Trump triumphant

Is China losing the trade war against America?

A weak Chinese stockmarket gives America the edge, at least in confidence

WHEN Donald Trump tweeted on August 5th that tariffs were working “big time”, American media sprang into action to test the claim. In China, editors were more circumspect. No major Chinese-language newspaper reported his tweets. One of his claims—that China’s stockmarket has fallen 27% in the past four months—was an exaggeration. But why would any self-respecting propagandist in Beijing dwell on that? Chinese stocks have indeed fallen sharply (see chart), which officials do not wish to emphasise.

And this is just one of a series of awkward facts for China as its trade war with America deepens. The yuan is down 8% against the dollar since April, and near its weakest in more than a year. A shrinking trade surplus produced a current-account deficit in the first half of 2018, China’s first such gap in at least two decades. More broadly, China’s growth is slowing at a time when America’s economy is expanding at its fastest pace since 2014. No wonder Mr Trump feels that he is on the right path, and that Chinese investors are jittery. 
Making matters worse for China is a whiplash effect. Until recently officials and executives believed their own declarations of technological prowess. Privately, advisers were confident that Mr Trump could be placated with promises to ramp up imports from America. Now both views look wanting. An agreement for China to buy more American natural gas and soyabeans collapsed in June. Chinese officials are keenly aware of vulnerabilities; had America maintained its sanctions on sales of semiconductors to ZTE, the Chinese telecoms giant might well have gone out of business. Those with a conspiratorial mindset see things in a darker light.

“The Americans don’t want a deal. They want to screw us,” says a fund manager.

The asymmetry in the trade war is another uncomfortable fact. Since America buys far more from China than vice versa, America has more scope to impose tariffs. This imbalance, long discussed in theoretical terms, is close to becoming a hard reality. Mr Trump has instructed his trade team to consider 25% tariffs on $200bn of Chinese imports as early as September, taking the total affected by its tariffs to about $250bn, with room for twice that amount. China’s threatened retaliation, announced on August 3rd, will be tariffs on $60bn of American imports. This would take the total under its tariffs to $110bn, with little room for more.

China has other weapons at its disposal. It can disrupt the lucrative Chinese operations of American businesses, from Apple to Starbucks. But that would have downsides. Declaring bogus justifications (health violations, say) would reinforce foreign criticism of government meddling in China’s economy. And the nature of such interference, unlike tariffs, is that it will not be announced in advance, meaning it can take longer to register the impact.

The timing of the trade war is most inconvenient for China. Over the past two years the government has waged a campaign to rein in debt levels. Finally this has started to bite, with credit growth slowing sharply. Officials could opt to abandon their tightening stance in order to counteract the trade turmoil. But that might erase the gains from the deleveraging. This explains their restraint so far. At a meeting of the Politburo on July 31st, China’s leaders noted that it was a priority to support growth amid the “clear change” in the external environment, but also pledged to press on with their efforts to control debt. Investors who had hoped for more easing were disappointed.

So there is cause for concern about China’s growth outlook. But markets may be unduly pessimistic. One conclusion from the past few weeks is that policymakers now accept that the trade war is real, and are starting to cushion the economy. The boost to exports from the falling yuan, down about 6% on a trade-weighted basis since mid-June, should be “roughly proportionate” to the blow from the first $50bn of American tariffs and some of the next $200bn, says Andrew Tilton, the chief Asia economist at Goldman Sachs. At the margins, he adds, China is shifting to a more active fiscal policy. Officials have made it easier for cities to get funding for infrastructure projects. One government adviser says there is discussion of a bigger stimulus, likely to be focused on promoting consumption rather than investment.

The economic backdrop to the trade war could also change over the next year. As China tiptoes towards easing, its credit growth should pick up. Meanwhile, America may be near the top of its growth cycle, with gains from last year’s tax cut set to dissipate. Louis Kuijs of Oxford Economics, a research firm, says the divergence in their stockmarkets might reflect overconfidence in America and an evaporation of confidence in China. “Both reactions seem exaggerated,” he says. With no resolution to the trade war in sight, there will be time enough to test this proposition.

China and Russia’s dangerous liaison

The west ignores the alliance forming between Moscow and Beijing at its peril

Jamil Anderlini

In the annals of western intelligence blunders, the failure to notice the Sino-Soviet split in the frigid depths of the cold war looms very large. Despite a small group of heretical CIA officers pointing to mounting evidence from the late 1950s onwards, successive governments in Washington and elsewhere refused to believe that the two biggest members of the communist bloc actually hated each other. It was not until China and Russia fought a war along the Siberian-Manchurian border in 1969 that the sceptics finally accepted the schism was real.

Today the west risks making the opposite mistake by dismissing the anti-western, anti-US alliance that is now forming between Moscow and Beijing. At a conference in Singapore in June, Jim Mattis, US defence secretary, talked about a “natural non-convergence of interest” between Russia and China and his belief that both countries had more in common with America than with each other.

This idea that Russia and China can never really be friends is just as wrong and dangerous as the cold war dogma that portrayed global communism as an unshakeable monolith.

Even as many in the west dismiss or ignore the rapidly warming ties between the two countries, presidents Vladimir Putin and Xi Jinping have gone to extravagant lengths to praise each other, in a budding bromance.

According to Mr Putin, Mr Xi is the only foreign leader he has celebrated his birthday with — over a glass of vodka and a plate of sausage. For his part, Mr Xi recently called the Russian president his “best, most intimate friend” while presenting him with China’s inaugural friendship medal.

It is easy to dismiss this all as superficial posturing, but such gestures between autocrats matter immensely to their respective systems. The two leaders have met at least 26 times since Mr Xi made his first overseas trip as paramount leader to Moscow in 2013.

It is true that Russia’s ego has been bruised by the obvious role reversal — from the former Soviet Union as “big brother” to Russia as “little brother” today. But China has been careful to save Moscow’s pride — by speaking of the two as equals, massaging Mr Putin’s ego and offering many of his confidantes and advisers lucrative contracts.

While heavily lopsided — Russia’s economy is about one-tenth the size of China’s — the countries’ economic relationship is critical for both sides. China is the world’s biggest importer of crude oil; Russia was China’s biggest supplier last year and Beijing has lent tens of billions of dollars to Moscow to secure future oil and gas supplies.

Crucially, from Beijing’s perspective, oil imports from Russia do not need to travel by ship through strategic chokepoints, such as the Strait of Malacca or the Gulf of Aden, that can easily be shut off by the US military.

But even more significant than their economic entanglement is the military relationship between the neighbours. On his first trip abroad in his new role in April, Wei Fenghe, China’s defence minister, visited Moscow with a very direct message: “The Chinese side has come to show Americans the close ties between the armed forces of China and Russia,” he told his counterpart. “We’ve come to support you.”

Again, this is not just friendly rhetoric. Until recently, Chinese naval vessels had not strayed from the country’s coastline for centuries, but today its warships conduct regular joint exercises with Russia from the Sea of Japan to the Mediterranean. For decades, Russia resisted selling its most advanced military equipment to China but it has now abandoned that policy. In May, Beijing deployed the latest model Russian fighter jets in a show of force over democratic, self-ruled Taiwan.

The most important unifying factor between the two is ideological. Mr Xi and Mr Putin are strongmen autocrats who share an aversion to representative government and a deep fear that they will one day be thrown out of office by a US-backed “ colour revolution”. Their tightening embrace is as much about antipathy towards the US and the US-dominated global order as their rapidly growing common interests. This presents an opportunity for Washington to drive a wedge between them before their alliance becomes unbreakable.

The failure to accept the reality of the Sino-Soviet split in the early 1960s allowed the so-called “domino theory” — the idea that global communism had to be confronted everywhere to stop its spread — to become orthodoxy in Washington. If the US had attempted rapprochement with China a decade earlier than it did under Richard Nixon, perhaps the horrors of the Vietnam war and China’s Cultural Revolution could have been avoided.

Thanks to its continued rise and obvious ambition to supplant the US, China is a far bigger long-term challenge for America than Russia. No less a figure than Henry Kissinger — the architect of that reconciliation with China in 1972 — has reportedly counselled Donald Trump to pursue a “reverse Nixon-China strategy” by seeking to befriend Moscow and isolate Beijing.

Given the current investigation into possible collusion with Russia, it will be almost impossible for the US president to pursue such a strategy successfully. But American institutions, and whoever succeeds Mr Trump as president, must recognise how serious a threat the nascent Sino-Russian alliance is to US interests — and the current world order.

Rebalancing China and Bracing for the Trade War

By Phillip Orchard


It has been 40 years since Deng Xiaoping launched China’s “reform and opening up” policy. By most metrics, China’s economic “miracle” has indeed been nothing short of preternatural, with some 800 million people rising out of poverty over the span of just a few generations and the country becoming an indispensable part of the global economy. But this growth happened neither evenly nor sustainably, and it’s running out of the sort of low-hanging fruits that fueled China’s rise.

As a result, like most developing countries, China has a fundamental problem: It wants to transition to a consumption-based economy (which is more stable than relying on exports and investment), but its domestic consumer base is not yet wealthy enough to support the level of economic productivity needed to allow for that transition. With a trade war looming, a shift to domestic consumption is becoming all the more urgent. Beijing is scrambling to conjure up yet another economic miracle.

This Deep Dive will explain why the economic model that made much of China rich is nearing its expiry date, with continued, even if slowly declining, dependence on cheap exports and investment now creating as many problems as it solves. We’ll check in on China’s efforts to make the leap many of its neighbors did long ago, to a more stable model based on consumption, services and high-tech industry. Ultimately, we conclude that China’s progress has been mixed, at best, with new risks emerging on the road ahead.
Why China Needs to Rebalance
More than anything else, China’s growth has been fueled by three things: cheap exports, investment and the one-time gains of land and resource privatization. This is the standard blueprint for developing economies (cheap exports, in particular), taking advantage of low wages to piggyback off growth in wealthier countries by both undercutting their industries and making a pretty penny on their voracious appetites for consumption.

There are two overriding problems with a dependence on cheap exports. First, China’s ability to sustain its economy hinged too much on economic conditions outside the country. China has been overly beholden to its customers, most of them located in distant markets, none of them immune to their own periodic downturns in consumption or protectionist social pressures. If the U.S. or European economies crashed, so too would China’s. Following the crash of the U.S. economy in 2008, for example, Chinese exports fell off a cliff – including by a record 26 percent year-over-year in February 2009. That January, the Chinese government estimated that 20 million migrant workers had lost their jobs in 2008 because of the global economic slowdown.

Second, the wealthier China becomes, the more difficult it becomes to sustain this export-heavy model. Rising standards of living push wages up, making Chinese exports less competitive and giving foreign firms in the country cause to look to lower-cost alternatives. China wants to accommodate this shift by moving into high-tech, higher-value exports, but here it is facing stiff competition from countries that climbed the value ladder decades ago. This is known as the middle-income trap – something China is desperate to avoid. The challenge for China has only been intensifying as its neighbors in South and Southeast Asia, in particular, began investing heavily in manufacturing and export infrastructure since putting the regionwide chaos wrought by the Cold War largely behind them.

Reliance on investment, the bulk of it government-driven, has enabled Beijing to keep the economy humming somewhat amid global downturns in consumption and (most important, considering China’s outsize socio-economic risks) keep employment generally steady. The 4 trillion yuan ($586 billion) firehose of stimulus Beijing opened up in late 2009 enabled China to bounce back from the crisis much quicker than most of the West. But this created its own problems. In China, among other unintended consequences, it has resulted in a system that’s awash in cheap credit and not enough productive places to put it. This can lead to industrial inefficiency and unprofitability; wildly inflated real estate and land bubbles; and firms, banks and local governments saddled with unsustainable debt loads, among other side effects. The Chinese economy is littered with ticking time bombs.

Thus, China is in a race against the clock – before Western economies crash again, before its internal debt loads and asset bubbles start a crisis at home – to rebalance the economy away from low-cost exports and investment and toward domestic consumption, high-value manufacturing and services. China’s aging, shrinking workforce will only make this endeavor more difficult. And now, China has yet another pressing reason to rebalance: the growth of protectionist political forces in Western economies. China’s progress will affect its ability to ride out a trade war with the U.S. In theory, at least, the calculus is fairly straightforward: The less the Chinese economy relies on exports to the U.S., the less measures by the U.S. to limit China’s access to the world’s largest consumer market will sting. And the more U.S. businesses rely on China’s own growing consumer base, the harder China can punch back.
Mixed Results
On the whole, China’s rebalancing process has proceeded in fits and starts. This is, in part, because different measures can work against each other. For example, reforms to rein in excessive lending to oversized exporting sectors can hurt domestic consumption by, say, lowering employment. More so, it reflects the reality that the Communist Party of China’s paralyzing fear of social unrest and power struggle has compelled Beijing to continually try to thread the needle between structural reforms and the status quo.

On external rebalancing, at least, China has indeed been gradually easing its dependence on exports for quite some time.
As a percent of China’s gross domestic product, Chinese exports have declined from as high as 38 percent in 2006 to around 20 percent in 2017. Of course, this trend wasn’t solely the result of structural reforms aimed at easing dependence on exports. The 2008 crisis and subsequent decline in global consumption played a major role. Over this same period, China’s GDP growth was nearly cut in half, from 12.7 percent to 6.9 percent last year. (As we’ve noted several times, official Chinese data should always be taken with more than a pinch of salt.)

It’s true that China’s slowdown wasn’t nearly as steep as in Western countries. But for about a decade, this, like its “success” on the external balancing front, came primarily from investment – not, as Beijing would hope, from its burgeoning consumer class. From the early 2000s until around 2011, investment as a share of GDP jumped from roughly 37 percent to 47 percent. By comparison, in developed countries, investment generally accounts for around 20 percent of GDP. Meanwhile, the contribution of Chinese consumption to GDP declined from around 63 percent in 2000 to just 48 percent a decade later, before beginning to tick back upward, according to the World Bank and Organization for Economic Cooperation and Development.

Initially, the outsize role of investment wasn’t necessarily a problem. China’s entry into the World Trade Organization in 2001 had accelerated an investment boom that, for about a decade, effectively commiserated with a boom in exports. The growth in dependence on exports may have made Beijing uneasy in the big picture, but at least the investment was generally being put to productive and profitable uses. This began to change once demand for exports crashed in 2008, forcing Beijing to start shoveling stimulus money into whatever domestic projects would keep its people and businesses busy. According to International Monetary Fund figures, credit intensity in China – the ratio of credit needed to generate 1 trillion yuan of nominal GDP – soared from around 1.3-to-1 to around 4.8-to-1 in a year after the crisis hit. In other words, investment in China stopped getting the same bang for the buck. Exports rebounded sharply beginning in 2010, and investment as a share of GDP leveled off in 2012. But China’s addiction to credit hadn’t really receded, and the amount of liquidity sloshing around in the system began dragging down efficiency. In 2016, in fact, credit intensity reached 5.3-to-1, surpassing even the stimulus-soaked levels reached in 2009. The reality is that breakneck growth in China was always going to be difficult to perpetuate; as economies grow larger, high growth rates naturally get harder to sustain. The problem in China has been that the government, until recently at least, feared that any major slowdown would lead to social unrest, so it kept its foot on the gas.
Though relying less on exports and more on investment would theoretically help blunt the direct effects of the trade war in the short term, if it doesn’t make China’s economy more resilient as a whole – or if it actively raises the risk of a financial crisis – it magnifies the risks that any hit to exports from the trade war would destabilize the economy. Investment, in other words, transformed quickly from a palliative to an anabolic steroid, intensifying all sorts of other problems, from unprofitability to credit and land bubbles to local government debt loads to pollution. According to the Institute of International Finance, for example, gross debt rose from 170 percent of GDP to nearly 300 percent between 2008 and 2017. The systemic risks these pose to China is a core reason China has re-embraced the rise of a dictator in the form of President Xi Jinping.
Still, since the beginning of this decade, China has found some reason to be optimistic – in particular, the greater role domestic consumption has played as a growth driver. Gross consumption (combined public and private) as a share of GDP growth has gradually ticked upward, from less than 50 percent in 2010 to nearly 65 percent in 2016, according to official figures. As a result, over this same period, investment as a share of GDP growth fell by around 3 percent without dealing a major blow to the economy. Meanwhile, China’s current account surplus has declined from its peak of about 10 percent of GDP in 2007 to 1.3 percent in 2017. Notably, the current account actually registered a rare deficit in the first quarter of this year. Meanwhile, services’ share of GDP is approaching 50 percent – which is important because the sector is less capital-intensive than the industrial sector, less tied to exports and often reflects growing consumer spending.

China took a modest step back last year by some metrics, with exports taking a slightly larger share and consumption declining to 59 percent – its first drop in five years. The increased share held by exports can be credited in part to strong global demand, so the increase wasn’t necessarily bad news. Importantly, moreover, investment growth remained in check at 44 percent of GDP growth, roughly in line with recent years. According to the IMF, the credit intensity ratio improved to 3.9-to-1, suggesting credit is being put to better use in at least some sectors as Beijing’s ambitious structural reform agenda has kicked in.

On the flip side, return on assets held by China’s 150,000 state-owned enterprises has bottomed out over the past two years to just above 2 percent, a level not hit since the 2000s. Private firms are faring better than SOEs, though even their returns have nonetheless been dropping steadily, from more than 14 percent in 2011 to around 10 percent last year. Notably, SOEs are also playing a more dominant role in the economy, their share of assets growing steadily over the past decade to more than 200 percent of GDP in 2016 and their share of investment nearing a post-2008 high of 150 percent. This matters to the rebalancing effort because SOEs account for around 20 percent of employment and play an outsize role in metabolizing state-directed investment. Considering just how much bloated SOEs are used by Beijing to absorb excess labor, nonperforming loans and toxic assets, their weakness can be viewed as a reflection of the underlying fault lines waiting to rock the economy as a whole.
Whither Chinese Consumers?
This relates to another reality complicating China’s rebalancing picture: The growth in consumption has relied heavily on public spending. Since the turn of the century, the composition of China’s consumption picture has remained strikingly consistent, with government expenditures accounting for between 25 and 27 percent of total consumption and household spending making up the rest. As a share of GDP, however, private consumption steadily dropped for the first few decades of China’s reform period, from upward of 50 percent in the 1980s to just 35 percent in 2010. If China were truly rebalancing, we’d expect to see Chinese consumers pick up even more of the slack. There are some signs of optimism here, but also ample reason for concern. Since 2010, private consumption as a share of GDP has grown from around 35 percent to just more than 39 percent the past two years. Still, by comparison, private consumption in the U.S. has accounted for upward of 65 percent of GDP since 2000. In Japan, this figure has remained in the mid-50s.

Part of the reason Chinese consumers don’t spend as much is the heavy cultural emphasis on savings. This is good to the extent that it buffers consumption during downturns and makes up for the country’s weak social safety nets. (Similarly, China’s homebuyers are typically required to make down payments exceeding 50 percent, limiting discretionary spending elsewhere, but also making the housing markets somewhat less vulnerable to a cascading crisis akin to what sank the U.S. in 2008 since Chinese homeowners have so much equity sunk into their homes.) High savings rates have also enabled China to fuel its investment boom without heavy borrowing from abroad, unlike most developing economies, many of which routinely face default. On the other hand, high savings prevents private consumption from becoming the dominant driver of the economy and easing dependence on foreign buyers. (In this regard, China is similar to Japan and South Korea, both of which had high savings rates early on in their development before establishing robust consumer bases.)

The relatively low share of private consumption also stems from core aspects of the economic model that fueled China’s rise. A weak currency, measures that have suppressed wages and deposit rates capped below inflation may all be good for keeping exports competitive, sustaining heavily indebted SOEs and fueling investment, but they also encourage savings at the expense of consumption. (Or, worse, they encourage risky investments in high-yield wealth management products.) The lack of social safety nets has had a similar effect. Of course, this model is what Beijing is now trying to change.

Thus, to gauge whether Chinese consumers are both earning and spending more, the indicators to watch going forward will be metrics like household disposable income, retail sales and so forth, as well as household savings and debt. Household disposable income has been rising by around 9 percent per year, ticking slowly upward as a share of GDP, from 59.8 percent in 2013 to 60.6 percent last year. Considering how much GDP has grown, this means that aggregate incomes have surpassed $5 trillion a year. Recent studies by Credit Suisse and McKinsey show that discretionary spending on things like travel and recreation has been surging. Overseas travel, in fact, may be the single biggest contributor to China’s shrinking current account surplus. Meanwhile, household savings as a share of disposable incomes have started to come down, from 38.5 percent in 2013 to 35.5 percent last year.

With respect to the trade war, this matters because as Chinese consumer power has grown, so too have U.S. exports to the Middle Kingdom – some 115 percent over the past decade to nearly $120 billion today. General Motors sold nearly a million more cars in China last year than in the United States. Beijing can’t match U.S. tariffs dollar for dollar, because it doesn’t buy enough goods from the U.S. to do so. But it can at least try to make it politically unpalatable for the U.S. to continue the trade war by targeting sectors that look at China’s burgeoning consumer market with yuan signs in their eyes.

There are, of course, trade-offs to this shift. For one, household debt in China is surging, from 33 percent of GDP in 2013 to 49.2 percent last year, according to the IMF, putting the debt-to-income ratio in China at 120 percent and growing. This is manageable but rising beyond levels considered safe. Chinese credit card debt has expanded at three times the rate of balances in the U.S., while bank lending to households has surged an estimated 73 percent over the past three years, according to the central bank, most of it going to real estate. Moreover, a vast amount of this debt is held outside the formal banking system. Lending from small online peer-to-peer lenders tripled in volume to 2.3 trillion yuan from 2015 to 2017. Last month, dozens of such lenders went belly up, leading to small-scale protests in Beijing.
Moreover, while average household incomes have been rising (by 9.1 percent through the first three quarters of 2017), the median income hasn’t kept pace (up 7.4 percent over the same period). This indicates that income growth has been largely concentrated among high earners.

This reflects a dominant underlying reality both driving and constraining the rebalancing effort. In effect, there are two Chinas. One, coastal China, already has an advanced economy climbing the value chain – one that looks quite a bit like its competitors in Japan, South Korea and Taiwan. The other, interior China, hasn’t yet reaped the fruits of the country’s reform and opening period to nearly the same degree; its economy looks quite a bit like a house of cards.

Of course, the two Chinas are tied at the hip. Beijing is trying to find a way to make the success of either dependent on the other, to have coastal capital and technology modernize the interior, and to have the interior’s mass reduce the coast’s dependency on foreign buyers and keep the Chinese labor pool competitive. China isn’t all that unique in this regard; the economies of the American West Coast, Texas and the Northeast have long both sustained and benefited from a similar relationship with less prosperous U.S. states. What’s different in China is the whirlwind time frame in which Beijing is trying to complete this process – and the stakes if it fails. Reconciling the gaps between the coasts and the interior is an age-old challenge in China, after all, and one where failure has sunk many a dynasty.

This Year’s Big Disrupter: The Dollar

Lucrative trades were upended by the second-quarter rise in the dollar. Getting the greenback’s path right matters.

By Richard Barley

Much of the disruption to global financial markets this year has come from a source close to home: the U.S. dollar.

Investors obsess over stock indexes and bond yields but the most important number in financial markets may be the dollar’s exchange rate. That was clear when the dollar’s sudden rise in the second quarter derailed many moneymaking trades and changed the path of economies and industries. In some places, the pain is extending: The Turkish lira went into meltdown this week, sending ripples through global markets. Friday, the ICE dollar index hit a fresh one-year high.

The dollar’s rebound came after a broad decline in 2017, as growth outside the U.S. picked up.

That lured investors into riskier bets: the MSCI Emerging Markets stock index gained over 30%.

This year kicked off in similar style. But then U.S. growth vaulted higher and momentum stalled elsewhere, sending the dollar on an unexpected upturn. It gained 5.5% against the euro and 4.2% against the yen in the second quarter; moves in emerging markets were even bigger, with the greenback up 17% against the Brazilian real and 16% against the South African rand. 

Nearly everything that surged in 2017 has wilted in 2018. After months of tumult, there is reason to believe the rest of the year will be calmer for the dollar, meaning less risky for emerging markets and other volatile assets.

The oddity is that much of the uncertainty about global growth has been generated by unorthodox U.S. policy, whether on tax, trade, or political alliances such as NATO. But even as the U.S. becomes the global disrupter, its assets have proved more alluring for investors. The dollar has kept its role as a magnet in times of doubt.

That is in part because the dollar remains so dominant. In the $5.1-trillion-a-day foreign-exchange market, the U.S. currency is on one side of 88% of all trades, according to the Bank for International Settlements’ 2016 survey. While its weight in foreign-exchange reserves has declined a little, it still accounts for 62.5% of the $10.4 trillion in allocated reserves identified by the International Monetary Fund. The euro, meanwhile, accounts for 20.4%. U.S. capital markets are the biggest and most liquid in the world, making the dollar attractive both to companies looking to raise finance and investors with cash to put to work.

The dollar’s path not only reflects changes in global growth, but can also steer them. Most notably, a rising dollar tightens financial conditions in emerging markets: It may lead central banks to raise rates to shore up their currencies, for example, or dampen the appetite of commercial banks to lend in dollars since their chances of getting paid back declines as the local currency falls. While floating exchange rates in emerging markets have reduced the risk of sudden explosive crises, they come at this cost.

The dollar’s performance in the second half could be less disruptive. Against major currencies like the euro, the greenback has stopped climbing. A good deal of divergence between growth and monetary policy in Europe and the U.S. already looks priced in.

Where the dollar’s strength has exposed weak links in emerging markets, it may continue to cause problems. For countries like Turkey, where the lira is down 36% this year, the problem now is homegrown, not external: There is a serious loss of investor confidence that wouldn’t be solved by a broad-based weakening in the dollar. The bigger picture will be influenced a good deal by the trade dispute between the U.S. and China and whether the Chinese yuan continues to fall, raising depreciation pressures on other currencies.

 The dollar has rebounded after a broad decline in 2017.
The dollar has rebounded after a broad decline in 2017. Illustration: photo illustration by WSJ; iStock (2)        

For all that the dollar’s rise has accompanied stronger growth in the U.S.—with second-quarter gross domestic product expanding at a 4.1% annualized clip—there is a domestic downside.

Over time, a stronger dollar can hurt U.S. corporate profits as exports become less competitive and foreign earnings are worth less translated back into dollars. While tax cuts have boosted economic growth, they have also raised the budget deficit, which may lead investors to start thinking about the scale of U.S. borrowing.

The flip side could be a debate about whether assets denominated in other currencies are cheap enough to be attractive. Growth outside the U.S. has shown signs of stabilizing, and overseas stocks have started to rebound. A less disruptive dollar could, given time, add to the momentum beyond American shores.

Stuck in the past

Overhaul tax for the 21st century

Today’s tax systems are unforgivably cack-handed

IF YOU are a high earner in a rich country and you lack a good accountant, you probably spend about half the year working for the state. If you are an average earner, not even an accountant can spare you taxes on your payroll and spending.

Most of the fuss about taxation is over how much the government takes and how often it is wasted. Too little is about how taxes are raised. Today’s tax systems are not only marred by the bewildering complexity and loopholes that have always afflicted taxation; they are also outdated. That makes them less efficient, more unfair and more likely to conflict with a government’s priorities. The world needs to remake tax systems so that they are fit for the 21st century.

Let me tell you how it will be

Jean-Baptiste Colbert, the finance minister of Louis XIV of France, famously compared the art of raising tax to “plucking the goose so as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”. Tax systems vary from one economy to another—Europe imposes value-added taxes, America does not. Yet in most countries three flaws show how the art of plucking has failed.

One is missed opportunities. Expensive housing, often the result of a shortage of land, has yielded windfall gains to homeowners in big, global cities. House prices there are 34% higher, on average, than five years ago, freezing young people out of home ownership. Windfall gains should be an obvious source of revenue, yet property taxes have stayed roughly constant at 6% of government revenues in rich countries, the same as before the boom.

Another flaw is that tax sometimes works against other priorities. Policymakers in the rich world worry about growing inequality, which is at its highest level in half a century. In the OECD, a group of mostly developed countries, the richest 10% of the population earn, on average, nine times more than the poorest 10%. Yet over this period, most economies (though not America’s) have shifted the composition of labour taxation slightly toward regressive payroll and social-security levies and away from progressive income taxes.

Tax systems have also failed to adapt to technological change. The rising importance of intellectual property means that it is almost impossible to pin down where a multinational really makes money. Tech giants like Apple and Amazon stash their intangible capital in havens such as Ireland, and pay too little tax elsewhere. This month it emerged that Amazon’s British subsidiary paid £1.7m ($2.2m) in tax last year, on profits of £72m and revenues of £11.4bn. By one recent estimate, close to 40% of multinational profits are shifted to low-tax countries each year.

The “solutions” to such problems often only exacerbate the daunting complexity of today’s tax code—and, if lobbies have their way, add extra loopholes too. The European Union wants to determine when firms have a “virtual nexus” in a state, and will then allocate profits across countries using a complicated formula. America’s supposedly simplifying recent tax reform included stunningly complex new rules for multinationals. International efforts to co-operate to prevent profit-shifting have made progress. But they are hamstrung by disagreements over how to treat technology firms and competition for investment in a world where capital crosses borders.

Fundamental tax reform can boost growth and make societies fairer—whatever the share of GDP a government takes in tax. Fortunately, the principles according to which rich countries can design a good system are clear: taxes should target rents, preserve incentives and be hard to avoid.

All countries should tax both property and inheritance more. These taxes are unpopular but mostly efficient. In a world where property ownership brings windfalls that persist across generations, such taxes are desirable. A conservative first step would be to roll back recent cuts to inheritance tax. A more radical approach would be to introduce a land-value tax, the most efficient of all property taxes and one with a long liberal heritage.

Economists are sceptical of taxing other forms of capital, for the good reason that it discourages investment. But capital’s share of rich-world GDP has risen by four percentage points since 1975, transferring nearly $2trn of annual global income out of paycheques and into investors’ pockets. Given that competition is declining in many markets, this suggests that businesses are increasingly able to extract rents from the economy. Taxes on capital can target those rents without disturbing incentives so long as they include carve-outs for investment.

To stop companies shifting profits, governments should switch their focus from firms to investors. Profits ultimately flow to shareholders as dividends and buy-backs. But few people are likely to emigrate to avoid taxes on their investment income—Apple can move its intellectual property to Ireland, but it cannot put its shareholders there. Corporate tax should be a backstop, to ensure that investors who do not pay taxes themselves, such as foreigners and universities, still make some contribution. Full investment expensing should be standard; deductions for debt interest, which incentivise risky leverage for no good reason, should be scrapped.

As the labour market continues to polarise between high earners and everyone else, income taxes should be low or negative for the lowest earners. That means getting rid of regressive payroll taxes which, in North America, could be replaced with underused taxes on consumption. Though these are also regressive, they are much more efficient.

One for you, nineteen for me

Adam Smith said that taxes should be efficient, certain, convenient and fair. Against that standard, today’s tax policies are unforgivably cack-handed. Politicians rarely consider the purpose and scope of taxation. When they do change tax codes, they clumsily bolt on new levies and snap off old ones, all in a rush for good headlines. Rewriting the codes means winning over sceptical voters and defying rapacious special interests. It is hard work. But the prize is well worth the fight.

Japan begins to embrace the 100-year life

Tokyo is waking up to the huge implications — as well as opportunities — in healthcare, finance, housing and technology of an ageing society

When The 100-Year Life first appeared in mid-2016, the book about longevity and societal change sold only modestly in the west. Some took it as an inspiring road map, some as a warning, some as a niche-interest read for human resource departments or pension specialists.

But when the translated version was published in Japan a few months later, it hit the world’s most aged nation like a jolt of electricity.

To Japan, the book’s central thesis — that individuals, institutions, government, finances and infrastructure need urgent preparation for a time when millions can reasonably expect to live for a century — touched the rawest of nerves. It became a huge bestseller, transforming the public debate and crystallising what had been a murky discussion of demography-themed hopes and fears.

That clarity has spurred the country, where 27 per cent of the population is over 65, half is over 50 and deaths have exceeded births for more than a decade, into a grand show of action. The cover of a manga comic version of 'The 100-Year Life' (published as 'Life Shift' in Japan)

Sceptics maintain that it is no more than that — a show. But like a grandfather finally admitting that he needs bifocals, Japan has embraced the idea of the 100-year life as an overarching policy directive. It has long seen the more terrifying implications of that in surging healthcare costs and the emergence of “dementia towns”, where a fifth of residents are suffering from cognitive decay. But the potential upsides are also now receiving attention. In 2017, consumption expenditure rose most strongly in the over-59 age group. Young Japanese may husband their yen carefully; seniors are spending more on meat, cars, smartphones and package tours.

Brokers have identified three related “buy” calls: companies that run nursing homes or dispatch caregivers, manufacturers of robots to help or replace Japan’s greying workforce, and fitness centres that focus on gym fanatics in their latter decades. Japan’s decision to embrace the 100-year life, joke brokers, is the call of the century: it remains to be seen whether it can ever pay off.

Florian Kohlbacher, an author of extensive research on Japanese demographics, is one of many experts struck by how late this burst has come. Japan is very clearly at the global forefront of ageing, he says, and should be a clear leader in developing the policies and products that demands.

“Most of the future we don’t know, except for demographics . . . so [if] we know what is going to happen, why don’t we act? [Japan’s] population has peaked out, it’s shrinking— you’d assume this is the number one topic that you address. But why do we not see more action taken? One reason is, we still, today, look at ageing as a problem, rather than an opportunity,” said Mr Kohlbacher.

The negative take is compelling. A 2017 book called Future Chronology also sold extremely well and paints Japan’s future as a yawning chasm between “the coming reality and the current state of public and private-sector planning”. Masashi Kawai’s grim vision of millions of crumbling, vacant homes and tower blocks becoming “nursing homes in the sky” suggests the number of annual births falling below 1m in 2016 should have rallied people sooner. He guesses that technology cannot address the shortfall and predicts a time when Japan is not only short of crematorium space, but lacks the monks to administer the last rites.

In terms of the public purse, the risks are clear: by 2025, when the immediate postwar baby boomers turn 75, social security expenditures will surge under a scheme that patients become responsible for a smaller ratio of their medical costs as they get older.

But the purely doomsaying approach to ageing may have shifted slightly as policymakers see the idea of an army of healthy elderly citizens who actively want to work as a blessing.

Wearable technology: a nurse in an exoskeleton lifts an elderly patient © AFP

Business leaders, bureaucrats, educators and swaths of the general public have absorbed the warnings in the The 100-Year Life (which was published under the name LifeShift in Japanese) but also welcomed its conviction that there can be opportunity in longevity, given the right policies.

The book emboldened the Japan Gerontological Society to call for the definition of “elderly” to be revised from “over 65” to “over 75”. The phrase hyakunen jinsei (100-year life) has bustled into corporate vocabulary; big companies in financial services and construction say they are using the idea to drive fundamental shifts in their business models.

In some cases, such as manufacturing, it is driving new technology investment in robotics and exoskeleton suits for older workers. In others, such as regional banking, where 50 per cent of lenders lost money in their core business in the financial year ending March 2017, it is one of the key considerations behind 15 mergers since 2008 and several more now in negotiation.

Lynda Gratton, co-author of 'The 100-Year Life'

Lynda Gratton, the London Business School’s professor of management practice and the book’s co-author, has become an adviser to Japan’s top leadership, informing ministers last year that it was likely that half the children born in Japan today will live beyond 100. This month, in a rare honour shared by the works of Karl Marx and John Maynard Keynes, the book will be released in manga comic format to ensure it reaches an even wider readership.

Not long after it hit Japanese bookshelves, an executive summary of The 100-Year Life landed on the desk of prime minister Shinzo Abe — struggling at the time to reignite public faith in his “Abenomics” reform programme.

Japan already knows better than anyone how quickly 100-year lives can proliferate even as the general population shrinks. Fifty years ago Japan had just 327 centenarians; in 2017 it had 67,824, and the largest per capita ratio of them in the world.

Ageing Japan© AFP 107Age expected to be reached by 50% of Japanese citizens born in 2007 3.36m Japanese men and women aged over 69 who were still working in 2016 ~40% Senior Japanese employees who say they want to work as long as they can

But Mr Abe, say senior officials close to him, knew a galvanising narrative when he saw one. The book’s blueprint, of people working much later into their lives, remaining in better health, continuing to gain skills and investing for a long stay on earth, had a note of optimism he desperately needed.

He saw too that it fitted in with other policies he has pushed — critics say unsuccessfully — such as making more nursery spaces available for the children of working parents, and workplace reform aimed at narrowing the pay and benefits gaps between regular and non-regular workers. It also offered the opportunity to slacken some of the barriers to foreign workers — a segment of the workforce that Mr Abe and others recognise will be critical for securing the necessary army of elderly caregivers that Japan’s demographics demand.

Within a year of the book’s publication, the Cabinet Office had assembled a diverse group of ministers, academics, business leaders and union representatives into the Council for Designing the 100-year Life Society. In a signal that Mr Abe, who chaired and attended all nine of the committee’s meetings, was open to all ideas, its ranks included a former footballer, Masako Wakamiya — an 83-year-old woman who designs iPhone games apps to keep the elderly stimulated, and Haruka Mera — a 30-year-old entrepreneur whose crowdfunding app has helped found a number of childcare businesses.

“I think that the 100-year life phrase made it easier for people to understand all the issues. The idea focuses people on the possibilities — it makes them realise that they could continue living for decades, and it makes it easier to imagine what needs to be done and how they need to plan their lives,” says Ms Mera.

Masako Wakamiya, one of the world's oldest iPhone app designers © AFP

Japan’s burst of activity, say senior government officials, arises in part from the fact that it has now accepted that it cannot, as it has habitually done in other areas of policymaking, reliably look elsewhere for guidance.

“We can ask why was Japan so late to do this, but they are actually the only big country that has formally decided to look at the ‘100-year life’ as a national project,” says Prof Gratton. “[Japan] has actually been fast at making it into a narrative.”

TV executives are already there. Before and After, Japan’s most popular property show, featured a section earlier this year showing how couples in their 70s could refit their homes to live comfortably with their centenarian parents.

The country’s biggest securities houses, Nomura and Daiwa, are also seizing the opportunity. They have attempted to soften their macho images by diverting large blocs of their sales forces into new face-to-face services for their inexorably ageing client base.

The brokerages’ strategy is to break with the past and patiently discuss the customer’s needs rather than badgering them for the hard sell. Nomura has dubbed this sales team its “Heartful Partners”, while Daiwa has gone for “Peace of Mind Planners”. They are jumping into a void that would, in the UK and US, already be teeming with independent financial advisers.

In June, the committee published its recommendations and, two days later, they were adopted by the cabinet. Key ideas from the 100-Year Life committee included significant improvements in long-term care worker pay, a “drastic expansion of recurrent education” to expand mid-career employment and laying the groundwork for raising employment levels of the elderly.

That last part, say analysts, is the key: most Japanese, whether for financial or social reasons, do not want to retire even at 65. In the Cabinet Office’s recent survey on the daily lives of the elderly, it found that roughly 40 per cent who are still working say they would like to continue until they are physically unable to carry on. Another 35 per cent would like to keep going until at least 70.

Companies desperate for staff as the working population shrinks are already finding ways to re-employ the just-retired, using short-term contracts for almost exactly the same role they just vacated but with fewer rights.

Shinzo Abe convenes the Council for Designing the 100-year Life Society last year

Far more of an undertaking will be the scrapping of Japan’s mandatory retirement system, which discriminates against the over-60s by forcing them off the regular payroll, and adjustments to Japan’s pervasive seniority-based pay system, which is evidently ill-suited to an era of super-long working lives.

Naohiro Yashiro, an economist at Showa Women’s University, says wages based on seniority and mandatory retirement ages can only be changed by structural reform and too many people want to maintain the status quo.

“The new phrase doesn’t change [the fact] that the government hasn’t done important reforms on, for example, pensions,” he says, adding that the ruling Liberal Democratic party would always balk at serious pension and medical reform given its voter base and donors. “They do not really feel panicked. They are closing their eyes to the real reforms they need.”

Prof Gratton sees it differently: “When people read our book in the US, the concern was that people will not be able to afford to get old. In Japan, it was never seen as a book about pensions. It was seen as a book about opportunity.”

Additional reporting by Flora Fushii-McIntosh