sábado, febrero 11, 2017



Death of a Brazilian justice

A tragedy highlights the growing political influence of the supreme court
ON JANUARY 19th Brazil lost a crucial man at a crucial moment. Teori Zavascki, a justice of the supreme federal tribunal (STF), died along with four other people in the crash of a small aeroplane off Brazil’s south-eastern coast. He leaves behind a devastated family, legions of admirers—and the most explosive dossier of cases before the country’s highest court.

Mr Zavascki became a household name—in spite of the string of consonants inherited from his Polish forebears—because he oversaw investigations into the corruption scandal centred on Petrobras, the state-controlled oil company. Known collectively as Lava Jato (Car Wash), these have dominated politics since 2014. They led indirectly to the impeachment last August of the president, Dilma Rousseff; she was not implicated, but her Workers’ Party (PT) was. Before he died Mr Zavascki was about to authorise plea-bargaining deals with businessmen that could lead to more prosecutions of politicians.
Michel Temer, who succeeded Ms Rousseff, must now appoint a replacement. He was not expecting to have a hand in shaping Brazil’s highest court. None of the 11 justices would have reached the retirement age of 75 before the end of his term in 2018. Mr Temer must now make a decision that will affect not only Lava Jato but the character of an institution that is playing an increasingly prominent—and political—role in Brazil’s public affairs.

The STF is a hybrid, part constitutional court and part final court of appeal. Its most controversial decisions stem from its third role: to try politicians with parliamentary or ministerial immunity. In November 2015, for instance, Mr Zavascki ordered the arrest of a PT senator for conspiring to help a Lava Jato witness flee the country. Last May he removed the speaker of the lower house of congress on the grounds that he had used his position to interfere with Lava Jato probes. Both rulings, upheld by Mr Zavascki’s fellow justices, set precedents. Citizens cheered.

The court’s popularity has risen as that of politicians has plummeted. Of congress’s 594 members, 35 are targets of Lava Jato inquiries; dozens more are accused of other misdeeds.

Leaked depositions seem to implicate Mr Temer and several cabinet members, though all deny wrongdoing. In surveys of public confidence in professions, judges come way ahead of politicians (though well behind firemen, the most trusted group). Sérgio Moro, a lower-court judge who investigates Petrobras miscreants, is a national hero.
When Brazil’s constitutional referees attract such adulation, there is reason to worry. Teori Zavascki was one of the soberest. More typical is the grandstanding Marco Aurélio Mello, who gained notoriety in December by abruptly ordering the speaker of the senate to resign over embezzlement charges. He did not consult his fellow justices and was overruled by them. The chief justice, Cármen Lúcia, stunned legal scholars recently when she suspended a federal order to block an account belonging to the state of Rio de Janeiro, which had missed a loan payment. Her efforts to end massacres by gangs in prisons have made her famous; she is sometimes tipped as a contender for the presidency.

The judges’ widening political role is not entirely their doing. The growing polarisation of politics puts pressure on the STF to act as an arbiter. Brazilian justices cannot throw out a case, however absurd. Each has 7,000-10,000 pending; the United States’ Supreme Court hears a few dozen a year.

Throughout Brazil’s political crisis, the court’s willingness to hold politicians accountable has helped sustain citizens’ trust in democracy.

But the court’s growing assertiveness is also a danger to democracy, contends Rubens Glezer of FGV Law School in São Paulo. Justices speak too much in public, often rashly. Live broadcasts of STF sessions amplify large egos. Cameras make it harder to concede mistakes. Some court-watchers have suggested removing TV Justiça, a public broadcaster, from the courtroom.

Others talk of turning the STF into a narrower constitutional court akin to Germany’s, or moving it back to Rio de Janeiro, the capital before 1960, to put distance between the judiciary and government’s other two branches in Brasilia.

Ideas for changing the court’s role are worth considering, but not right now, when they could be construed as interfering with Lava Jato. To avoid such accusations, Mr Temer has wisely said that the Lava Jato file should not pass to the judge that he appoints to succeed Mr Zavascki (as it normally would) but to one of the current justices (which is permitted in exceptional circumstances).

That person, in turn, would be wise to emulate the understated doggedness of Teori Zavascki.

Fed Grapples With Massive Portfolio

Years after the financial crisis, central bank considers what to do with holdings of long-term bonds and other assets

Federal Reserve Chairwoman Janet Yellen, seen Jan. 12, 2017, in Washington, has said the Fed would reduce its bondholdings once interest rate increases were ‘well under way.’ Photo: Aaron P. Bernstein/Getty Images

While Federal Reserve officials ponder when to raise short-term interest rates again, they are beginning to wrestle with another big policy decision—whether this is the year to start shrinking their immense portfolio of mortgage and Treasury securities.

The Fed has boosted its portfolio of long-term bonds and other assets to $4.45 trillion from less than $1 trillion in 2007, just ahead of the financial crisis. Officials believe the large portfolio has helped to spur economic growth by holding down long-term interest rates.

With the economy closer to healed from the financial crisis and recession, the central bank has already begun raising short-term rates. Fed Chairwoman Janet Yellen has said the Fed would reduce the bondholdings once interest rate increases were “well under way.” Many officials hope to get the portfolio back to some state of precrisis normalcy.

A great deal is at stake with the bond decision. Shrinking the portfolio could jolt financial markets, pushing up interest costs on government debt and mortgage bonds and reverberating through the broader economy.

Officials don’t know how markets will react when they shrink the holdings because they have never done it before. But they know plenty about the skittishness of investors. When they signaled they would end bond purchases in 2013, they sparked a market “taper tantrum” that sent interest rates higher and hurt emerging markets.

Fed officials hold their next policy meeting Tuesday and Wednesday. They are expected to keep interest rates and their portfolio steady.

The balance sheet debate is still in its early stages, but it is on Ms. Yellen’s mind. In a speech Jan. 19 at Stanford University, she noted the stimulative effects of the Fed’s bondholdings are diminishing over time as the moment nears for the Fed to shrink them. Sheer anticipation of a drawdown of the bonds could push long-term rates higher, she said in a footnote to her comments. That’s a reason to proceed cautiously.

Bond dealers surveyed by the New York Fed in December said they expected the central bank to keep its portfolio steady for another 18 months.

But several Fed officials have said recently the time to start shrinking the balance sheet could come in 2017. This year “might be a good time to play that card,” St. Louis Fed President James Bullard said in a December interview with The Wall Street Journal.

The Fed should raise its benchmark federal-funds rate above 1% “sometime this year,” Philadelphia Fed President Patrick Harker said Jan. 20. Once that happens, “the next step” is to do something to allow the balance sheet to start shrinking, he said.

Boston Fed President Eric Rosengren has also expressed sympathy for the idea.

“We’ve not yet made any precise decisions about when that will occur,” Ms. Yellen said in December.

Fed officials have said for a while they want to raise the fed-funds rate first because they’re most familiar with this tool. They also want it high enough so they have room to cut it later if needed to provide stimulus in response to another economic downturn.

Officials are starting to discuss the balance sheet plans now for several reasons.

First, they don’t see political support for letting it get any bigger. And like the argument about short-term rates, reducing it would give them some room to expand it later if they need to spur the economy.

Some also worry that raising short-term rates is boosting the dollar, which curbs exports and weighs on inflation, which is already below their 2% target. Shrinking the balance sheet instead of raising short-term rates could be a way to tighten financial conditions without bearing the costs of a stronger currency.

Many questions about mechanics loom. Officials have long said they won’t sell their securities, fearful it could jolt to markets. Instead, to shrink the portfolio they will alter their current practice of using the proceeds from maturing bonds to buy new ones, a process called reinvestment.

There are a few of ways they could do this. They could halt all reinvestment. They could reduce the amount reinvested gradually. Or they could start by reinvesting proceeds from long-dated maturities into shorter ones.

They also haven’t decided how big the balance sheet should be when they finish. “We are actively discussing and researching the question,” Mr. Harker said.

A January research note by Fed economists Erin Syron, Soo Jeong Kim and Bernd Schlusche projected the portfolio would decline to $2.7 trillion by 2025.

Former Fed Chairman Ben Bernanke has argued in favor of keeping the securities portfolio large, or reducing it only moderately.

Given changes in the way the Fed manages interest rates and other shifts in markets and the economy, he wrote in a blog post Thursday, “the optimal size” of the holdings could be more than $2.5 trillion currently and could reach $4 trillion or more over the next decade.

“In a sense, the U.S. economy is ‘growing into’ the Fed’s $4.5 trillion balance sheet,” he said, “reducing the need for rapid shrinkage over the next few years.”

Leading Power: A Look at Japan vs. China

By George Friedman and Jacob L. Shapiro

One of Geopolitical Futures’ most controversial forecasts is that by 2040, Japan will rise as East Asia’s leading power. Many readers often ask for an explanation of the logic in this forecast.
They understand that GPF is bearish on China. And while some readers may disagree on that point, they usually see that the reasoning is sound and that China will face serious problems in coming years… problems that will strain the Communist Party’s rule. 

Japan, however, seems a bridge too far. Its population is less than a tenth of China’s size (and it’s not just aging but shrinking). Japan also has a debt-to-GDP ratio over 229%. So, how is it that Japan will emerge in the next 25 years as East Asia’s most powerful country? 

A full answer would require more space than we have in this article. But a good place to start is a broad comparison of the structure of China and Japan’s economies (the second and third largest economies in the world, respectively). This analysis will reveal strengths and weaknesses for both and will aim to bring our forecast into sharper relief.
China’s Economic Weaknesses
The map above divides China into four geographic regions by contribution to China’s national GDP. These regions do not have any official administrative function, but China’s National Bureau of Statistics sometimes uses these divisions to understand how China’s economy is performing at a regional level. It also must be noted that these figures are likely manipulated for political purposes.

The data are taken from the annual yearbook of China’s National Bureau of Statistics but contain notable discrepancies. For example, the regional figures do not add up to the national figure—adding the regional numbers yields a GDP that is roughly 5% (approximately $54 billion) greater than China’s reported national figure.

Accepting that some of these figures may be inflated or downplayed for various reasons, they still reveal much about China’s economic weaknesses. The coastal Eastern Region accounts for more than half of all economic activity in China. Stated another way, nine of China’s 34 provincial administrative units produce more than half of the country’s total wealth.

The Central and Western regions, in turn, each produce about 20% of China’s economic wealth.
But that is somewhat misleading. The Western Region accounts for more than half of China’s total land area. When compared to other regions, it produces less than half the economic activity of the Eastern Region and produces the same amount as the Central Region, which is less than half its size.

The Northeastern Region appears to be an outlier. It accounts for just 8% of China’s GDP.
Most of this region’s economic activity is heavy industry and has been under severe pressure as China attempts to increase internal demand and decrease dependence on exports.   

In practical terms, this means that China’s biggest economic weakness… and its most potent enemy… is poverty. Regional economic disparities exist in many countries in the world. But in China, they have always been particularly acute, causing massive wealth disparity between China’s coastal provinces and its other regions.

China’s sheer size magnifies this problem. According to the World Bank, in 1981, roughly 1 billion Chinese people lived on less than $3.10 a day (at 2011 purchasing power parity).
The World Bank’s latest data (from 2010) show that the number dropped to 360 million that year.

That is an awesome accomplishment—not in the present-day colloquial sense of the word “awesome,” but in the sense that it is worthy of awe and wonder. The problem is that it is also insufficient. China has been growing at a remarkable rate for the past 30 years, but that growth is slowing down, and 360 million people still live in abject poverty.
Most of China’s economic success is enjoyed by the coast… not the rest of the country.

China is the most populous country in the world and the fourth largest in terms of area.
This is a source of great power for China, but it is also a double-edged sword.

On the one hand, it means there are great advantages. China can deploy huge armies. It is buffered from enemies by vast territory or harsh geography on all sides. It can also mobilize human capital like no other country. (India possesses a similar population, but its government is far weaker and less centralized than China’s.)
On the other hand, it means that China often spends more on internal security than it does on the much-vaunted People’s Liberation Army. It also rules over many regions that are not ethnically Han Chinese and that want greater autonomy (if not independence). And China must maintain a robust capability to guard its borders.

China is a formidable land-based power, but China has never been a global maritime power in its long history. It has always been susceptible to internal revolution and, at times, external conquest.

Size is not always the most important part of power. In this case, distribution of wealth may not be sexy, but it is more important.
Wealth Concentration in Japan
At first glance, this map of Japan would seem to imply a similar level of wealth concentration in certain regions. Like China, Japan is informally divided into regions and sometimes reports data at the regional level. Japan is made up of four main islands: Kyūshū, Shikoku, Honshu, and Hokkaido (there are other small islands, but these four mainly compose the Japanese nation-state).

Kyūshū, Shikoku, and Hokkaido constitute regions of their own. Honshu, by far the largest and most populous of the Japanese islands, is subdivided into five additional regions. Together, these five Honshu regions account for 87% of the Japanese economy.
About 43% of that economic activity comes from the Kantō Region’s seven prefectures. Stated another way, seven prefectures of a total of 47 generate 37.6% of Japan’s economy.

This map also separates Tokyo prefecture from the others to provide a sense of how much of Japan’s GDP comes from its capital city. Tokyo prefecture (by itself) accounts for just over 18% of Japan’s total GDP. (For reference, Russia is a significantly imbalanced economy, and Moscow accounts for over 21% of its economy.)

Factoring in the Tokyo greater metropolitan area increases this figure. According to the latest available data from the Organisation for Economic Co-operation and Development (from 2012), Tokyo had the largest GDP of any city in the world at $1.48 trillion. (Seoul was second with a GDP of less than half of that.) That means that greater Tokyo accounts for almost a third of Japan’s total GDP.

The disparity of wealth between China’s coast and interior is striking, but arguably it is even more pronounced at first glance when looking at this map of Japan.
Japan’s Advantage
Appearances, however, can be deceiving. Unlike China, Japan’s wealth is spread much more evenly among its population. On the simplest level, this is easier to accomplish with a population of 127.3 million than with a population of 1.3 billion.

It is not strictly about size: The diversity resulting from size is what holds China back. Japan does not have to deal with the type of coastal versus interior diversity that China does. There is, for example, a wide gulf in per capita income at both the rural and urban level in China. A rural household in Shanghai, for example, makes two times less than a rural household in Tibet, while an urban household in Tibet makes less than half of what an urban household in Shanghai does.

The latest per capita GDP data available at the prefectural level in Japan is from 2013, but it paints a different picture. The gulf between the prefectures with the highest and lowest per capita income is stark. Tokyo’s GDP per capita is 4.5 million yen ($40,000), while Okinawa’s is 2.1 million yen. But Tokyo is a significant outlier in this regard. In the China example, almost every coastal province could be compared with an interior province and a similar gulf would exist. In Japan, only Tokyo is significantly above the mean per capita income of 3.1 million yen for the entire country, and that is due, in part, to the higher cost of living in the city. There is wealth disparity in Japan to be sure, but the disparity is not on the same scale as that which exists at the provincial level in China.

Japan’s greatest challenge has little to do with regional wealth disparity or poverty.
Japan’s great weakness is its dependence on imports for food and raw materials.
According to Japan’s Ministry of Agriculture, Forestry and Fisheries, the country’s total food self-sufficiency ratio based on calorie supply was just 39% in 2015. Based on production value, it was just 66%.
According to last month’s import data released by the same ministry, Japan imported 24.3 million tons of cereals, of which Japan was self-sufficient only in rice. Japan relies almost entirely on imports for staples like wheat, barley, corn, and soy.

Energy is another example of this dependence on imports. One of the main reasons Japan entered World War II was to protect its access to oil. Today, Japan remains reliant on foreign sources of energy. Even before the Fukushima nuclear reactor accident in 2011, Japan relied on foreign sources for close to 80% of its energy supply. Since 2012, that number has risen to almost 91% (according to the US Energy Information Administration). For mineral resources like copper, lead, zinc, and others that are important for an industrialized economy, Japan is also highly dependent on imports.

Some will argue that Japan’s bigger problem is demographics. It is true that Japan has a rapidly aging population. But so does China: The number of working-age Chinese has been declining since 2013. Most European countries also face this issue… Germany most prominent among them. Demographics are notoriously hard to predict, as are the effects of demographic changes.

What can be said is this: Japan is one of the top investors in the world in artificial intelligence research, automation, and robotics technology in order to maintain productivity. And while Japanese society is homogenous and relatively unfriendly to outsiders, desperate circumstances could call for desperate measures and necessitate changing policies on immigration. The broader Asia-Pacific region also offers opportunities for Japan to find workers if it needed.

The point here is that Japan is facing a demographic problem, but so is much of the industrialized world. There are tangible things Japan can do to improve the situation. The same is not true of Japan’s lack of natural resources—there is no magic solution to not having enough copper at home.
A Comparison
Japan is the 62nd largest country in terms of area. Countries like Uzbekistan, Yemen, and Botswana are all bigger in size. It is the 11th largest in terms of population—Indonesia, Pakistan, and Bangladesh all have much larger populations than Japan. Neither of these facts disqualify Japan from rising as a regional power. The United Kingdom ruled the world with a small population and a country slightly smaller in area than Japan. Japan’s ability to dominate the region, therefore, cannot be ruled out based on size and demographics alone.

Unlike China, Japan has no land-based enemies—it is an island nation. Unlike China, the Japanese government has no concern about its ability to impose its writ throughout the entire country. Nor does it have to contend with a huge gulf in wealth disparity between different parts of the country. Japan has already managed a transition from a high-growth economy to a low-growth economy without revolution.

One man’s stagnation is another man’s stability. One man’s “Lost Decade” is another man’s “Stable Decade.” Japan’s weaknesses have manifested in the development of a strong navy able to guard maritime supply lines. It has also cultivated a tight alliance with a country that will guard those supply lines, the United States.

To be clear, China is still an immensely powerful country relative to most in the world. In addition, much of GPF’s writing remains focused on understanding how economic problems in China are manifesting in political challenges. For now, Japan is less dynamic and important… though it will become more so… and our writing will increase as it does.

For now, what happens in China has a major impact on the global economy, and a great deal is happening. China is also pouring money into developing its military capabilities—especially its navy—to be better prepared to assert Chinese power at a global scale, and these capabilities must be constantly tracked. The problem for China is that it is unclear if the country can pull off the kind of politically stable economic transition that Japan managed when its high-growth “miracle” ended in the early 1990s.

China has many constraints working against it. Japan has many constraints too, but it also has major advantages and imperatives that have led in the past to the development of Japanese power in the Asian Pacific.

 Major Inflection Point Coming  

This ratio is even scarier than it looks, says Hussman:
Historically-reliable valuation measures now approach those observed at the 2000 bubble peak. Yet even this comparison overlooks the fact that in 2000, the overvaluation featured a subset of very large-capitalization stocks that were breathtakingly overvalued, while most stocks were more reasonably valued (see Sizing Up the Bubble for details).  
In many ways, the current speculative episode is worse, because it has extended to virtually all risk-assets. To offer some idea of the precipice the market has reached, this chart shows the median price/revenue ratio of individual S&P 500 component stocks. This median now stands just over 2.45, easily the highest level in history.  
The longer-term norm for the S&P 500 price/revenue ratio is less than 1.0. Even a retreat to 1.3, which we’ve observed at many points even in recent cycles, would take the stock market to nearly half of present levels.

One of the reasons share prices have risen so dramatically relative to revenues is that corporations are earning a lot more on each dollar of sales these days. How are they doing that?

By squeezing their workers. The following chart, from the Economic Policy Institute shows labor’s share of corporate income plunging recently.

The next chart illustrates the same point from a different angle. Workers, it seems, have been producing more per hour but their pay hasn’t kept up as their bosses held onto more of the resulting profit.

A big part of this has been due to offshoring. If you close a factory where the workers make $30 an hour and set up in a place where your new workers make $5, then the $25 difference flows to the bottom line. Other contributors are automation, which is both inexorable and hugely favorable for the guys who own the robots, and the fact that the minimum wage in many states has kept up with neither the true inflation rate nor the increase in free-trade driven corporate earnings.

As EPI’s Josh Bivens puts it:
This 6.8 percentage-point decline in labor’s share of corporate income might not seem like a lot, but if labor’s share had not fallen, employees in the corporate sector would have $535 billion more in their paychecks today. If this amount was spread over the entire labor force (not just corporate sector employees) this would translate into a $3,770 raise for each worker.

For stock market investors, the scary thing about this imbalance between capital and labor is that it’s only temporary. As the details and magnitude of the scam have been exposed, the political tide has shifted. At the national level, fed-up US workers have installed an anti-free trade administration that is already tilting the playing field towards domestic workers. At the state and local level, calls for a higher minimum wage are being heard and acted upon. A major French party has even nominated a presidential candidate who wants to tax robots.

So it’s safe to assume that the above charts will develop serious inflection points going forward, as a rising share of profits flow to the nether regions of the org chart and investors respond by lowering the value they place on a given dollar of corporate revenues.
As Hussman notes, just a return to 1990s valuation levels would cut the average US stock in half.