from less than 20% in 2008. The spread (extra interest rate over government bonds) on these riskier securities is close to its lowest level since before the financial crisis. BlackRock, another fund-management group, says there is “a more favourable environment for issuers at the expense of lenders”, especially as the quality of the covenants protecting lenders has been deteriorating.

With the rate of bond defaults falling, and the global economy doing well, investors probably feel there is little to worry about. But there is a problem: the corporate-bond market is less liquid than it was before 2007, as banks have pulled back from their market-making roles.

Investors have found it easy to get into the market in search of higher yields. When the time comes, they will find it much more difficult to get out.