The UK is about to shoot itself in both feet

Britain’s demands for its negotiations with the EU are unrealistic

Martin Wolf

John Bull Both Barrels
© James Ferguson

Boris Johnson has an autonomy fetish. The UK prime minister’s fetish is the belief that his country not only has the sovereign right to shoot itself in both feet, but also has a duty to do so if the alternative is to allow EU institutions any role in its affairs.

Brexit, he insists, means autonomy. If he persists with this demand, it is likely that, early next year, the UK will suffer the complete rupture of trading relationships it has built up over 47 years.

Yesterday, the British government presented its demands for these negotiations. Unfortunately, they are unrealistic in three respects: the first is the hope that any agreement will be between “sovereign equals”; the second is the belief that the EU would agree a Canada-style agreement; and the third is that an Australian relationship with the EU, governed by World Trade Organization rules, is a reasonable alternative.

As a matter of international law, the UK is sovereign. But sovereignty is not the same thing as power. The EU has 446m people, against the UK’s 66m. Its economy is almost six times as big as the UK’s. The EU is also much less dependent on trade with the UK than is true the other way round. Let us be clear: this is not a relationship between equals.

The difficulty for the UK in its relationship with the EU is rather that it is too small to be an equal and too big not to matter. It is almost as important a trading partner of the EU as the US.

That is because distance is crucial in determining bilateral trade flows. Since the UK is a far more important trading partner of the EU than Canada, the bloc is also more wary of Britain’s capacity to disrupt its economy. At the same time, for Australia, trade with the EU is negligible.

But the EU is the UK’s most important trading partner. The UK must not accept the same trade relationship with the EU as Australia’s.

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The EU’s characteristically thorough mandate for the talks makes clear how it sees the negotiations. First, Brussels sees the “new partnership” as a “single package”. This is to cover “general arrangements” including the provisions on governance; “economic arrangements including trade and level playing field guarantees” (my emphasis); and security arrangements including law enforcement and judicial co-operation, foreign policy, security and defence.

Second, the issues are many and complex. These include data protection, participation in EU and Euratom nuclear programmes, trade in goods and services, intellectual property, public procurement, mobility of people, aviation, road transport, energy, fisheries, judicial co-operation, foreign policy co-operation and cyber security.

It beggars belief that all this can be agreed and ratified within a year. The idea that the UK should walk away if all this cannot be agreed in that brief time seems insane.

Finally, the EU states that “given the . . . UK’s geographic proximity and economic interdependence, the envisaged partnership must ensure open and fair competition . . . To that end, the envisaged agreement should uphold the common high standards in the areas of state aid, competition, state-owned enterprises, social and employment standards, environmental standards, climate change, and relevant tax matters.” What the EU is saying here is that your autonomy stops where it inconveniences us. If the UK insists upon it, then the deal it seeks may not be agreed.

To the reasonable conclusion that no deal is likely, three replies are possible.

The first is that the EU will give in. That is quite unlikely. For the EU to back down on the issue of the “level playing field”, to take one example, would require it to trust the UK not to compete by undermining the EU’s standards. But what else — the EU will ask — is all this freedom for?

What else have Brexiters been saying it is for? You are asking us to trust you, Mr Johnson.

Why should we?

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A second response is that it does not matter to the UK if no deal is reached. But it does. Even if the failure were “only” on the trade aspects of the negotiations, with other parts agreed, which is unlikely, the costs for the UK of a sudden disruption might be huge.

In 2018, the government’s own analysis concluded that the UK economy might end up between 6 and 9 per cent smaller, in the long run, under a “no-deal” scenario. This is significantly worse than the already bad outcome of a free trade agreement in goods. Moreover, a sudden shift from current arrangements would impose a shock. The UK would not, as Mr Johnson claims, “prosper mightily”. Responsible governments do not inflict such shocks on their economies.

A last response is that, in the end, Mr Johnson will retreat from his red lines. That is what he did last October over the Irish border issue, when he accepted the economic dismemberment of his own country, something his predecessor had refused outright, all the while denying he had done any such thing. The ability to surrender while successfully insisting that one has not is a form of genius. Maybe, the prime minister can find a description for humiliating surrenders that dress them up as great victories. I would certainly not put it past him.

This, however, is hope against hope. As things stand, there is a fundamental conflict over the scope of the envisaged agreements, over governance of the new deal and, probably most vexing, over data, fish and the “level playing field”.

There is in brief much disagreement over the nature of the prospective relationship and very little time in which to agree. A likely result is no deal.

If so, the greater the ensuing disruption, the more the Johnson government is likely to try to blame it on the EU. It might even seek revenge, possibly by trying to ally itself with the US against the EU.

Above all, remember this: a limited free trade agreement would be better than no deal; but it will still hurt.

An Orgy of Speculation

Jared Dillian

I may not be good for much, but I am good for detecting a peak of speculative activity.

As of the end of last week, we were there.

Let me give you some data points.

Look what happens when you cut retail trading commissions to zero:

Source: @Garth_Friesen

Of course, just the fact that Morgan Stanley is buying E*TRADE, a discount brokerage (that offers trades with zero commissions) was probably a sign of the top.

Next, we have a group of folks on Reddit who were coordinating manipulating stock prices higher through naked call buying. They did it with TSLA, and they’re doing it with MSFT and a bunch of smaller stocks. It’s incredible.

Of course, naked call buying was at an all-time high, according to Jason Goepfert at SentimenTrader.

Source: SentimenTrader

This is highly unusual.

AAPL was rolling over, according to Helene Meisler and her hand-drawn charts:

Source: @hmeisler

Of course, there is no more powerful contrary indicator than an Economist cover:

I mean, the timing on this just does not get any better.

The dollar has had a heck of a run:

While worryingly, bond yields are making all-time lows:

And gold is making fresh highs, things you don’t usually see at the top:

Meanwhile, we’re headed into an election where someone who is really bad for the economy and the stock market has a real chance at becoming president. I have spent the last 4 weeks arguing with my older subscribers, who believe there is no chance that Bernie will become president. I assure you that the chance is not zero.

So that’s where we are.

Again, if you have an 80/20 portfolio here (or a 100/0 portfolio), your exposure to equities is TOO HIGH. It should be much lower. But then I would be repeating myself, because I say that all the time.

Who knows: maybe you were lucky enough to de-risk on the highs.

I have not spent much time talking about stocks in the last few years because the stock market has made little sense, mostly because of the presence of price-insensitive buying. Indexing, buybacks, and short volatility. Price-insensitive buying is still around—for the time being. I don’t know what gets it to stop, but nothing goes on forever.

This is where we are.

Where We’re Going

It’s been easy to see where the bond market is going. I’ve had plenty of pushback on that in the last 12 months, and here we are, talking about pegging the yield curve. Regardless of what the economy does, the push for easier monetary policy and lower interest rates is relentless—especially in an election year.

I still maintain that we have not yet made the business cycle obsolete. Extended bull markets lead to periods of overinvestment and malinvestment. This speculation and froth must be worked off. It’s possible that you can work off an overbought condition by going sideways, but probably not in this case.

Risky assets pretty much went vertical. People have been burned so many times calling a top, that nobody wants to call a top, which means that this is probably the best time to call a top.

I don’t talk about this a lot, because I am very much a set-it-and-forget-it type of investor. But there are a handful of times in your life, maybe just two or three, where you could be at a big inflection point in the market, and it’s worth adjusting the asset allocation a little bit.

Heresy, I know. I haven’t done the research on this, but I suspect that timely shifts in asset allocation can make a big difference in performance over the years. You don’t have to top-tick things, you just have to get it in the ballpark.

Yes, I am a pessimist. Yes, I tend to believe that the worst possible thing always happens. For sure, the worst possible thing this time would be pretty bad. A recession before the election, with Bernie Sanders getting elected as a result. I’m pretty sure nobody had that in their investment outlook at the end of last year.

And no, I’m not worried about the coronavirus. I mean, I am, but it’s a one-time hit to global GDP, not something we’re going to be dealing with on an ongoing basis. But in the interim, we’ve reached full panic mode on the coronavirus.

What’s happened over the last 10 years has pretty much been the best-case scenario. Isn’t it reasonable to expect that at some point we might get the worst-case scenario?

I’m bearish on stocks for the first time since 2017. Of course, things can always get more ridiculous, but I think we’re in the ballpark.

History Shows Gold’s Rally May Only Just Be Getting Started

By Elena Mazneva, Ranjeetha Pakiam, and Justina Vasquez

- Holdings in bullion-backed ETFs remain low versus total assets

- Gold is a ‘resilient ballast’ in recessions, BlackRock says

Even with gold at seven-year highs, there’s still room for more gains if history is anything to go by.

Prices have surged this year as haven-seeking investors pour in. Markets have been shaken by worries that the coronavirus outbreak will cripple global growth, coupled with expectations for looser monetary policy around the world. Assets in bullion-backed exchange-traded funds are at the highest ever and money managers are holding a near-record bullish bet.

Yet gold remains a relatively small percentage of portfolios by historic standards. And as investors assess the virus threat to the world’s biggest economies, it’s worth remembering that the metal’s haven qualities are especially evident during recessionary periods.

Here are four charts that show why gold’s still got room to run.

ETF Holdings

After an unprecedented 25 straight days of inflows, the total value of gold held by exchange-traded funds tracked by Bloomberg is closing in on the record of over $144 billion reached in 2012. But while bullion holdings have jumped this year, they’re still relatively low as a proportion of total ETF assets.

“There is room for further demand -- particularly on the ETF side,” said Benjamin Jones, senior multi-asset strategist at State Street Corp.

Fewer than 10% of investors own gold and the metal probably makes up less than 2% of portfolios on average, according to Peter Grosskopf, chief executive officer of Sprott Inc., a money manager that specializes in precious metals.

“Investor participation in gold is still anemic,” Grosskopf said. He argues that investors should have at least 5% of their assets in gold as a form of insurance. “Even a small move in this direction would have the effect of squeezing a relatively smaller market much, much higher.”

Recession Threat

Gold will get a real chance to show off its haven credentials if the virus outbreak transforms into a pandemic. In that scenario, Oxford Economics estimates a cost of $1.1 trillion to global GDP, with both the U.S. and euro-zone economies suffering recessions in the first half of 2020.

“With coronavirus outbreaks reigniting fears of recession, it is worth noting gold has proved to be a resilient ballast in the last three recessions,” said Chris Dhanraj, head of U.S. iShares Investment Strategy at BlackRock Inc.

Stacking Up

A comparison of gold prices versus a range of other assets suggests that the metal may still be some way from becoming overpriced, said Michael Hsueh, a strategist at Deutsche Bank AG.

A Gold Bullion Dealer As Bitcoin's Nouveau Riche Run To The Metal As Cryptocurrency Crashes

While gold is now quite expensive compared with copper or oil, the ratios remain below their historic peaks.

Gold’s nominal peak would be about $2,700 in today’s U.S. dollars, Hsueh said. There’s likely “quite a fair share of investors who are looking for a pullback just so that they could buy.”

Mixed Messages

Gold’s 14-day relative strength index briefly moved above 70 this week, which typically suggests securities are overbought and poised for a decline.

But a closer look at the past few years suggests that the RSI isn’t such a reliable indicator for gold. On several occasions, the metal continued rising or held at elevated levels even after the index breached the 85 mark.

There’s always a risk during periods of turmoil that investors sell gold as a last resort, which happened for a period during the 2008 financial crisis.

Still, even if gold’s gains stall, that doesn’t mean the trend has to turn bearish, said Gary Christie, head of North American Research at Trading Central. At times, when the RSI dipped back to levels near 50, it was followed by a renewed price rally, he said.

“The long-term picture is good because momentum and trend indicators are still bullish,” he said.

Can Supply Chains Survive the Coronavirus? China, the U.S. and Germany Are Key

Whether the infectious disease spreads to other countries that make hard-to-replace products may be the acid test of its impact on global manufacturing this year

By Nathaniel Taplin

Workers sanitizing a market in South Korea, the country hardest-hit by the coronavirus epidemic outside of China. / Photo: kim hong-ji/Reuters .

This is the second column in a five part Heard on the Street series about the market and economic impact of the coronavirus epidemic.

Investors are used to the cliché about butterfly wings in Brazil and tornadoes in Texas.

It turns out that the butterfly—or bat, to be strictly accurate—was actually in China. Where the tornado will end is the big unknown.

The spread of new pneumonia-causing coronavirus probably originating in bats has shut down much of China. Companies as diverse as Apple, Hyundai Motorand Indian drugmakers are suddenly finding that parts from the world’s factory are unavailable, and the epidemic continues to spread rapidly in Korea, Japan and even Italy. The first crisis test of the complex global supply chains favored by multinationals since the 1990s could be here.

Disasters have disrupted Asian supply chains before, but there’s no real analog for the virus now spreading world-wide. When severe acute respiratory syndrome, or SARS, emerged from China in 2003, it infected just 10% as many people, and China’s weight in global exports is twice what it was then.

Today’s intricate global supply chains are also a relatively recent development, and certainly didn’t exist in 1918, when the “Spanish flu” pandemic devastated many countries around the world.

Amid all the unknowns for global manufacturing, one certainty is that timing will matter a lot.

If China can’t contain the epidemic within the next few weeks and get back to work, the risk of serious damage to local suppliers—and worse, shortages of Chinese parts abroad—will rise sharply. A recent survey found that about two-thirds of Chinese small and medium-size businesses had less than three months of cash on hand; nearly 40% had a month or less.

The ripple effect in industries like autos has so far been worst in nearby countries including Korea and Japan, where manufacturers are used to short delivery times and lower inventories rather than a month-long trip across the Pacific for parts. But if China’s shutdown stretches from one month into two, the damage to overseas customers will be more widespread.

Under any scenario, the worst-hit industries will be those like automobiles and electronics with specialized components whose supply chain is clustered in one country or a small group of countries. China is the world’s largest exporter but in 2014 still only accounted for about 8% of such “risky” hard-to-replace products, according to researchers at the International Monetary Fund. The U.S. and Germany both clocked in at 13%. What happens in those countries may end up being the real acid test for global supply chains.
Worryingly, some pharmaceutical products and medical devices are in the risky category, raising the possibility that drug production gums up just as global demand for pharmaceuticals to combat the virus leaps. A raw material needed to make paracetamol, the common fever and pain reducer, has become scarce in India in recent weeks as Chinese supply dried up, according to a Financial Times report. India is among the largest pharmaceutical exporters globally.

Multinationals in China are taking a wait-and-see approach. An early February survey by the American Chamber of Commerce in Shanghai found that half of respondents weren’t considering a change to their China strategy, while 40% said it was too early to tell. Investors who only weeks ago were salivating over the prospect of a global rebound now find themselves in the same boat.

‘Wild Capitalism’ in Venezuela

By: Allison Fedirka

In a development that would have been unheard of just a few years ago, the government in Caracas is slowly and quietly loosening its control over the Venezuelan economy. Markets are opening, regulations are being relaxed, and foreign countries are participating in its flailing state oil company.

Various Venezuelan media have dubbed this unexpected period of transition “wild capitalism” and “chaotic capitalism,” but whichever name sticks, the strategy of the government is clear: adapt or die.

It’s a fairly pragmatic response to the actions of the U.S., which hoped that economic pressure, widespread public protests and international support would bring an end to the Maduro administration. Instead, Caracas has simply become more creative and resourceful as it seeks to remain in power – this time by integrating its informal economy with its formal one.

Economic Pressure

For nearly 20 years, the United States has opposed the Venezuelan government on political and security grounds. But Washington grew more impatient as the Venezuelan economy tanked, thanks largely to low oil prices, high social welfare spending and economic mismanagement.

The social instability that followed was a perfect opportunity for the U.S. to tackle what it saw as a security threat head on to try to facilitate regime change. It employed a strategy of heavy economic pressure for three reasons.

First, U.S. military intervention in Latin America is risky, unpopular and historically counterproductive. Second, the strategy corresponds with a broader shift in national strategy away from military action as the force to bring about change. Third, the U.S. is the largest economy in the world and formerly Venezuela’s single biggest customer, so changes in trade patterns would disrupt the Venezuelan economy.

Initially, things went according to plan. Increasingly heavy sanctions aggravated the underlying weaknesses of the country’s economy. Working conditions and quality of life went from bad to worse for the vast majority of Venezuelans as hyperinflation, power outages and food shortages became commonplace.

The economy has contracted for the past six years, losing roughly two-thirds of its gross domestic product from 2013 to 2019, according to the International Monetary Fund. Projections for 2020 remain bleak as GDP is expected to contract by another 10 percent.

Emigration – particularly among oil industry experts – was a problem even during the Chavez administration, but economic decay over the past two years has accelerated the trend. As of this year, an estimated 4.7 million people – out of a population of 28.4 million – have fled the country.

New Asylum Claims by Venezuelans Worldwide

Washington also enacted a political strategy of supporting Maduro’s enemies to capitalize on public discontent and usher in a new government, culminating with Juan Guaido, the president of the opposition-led National Assembly, declaring himself the president in 2019. For a brief moment, it seemed that pressures were aligning such that the U.S. would deliver the intended results.

Except it didn’t. Economic restrictions and lack of availability of goods expanded a robust parallel market that became essential for procurement of basic public goods. Before the U.S. levied its sanctions, economic hardship taught Venezuelans the value of acquiring and saving strong foreign currency, namely the U.S. dollar.

Those who could established bank accounts in the U.S. Meanwhile, early expatriate Venezuelans, many of whom were educated and/or wealthy enough to find work abroad, provided a steady flow of U.S. dollars directly to their fellow Venezuelans. Indeed, remittances to Venezuela have risen sharply since 2016, totaling an estimated $3.7 billion-$4 billion in 2019, according to Ecoanalisis. (The increase owes to both the number of transactions and value of transactions.)

According to a Consultores 21 survey, some 40 percent of the population has received remittances at some point in time and another 32 percent receive remittances on a regular basis. When government restrictions made it harder to get or use U.S. dollars, more informal or electronic means were employed to get dollars into the country. This rendered the local bolivar essentially worthless as bartering and foreign currencies have become the preferred choice for commercial transactions.

Remittances to Venezuela

Rather than fight the dollarization of the economy, the Maduro government embraced it. It relented on some currency controls and allowed a freer circulation of dollars because doing so would help to normalize the economy.

After all, a recent Ecoanalitica report estimated that over half of the country’s transactions occur in U.S. dollars and that there are likely more dollars circulating in the country than bolivares. Changes in fiscal policy now allow for some purchases of foreign currency with a 25 percent value-added tax.

This allows for fees and goods to be purchased and sold in foreign currency on a larger scale, making them more accessible to those with foreign currency. Businesses have also resorted to dollar-denominated transactions.

Over the past few months, banks have begun to offer custodial services for holding billions of U.S. dollars and euros in cash for businesses that want to avoid ties with the government and thus evade sanctions. This may not be much help to those without access to dollars, but it has lowered inflation in the dollar-denominated economy while giving more access to more people for basic goods.

The Maduro government has eased off other areas of the economy too. It has let imports in and lifted restrictions on certain exports. Goods can now be shipped out of Cabello Port in Carabobo without the requisite red tape. Price controls have also been lifted on many goods, and companies have been allowed to invest what small funds they have.

But the most notable changes pertain to state-run oil company PDVSA. The lack of funds to repair dilapidated equipment, improve production and support business operations like refining has led PDVSA to look for support from foreign oil players, particularly Rosneft, to conduct its business. The government is also in talks with Spain’s Repsol and Italy’s ENI on how to partner or take a share in the company in exchange for capital and assistance in a scheme of virtual privatization.

Saving Face

All these measures demand a certain political flexibility to mitigate whatever risks they could pose, considering they fly in the face of Maduro’s previous policies. By allowing for reform, he has tacitly admitted that those policies have failed.

Caracas has made sure to sell the changes without losing face. In some cases it downplayed them. In others, such as dollarizing the economy, it simply passively allowed it to happen. The government has also attempted to employ traditional revolutionary rhetoric when publicly speaking of the changes, framing them as measures necessary to help the poor in Venezuela and respond to economic attacks. (The regime’s roots are buried deep in Hugo Chavez’s legacy; echoing him lends Maduro some legitimacy.)

Still, Venezuela is long past the point where it can downplay or ignore its plight. When Maduro opened the judiciary session this year, he acknowledged that the U.S. isn’t entirely to blame for everything wrong in the country – a pretty significant rhetorical departure for him – adding that more work was needed to transform the country. He received a standing ovation.

But Maduro still has to tread carefully. He shares a delicate balance of power with Diosdado Cabello, the head of the Constituent Assembly (the pro-government legislature) and current #2 in the governing PSUV party, and Vladimir Padrino Lopez, the minister of defense. (Economic liberalization would be particularly galling to a dyed-in-the-wool Chavista such as Cabello.) There are also two competing legislatures that would be involved in whatever economic change is made into law.

Which is to say that Maduro’s hold on power is still precarious. “Wild capitalism” hasn’t solved any problems – things are still very expensive, and not everyone benefits from access to foreign currency – and Maduro risks alienating his supporters by seemingly turning his back on the legacy of Chavismo.

This means he is still vulnerable to losing power and opening a path for a more moderate Chavista to step in, rather than someone like Guaido who marked a complete departure from the regime. This is the opposite of what the U.S. had in mind.