The Stock-Market Disconnect

The best explanation for why stock markets remain so bullish despite a massive recession is that major publicly traded companies have not borne the brunt of the pandemic's economic fallout. But having been spared by the virus, they could soon find themselves squarely in the sights of a populist backlash.

Kenneth Rogoff

CAMBRIDGE – Why are stock-market valuations soaring when the real economy remains so fragile? One factor has become increasingly clear: The crisis has disproportionately affected small businesses and low-income service workers. 

They are essential for the real economy, but not so much for equity markets. True, there are other explanations for today’s lofty valuations, but each has its limitations.

For example, because stock markets are forward-looking, current stock prices may reflect optimism about the imminent arrival of effective COVID-19 vaccines and radically improved testing and treatment options, which would allow for a more limited and nuanced approach to lockdowns. 

This outlook may be justified, or it may be that markets are underestimating the likelihood of a severe second wave this winter, and overestimating the efficacy and impact of the first-generation vaccines.

A second, and perhaps more convincing, explanation for today’s stock market performance is that central banks have pushed interest rates down to near zero. With markets convinced that there is little chance that rates will rise in the foreseeable future, prices of long-lived assets such as houses, art, gold, and even Bitcoin have all been driven upward. 

And because tech firms’ revenue streams are tilted far into the future, they have benefited disproportionately from low interest rates.

But, again, it is not clear that markets are correct in anticipating a never-ending continuation of low interest rates. After all, the long-term adverse supply effects, particularly from deglobalization, may linger long after global demand has recovered.

A third explanation is that in addition to providing ultra-low interest rates, central banks have directly backed private bond markets – representing an unprecedented intervention in the case of the US Federal Reserve. These private bond purchases should not be thought of as monetary policy in a conventional sense. Rather, they resemble a quasi-fiscal policy, with the central bank acting as an agent for the Treasury in an emergency situation.

As such, this particular intervention is likely to be temporary, even though central banks have not yet succeeded in telegraphing that fact to markets. Despite sharply elevated macroeconomic volatility and a rising supply of corporate debt, interest-rate spreads over government debt have actually narrowed in many markets, and the number of major corporate bankruptcies to date remains remarkably low considering the magnitude of the recession.

At some point, markets will be disabused of the notion that taxpayers will cover everything indefinitely. Central banks are ultimately constrained in the amount of risk they are allowed to assume, and the belief that they still have an appetite for taking on more could be challenged if a severe second wave arrives this winter.

While these three explanations offer some insights into why stock prices are rising at a time when the real economy is heading south, they tend to miss a big piece of the puzzle: the economic pain inflicted by COVID-19 is not being borne by publicly traded companies. 

It is falling on small businesses and individual service proprietors – from dry cleaners to restaurants to entertainment providers – that are not listed on the stock market (which leans more toward manufacturing). 

These smaller players simply do not have the capital needed to survive a shock of this duration and magnitude. And government programs that have helped keep them afloat for a while are beginning to lapse, raising the risk of a snowball effect in the event of a second wave.

Some small-business failures will be seen as part and parcel of the broader economic restructuring that the pandemic has triggered. But plenty of otherwise viable businesses also will fail, leaving large publicly traded companies with an even stronger market position than they already had. 

In fact, that is yet another reason for the market euphoria. (True, some large businesses have filed for bankruptcy protection, but most – not least brick-and-mortar retailers – were already in trouble before the pandemic).

Further underscoring the unequal impact of the pandemic, government tax revenues have not fallen by nearly as much as one might expect, given the magnitude of the recession and record post-war unemployment levels (or, in Europe’s case, the massive outlays to pay furloughed workers). The reason, of course, is that the job losses have been concentrated among low-income individuals who pay less in taxes.

But today’s elevated stock markets face risks that are not only economic, including but not limited to the significant possibility of an unprecedented political crisis following the US presidential election this November. 

After the 2008 financial crisis, there was a widespread backlash over policies that seemed to favor Wall Street over Main Street. This time, Wall Street will again be vilified, but populist wrath also will be directed toward Silicon Valley.

One likely outcome, especially if the ongoing process of deglobalization makes it more difficult for corporations to shift their operations to low-tax countries, will be a reversal of the trend decline in corporate tax rates. That will not be good for stock prices, and it would be a mistake to think the populist response would stop there.

Until lofty stock-market valuations are underpinned by a broad-based recovery in both health and economic outcomes, investors should not get too comfortable with their outsize pandemic profits. What goes up can also come down.

Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. He is co-author of This Time is Different: Eight Centuries of Financial Folly and author of The Curse of Cash.

Answering the Question of Iran

The U.S. can’t truly leave Iraq without dealing with Iran.

By: Allison Fedirka

Earlier this week, the U.S. special representative for Iran said Washington would keep putting additional pressure on Iran in the days and weeks ahead. 

He also said that Iran had reached a moment where it recognized it could not indefinitely withstand such pressure and would have to either sign a new nuclear deal with Washington or abandon its regional strategy – that is, using proxies to carve out a sphere of influence to the Mediterranean Sea. 

The U.S. and Iran spar verbally all the time – and sometimes violently – but there’s reason to believe there’s bite behind Washington’s barks, and that tensions may soon intensify again.

The U.S. wants to reduce its global military footprint, especially in the Middle East, as it pivots to the Indo-Pacific. The ideal outcome would be a light security presence in certain hotspots that can be quickly scaled up in case of emergency. Though Washington has already done much in that regard, Iran’s presence in Iraq complicates the withdrawal. 

The U.S. doesn’t want to leave a country it has been at war with for nearly 20 years just to see Iran gain more political and security control there than it already had. 

Tehran’s nuclear ambitions, moreover, threaten to destabilize the region, and an unstable region will be more difficult to vacate. 

Squaring away the U.S. military departure from Iraq along with the Iraqi economy’s reconstruction efforts means finding a way to reduce the threat of Iranian influence. In other words, time is winding down to settle the status of Iran.

In light of an uptick in rocket attacks conducted by Iran-backed Shiite militias against U.S. targets, there are now signals coming out of Iraq suggesting what the U.S. plan is. 

A strong military response by the U.S. is a nonstarter; it would be counterproductive to withdrawal efforts. 

But Washington can use political pressure, economic incentives and smaller-scale security moves to support Baghdad cracking down on the militias. For example, Washington appears ready to follow through on its threat to relocate its embassy in the Green Zone if security there remains suspect. 

There were also reports from Kurdistan late last week that U.S. coalition airstrikes against the Islamic State in northern Syria also hit targets belonging to the Popular Mobilization Forces, the loose collection of Iraq’s Shiite militias, in Anbar province. (The PMF initially confirmed the story but later denied it.)

Baghdad seems to have acquiesced to U.S. demands. Iraqi Prime Minister Mustafa al-Kadhimi called for the creation of a military and security commission to investigate the recent rocket attacks, particularly those targeting U.S. assets. 

National Security Adviser Qasim al-Araji will oversee the investigation and report results directly back to the prime minister in 30 days. 

However, curbing Iranian influence among Iraqi militant groups will rely on the Iraqi federal government’s ability to stand on its own against militias sympathetic or financially beholden to Tehran – something the Iraqi government has been unable to do thus far.

Meanwhile, there are signs that Israel, a critical ally in the U.S. coalition against Iran, is also increasing pressure on Tehran. It has taken more responsibility for military strikes against Iranian proxy forces, largely because they are positioned along Israel’s borders. 

Just last week, Israeli Prime Minister Benjamin Netanyahu accused Hezbollah, the Lebanese militia, of maintaining a missile storage facility in a suburb of Beirut, which, if true, could lead to an Israeli attack. (Tactically, Israel is in a tough spot. It cannot afford to sit idly by, but attacking a site such as the one Netanyahu identified would cause mass civilian casualties and all but guarantee war.) 

For its part, Lebanon is trying to maintain the status quo with Israel, as evidenced by its agreement to reengage with U.S.-mediated maritime and land border talks. But talks have broken down before, and there’s no guarantee that these won’t either.

Two other developments together suggest that a move against Iran may be near. The French Foreign Ministry announced Oct. 1 that the European-led maritime surveillance mission’s mandate to operate in the Strait of Hormuz has been extended through 2021. 

Though the mission is not directly part of the U.S. pressure campaign and these waters have been relatively quiet in the past few months, that the statement was made at all shows that the potential for escalation still exists.

More directly related is the Oct. 6 statement from an official of Iran’s Ministry of Economic Affairs and Finance that Tehran was struggling to pay overtime, bonuses and pensions. The government had been selling surplus properties to acquire the needed funds to make ends meet, but the parliament temporarily stopped the practice on legal grounds. 

Whatever the case may be, the government is clearly hurting financially, and though it has the tools to temper public unrest, political patronage and protection come much easier with a fuller treasury.

It’s not entirely clear what more, if anything, the U.S. has in store for its maximum pressure campaign against Iran. Washington relied nearly exclusively on economic and diplomatic sanctions lately, so much so that it’s hard to imagine what else is left to sanction. 

It’s also unclear if Israel is truly prepared to move on Iran beyond airstrikes in Syria – or what would have to shift to change Israel’s mind. What is clear is that the U.S. has to settle the Iran question before it vacates Iraq, and that in the meantime, the Iranian people will bear the brunt of the suffering.  

As Luxury Watch Sales Slow, One Retailer Speeds Up

A stellar performance at Watches of Switzerland can’t be taken as a sign of a wider recovery for the travel-dependent industry

By Carol Ryan

Plunging tourist demand for luxury watches hasn’t held back one specialist retailer—quite the opposite. Unfortunately, there is little chance that its larger peers can mimic the performance.

Shares in Watches of Switzerland, a multi-brand seller taken public by buyout firm Apollo in June 2019, rose 22% in morning trading Tuesday. The company increased its sales and profit guidance following remarkably strong sales to date during its second quarter, which ends on 25 Oct. Sales for the first 10 weeks of the period are up 20% compared to the same weeks of 2019.

The company has experienced the same collapse in international business seen across the luxury-goods sector. Sales made to tourists and in Watches of Switzerland’s airport stores shrank to less than 10% of total revenue in the current quarter, down from one-third this time last year.

Exports of Swiss watches fell by 12% year over year, according to the Federation of the Swiss Watch Industry. / PHOTO: ARND WIEGMANN/REUTERS

Yet it is making up the difference, and then some, by selling to locals. This isn’t the case for the wider market: In August, exports of Swiss watches fell by 12% year over year, according to the Federation of the Swiss Watch Industry.

Watches of Switzerland’s footprint and focus are advantages for now. The company only has stores in the U.K. and U.S., where it has courted local customers. 

Even in more normal times, sales to Chinese nationals were under 10% of the total, compared to as much as 40% for a major luxury brand. Large listed watchmakers Swatch and Compagnie Financière Richemont, which owns Vacheron Constantin, are both taking a heavy hit in their empty European and Hong Kong boutiques now that the Chinese aren’t traveling.

Local clients are still keen to spend on the right brand. Watches of Switzerland makes around 60% of its sales from three of the best in the industry: Rolex, Patek Philippe and Audemars Piguet. 

Long waiting lists for these companies’ products keep a floor under demand. As all three manufacturers are privately owned, Watches of Switzerland is the only way for investors to get exposure to their healthy sales growth.

Of course, a retailer will never achieve the same margins as a big luxury watch manufacturer—one reason why Watches of Switzerland’s shares trade at 20 times next year’s earnings, compared to 36 times for Richemont. 

The retailer’s high exposure to the U.S. market may also be a drag as political turbulence rises ahead of the November election. 

Yet other listed companies in the Swiss watch business will struggle to show the same resilience in this crisis.

A new cold war: Trump, Xi and the escalating US-China confrontation

In the first of a series, Gideon Rachman explores how the rivalry between the two superpowers is starting to feel eerily familiar

Gideon Rachman in London

        © FT montage; Getty. Then: Truman vs Stalin. Now: Trump vs Xi

“From Stettin in the Baltic to Trieste in the Adriatic, an ‘iron curtain’ has descended across the continent.” Winston Churchill’s speech in Fulton, Missouri, in March 1946 is remembered as a key moment in the outbreak of the cold war.

If future historians are ever looking for a speech that marked the beginning of a second cold war — this time between America and China — they may point to an address by Mike Pence delivered at Washington’s Hudson Institute in October 2018. “China wants nothing less than to push the United States of America from the western Pacific . . . But they will fail,” the vice-president declared. “We will not be intimidated and we will not stand down.” Pointing to China’s political system, Mr Pence argued: “A country that oppresses its own people rarely stops there.”

For students of the first cold war between the US and the USSR, some of this sounded eerily and worryingly familiar. Once again, the US is facing off against a rival superpower. Once again, a military rivalry is taking shape — although this time, the main theatre is the western Pacific rather than central Europe. And once again, the conflict is being framed as one between the free world and a dictatorship. To add to the sense of symmetry, the People’s Republic of China, like the Soviet Union, is run by a Communist party.

Even in the past few months, the deterioration in relations between the US and China has rapidly gathered pace, against the backdrop of a feverish election campaign in the US. Military tensions in the Pacific are rising. Taiwanese officials say the September exercises by the Chinese military within its air defence buffer zone were the most significant threat to its security since Beijing launched missiles into the seas around the island in 1996. The US has a commitment to help the country defend itself.

The US has moved aggressively to block Chinese technology firms, such as TikTok and Huawei — from expanding their international operations, or buying US-made computer chips. China and America are even indulging in tit-for-tat expulsions of journalists.

And coronavirus, which originated in China, has devastated the global economy and led to more than 200,000 deaths in America. President Donald Trump, who is currently in hospital after testing positive for the virus, has made it clear that he holds the government of China directly responsible for the pandemic.

In another confrontational speech that will probably be remembered by historians, secretary of state Mike Pompeo warned in July that five decades of engagement with China had been a failure.

“If we don’t act now, ultimately, the [Chinese Communist party] will erode our freedoms and subvert the rules-based order that our free societies have worked so hard to build,” he said, speaking at the Californian library of Richard Nixon, the president who reopened ties with Beijing during the cold war. “The old paradigm of blind engagement with China simply won’t get it done. We must not continue it. We must not return to it.”

New uncertainty

For Joseph Nye, a professor at Harvard University and former senior Pentagon official, US-China relations are now “at their lowest point in 50 years”.

There is even a fear that, as in the cold war, the world could increasingly divide into two blocs — one that looks to Washington and one that looks to Beijing. That may sound implausible in a world of globalised supply chains. But, especially in the tech sector, there are signs that this is already starting to happen.

As the Huawei case illustrates, the US is now clearly leaning on its allies to cut tech ties with China — and, in some cases, such as in Britain and, to an extent, Germany, the pressure is working. China, however, is also building its own global network of influence through trade and its Belt and Road Initiative — which could involve loans and investment of up to $1tn in infrastructure development outside China.

Henry Kissinger, the former US secretary of state who helped bring about the rapprochement between the US and China in the 1970s, said last year that Beijing and Washington were now in the “foothills of a cold war”.

If China’s growing technological prowess has captured US attention this year, its defence capabilities are also driving the growing anxiety. China’s rapid military build-up has altered the balance of power between Beijing and Washington. The Chinese navy now has more ships than the US navy — and they can all be concentrated in the western Pacific. China has also developed a formidable range of missile and satellite weaponry that could threaten American aircraft carriers and disrupt the US military’s communications.

In a recent article, Michèle Flournoy, who is tipped as a possible US defence secretary if Joe Biden wins the presidential election, worried that “dangerous new uncertainty about the US ability to check various Chinese moves . . . could invite risk-taking by Chinese leaders”, adding: “They could conclude that they should move on Taiwan sooner rather than later.”

Since President Xi Jinping came to power in 2012, China has become more assertive overseas and more authoritarian at home

Ms Flournoy’s recommendation is that America should strengthen its military capacity, so as to restore deterrence. The fact that a prominent Democrat is taking this position points to an important aspect of the new US-China rivalry: it will not disappear if Mr Trump loses the White House in the presidential election.

There is no doubt that the current US president uses much more confrontational language with China (and indeed most countries) than any of his predecessors. Mr Trump’s single-minded focus on the US trade deficit with China and his protectionist policies are also distinctive. 

But Mr Trump may have helped to bring about a permanent shift in orthodox opinion in Washington. Daniel Yergin, an economic historian, notes that “while Democrats and Republicans hardly agree on anything today in Washington, one thing they do agree on is that China is a global competitor and that the two countries are in a technology race”.

A Biden approach to China would place more emphasis on American alliances than the Trump administration, and would probably make less use of tariffs. The Democrats would also look to work with China on climate change. But a Biden administration would not alter the basic premise of the Trump policy — which is that China is now an adversary.

In Beijing, this move towards a “cold war mentality” is decried — and is often attributed solely to America’s supposed refusal to accept a multipolar world. It probably is the case that there is a bipartisan determination in Washington to retain America’s status as “number one”. But the Chinese view skates over the extent to which Beijing itself has contributed to the emergence of a second cold war.

Since President Xi Jinping came to power in 2012, China has become more assertive overseas and more authoritarian at home. Beijing’s construction of military bases across the South China Sea has been perceived in Washington as a direct challenge to American power in the Pacific. 

Constitutional changes that would allow Mr Xi to rule for life, the crackdown in Hong Kong and the mass imprisonment of the Uighur minority have all driven home the message that China is becoming more dictatorial — dashing any remaining hopes in Washington that economic modernisation in China would lead to political liberalisation.

Winston Churchill delivering his speech ‘The sinews of peace’ at Fulton, Missouri, in March 1946 is remembered as a key moment in the outbreak of the cold war © Popperfoto via Getty

An increasingly wealthy, illiberal and aggressive China is much easier to see as a dangerous rival that needs to be confronted. In public the Chinese leadership continues to decry the “zero-sum thinking” of the Americans. 

In private, however, the Xi leadership seems to regard the US as a dangerous rival, intent on overthrowing Communist party rule. As long ago as 2014, Wang Jisi, a well-connected Beijing academic, wrote that China’s leadership was preoccupied by “alleged US schemes to subvert the Chinese government”.

If continuing rivalry between the US and China is inevitable, how do the two sides match up?

It is generally acknowledged that the military gap between Washington and Beijing has narrowed considerably. But the US has a network of allies that China cannot replicate. There is no “Beijing Pact” to rival the Warsaw Pact that once bolstered the Soviet Union. 

On the contrary, other key powers in the Indo-Pacific region are treaty allies of the US, including Japan, South Korea and Australia. And India, while it is not a formal ally of the US, is likely to tilt towards Washington following the recent deadly confrontations between Indian and Chinese troops on the two nations’ disputed border.

     US president Donald Trump, left, has made it clear that he holds the government of China directly responsible for the coronavirus pandemic © Andy Wong/AP

However, if America stood aside in the event of a Chinese assault on Taiwan, then the US alliance system might not survive the shock. Conversely, if the rivalry between Beijing and Washington never escalates into military confrontation, then China has other assets it can deploy. It is the largest trading partner for more than 100 nations; compared with 57 nations for America.

China is also a plausible rival to the US in a tech race. It is clear that some Chinese tech firms are vulnerable to cut-offs of key American components — in particular computer chips and semiconductors. On the other hand, China is ahead in certain technologies, such as mobile payments, and it is a formidable competitor in other areas such as artificial intelligence and medicine.

A scientific rivalry between America and China is certainly reminiscent of the US-Soviet rivalry, which was driven by a space race.

Vice-president Mike Pence said at Washington’s Hudson Institute in October 2018: 'China wants nothing less than to push the United States of America from the western Pacific . . . But they will fail' © Jacquelyn Martin/AP

Integrated rivals

But while the parallels between the current US-China rivalry and the start of the cold war are striking, there are also some important differences. The most obvious is that the economies of the US and China are deeply integrated with each other. Trade between China and the US amounts to more than half a trillion dollars a year. 

China owns more than $1tn of US debt. Important American companies rely on making and selling their products in China. Manufacture of the Apple iPhone is built around a supply chain based in southern China. There are more Kentucky Fried Chicken restaurants in the PRC than in the US.

This economic intertwining has also created a degree of social convergence. China may be run by a Communist party, but its major cities are throbbing with commercial life, private enterprise and western brands, and could never be mistaken for the grey uniformity of Soviet Russia. 

“Chinese society is more similar to American society than Soviet society ever was,” Yale University historian Odd Arne Westad noted in Foreign Affairs magazine.

There are also strong scientific and educational ties between China and the US. Mr Xi’s daughter was educated at Harvard. Stalin’s daughter was not sent to Yale.

China is also a plausible competitor to the US in a tech race, reminiscent of the US-Soviet rivalry driven by a space race © Aleksandar plaveski/EPA-EFE

Given the levels of economic and social integration between the US and China, some scholars argue that the cold war may not be the best historical analogy — although some of the other potential comparisons are no less alarming. 

Margaret Macmillan, who has written a history of the origins of the first world war, thinks the “more important parallel is the UK and Germany before 1914”. 

This was a classic great power rivalry between an established and a rising power. At the time, some argued that the extent of economic integration between Germany and Britain made war both irrational and unlikely. But that did not prevent the two nations sliding into hostilities.

Mr Westad, an expert both on China and the cold war, points out that, unlike the Soviet people in 1946, the Chinese have enjoyed 40 years of peace and prosperity. 

Therefore, “in a crisis, the Chinese are more likely to resemble the Germans in 1914 than the Russians after the second world war — excitable, rather than exhausted,” he says.

A yearning to test and demonstrate national strength is certainly visible in nationalist circles in China. Hu Xijin, editor of the Global Times newspaper, tweeted in July that China “is fully capable of destroying all of Taiwan’s military installations within a few hours, before seizing the island shortly after. Chinese army & people have such self-confidence.”

The Chinese navy now has more ships than the US navy, and they can all be concentrated in the western Pacific © Reuters

Another historical analogy, less discussed in the west but often heard in Tokyo, is the clash between Imperial Japan and the US that reached an endpoint in the second world war. As a senior Japanese diplomat sees it: “The Chinese are making the same mistake we made, which is to challenge American hegemony in the Pacific.” 

But at the time of Pearl Harbor, the Japanese economy was just 10 per cent the size of America’s. China, by contrast, now has an economy that is two-thirds the size of America’s — and larger when measured by purchasing power.

There is one further aspect in which the comparison between modern China and the Japan of the 1930s is suggestive. Imperial Japan argued that it was liberating Asia from western imperialism (countries invaded by the Japanese, such as China and Korea, did not see it that way). 

There is a similar hint of a “clash of civilisations” in some Chinese nationalist discourse — in which the rise of China is portrayed as ending centuries of domination of the global order by white, western nations.

The Anglo-German rivalry and the US-Japanese confrontation culminated in war. But they broke out in an age before nuclear weapons. By contrast, the threat of nuclear annihilation defined the cold war. 

Perhaps as a result, US and Soviet forces never clashed directly during the cold war, although they often battled through proxies. Yan Xuetong, a prominent scholar at Tsinghua University in Beijing, has argued that fear of nuclear conflict makes it unlikely that China and America will ever go to war — which would make the current US-Chinese confrontation more like the cold war, than the run-up to the two world wars.

Michèle Flournoy, tipped as a possible US defence secretary if Trump loses the election, said the US should strengthen its military capacity to restore deterrence . . .  © Mark Wilson/Getty

. . . suggesting the new US-China rivalry will not disappear if Democrat Joe Biden enters the White House  © Kevin Dietsch/Bloomberg

Strength of systems

But perhaps the most intriguing comparison is about how the cold war ended, rather than how it began. The contest was not settled on the battlefield or in space. In the end, it was determined by the relative resilience and success of the two societies — the US and the USSR.

Ultimately, the Soviet system simply collapsed under the weight of its own internal problems. (Ironically, this was the fate that Communists had long predicted for the capitalist system). The USSR’s fate vindicated the strategy first sketched out by the American diplomat George Kennan, who in 1946 had advocated the patient containment of Soviet power while awaiting the system’s ultimate demise. Kennan also argued that the vitality of America’s own system would be crucial in any contest with the USSR.

It is this last comparison which should disquiet the Americans and their allies most. 

The current presidential election threatens to provoke a crisis in the American democratic system of a sort that has not been seen since the 19th century. 

Even if the US achieves the peaceful transition of power that Mr Trump has failed to guarantee, the Trump era has revealed social and economic divisions that have turned America inwards and damaged the country’s international prestige.

A yearning to test and demonstrate national strength is certainly visible in nationalist circles in China © Thomas Peter/Reuters

The spectacle of the Trump-Biden contest has strengthened the sense in China that the US is in decline. Eric Li, a trustee of the China Institute at Shanghai’s Fudan University, inverts the cold war analogy — by casting the US as the USSR, in the grip of an “existential brawl between two near octogenarians”, referring to Mr Trump and Mr Biden. 

“Remember [former Soviet rulers] Brezhnev, Andropov and Chernenko?” By contrast, according to Mr Li, “China today is the opposite of what the USSR was decades ago. It is practical, ascendant and globally connected.”

For all the confidence of pro-government intellectuals in China, like Mr Li, there is no doubt that Mr Xi’s China also has significant internal problems. As Mr Westad notes, it is “a de facto empire that tries to behave as if it were a nation-state” and the strains are showing from Hong Kong to Tibet to Xinjiang. But the PRC has also demonstrated an economic prowess that the USSR never possessed.

If the US and China are indeed embarking on a new cold war to determine which country will dominate the 21st century, the vitality of their domestic systems may ultimately determine who prevails.

The three pillars

Why, despite the coronavirus pandemic, house prices continue to rise

Monetary policy, fiscal measures and buyers’ preferences explain the unlikely boom

During the global recession a decade ago, real house prices fell by an average of 10%, wiping trillions of dollars off the world’s largest asset class. Though the housing market has not been the trigger of economic woes this time, investors and homeowners still braced for the worst as it became clear that covid-19 would push the world economy into its deepest downturn since the Depression of the 1930s.

That pessimism now looks misplaced. House prices picked up in most middle- and high-income countries in the second quarter. In the rich world they rose at an annual rate of 5% (see chart 1). Share prices of developers and property-traders fell by a quarter in the early phase of the pandemic, but have recovered much of the fall.

Some markets are fizzing. In August house prices in Germany were 11% higher than the year before; rapid growth in South Korea and parts of China has prompted the authorities to tighten restrictions on buyers. 

In America growth in the median price per square foot accelerated more quickly in the second quarter of 2020 than in any three-month period in the lead-up to the financial crisis of 2007-09. Three factors explain this strength: monetary policy, fiscal policy and buyers’ changing preferences.

Consider monetary policy first. Central bankers around the world have cut policy rates by two percentage points on average this year, reducing the cost of mortgage borrowing. Americans can take out a 30-year fixed-rate mortgage at an annual interest rate of just 2.9%, down from 3.7% at the beginning of the year. 

Studies suggest a strong link between falling real interest rates and higher house prices. Some borrowers can afford to take out bigger mortgages; others find it easier to manage their existing loans. 

Landlords are willing to pay more for property, because yields on other assets have dropped. In both America and Britain, mortgage lending is running at post-financial-crisis highs.

That is not to say that it has become easier for everyone to borrow. In fact, obtaining a mortgage has become harder for many. Brokers, fearful of the long-term economic impact of covid-19, have pulled back on riskier lending. British banks, for instance, are offering fewer high-loan-to-income mortgages. 

In America few loan officers at banks said they were tightening lending standards before the pandemic; now 60% do. In contrast with previous periods of strong house-price growth, there is little evidence of lax lending standards.

Fiscal policy, the second factor, may therefore be more important in explaining buoyant prices. In a normal recession, as people lose jobs and their incomes fall, foreclosures drag house prices down—not only by adding to the supply of houses on the market, but also by leaving ex-homeowners with a blemish on their credit history, making it harder for them to borrow again. 

But this time governments in rich countries have preserved households’ incomes. 

Handouts through wage subsidies, furlough schemes and expanded welfare benefits amount to 5% of gdp. In the second quarter of the year households’ disposable incomes in the g7 group of large economies were about $100bn higher than they were before the pandemic, even as jobs disappeared by the millions.

Other measures directly support the housing market. Spain, for instance, has allowed borrowers to suspend their mortgage repayments. Japan’s regulators have asked banks to defer principal repayments on mortgages, and the Netherlands temporarily banned foreclosures. 

In the second quarter the number of owner-occupied mortgaged properties that were repossessed in Britain was 93% lower than in the same period in 2019, the result of policies that dissuade repossessions. In America foreclosures, as a share of all mortgages, are at their lowest level since 1984.

The third factor behind the unlikely global housing boom relates to changing consumer preferences. In 2019 households in the median oecd country devoted 19% of spending to housing costs. 

With a fifth of office workers continuing to work from home, many potential buyers may want to spend more on a nicer place to live. Already there is evidence that people are upgrading their household appliances.

People also seem to be looking for more space—which, all else being equal, raises house prices. Though the New York and San Francisco housing markets look weak, there is little wider evidence to support the idea that people are fleeing cities for the suburbs, at least in America. 

Data from Zillow, a housing marketplace, suggest urban and suburban property prices are rising at roughly the same pace; price growth in the truly get-away-from-it-all areas is actually slowing (see chart 2). 

It seems more likely that people are looking for bigger houses near where they already live. 

In Britain prices of detached houses are rising at an annual rate of 4%, compared with 0.9% for flats, and the market for homes with gardens is livelier than for those without.

Can house prices continue their upward march? Governments are slowly winding down their economic-rescue plans, and no one knows what will happen once support ends. But lower demand for housing may run up against lower supply. High levels of economic uncertainty deter investment: in America housebuilding has fallen by 17% since covid-19 struck. 

The experience of the last recession suggests that even when the economy recovers, construction lags behind. 

It may take more than the deepest downturn since the Depression to shake the housing market’s foundations.