The Global Trade System Could Break Down

Anne O. Krueger  

sinking cargo ship

WASHINGTON, DC – Ten years after the failure of Lehman Brothers, we know that multilateral action was crucial in preventing the so-called Great Recession from becoming even worse than it was. Back then, it was the global financial system that was tottering. Today, it is the global trade system that is in jeopardy.

Over the past 70 years, multilateralism has served the world well. Much to its credit, the United States eschewed retribution and reparations after World War II. Instead, it led the way in establishing the three major economic institutions – the International Monetary Fund, the World Bank, and the World Trade Organization (formerly the General Agreement on Tariffs and Trade, or GATT) – that form the basis of the international economic order that is still in place today.

Each of these institutions has made a significant contribution to global economic growth, but none more so than the WTO. Owing to the expansion of an open multilateral trading system under the GATT/WTO, trade since WWII has grown 1.5 times faster than global GDP.

Though multilateralism is no less important today than it was throughout the post-war era, threats against the WTO are increasing. Chief among them are the ongoing attacks from US President Donald Trump’s administration, which is trying to undermine the institution both in letter and in spirit.

During the onset of the financial crisis a decade ago, many feared that countries would erect new trade barriers, because that is what happened in the 1930s and during other post-war recessions. But trade restrictions were largely avoided, because the WTO and G20 stepped in to facilitate multilateral cooperation. The global volume of trade did not shrink nearly as much as it could have; and by 2011, it had recovered to its pre-crisis level.

The WTO’s 164 member economies have committed to supporting an open multilateral system, and to common rules and procedures that are meant to help that system grow. These rules do for international trade what domestic commercial codes do for contracts and transactions between parties within a given jurisdiction.

Under WTO rules, international trading firms are subject to the same national regulations as domestic firms, and traders have the same rights as nationals in trade partners’ courts. Governments may not discriminate against other WTO members (meaning that a benefit for one trading partner must be extended to all). Tariffs are permitted only under certain circumstances. And alleged rule violations are referred to the WTO’s Dispute Settlement Body.

The assurance that trading firms will receive fair regulatory and judicial treatment from member-state governments is essential; and the principle of nondiscrimination has been a tenet of the global trade system since its inception. These are the provisions that make the system truly multilateral.

Under the WTO framework, the principle of most-favored nations (MFN) allows for multilateral trade negotiations among equals. Through such negotiations, the average tariff on manufactured goods among advanced economies has been reduced from over 40% in the late 1940s to around 4% today – much to the benefit of all members.

The WTO’s dispute-settlement mechanism (DSM) is also vital for global trade. When a country’s authorities believe that a trading partner is violating mutually agreed rules, they can bring their case before the WTO. WTO arbitration panels will then consider the arguments from each side, and hand down penalties when appropriate. For its part, the US has won more than 90% of the dispute-settlement cases that it has brought.

Like the mainspring of a mechanical watch, the WTO operates as the inner workings of the global trade system. It is not visible, but it is absolutely essential to keep the mechanism functioning.

And yet, despite the WTO’s vital importance, it is being weakened. The most immediate threat is to the DSM. At least three arbitration judges are needed to hear an appeal, but the Trump administration has been blocking all of the nominees to replace those whose terms are expiring. Once there is no quorum, no appeals cases can be heard, and some countries might start to violate WTO rules with impunity.

Another significant threat to the WTO framework is the Trump administration’s use of the national-security provision to justify its discriminatory tariffs on imported steel and aluminum. Obviously, the US is not facing a genuine national-security threat from allies such as Canada or Japan, which means that its tariffs are certainly a violation of the spirit – and probably also the letter – of WTO rules.

The US tariffs have already undermined global growth and weakened the WTO. In a world of cross-border supply chains and increasing interconnectivity, the unnecessary disruption to the iron and steel trade will result in less production not just in exporting countries, but also in the US. And the likelihood that other countries will retaliate makes the situation all the more dangerous.

In any event, discriminatory tariffs will almost certainly fail to accomplish Trump’s stated goal: a reduction in the US’s bilateral trade imbalances. The current-account balance of any country is the difference between its domestic savings (public and private) and domestic investment. Unless savings increase or investment falls, a current-account gap cannot be narrowed.

Any effort to undermine international trade – a leading engine of global economic growth since the end of WWII – will inevitably impose high costs on everyone, including the working-class members of Trump’s political base. The international community beyond the US must stand up to Trump and reaffirm the principles of an open multilateral system – before it’s too late.

Anne O. Krueger, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is Senior Research Professor of International Economics at the School of Advanced International Studies, Johns Hopkins University, and Senior Fellow at the Center for International Development, Stanford University.

Private equity buying banks is not a good mix

The financial crisis taught that spiralling leverage can be dangerous

Blackstone has paidt €1bn for a 60% stake in Luminor

One deal does not necessarily signal a trend. But it is to be hoped that Blackstone’s €1bn purchase last week of a 60 per cent stake in Luminor, a Baltic lender — one of the largest private equity banking deals of the past decade — does not mark the start of a series of such acquisitions.

In itself, the deal looks straightforward. If approved by regulators, it will offer Sweden’s Nordea and Norway’s DNB, Luminor’s owners, a convenient way to reduce exposure to a market they no longer view as a priority. Blackstone sees a chance to boost Luminor’s return on equity, which lags behind some other Nordic banks, and says the Baltics are a high-growth market.

That makes this deal different from the rescues over the past two years of Germany’s HSH Nordbank by US private equity groups led by Cerberus and JC Flowers, and of Portugal’s Novo Banco by Lone Star of the US — or from JC Flowers’ stake in the UK’s Kent Reliance building society in 2010. Those deals either saved ailing institutions or met regulators’ demands to find new owners for parts of restructured banks.

While specialist investors may offer the only viable option in exceptional cases, any tendency in which banking becomes a normal destination of private equity funds seems ill-advised. Indeed, widespread mixing of private equity with banking could be a recipe for disaster.

Both sectors are highly leveraged. Boosting one with the other would be toxic. If the financial crisis taught us anything, it is that spiralling levels of leverage are not a good idea. A decade since the crisis erupted, the continuing weakness of parts of Europe’s banking sector makes prudence even more well-advised. High volumes of non-performing loans continue to afflict several banking markets; economic growth remains subdued.

Private equity, meanwhile, is looking like a bubble waiting to burst. Deal valuations are at record highs, surpassing pre-crisis levels. Globally, about half of private equity deals last year were priced at over 11 times the target company’s earnings before interest, taxes, depreciation and amortisation, according to Bain & Company. In the UK, that multiple spiked to an astonishing 26 times ebitda in Jacobs Holding’s acquisition of Cognita, a private schools group, earlier this month.

High deal valuations are being accompanied by growing levels of leverage, too. Between January and August this year, debt to ebitda ratios on European deals averaged 5.59 times, according to S&P Global Market Intelligence. This hovers worryingly close to the pre-crisis peak of 6.12. The European Central Bank’s advice to the institutions it oversees is for their own leveraged transactions to keep under a ratio of 6 times. It appears that many private equity deals would not pass that test.

With unprecedented levels of capital at their disposal, private equity funds might not care. Over the past five years, private equity houses have raised a total of $3tn. They are still sitting on some $1.7tn of unallocated capital. New sectors, such as banking, might catch their attention. A few successful deals, beyond one-off rescues, might lead other funds to follow suit.

Banking should not become just another investment sector for private equity houses. Problems could quickly escalate and move from the latter to the former, potentially leading to systemic failures. The consequences could be dangerous. Blackstone’s acquisition may well turn out a success for all parties involved. But it is not one that other PE counterparts should be rushing to copy. Banking regulators should keep a close eye on such deals.

In the Philippines, Coup Rumors Are Just Rumors

The days of political agitation by the military are long gone.

By Phillip Orchard         

On Sept. 11, in an interview that’s bizarre and provocative even by his standards, Philippine President Rodrigo Duterte challenged dissident soldiers to try to mount a rebellion. The firebrand president said he had evidence that a sitting senator and some communist rebels were plotting to assassinate him and seize power on Sept. 21, the anniversary of the declaration of martial law by deposed dictator Ferdinand Marcos. This capped two weeks of high political drama that began when Duterte ordered the military and police to arrest the senator in question, Antonio Trillanes IV, a vocal Duterte critic who has regularly badgered the president about corruption allegations and accused him of being soft on China.

To be fair, Trillanes has a history of usurpation. As a junior naval officer, he helped lead a pair of failed uprisings in the mid-2000s. Former President Benigno Aquino granted Trillanes amnesty as part of a plea deal in 2011, but Duterte unilaterally revoked the deal on Aug. 31. The move set off a war of words between supporters of the president and those of Trillanes, with both sides trying to pull the military back into the political fray.

The military is mostly trying to stay out of it. On Monday, the head of the Philippine armed forces denied rumors that there was widespread discontent among the rank and file, yet he felt the need to remind them to stay out of politics. (The statement was a response to an incident in which a small group of soldiers and police tried to detain Trillanes but were blocked from entering the Senate, where Trillanes has been holed up.) The military also felt compelled to publicly deny rumors swirling in Manila of “unusual troop movements." Defense Secretary Delfin Lorenzana, reprising what’s become a familiar role, downplayed the president’s claims and said the military wouldn’t detain Trillanes unless the courts issued a warrant, though he backed up Duterte’s claims about communist rebel involvement in the alleged plot. Notably, however, the military is also believed to have leaked documents supporting the validity of Trillanes’ original amnesty deal.

Along with the military’s apparent refusal to act on Duterte’s extrajudicial arrest order, this raises questions about the military’s loyalty to the president. Still, it’s unlikely that Duterte is in real trouble. Coup rumblings have dogged Duterte since before his inauguration in 2016, the rumor mill fueled by his divergence from the defense establishment on the South China Sea dispute, his outreach to Muslim Moro separatists and communist rebels, and the unpopularity of his drug war with the politically influential Catholic Church.

But there’s never been much substance to the rumors — even in late 2016, when Duterte issued an order restricting military personnel to their barracks, ostensibly as a way to prevent them from joining mass demonstrations against the burial of Marcos in the national heroes’ cemetery. Duterte has even generally welcomed the rumors, while hinting that he may step down to make way for a hand-picked successor before his six-year term expires anyway.

The days of political agitation by the Philippine military, which helped bring an end to the Marcos regime and then promptly tried and failed four times to oust his successor, appear to be long gone. The last time the military played any role as kingmaker was in 2001, when it declared that it would not crack down on mass protests against former President Joseph Estrada, leading to his resignation under corruption allegations. The two “coup” attempts led by Trillanes in 2003 and 2007 against former President Gloria Macapagal Arroyo amounted to little more than seizing control of a pair of luxury hotels in a Manila business district.

Indeed, despite its reputation for political adventurism, the Philippine military is too divided along factional and socio-economic lines to take out presidents, and has been for some time. For a coup to succeed in the Philippines, it would need the support of the public, civil society groups and factions of the security apparatus outside the armed forces. There are few signs of any of these elements today. Duterte's approval ratings have dipped somewhat, but he still commands a lot of public support. Protests against his drug war failed to gain momentum. He’s successfully navigated some of the most contentious parts of his agenda, including the Mindanao peace process. By all accounts, he’s broadly popular with the rank-and-file of the military, and he's had two years to stack the senior brass with loyalists and dole out pay raises across the board. He’s gradually abandoned his anti-U.S. rhetoric and moderated his outreach to China. If Trillanes had the backing to pose a real threat, it’s doubtful that he’d be hiding out in his Senate office.


Even so, the latest standoff shouldn’t be dismissed as mere political theater. The battle for the Philippines between the United States and China isn’t going to be settled anytime soon, and the political strength of a Philippine leader will play a small role in that regard. It’s notable, then, that Trillanes’ corruption allegations have elicited such a strong response from the president. (Another opposition senator who’s been needling the president on corruption was jailed last year.) Philippine presidents, more often than not, have left office under clouds of corruption. This particular episode comes as Manila and Beijing are moving to reach an agreement on joint oil and gas exploration in parts of the South China Sea that the U.N. Permanent Court of Arbitration ruled are in the Philippines’ exclusive economic zone. Chinese Foreign Minister Wang Yi is set to visit for talks on joint development next week.

Any deal on the matter promises to be legally contentious and politically risky, inviting accusations of the president selling resources to a country that has blocked every Philippine attempt to develop its own oil and natural gas. A similar agreement between Manila and Beijing reached in 2003 fell apart by 2008 over corruption allegations against Arroyo – the president Trillanes twice tried to oust. The Philippines’ existing fields are rapidly depleting, so Manila is desperate to find a way to bring new fields online in the South China Sea. And with Western powers declining to intervene on Manila’s behalf, the Philippines has little choice but to negotiate on Beijing’s terms. There are some fights that Philippine presidents can’t help but pick.


Markets are suffering from a nasty bout of millenarianism

Contrary to popular wisdom, there are reasons to be cheerful

A SKIT in the 1979 film, “The Secret Policeman’s Ball”, features Peter Cook, a revered British comedian, as the leader of a cult whose members have gathered on a mountain to watch the end of the world. His followers are full of questions. How will the Earth perish? Will there be a mighty wind? What will happen to homes? “Well, naturally they will be swept away and consuméd by the fire that dances on the Jeroboam,” he replies. “Serve them bloody well right!”

The skit sends up the millenarian sects of medieval Europe whose adherents believed they were living in the “end times” or “last days”. It could as fittingly be aimed at many investors today. A strain of millenarian thinking has been common since the bankruptcy of Lehman Brothers ten years ago this month. Its devotees, too, rail against a discredited priesthood and its vices—in this case, central bankers and quantitative easing (QE). They also maintain that a reckoning is due.
Perhaps it is. As the crisis that followed the collapse of Lehman brought home, it is a mistake to be complacent about what may happen next. Extreme economic and financial events are far more likely than investors had believed. But the real lesson of Lehman is not so much that very bad things can occur. It is that anything might. Investors should of course be mindful of the risk of further crises. But they should also keep in mind the possibility that things might turn out just fine.

Admittedly, this is hard. It is far easier to think of ways that things might soon go wrong.

America’s stockmarket is pricey. Its economy has enjoyed a long expansion. Perhaps the Federal Reserve will tip it into recession. The trouble in emerging markets may worsen. The euro zone is accident-prone. It still lacks a shared mechanism for propping up the economy by fiscal means. Meanwhile, China’s economy has slowed. Its debt mountain looms large. President Donald Trump’s numerous trade wars present another threat.

Moreover, the origins of a crisis can often be found in the response to the previous one. The Fed’s interest-rate cuts following the East Asian and Russian crises helped blow up the dotcom bubble. When that burst, the Fed slashed interest rates and fuelled a housing boom and bust that did for Lehman Brothers. There is good reason to worry that the end of QE in Europe, and its reversal in America, will unsettle financial markets.

Deliver us from salvation

The possibility that markets might be surprised by good news may seem absurd. It is natural to respond to trauma with caution. But this caution can be so extreme that it impairs people’s judgment. In “The Pursuit of The Millennium”, first published in 1957, Norman Cohn showed that outbreaks of millenarianism often followed a big disruption of some kind—a plague, a famine or even a sharp increase in prices. Prophets of doom tend to spring up after disasters. When you have just lived through one trauma, another seems more plausible.

But disaster can breed so much caution that a crisis becomes less likely, says Eric Lonergan of M&G, a fund-management group. He cites the example of the East Asian crisis in 1997-98. The countries it affected went on to make sure they would not be at risk of another balance-of-payments crisis. Likewise, after a crisis as far-reaching as the most recent one, levels of watchfulness among rich-world policymakers militate against the risks of a global recession. “Your prior [assumption] should be for a very long expansion,” says Mr Lonergan.

So how might it all go right? It is encouraging that a number of Fed governors seem anxious about the risk of tightening monetary policy too much. Emerging markets may be out of favour, but only a handful are plagued by the old evils of inflation and over-reliance on foreign financing. The chance of progress on fiscal risk-sharing in the euro zone is higher than is generally appreciated. Daniele Antonucci of Morgan Stanley notes the promising noises coming out of Germany. The threat of a trade war has reduced the likelihood of global recession, reckons Mr Lonergan. It has spurred the Chinese authorities to stimulate the economy sooner than they would have otherwise.

Optimists can seem naive. Looking on the bright side does not have the same intellectual cachet as forecasting calamity. Prophets of doom know they will eventually be proved right. It is the nature of business cycles that recessions happen. Good news is just bad news postponed. When the doomsayer played by Peter Cook is forced to recognise that the Earth has not been consumed by flames, he is phlegmatic. “Never mind, lads,” he tells his followers. “Same time tomorrow?”