China should really start to worry about Trump

As Europe wins a reprieve over trade the portents for Beijing have commensurately darkened

Edward Luce

US president Donald Trump, pictured here on the right with Chinese counterpart Xi Jinping, has cut himself far more leeway to indulge in China-bashing

It was Wednesday so Europe went from being a “foe” of America to a “great friend”. Next Monday might be different. Perhaps Europe will still be in Donald Trump’s good books. The only person who can say for sure is Mr Trump. Even he probably has little idea. But my hunch is that the ceasefire he struck with Jean-Claude Juncker, president of the European Commission, will hold. Mr Trump loves applause and the last-minute trade agreement with Brussels earned a transatlantic ovation. Europe has won a reprieve. The portents for China have commensurately darkened.

They were already dimming before Mr Trump’s latest rabbit trick. His squeeze on China is now likely to be backed by the Europeans and the US business community. Both have long advocated combined western pressure on China to put foreign investors on a level playing field. Both share deep concern about China’s systemic technology transfer. Neither like the sound of Xi Jinping’s “Made in China 2025” plan, since it aims to eat their lunch on artificial intelligence. Mr Trump has cut himself far more leeway to indulge in China-bashing.

The chances are that he will use it. There are three forces conspiring to worsen US-China relations. The first is politics. As the US midterm elections loom, the temptation to scaremonger on China will grow. It worked for Mr Trump in 2016. Then he accused China of raping the US economy. He said nothing similar about Europe. Then, as now, most Americans associated post-industrial ravage with China. They did not accuse Europe of stealing their manufacturing jobs. Nor did they blame technology, as they should have. It is hard to win an election against robots. Beijing offers a tried and tested target.

The second is geopolitics. Mr Trump needed China’s help during his first 18 months to tighten the screws on North Korea. Without Chinese sanctions, it is hard to imagine Kim Jong Un would have agreed to North Korea’s full denuclearisation. The carrot was the lifting of those sanctions. Anyone could have told Mr Trump that Mr Kim was playing him along. Either way, China will be far less willing to tighten the vice on North Korea a second time. It is already relaxing border restrictions. When the North Korea deal fails, Mr Trump will need someone to blame. At some point Mr Trump is likely to resume the suspended US-South Korea war games, which will escalate tension with China.

China is also on the wrong side of Mr Trump’s Iran policy. As he steps up his rhetoric against Iran, Europe will grudgingly comply. For most European companies, the pain of lost American business far outweighs any earnings prospects in Iran. It is a different calculation for China. During Iran’s last bout of isolation, Beijing was its mainstay. China will step up again. This time, however, it will be in defiance of Mr Trump. Taiwan offers Mr Trump the juiciest prospect of retaliation. He has also rehearsed this one before. The first congratulatory call he took after the 2016 election was from Taiwan’s leader, Tsai Ing-wen. Beijing chose to ignore Mr Trump’s dramatic breach of protocol. It is unlikely to treat him with kid gloves a second time. Taiwan is to China what Cuba was to the US during the Cold War — a bright red line. It will not tolerate any dilution of America’s “One China” policy.

The third is the lack of Chinese flexibility. Mr Trump’s complaints about Europe are exaggerated and hypocritical. He has a far stronger case against China. Should he genuinely want a deal with Europe on industrial goods, which is anybody’s guess, it ought to be possible. Europe’s surplus with the US is barely half of China’s. Both sides of the Atlantic are already relatively open. There is scope for creative negotiation if there is a will.

By contrast, Beijing’s stance is theological. Mr Xi’s “Made in China” goal is to his economic strategy what Taiwan is to China’s national identity. It is non-negotiable. In China’s eyes it is entirely reasonable. China lost face during the so-called “century of humiliation” at the hands of colonial powers. It is now well into its century of restoration. It will take more than bluster to persuade Mr Xi to change course.

Are the US and China destined to clash? No. But it is becoming easier to imagine. Mr Xi will try to play the waiting game. He will find opportunities to let Mr Trump declare cosmetic wins. But his margin for error is shrinking. Mr Trump is not the type of president to bide his time.

Healthy returns

Private equity is piling into health care

High prices and stiff competition mean investors must think creatively

LAST month KKR, a private-equity firm, announced that it would buy Envision Healthcare, one of America’s largest providers of doctors to hospitals. The deal was valued at $9.9bn, including debt. If shareholders agree to the sale, it will be the largest in a string of health-care investments by KKR, including an ambulance service, a company that helps treat children with autism and a maker of medical devices.

“Ten years ago only a few private-equity houses had dedicated health-care teams,” says Dmitry Podpolny of McKinsey, a consultancy. “Today nearly everyone does.” Last year saw a frenzy of deal activity, the highest by value since the go-go year of 2007. 

Private-equity funds are not the only ones keen on the industry. Institutional investors, tech-focused funds, generalist asset managers and corporate buyers are sniffing around, too. As they chase a limited number of targets, they are pushing up prices. Not high enough to dampen interest, however: health care is loved by investors for its resilience in downturns. It held up in 2000, when the dotcom bubble burst, and in 2008, during the financial crisis. People who need medical care rarely wait for an economic recovery. “Particularly late in the cycle, or if you’re leveraged, the sector can offer stability,” says Jim Momtazee of KKR.

But interest is not merely defensive. America’s health-care market has grown faster than GDP for decades and annual spending is now $3.5trn. Further growth worldwide will be fuelled by ageing populations, the rising prevalence of chronic diseases, new treatments and an expanding middle class. According to McKinsey, in 1990-2015 health care offered shareholders higher total returns than any other sector.

Health care has an added appeal for private-equity investors, says Bain, another consultancy. It has been comparatively untouched by the innovation, disruption and consolidation that have driven costs down elsewhere. Investors argue that they can add value by consolidating assets and making companies more efficient, for example with technology or better joint purchasing. Laboratories are a case in point. A decade ago most labs in America and Europe were small; now megalabs dominate. Dentists, radiologists, ophthalmologists and care homes are consolidating, too.

Investors are less vocal about complex systems of reimbursement, though they are another draw. Those receiving health care are rarely those who pay for it, which helps providers be opaque about charges. As payers try to control costs, particularly in America, they are shifting from reimbursing by treatment to reimbursing by outcome. In response, health-care firms are seeking to reposition themselves through mergers and acquisitions.

Recent months have seen a string of deals between payers and providers, such as the buy-out of Kindred Healthcare by Humana, a large American health insurer, together with TPG and Welsh Carson, two private-equity firms. During such corporate shake-ups, being private can be useful. “Public markets are impatient and focused on quarterly results,” says Kara Murphy of Bain. “With private capital you can bet on what a company could become rather than what it is.” The particular sensitivities associated with the industry are another consideration. “Given the extra scrutiny that the health-care industry gets, it’s often better for the company to be private,” she adds.

Corporate buyers looking to expand into new products or markets offer private-equity firms an exit route. An example is the sale in 2016 of Truven Health Analytics, a health-data cruncher, by Veritas Capital to IBM for $2.6bn. The tech giant paid more than double what Veritas had paid four years earlier. But the data firm was well matched with Watson, IBM’s artificial-intelligence platform, which it is promoting as a diagnostic tool.

High prices and stiff competition mean investors must think creatively. “When everything is expensive we look for quality assets in niche markets with high barriers to entry and high growth opportunities,” says Philippe Poletti of Ardian, a European private-equity firm. Lateral thinking led it to disinfectants. In 2013 it co-invested in Laboratoires Anios, a French maker of hand-sanitisers, cleaning materials for hospital equipment and the like. After bulking up the sales team and investing in innovation, it made five acquisitions, in Brazil, Turkey and elsewhere. And it identified a niche within a niche—products for cleaning and disinfecting endoscopes—which it thought it could dominate, for example by buying a producer of endoscope-cleaning machines (which in turn use Anios’s chemicals). When Ardian cashed out last year, turnover had expanded by 25% and earnings by 50%.

Public scrutiny of health-care provision, not to mention complex webs of national regulations and payments systems, mean that investors have often preferred products to services. It is easier to sell latex gloves or bandages than surgery across borders. This also helps explain why private equity has made greater inroads into American health care than into Europe’s smaller, more varied markets (where public systems have also often resisted private investment). But that very fragmentation may mean that Europe’s health-care market is next to fall.

Budget constraints are making governments there more open to private capital. Several countries, including Finland and Spain, are turning towards public-private partnerships and some investors hope that Britain’s struggling National Health Service will become more welcoming. “In Europe almost every country faces ageing populations and in 10-20 years they will need health care,” says one fund manager. “There’s a huge challenge in providing for that growing demand while increasing efficiency. PE can help solve that problem.”

Scarce assets, stiff competition, cheap debt and large amounts of “dry powder” make a volatile mix. “Valuations are very high, but I really can’t see an end in sight,” says Martin Gouldstone of Results Healthcare, an advisory firm. Such remarks normally suggest bubbles. But health care is not normal. Some parts may be hyped (bits of biotech and med-tech spring to mind). There will be disruption as big new actors such as Amazon barge in. But as long as human bodies fail, they will need fixing.

sábado, agosto 18, 2018



QE Turns Ten

Stephen S. Roach

NEW HAVEN – November 2018 will mark the tenth anniversary of quantitative easing (QE) — undoubtedly the boldest policy experiment in the modern history of central banking. The only thing comparable to QE was the US Federal Reserve’s anti-inflation campaign of 1979-1980, orchestrated by the Fed’s then-chair, Paul Volcker. But that earlier effort entailed a major adjustment in interest rates via conventional monetary policy. By contrast, the Fed’s QE balance-sheet adjustments were unconventional and, therefore, untested from the start.

The American Enterprise Institute recently held a symposium to mark this important milestone, featuring QE’s architect, Ben Bernanke. What follows are some comments I offered in an accompanying panel session that focused on lessons learned from QE.

The most important lesson pertains to traction — the link between Fed policy and its congressionally mandated objectives of maximum employment and price stability. On this count, the verdict on QE is mixed: The first tranche (QE1) was very successful in arresting a wrenching financial crisis in 2009. But the subsequent rounds (QE2 and QE3) were far less effective. The Fed mistakenly believed that what worked during the crisis would work equally well afterwards.

An unprecedentedly weak economic recovery – roughly 2% annual growth over the past nine-plus years, versus a 4% norm in earlier cycles – says otherwise. Whatever the reason for the anemic recovery – a Japanese-like post-crisis balance-sheet recession or a 1930s style liquidity trap – the QE payback was disappointing. From September 2008 to November 2014, successive QE programs added $3.6 trillion to the Fed’s balance sheet, nearly 25% more than the $2.9 trillion expansion of nominal GDP over the same period. A comparable assessment of disappointing interest-rate effects is reflected in recent "event studies” research that calls into question the link between QE and ten-year Treasury yields.

A second lesson speaks to addiction – namely, a real economy that became overly reliant on QE’s support of asset markets. The excess liquidity spawned by the Fed’s balance-sheet expansion not only spilled over into equity markets, but also provided support for the bond market. As such, monetary policy, rather than market-based fundamentals, increasingly shaped asset prices.

In an era of weak income growth, QE-induced wealth effects from frothy asset markets provided offsetting support for crisis-battered US consumers. Unfortunately, along with this life support came the pain of withdrawal – not only for asset-dependent consumers and businesses in the United States, but also for foreign economies dependent on capital inflows driven by QE-distorted interest-rate spreads. The taper tantrum of 2013 and the current travails of Argentina, Brazil, and other emerging economies underscore the contagion of cross-market spillovers arising from the ebb and flow of QE.

A third lesson concerns mounting income inequality. Wealth effects are for the wealthy, whether they are driven by market fundamentals or QE. According to the Congressional Budget Office, virtually all of the growth in pre-tax household income over the QE period (2009 to 2014) occurred in the upper decile of the US income distribution, where the Fed’s own Survey of Consumer Finances indicates that the bulk of equity holdings are concentrated. It is hardly a stretch to conclude that QE exacerbated America’s already severe income disparities.

Fourth, QE blurs the distinction between fiscal and monetary policy. Fed purchases of government securities have tempered market-based discipline of federal spending. This is hardly a big deal when debt-service costs are repressed by persistently low interest rates. But with federal debt held by the public nearly doubling between 2008 and 2017 – from 39% to 76% of GDP – and likely to rise further in the years ahead, what is inconsequential today could take on considerably greater importance in an interest-rate environment that lacks the QE subsidy to Treasury financing.

A fifth lesson pertains to the distinction between tactics and strategy. As lender of last resort, the Fed deserves great credit for stepping into the breach during a wrenching crisis. The problem, of course, is that the Fed also played a key role in condoning the pre-crisis froth that took the system to the brink. This raises a fundamental question: Do we want a reactive central bank that focuses on cleaning up the mess after a crisis erupts, or a pro-active central bank that leans against excesses before they spark crises?

That question – whether to “lean or clean” – has fueled a raging debate in policy and academic circles. It has an important political economy component: Are independent central banks willing to force society to sacrifice growth in order to preserve financial stability? It also bears on the bubble-spotting debate. Yet as difficult as these problems are, they pale in comparison to the foregone output of America’s anemic post-crisis recovery.

That raises two additional questions: Might a pro-active Fed have prevented the crisis from occurring in the first place? And should it be more aggressive in normalizing interest rates?

The Fed’s preference for glacial normalization both in the early 2000s and now keeps monetary policy on emergency settings long after the emergency has passed. Doing so raises the distinct possibility that the Fed will lack the ammunition it will need to counter the inevitable next recession. And that could well make the lessons noted above all the more problematic for the US economy.

Unsurprisingly, Bernanke offered a very different take on many of these issues at the AEI symposium. He argued that the Fed’s balance-sheet tools are merely extensions of its traditional approach, stressing that “conventional and unconventional monetary policy works through the same channels, with the same mechanism.”

That is debatable. By conflating QE-induced wealth effects with the effects on borrowing costs that arise through conventional channels, Bernanke conveniently sweeps aside most of the risks described above – especially those pertaining to asset bubbles and excess leverage.

Ten-year anniversaries are an opportunity for reflection and accountability. We can only hope that circumstances don’t require another unconventional policy experiment such as QE. But in the event of another crisis, it would pay to be especially mindful of QE’s shortcomings. Unlike Bernanke, I fear there is good reason to worry that the next experiment may not work out nearly as well.

Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University's Jackson Institute of Global Affairs and a senior lecturer at Yale's School of Management. He is the author of Unbalanced: The Codependency of America and China.

U.S. Leans on Domestic Bond Buyers

By Daniel Kruger, bond market reporter

The U.S. government has been issuing more debt, but it's not getting more foreign buyers in the door.

As a result, U.S. investors have so far financed all of this year’s increase in the federal government’s borrowing.

Foreign holdings of the debt have remained essentially flat, though the government’s borrowing has risen by $500 billion, giving foreign investors the smallest share of U.S. government debt since 2003.

Even as yields on Treasury securities have risen to multi-year highs, foreign demand for debt at government bond auctions has slowed to the weakest level since 2008. Yields rise when bond prices fall.

The drop in demand is happening as Treasury yields approach their highest premiums over German and Japanese debt since the 1980s and as the dollar is in the middle of a rally that caught many investors by surprise. The drop-off in foreign interest also comes as the Federal Reserve is reducing the size of its government bond holdings as part of an effort to restore monetary policy to precrisis norms.

Investors and analysts cite two impediments that are discouraging foreign investment. One is the strength of the dollar has made it more expensive for investors in Japan and Europe to hedge the currency risk of buying Treasurys. The second is a new concern about the sustainability of U.S. borrowing practices at a time when the Trump administration is forecast to run a series of trillion-dollar budget deficits beginning as soon as 2020.

The hedging costs are “so high and so punitive that it’s no longer attractive” to buy Treasurys, said Torsten Slok, chief international economist at Deutsche Bank. The cost is typically close to the premium of short-term U.S. government bill yields over short-term yields overseas. Those rates are compared with short-term government debt yields, which are closely tied to each market’s central bank’s policies. The Federal Reserve is holding its target rate in a range between 1.75% and 2%, while rates for the Bank of Japan and the European Central Bank are negative.

At the same time, some foreign investors are concerned that the $1.5 trillion tax cut passed by Congress in December will over-stimulate the U.S. economy, leading to an acceleration in inflation and potentially higher bond yields and interest rates.

Americans have been saving more than was thought

US rate revised higher after statistics overhaul, with GDP figure also altered

Kadhim Shubber in Washington

The US savings rate was higher in recent years than previously measured, according to revised official figures that assume greater levels of tax evasion by business owners.

The data show the average savings rate at 7 per cent between 2013 and 2017, up from the previous figure of 5 per cent.

The revision came in the latest economic statistics update from the Bureau of Economic Analysis, which included higher estimates of the amount of income proprietors fail to report to tax authorities.

“This shift in the rate is an income story, it is not a consumption story,” said David Wasshausen, head of the national income and wealth division at the Bureau.

The Bureau also revised down gross domestic product growth for 2017 from 2.3 to 2.2 per cent, with much of the reduction falling in the second half of the year.

The revisions moved GDP growth in the fourth quarter of last year down from 2.9 to 2.3 per cent, largely due to new estimates of business inventories and fixed investment.
 In the years 2012 to 2016, the Bureau made similar adjustments to quarterly GDP growth, with upward revisions in the first half of the year and downward revisions in the second half, in part due to updated seasonal adjustments.

Every five years, the Bureau issues a comprehensive update of the national income and product accounts, incorporating new measures of economic growth and estimates for price information.

The Bureau figures published on Friday indicated an extra $650bn of proprietors income from 2012 to 2017, or an average 8 per cent upward revision in each of those years. Proprietors income measures the profits made by sole proprietorships and partnerships.

The numbers drew on a tax gap study done by the Internal Revenue Service in 2016 and drove much of the upward revision in the savings rate.

The personal savings rate in the US has been on a long decline since the 1970s, a trend that began to reverse after the financial crisis. The figure is calculated by comparing the difference between disposable incomes and personal expenditures.

This latest update left the economic picture relatively unchanged in aggregate, with average annual GDP growth between 2012 and 2017 unchanged at 2.2 per cent.

The data showed an increase in technology investment, largely due to a better understanding of cloud computing supply chains. Bureau officials had “been a bit puzzled” about why some cloud computing investment appeared to be missing from the previous data, said Erich Strassner, head of its industry applications division.

He said the Bureau had carried out an analysis of global supply chains to understand the problem better and had reclassified certain imported servers and storage devices from intermediate inputs — or partially finished goods — to final, fixed investment related to cloud computing.

“The result of all this is going to be an upward revision to high-tech investment,” said Mr Strassner.