Moscovici and the National Team

Doug Nolan

From the perspective of monitoring an unfolding global crisis, things turned only more concerning this week. The Shanghai Composite declined to 2,450 in early Friday trading, the low since November 2014 - and down almost 26% y-t-d. Across the globe in Europe, Italian 10-year yields jumped to 3.80% in early-Friday trading, the high going back to January 2014. The spread between Italian and German 10-year sovereign yields surged to as high as 340bps, the widest spread since March 2013.

October 19 - Reuters (Samuel Shen, Andrew Galbraith and Noah Sin): "China's regulators lined up to rally market confidence on Friday with new rules, measures and words of comfort… Vice Premier Liu He, who oversees the economy and the financial sector, supplemented regulators' moves by saying the recent stock market slump 'provides good investment opportunity…' Earlier in the day, the securities regulator, central bank and banking and insurance regulator all pledged steps to bolster market sentiment… Friday's announcements were largely aimed at putting a floor under the tumbling stock market."

"With pressure mounting and anxiety setting in, China's stock markets are anticipating the comeback of the 'national team,'" read the opening sentence of an early-Friday morning article from Beijing-based business media group Caixin. Sure enough, the Shanghai Composite rallied 4.1% off morning lows to close the session up 2.6%. The ChiNext growth index surged 5.6% from its opening level to gain 3.7% for the day. Friday's afternoon rally, however, couldn't erase the week's losses. The Shanghai Composite ended this week down another 2.2%. ChiNext's Friday melt-up reduced the week's losses to 1.5%.

October 19 - Reuters (Massimiliano Di Giorgio): "European Economics Commissioner Pierre Moscovici said on Friday he wanted to reduce tensions with Italy over its 2019 budget, adding it was important to see how Rome responded to the Commission's objections to the fiscal plan. Speaking at a news conference after a two-day visit to Rome, Moscovici said Brussels shared Italy's declared goals of boosting growth and cutting debt, and reiterated that no decision had yet been taken over the budget. He said he wanted to 'reduce tensions and maintain a constructive dialogue' with Italian authorities…"

At least for a few hours, Commissioner Moscovici's comments quelled tensions in the Italian (and European) bond market. After trading as high as 3.80% early in Friday's session, yields then sank 32 bps to end the week at 3.48%. Italy's bank index rallied almost 5% off intraday lows to end the session down 0.4% - and the week down 2.9%. Italy's MIB equities index rallied 2.0% to end the day little changed (down 0.9% for the week).

It's worth noting that Spain's 10-year yields ended the week up six bps to 1.73%, trading this week to the highest yields since March 2017. Things were looking dicey early Friday, as Spanish yields jumped to 1.82%. This briefly pushed the Spanish to German sovereign yield spread to 140 bps, the wide since March 2017. Portuguese yields traded as high as 2.11% Friday morning, with the spread to bunds widening to 170 bps (widest since May). Portuguese yields ended the week at 2.01%.

European debt markets dodged a bullet. After trading down to about 39 bps early Friday, German bund yields ended the week four bps lower at 0.46%. Friday afternoon's bond rally pushed Italian yields down nine bps for the week to 3.47%. Portuguese yields ended the week two bps lower and French yields three bps lower. Moscovici saved the day, reversing what appeared to have the makings of a problematic de-leveraging episode and blowout in European periphery yield spreads.

October 17 - Bloomberg: "China's broadest measure of new credit jumped in September, exceeding all estimates, as officials changed the dataset to reflect surging bond issuance amid steps to encourage investment in infrastructure. Aggregate financing stood at 2.21 trillion yuan ($319bn) in September… That compares with an estimated 1.55 trillion yuan… The central bank revised the calculation for aggregate financing for a second time this year, adding in local government special bond issuance. That took the total in August to 1.93 trillion yuan, from 1.52 trillion yuan previously. New yuan loans stood at 1.38 trillion yuan, versus a projected 1.36 trillion yuan and 1.28 trillion yuan the previous month. Broad M2 money supply increased 8.3%, from 8.2% in August. China's policy makers have stepped up their efforts to increase credit supply…"

It is not only the Europeans galvanized to quash intensifying Crisis Dynamics. China's September Credit data was an eye-opener. "Aggregate financing" jumped to 2.210 TN RMB, or $319 billion, with system Credit continuing its ongoing double-digit annual expansion (10.6%). September growth was about 40% above estimates and a 45% jump from August (growth is typically stronger in September). This puts system Credit growth (excluding national government borrowings) for the first nine months of 2018 at $2.087 TN, down about 10% from comparable 2017. After a huge September, Q3 Credit growth ran slightly ahead of Q3 2017.

Chinese officials again adjusted the composition of aggregate financing data, which now includes local government bond issuance. According to Bloomberg (Chang Shu and Justin Jimenez) "netting out the new sub-component…, the figure comes in… lower than the consensus forecast." September saw enormous issuance of "special local government bonds" (apparently for infrastructure spending), more than offsetting the ongoing contraction of "shadow" lending. Barely positive for the month, net Corporate Bond Issuance slowed notably.

New bank loans came in at about $200bn, only somewhat above estimates. Year-to-date, new loans are running 18% above comparable 2017. Consumer (chiefly mortgage) borrowings remained quite strong, at $108bn in September. This puts y-t-d consumer borrowings 18.2% above comparable '17.

October 15 - Bloomberg (Chris Anstey): "China's moves to boost liquidity in an effort to safeguard economic growth are eroding the country's yield premium over the U.S., putting 'renewed pressure' on the yuan, according to Citigroup... 'Going by its latest policy moves, China has likely halted or even abandoned its financial-deleveraging program' amid the trade war with the U.S., Liu Li-Gang, chief China economist at Citigroup…, wrote... The People's Bank of China has pumped 3.4 trillion yuan ($492bn) into the banking system so far this year through regular open-market operations and cuts in lenders' required reserve ratios, Citigroup estimates."

Beijing these days faces a very serious dilemma managing system Credit. As has over the years become quite the pernicious habit, officials are responding to heightened Bubble Fragility by aggressively stimulating system Credit. They would surely favor the expansion of productive Credit, but increasingly it appears they'll take lending growth wherever they can get it. Portends trouble.

A few of the more obvious problems: 1) Especially with the crackdown on "shadow" finance, Beijing now pushes enormous quantities of risky late-cycle Credit into an already bloated and vulnerable banking system. 2) Stimulus measures are prolonging late-cycle excess throughout increasingly fragile mortgage and apartment Bubbles. 3) China risks stirring further consumer price inflation momentum. September's 2.5% y-o-y CPI rise was exceeded only one month going back to 2013. 4) The size and characteristics of China's runaway Credit expansion pose escalating risk to their already vulnerable currency.

October 14 - Reuters (Clare Jim): "China's property developers usually look forward to the months dubbed 'Golden September and Silver October' as the high season for new home sales. This year is proving to be different. Instead, they are feeling a chill and one major realtor has warned that 'winter' is coming as developers struggle to maintain sales momentum despite gimmicky promotions and discounts. After almost two years of local and central government measures to calm the red-hot market, more signs are emerging that the property sector, a major pillar of China's economic health, is finally slowing down… 'There's downward pressure on home prices especially in third and fourth-tier cities,' said Nomura chief China economist Ting Lu. 'They have been previously rising on stimulus policies for two to three years and now they have reached a peak.'"

October 16 - Financial Times (Tom Hancock): "A wave of protests by Chinese homeowners against falling property prices in several cities has raised fears of a downturn in the country's real estate market, adding to pressure on Beijing to stimulate the economy. Homeowners in Shanghai and other large cities took to the streets this month to demand refunds on their homes after property developers cut prices on new properties to stimulate sales. In Shanghai, dozens of angry homeowners descended on the sales office of a complex that offered 25% discounts to demand refunds, causing clashes that damaged the sales office, according to online reports that were quickly removed by censors. Similar protests have been reported in the large cities of Xiamen and Guiyang as well as several smaller cities."

Keep in mind that these are China's inaugural mortgage and housing Bubbles. Borrowers have never experienced a nationwide downturn. Neither have bankers; same for regulators. A housing bust would pose risk to social stability, not to mention the banking system and economy. Chinese officials over the years have tried about everything to rein in the Bubble. They were just never willing to inflict the degree of pain necessary to break inflationary psychology. They mistakenly cultivated the perception apartment prices only rise, and Beijing will always act to support the market. Now they face a gargantuan Bubble with limited options.

The easy bet is that Beijing will see few alternatives than to adopt only more aggressive reflationary measures (they "worked," after all, in the U.S. and elsewhere!). But will China enjoy the latitude to pull it off? There's a question well worth pondering: "Is China 'emerging' or 'developed'?" Emerging economies invariably lose the flexibility for aggressive Credit expansion and system reflation. Over recent months, we've watched Argentina hike rates to 60% and Turkey to 24%. Other EM central banks raised rates more moderately, all measures to stem the risk of disorderly currency collapse.

Will China retain the flexibility to set low interest rates, to aggressively expand Credit along with adopting other reflationary measures? Or is China, the "King of EM," facing the prospect of a destabilizing currency crisis? A scenario where China is forced to hike rates to support the renminbi would be so destabilizing for its apartment Bubble and banking system that it's difficult to contemplate. That leaves international reserve holdings, capital controls and a rather pressing question: How much "hot money" (and leverage) has gravitated to China's high-yielding instruments?

When I ponder China's incredibly bloated banking sector, its historic apartment Bubble, its local government debt issues, massive future national government borrowings - and likely one of the most maladjusted economies ever - unfortunately I don't see a stable currency in China's future.

October 16 - Financial Times (Don Weinland): "China could be facing a 'debt iceberg with titanic credit risks' following a boom in infrastructure projects by local governments around the country, S&P Global has warned. Local governments may have accrued a debt pile hidden off their balance sheet as high as Rmb30tn to Rmb40tn ($4.3tn to $5.8tn) following 'rampant' growth in borrowings, the rating agency estimated. The mounting debt in so-called local government financing vehicles, or LGFVs, hit an 'alarming' 60% of China's gross domestic product at the end of last year and was expected to lead to increasing defaults at companies connected to regional authorities… Richard Langberg, an analyst at S&P, said there are Chinese cities with 'hundreds' of the local financing vehicles across the country. While defaults at a handful of smaller LGFVs could be handled by the financial sector, 'if they start to let the bigger ones go then we are getting into uncharted territory,' he said."

October 16 - Bloomberg: "The rout in Chinese equities is throwing the spotlight on $613 billion of shares pledged as collateral for loans. Loans extended to company founders and other major investors who pledged their shareholdings as collateral emerged as a popular financing channel in recent years. But given the losses in equities -- Shenzhen's stock benchmark is down 33% in 2018 -- there's a growing risk that brokerages will be forced to sell the shares, accelerating the downturn. At least 36 companies have seen pledged shares liquidated by brokerages since the start of June, more than triple the 10 in the first five months of the year… At least two firms announced after Monday's close that their shares were at risk of forced selling… 'There's a liquidity crisis in the stock market, and pledged shares are again starting to sound the alarm,' said Yang Hai, analyst at Kaiyuan Securities Co. 'If there are no real policies to cure the array of problems and ailments in our market, no one will be willing to take the risk.'"

Reports say a meeting is being arranged between President Trump and Chinese President Xi Jinping at the coming G20 meeting, tentatively for November 29th. Much could unfold by then. The mid-terms are now just two weeks from Tuesday. And it is especially challenging to look out six weeks and contemplate the status of global markets. "Risk off" has gained significant momentum around the globe.

With their stock market in a tailspin, one might expect the Chinese to be rather motivated to adopt conciliatory language and work toward progress on the trade front. Yet there's another scenario that is not as obvious - and certainly not comforting: Mr. Xi and Chinese leadership may feel they have been betrayed and mocked. They distrust the Trump administration, now recognizing their true objective is not trade as much as it is containing China's ascending financial, economic, technological, military and geopolitical power. They are livid that the administration would adopt such a belligerent approach and relish in China's financial distress. A new Cold War has commenced. It would be a zero-sum battle of rival superpowers.

The administration clearly believes they have the Chinese right where they want them. President Trump is quick to note the big decline in China's stock market. For a number of years now, I've feared a major consequence of a bursting Bubble would be the Chinese blaming "foreigners" (chiefly the U.S. and Japan) for their hardship. I just never imagined it would be so straightforward for Beijing to directly link a cause and effect.

The Chinese Bubble is again at the precipice. The last comparable episode, back in late-2015/early-2016, unfolded in a different global backdrop. China implemented additional stimulus measures, while the ECB and BOJ boosted QE and the Fed postponed "normalization". For the most part, rates were near zero globally and bond yields were declining. Pricing pressures were still leaning disinflationary. Global risk markets were neither as inflated nor as fragile as now.

That crisis episode saw the PBOC employ $100s of billions of reserves to stabilize the Chinese currency, in a global backdrop approaching $2.0 TN of annualized central bank liquidity injections. Back then, China was facing a relatively stronger economy and a booming apartment Bubble inclined for "Terminal Phase" excess.

The Chinese have considerably less flexibility today. The burst EM Bubble poses major financial and economic risks for a much more fragile Chinese system. At about $3.0 TN, China's international reserves are down a (mere) trillion from 2014 highs. And pushing more Credit, investment and speculation into Chinese housing at this "Terminal Phase" is a perilous proposition.

For too long China needed to rein in Credit growth. They made an attempt. Not surprisingly, the results have been unsatisfying. The risk of Bubble implosion has now incited yet another round of stimulus measures. But Bubble risk is indomitable, risk that expands parabolically during the "Terminal Phase." I believe there are a number of important factors - domestic and international, economic and financial - working against Beijing's current stabilization efforts. Chinese officials might be at the cusp of finally losing control. The Trump administration provides a most convenient scapegoat.

Politics puts the skids under the bull market

The tussle between the US and China risks dragging down the world economy

Martin Wolf

Bull markets, it is said, climb a wall of worry. When the last worrier turns into a fully invested optimist, the market has nowhere to go but down. That might be what has just happened: so much optimism was already in the prices of financial assets — in the US, above all — that once worry returned they had nowhere to go but down. How far might unfolding events exacerbate the worries? A long way, is the answer.

As the annual meetings of the IMF and World Bank last week made clear, reasons for concern abound. Above all, a struggle between old and new superpowers has arrived. This may change everything.

The good news is that the IMF’s World Economic Outlook continues to forecast strong economic growth, with global output growing 3.7 per cent this year and next (at purchasing power parity), as in 2017. The bad news is that this is a reduction of 0.2 percentage points in 2018 and 2019 from its April forecast. Above all, “the balance of risks . . . has shifted to the downside in a context of elevated policy uncertainty”.

On the downgrade, the report emphasises negative surprises to growth in some high-income countries in early 2018, US-initiated trade wars and problems in emerging market economies, which are due to country-specific weaknesses, tighter financial conditions, geopolitical tensions and higher oil prices. The Fund stresses that the surge in oil prices, partly related to the re-imposition of sanctions on Iran, might worsen. This would damage vulnerable oil importers. Moreover, with above-potential rates of growth and low unemployment in many high-income economies, notably the US, inflation could surprise on the upside. Even without this, monetary “normalisation” in high-income countries has a way to go.

As Warren Buffett says, “you only find out who is swimming naked when the tide goes out”.

The most naked are those with vulnerable balance sheets — high leverage and big maturity, liquidity and currency mismatches. When the tide of easy financial conditions goes out, financial and economic distress is then inevitable. Already, a number of emerging economies have succumbed, Argentina and Turkey being obvious examples. A big decline in risk appetite, possibly triggered by trade wars or accelerated monetary tightening in high-income countries, could well trigger a more generalised capital flight.

A jump in risk aversion would affect financial — and thus economic — stability more broadly. Valuations of risky assets are, in many cases, stretched and balance sheet vulnerability is pandemic, as the Global Financial Stability Report makes plain. Just a small shift in global financial conditions managed to damage some emerging economies. But, as the financial stability report points out, the aggregate debt of households, non-financial companies and governments in countries “with systemically important financial sectors now stands at $167tn, or over 250 per cent of aggregate gross domestic product”, compared with 210 per cent in 2008. Many debtors must be vulnerable to rising interest rates.

The US government has not helped by embarking on a highly irresponsible, pro-cyclical fiscal expansion on top of what the IMF labels “already unsustainable debt dynamics”. Yet private sector excess is not hard to find there either. In the eurozone, leverage in the corporate and government sectors remains high. The Chinese economy, too, is highly indebted.

Meanwhile, important asset prices remain elevated. In the US, the cyclically adjusted price/earnings ratio, developed by the Nobel laureate Robert Shiller, remains higher than it has been at any time in 137 years — except in 1929 and in the late 1990s and early 2000s. That is true even if one looks at an eight-year moving average of real earnings, instead of the normal 10-year one, thereby excluding the years of the crisis. An accident has been waiting to happen. Last week, a small one duly happened.

Chart showing how US equity prices remain high

The world’s economy and financial systems are fragile — nobody can know how fragile until they are really tested. Yet the most important source of fragility is political; a lagged legacy of the financial crisis. In country after country, populists and nationalists are in, or close to, power. Salient characteristics of such politicians are myopia and entrenched ignorance. Inevitably, they spread uncertainty. The Italian government, for example, has undermined confidence that Italy will stay in the eurozone, with perilous results.

Chart showing how global financial vulnerability has increased

The biggest shift of all is in the US. Last week, President Donald Trump broke a longstanding taboo by condemning recent tightening by the Federal Reserve. Under him, the US has also embarked on an assault on the World Trade Organization’s dispute settlement system and an open-ended trade war with China.

Above all, the US administration seems set on a new cold war with China. Mr Trump even talks of stopping the Chinese economy from becoming bigger than that of the US. Even if this stayed a cold war, not a hot one, it would be far more significant for the US than was its rivalry with the Soviet Union: China is more populous and its economy is far better run, more dynamic and more integrated with the world’s.

This folly might not matter so much in good times. But what will occur in the next crisis? Will policymakers co-operate as they did in 2008 and 2009? This question holds force within countries, within groupings such as the eurozone, and across the world as a whole. The open world economy might collapse.

These are dangerous times — far more so than many now recognise. The IMF’s warnings are timely, but predictably understated. Our world is being turned upside down. The idea that the economy will motor on regardless while this happens is a fantasy.

lunes, octubre 22, 2018



China’s Governance Tightrope

Zhang Jun  

xi jinping

SHANGHAI – Five years ago, China’s leaders decided to target modern state governance as a top reform priority. The goal of such reform is to improve the state’s capacity to adapt to the sheer size and increasing complexity of the Chinese economy, and to mitigate risk. Achieving this objective will not be easy.

To understand why, and what it will take to succeed, consider how Chinese governance has worked in recent decades. Overall, governing the country involves a combination of political centralization and economic decentralization. In particular, China’s spectacular income growth has been enabled by a delicate balance between the concentration of political power in the hands of the central leadership and the delegation of economic management to local authorities.

This balance has often proved difficult to maintain. For example, when China still had a fully planned economy, Mao Zedong had to delegate the management of state-owned enterprises (SOEs) to local authorities for some time in order to boost production, as local governments were in a better position than the industrial ministry in Beijing to manage local suppliers. But, within a few years, this system had become so disorganized, due to economic chaos in the wake of decentralization, that the central government reasserted its control.

Nonetheless, in 1978, Deng Xiaoping not only delegated authority to local governments, but also increased their revenue through a system of fiscal contracting, in an effort to maximize their contribution to overall GDP growth. Again, the plan worked for a while – until China’s leaders confronted the downside of fiscal decentralization: the central government’s declining revenue share under this system limited its capacity to assert its authority and manage macroeconomic stability. As a result, in 1994, the central government had to revise the intergovernmental fiscal relationship. It reverted from fiscal contracts to a system in which the central government acquired the majority of tax revenues and the revenue share of local governments was substantially reduced.

But while this change strengthened the central government’s hand, it undermined local governments’ ability to sustain their spending, which still amounted to some 80% of total government expenditure. In other words, revising the intergovernmental fiscal relationship did not calibrate the expenditure responsibility between central and local governments. To this day, local governments have to raise extra-budgetary funds to finance the rising deficit between revenues and expenditure.

Understandably, Chinese local leaders have not negotiated a reduction in their share of total expenditure responsibility, not least because the central government has appointed provincial leaders over whom it maintains substantial control. Meanwhile, since 1994, the central government has implemented a performance-based system for assessing and promoting local leaders, thereby fueling competition among local authorities. This point is the key to a better understanding of Chinese governance today, which the economist Chenggang Xu aptly describes as a “regionally decentralized authoritarian system.”

It is not easy to assess this system, because competition among local authorities has always had both good and bad outcomes. While this horizontal competition has helped China to reach growth targets, central leaders must be supportive of local leaders’ discretionary powers, authority to raise funds, and capacity to attract investment.

In most cases, however, local officials would abuse such powers and do more than needed. For example, local authorities have long had a perverse incentive to improve their own standing by allocating resources to image-building projects that serve no genuine economic need or purpose. This might boost growth in the short term, but unproductive investments can also threaten macroeconomic stability in the longer term.

Another difficulty in assessing Chinese governance arises from the complicated relationship between politics and business in different regions. Decentralization rewards local officials who are competent and devoted to supporting economic growth. But it also creates opportunities for these officials to forge surreptitious ties with business owners, and this undermines growth in the long run. Because of the strong competition to stand out in terms of growth, especially at the provincial level, many lower-level officials use their authority more to advance their personal interests. At the same time, business owners seek illicit relationships with local officials to gain protection, privileges (such as contracts), loans, a blind eye to safety standards, and regulatory exemptions – activities that generate financial risks and undermine competition by raising entry barriers for more efficient enterprises.

The delegation of discretionary power to the bottom of the system could therefore create a dilemma for the central leadership: exercising more control would hurt growth, but so would the rampant corruption that results from not exercising it.

Yet the solution is not as simple as cracking down on graft. Since President Xi Jinping launched his anti-corruption campaign in 2012, China’s overall economic performance has not improved, partly owing to local officials’ increased reluctance to take bold steps to boost growth.

The crux of the problem may lie in China’s system of upward accountability in governing its officials. While Chinese governance undoubtedly has its advantages – in particular, it enables the central government to mitigate risks, including preventing debt and financial weakness from triggering crises – it can hamper the kind of policy experimentation needed to sustain economic progress.

Given the system of upward accountability, de-emphasizing GDP growth in assessing the performance of local officials would help reduce these officials’ incentive to abuse decentralized powers and make unproductive investments. But if Chinese leaders do not abandon the system of upward accountability, how would they measure and assess local officials’ relative performance? A step toward introducing downward accountability into the governance system is perhaps necessary.

China’s leaders are right in the sense that the country’s governance must be modernized. To succeed, however, they may have to revise their approach to managing local governments and introduce greater downward accountability in assessing their performance. This shift undoubtedly carries risks, but ultimately they are worth taking in the course of adapting governance for continued economic development.

Zhang Jun is Dean of the School of Economics at Fudan University and Director of the China Center for Economic Studies, a Shanghai-based think-tank.

The Shadowy Arms Trade

A Look Back at a Questionable Tank Deal

By Sven Becker and Michael Sontheimer

An intermediary received a commission of almost $200 million for the sale of battle tanks to United Arab Emirates. Some of that money, though, may have been used to bribe government officials.
French-made Leclerc tanks in Yemen
French-made Leclerc tanks in Yemen

The tanks were first deployed in combat three summers ago. In early August 2015, they rolled along Yemen's N1 highway, heading north to Al Anad Air Base. Their orders were to help government troops beat back the rebels.

The battle for the base only lasted a few days, after which the Sunni government declaredvictory over the Houthi rebels. The success came partly due to its foreign backers, most notably the United Arab Emirates. Abu Dhabi had sent a brigade of Leclerc tanks to rout the Houthi rebels from the air force base.

The Emirates once shelled out more than $3 billion (2.6 billion euros) for 436 Leclerc tanks and other armored vehicles. The motors were from Germany, manufactured by the Motoren und Turbinen Union (MTU) in the city of Friedrichshafen on the shores of Lake Constance. The transmissions were from a company called Renk AG in Augsburg. The tanks were assembled by Giat, a state-owned enterprise in France that is now a part of the French-German joint venture Nexter.

Abu Dhabi is a party to Yemen's civil war, which has left thousands of people dead. It's unclear how many of those deaths were because of the tanks the Emiratis sent, but it is possible to reconstruct just how the machines found their way to the Arabian Peninsula. The whistleblowing platform WikiLeaks has published a rare document that pulls the curtain back on the international arms trade. DER SPIEGEL, along with the French online investigative journal Mediapart and the Italian newspaper La Repubblica, were given early access to this document.

It describes an arms deal of immense proportions: The commission alone amounted to a whopping $235 million. Of that, $195 million flowed from Giat, through a letterbox company in the British Virgin Islands, and on to the enigmatic Arab businessman Abbas Ibrahim Yousef Al Yousef.

Bribes in Germany?

He is considered one of the Emirates' richest men. There are some indications that Yousef didn't keep all the money from the commission for himself, but that he passed some of it on to Arab officials. The documents also raise the question of whether bribes were paid to anyone in Germany to ensure the export of the motors and the transmissions went smoothly. In 2009, Yousef said: "I undertook the lobbying of the German authorities and was instrumental in ensuring that the necessary approval or waiver was obtained."

That's according to a ruling handed down by one of the International Chamber of Commerce's arbitration courts, which met secretly in Paris. When a deal was reached on the sale of Leclerc tanks to the UAE, Giat and Yousef agreed on a commission of 6.5 percent, the equivalent of $235 million. The managers of the French state-owned company sent regular payments to Yousef until March 2000, but they stopped after about $195 million. This didn't sit well with the businessman. He turned to the arbitration court and demanded he be paid the remaining $40 million. While pleading his case, he included some highly sensitive details. These are reflected in the ruling handed down by the arbitration court, which was anonymously provided to WikiLeaks.

Arms deals tend to have a long lifecycle. Fighter jets, battleships and tanks are ordered and delivered over a period of several years and must be kept in good repair. The beginning of the billion-dollar deal with the Leclerc tanks can be traced back to an era in which the French socialist Francois Mitterrand was in charge in France and Helmut Kohl, a Christian Democrat, was chancellor of Germany.

In the 1980s, French generals dreamed of a modern battle tank. The main gun -- a 120-millimeter caliber weapon -- should automatically reload itself, they thought, making it possible for a three-man crew to operate the tank, rather than the conventional four. The tank should be lighter, smaller and nimbler than the German Leopard or the American M1 Abrams.

The high cost of development drove Giat to look beyond France for potential buyers. That's how Yousef, the arms dealer, got involved. The Emirati businessman had apparently been an intermediary for Giat and the UAE since 1989.

Like most people in the secretive world of international arms sales, Yousef rarely makes public appearances. He is ostensibly from the same village as Sheikh Zayed bin Sultan Al Nahyan, the UAE's founding father and a former president. Yousef's contacts within the family of the current Emirati president are said to be good as well. As a young man, Yousef flew fighter jets manufactured by the French company Dassault. A once-powerful manager in France described him as being very Western-oriented. Yousef worked as a middleman for many French weapons manufacturers in the UAE, the manager said.

But business wasn't always kosher. Last year, Yousef was identified as perhaps having been involved in a possible corruption affair at Airbus. The German-French aerospace giant had paid 19 million euros to another company called Avinco, which bought and sold used airplanes and helicopters, and had used a sham firm to cover its tracks. Yousef appears to have been behind Avinco. The businessman allegedly shifted the lion's share of the payments from Airbus to another company in Panama. What happened to the money after that is unclear. Yousef was not available for comment. When asked, Airbus said the case would be investigated.


As a businessman, Yousef hasn't limited himself to weapons deals. He invested a portion of his profits into the Munich-based organic supermarket chain Basic AG. Today, his son sits on the company's advisory board.

Some strands of the tank deal lead back to Germany. The Emirati arms buyers were smitten with the Leclerc. But Sheikh Zayed bin Sultan Al Nahyan wanted his new tanks to have similar motors as the German Leopard 2, a 12-cylinder model from MTU in Friedrichshafen with transmissions from Renk in Augsburg. The Emiratis had their hearts so set on the German motor that they even offered to cover the additional development costs of 60 million francs, or roughly 9 million euros. Yousef proudly told the arbitration court: "The idea was tochoose the best parts of the competitive products and pull them together to make the best tanks in the world."

But the German motors complicated the deal. In Germany, exports of war machinery are subject to the War Weapons Control Act. A special body known as the Federal Security Council controls the export of military weapons and war machinery. At the time of the deal, the council was made up of Chancellor Kohl and seven ministers from his coalition government.

Normally, the council signs off on weapons exports to France without issue. But there was an additional consideration this time around, namely that the buyer was located in a crisis region.

The Iraqi dictator Saddam Hussein had recently invaded neighboring Kuwait, which had prompted the United States and 30 other countries to come to Kuwait's defense. One of those countries was the UAE, which had provided 1,000 soldiers.

The Federal Security Council's decisions are secret and it's rare for details to trickle out. In the case of the Leclerc tanks, however, the German newsmagazine Focus reported in February 1993 that the council had signed off on the deal. Most recently, the Federal Security Council has proven itself to be "rather rigid," such as during deliberations about exporting arms to Thailand, but back when it was considering the tank deal, it was "less picky" and approved the delivery of motors on Dec. 8, 1992.

And with that, the deal was sealed. To this day, it remains the only time Germany has ever exported Leclerc tanks. The Emiratis ordered 388 battle tanks, 46 armored recovery vehicles, two driver training vehicles plus accessories for $3.6 billion. A significant chunk of that money flowed to Germany. MTU delivered 473 motors for 300 million deutsche marks, worth about 150 million euros today. There were also the transmissions from Renk.

Following the Money

When contacted for comment, MTU said it knew nothing about any cooperation with an Arab middleman. "According to our records," a company spokesman said, there was "neither a cooperation with lobbyists nor did a Mr. Abbas Ibrahim Yousef Al Yousef appear."

Giat, however, acknowledged knowing Yousef. The French state-owned company admitted Yousef had received a commission of 6.5 percent of the total price of the deal. The final sum came out to $234,875,369.40. One stipulation of the deal was secrecy: No one besides those directly involved should know about it. The money didn't go to Yousef directly, instead flowing to his shell company Kenoza Industrial Consulting & Management, located in the British Virgin Islands.

The Caribbean tax haven is notorious for keeping secret the names of people who stash their money there. Yousef also used accounts in Gibraltar and Liechtenstein. From his Kenoza account, the money was transferred to Yousef's holding company, according to Yousef's wealth manager, who revealed the money trail to the arbitration court in Paris. Yousef was trying to cover up where the money had come from.

But one question remains: Who profited from the payments from France? Only Yousef? Or were government employees or other officials bribed with a portion of Yousef's commission?

The judges in Paris wanted to know this too. They called upon Yousef and Giat to explain their business relationship more closely. Only then would they be able to assess whether Yousef had a right to the remaining $40 million. During oral proceedings, the judges' follow-up questions caused scenes that likely would not have happened had the case been heard in a public court.

Representatives from Giat openly admitted that parts of the commission had been used to pay bribes. The "real intention was to facilitate the conclusion of the UAE contract by offering civil servants or other officials from the United Arab Emirates part of its commission," they said.

The contract, they added, was "consequently both contrary to morality and public policy."

They went on to say that Kenoza planned and actually carried out acts of corruption. But the weapons manufacturer couldn't say who Yousef had actually bribed. The business relationship between Yousef and Giat apparently had not left a trace, the company's representatives said.

Investigations and Prison Sentences

For a long time in France, and in Germany, it was not illegal to bribe a foreign official. But then in 2000, France implemented a guideline from the Organization for Economic Co-operation and Development aimed at fighting corruption. Now bribes would be met with investigations and prison sentences. From then on, Giat managers told the arbitration court, the payments to Yousef were no longer viewed as permissible, and that's why they stopped them. Nexter, Giat's legal successor, declined to answer questions from DER SPIEGEL, citing confidentiality clauses.

Yousef denied all corruption charges in front of the arbitration court. The commissions he received "were not used to pay UAE officials," he said. Instead, he had invested the money in his companies "in various parts of the world."

When the judges wanted to know what Yousef had done to earn his paycheck, he was unable to provide any documents. He had "destroyed his notes in order to protect Giat's confidentiality."

He described his role as follows: "I developed a good working relationship with the GIAT team and spent a considerable amount of time with them advising on the best way to present their products from the point of view of UAE culture, psychology and the business and governmental environment. I relayed to them at each stage what the UAE authorities were thinking." But Yousef preferred not to reveal who his negotiating partner was on the Arab side. At Giat, he was in contact with the chairman of the board and the head of sales.

Yousef also didn't want to talk about his contacts in Germany. Prior to oral testimony, he explained in writing that he had ensured the issuance of an export permit, "a process which involved decision-makers at the highest levels in both France and Germany." When the judges wanted to know more during oral arguments, Yousef clammed up. In response to the question as which German officials he had met with, he answers: "Nobody." No politicians, no officials, allegedly only lobbyists.

Multiple Years for Corruption

Is that true? German politicians in those years had plenty of experience in dealing with arms lobbyists and exports to the crisis regions in the Arab world. The government of Chancellor Helmut Kohl approved the 1991 sale of 26 Fuchs armored reconnaissance vehicles to Saudi Arabia, a deal which ultimately led to the largest corruption affair in postwar German history.

The affair focused on Thyssen Henschel's payment of 220 million deutschmarks into dark channels. A number of public prosecutors launched investigations into high-ranking members of government, including then-Economics Minister Jürgen Möllemann, whose ministry was responsible for the deal. In 2005, the Augsburg District Court convicted Ludwig-Holger Pfahls, a former state secretary in the Defense Ministry, for acceptance of benefits and tax evasion and sentenced him to 27 months in prison. He admitted to having accepted 873,000 deutschmarks in connection with the armored vehicles.

The question as to whether bribe money was paid to Germany in connection with the Leclerc tank order was left open in front of the arbitration court. Clarification can hardly be expected from Germany. Kohl and others who were involved have since passed away. Volker Rühe and Theo Waigel, who were defense minister and finance minister at the time, respectively, both responded to a query by saying they have no memory of the event. Others chose not to respond to requests for comment at all.

It is, however, clear that the German company Renk AG paid a 2.6 million euro "consultation fee" to the Swiss accounts belonging to two shadowy figures from France for the Leclerc contract. In 2005, a Paris court sentenced those men to multiple years in prison for corruption. In the same trial, two German employees of Renk were handed an 18-month suspended sentenced and fined 100,000 euros each.

Yousef could likely provide information about other members of a network of corruption, but he's not inclined to. That is another reason why he lost out in the September 2010 proceedings of the Paris arbitration court. The judges refused to grant him the $40 million he was demanding given that he refused to say what the money was for. In the end, Yousef actually ended up with less money than before. The judges made him pay for the costs of the proceeding: $550,000.

The Titans Must Not Fall

by: The Heisenberg

- The lack of convincing follow-through from Tuesday's rally is disconcerting, especially in the context of Netflix's beat.

- "Long FAANG" remained the most crowded trade on the planet in October, topping the list for the 9th straight month.

- If you're bullish into year-end, Tech and Growth must not fall.

This reiterates a critical point I’ve been making over the past week while pitching the tactical “constructive Equities” call over the next 1m-3m: IF you think SPX rallies into year-end, you then too MUST have a positive view on Tech / Growth.
That's from a Wednesday morning note penned by Nomura's Charlie McElligott.
If you recognize the general thrust of it, that's because it echoes something I said on Tuesday afternoon while documenting what, by the end of the day, turned into a monumental bounce for U.S. equities (SPY). The following excerpt is from "Finger Pointing And Rotation Frustration: Thoughts On A Tuesday":
It is clear (to me anyway), that the market can't handle this rotation [from Growth to Value]. There's just too much leadership concentrated on one side of the equation.
Last week's technical rout unfolded against a backdrop of a what would eventually morph into a global Growth-to-Value rotation. Unsurprisingly (and really, by definition) that ultimately translated into a pretty epic unwind in Momentum (MTUM).
If you're (still) wondering what catalyzed Tuesday's surge, you can thank delta hedging, nearly $7 billion in CTA flows (SPX futs) and a precipitous squeeze in all manner of short factors.
Here's the one-day Tuesday change in Goldman's most-shorted basket:
That's but one representation. Tuesday was also the largest one-day move in a variety of other short factors including, but by no means limited to, Citi's high short interest basket.

After the bell on Tuesday, Netflix (NFLX) delivered a stellar set of numbers which by many accounts "should" have translated into more risk-on sentiment Wednesday (and by the way, spare me your belabored attempts to explain why people "shouldn't" be excited about Netflix's numbers, because if anybody cared about cash burn, the stock would have collapsed a long time ago).
Despite the beat, there wasn't much enthusiasm on Wednesday when it came to building on Tuesday's gains. At a macro level, sentiment took a predictable hit from stalled Brexit negotiations and ongoing jitters about the Italian budget, but it's difficult to ascribe Wednesday's lackluster U.S. session to that.
The lack of follow-through at the broad-market level following the Netflix beat isn't great news for a variety of reasons, the first of which is simply that, as noted above, you have to be bullish on Tech (QQQ) and Growth (IVW) if you're going to maintain a constructive outlook on the market through year-end.
Here's the latest "most crowded trades" chart from BofAML's Michael Hartnett (as you're probably aware, these visuals come from Hartnett's popular Global Fund Manager survey, which is always good for a headline or five when the latest edition hits):
As you can see, "Long FAANG+BAT" extended its reign at the top of the "most crowded trade" list for a ninth consecutive month in October.
In the simplest possible terms, there's a ton of market leadership concentrated in those names and everyone is still parked in that trade. If it gets moving in the "wrong" direction and doesn't rebound quickly, the exodus will be amplified by that crowding. The "perpetual motion machine" (to quote Howard Marks) dynamic that pushed those names inexorably higher over the past several years will go into reverse.

Factor crowding could exacerbate the situation as it apparently did last week.
Recall how, on Tuesday, I highlighted some commentary from JPMorgan's Nikolaos Panigirtzoglou, who flagged what certainly looked like a pretty epic bout of de-risking by the Long/Short crowd in October. That's a ~$900 billion universe and hedge funds are notoriously predisposed to favoring tech. On the bright side, the recent collapse in the beta of that universe to the S&P suggests the current bout of deleveraging from those funds has run its course, but the fact that it occurred in the first place (and likely exacerbated the early October drawdown) is evidence to support the contention that ongoing problems for hedge fund favorites represent a risk to the market more generally.
As you can probably imagine, there's some ambiguity around this following the Communications Services sector reclassification. Below is a snapshot of sector performance through Tuesday (i.e., in the lead up to Netflix's report). As Bloomberg's David Wilson wrote earlier this week, "though it fared better than the S&P since its introduction on September 24, the communications services sector hasn't exactly been a standout".
Goldman addresses this in a sweeping new note out Thursday which, in its entirety, serves as an attempt to dispel the idea that crowding and valuations are setting tech up for a tumble (in other words, it's a "calm down" type of note). Here is a short but useful excerpt on the reclassification as it relates to hedge funds:
InfoTech is certainly popular among hedge funds, but funds are actually underweight InfoTech following the reclassification of (FB) and (GOOGL) into the Comm Services sector. Info Tech continues to comprise the largest hedge fund net sector allocation (18%) and 24% of the constituents in our hedge fund VIP basket are Info Tech stocks. But the reclassification of a few popular growth stocks means that hedge funds will actually be 188 bp underweight the new Info Tech sector versus the Russell 3000. 
Again, there's too much ambiguity in all of that for me to draw any conclusions right now, but let's just go ahead and assume that hedge funds are going to be long a whole lot of FANG and FAAMG (or whatever the "correct" acronym is these days) and also a lot of (BABA) until there's a compelling reason to not be long anymore, and that's precisely the point. The trade is crowded and if those names start to underperform and it begins to look like that underperformance might persist, one wonders whether aggressive paring of those longs could exacerbate said underperformance.
With all of the above in mind, consider a couple of additional excerpts and another visual from the same Goldman note:
Info Tech has returned 593% since the US equity market trough in March 2009. 74% of the rise from realized earnings growth and 11% from P/E expansion, compared with 67% and 18% for the S&P 500 respectively. Even if valuations are flat or contract going forward, the rapid growth prospects of the sector should continue to drive share price gains.
That's true, but the "rapid [earnings] growth prospects of the sector" can only "continue to drive share price gains" if the market responds to earnings beats. That's why the lack of convincing follow-through from Netflix's earnings report is concerning.
Just to reiterate, you can make all manner of classification-related arguments here (e.g., "Well, Netflix was in Consumer Discretionary", etc.), but you get the point. This is all the same trade. Here's Goldman one more time to underscore what I mean:
This report focuses on the newly redefined S&P 500 Information Technology sector. Although several large-cap “technology” stocks such as FB, GOOGL, NFLX, and AMZN are not classified as Information Technology stocks under the GICS classification, we have included line-items for these popular growth stocks in several analyses for reference. 
It simply cannot be the case going forward that these market heavyweights start balking at robust earnings growth. Last week clearly demonstrated that a rotation from Growth to Value (IVE) isn't palatable and the crowding in these names means that the rush to the exits has the potential to accentuate any drawdowns.
Critically, Q3 will likely mark "peak earnings" in the U.S. The effects of the tax cuts and stimulus are set to wane going forward, and you can expect fewer buybacks after this year as well.
In other words, to the extent you think robust earnings growth has helped shield U.S. equities from the international malaise this year, just note that this quarter is likely to be as good as it gets. Here's a sector-by-sector breakdown of current EPS growth versus consensus expectations and Barclays estimates:
You could conceivably argue that as earnings growth for the rest of the market decelerates, investors will be even more enthusiastic about the growth prospects for the high-flyers that constitute the most crowded trade on the planet. But that kind of begs the question in the context of this post. That is, the response to the Netflix beat was fleeting at the stock level and non-existent at the index level. That doesn't seem like a market that's excited about chasing the leaders higher based on good earnings.
One final (largely unrelated) point: Rates vol. and FX vol. have come back down after last week's spike, which is good news from a 30,000 foot perspective.

The New American Strategy

The U.S. no longer wants to manage its problems primarily through force.

By George Friedman

The U.S. envoy for Syria, James Jeffrey, said Thursday that the U.S. would remain in Syria as long as Iran does. He then clarified that this does not necessarily mean U.S. forces would remain there. Jeffrey’s statement is important not only in the Syrian context but also in terms of broader U.S. strategy.

Since 1945, the United States has held to a strategy that in the event of significant challenges, it would not only be a major force but lead the way in combat. During the Cold War, when the primary adversary was a single country, the Soviet Union, this made sense. The stakes were astronomical then. The U.S. needed to make certain that the Soviets didn’t dominate all of Europe and control its economic and technical capabilities. This was the overriding conflict at the time. When the Korean War broke out, or when there was communist pressure in Southeast Asia, it was regarded as part of a global struggle that required U.S. intervention. The major resistance against a key adversary, with U.S. command and forces leading the way, did not take place in Europe, as expected. Oddly, it occurred in Kuwait, with U.S. commanders leading a coalition and American troops deployed without limit. The irony is that the military aspect of the strategy was implemented against Iraq, not the Soviet Union. It reminds me of James Dean’s line in Rebel Without a Cause. When asked what he was rebelling against, he answered, “What have you got?”

9/11 triggered the same response. The threat was to the homeland, and the primary responder was the U.S. military. This was a completely understandable response. Anyone who wasn’t frightened in the aftermath of 9/11 was not in touch with reality. No one knew what was coming next. But strategically, it didn't make much sense. This was not the Cold War, and the Islamic world was not the primary adversary. It was fragmented. It didn’t present a profile that could be readily engaged by massive military intervention. Most important, the U.S. was now the only global power, and while the war against jihadists was critical, it could not be the sole focus. U.S. strategy was in a way trapped in the Cold War model of seeing only one enemy; everything else was secondary.

The alternative model was really the only one that was sustainable: the British model. The British rarely used main force in managing their global interests. They had some force in some places but managed its threats by using the local balance of power. India was fragmented among local rulers with competing interests. The British supported some rulers against others with money, weapons or small units, and they leveraged local tensions to their benefit. They had interests throughout the world, and the constant application of main force would have exhausted them.

The U.S. has been at involved in exhausting and inconclusive combat for 17 years. It did not achieve the political ends intended. In Syria, there are Turkish forces and Russian forces as well as local forces, all of whom might be motivated to contain Iran. Nearby are the Israelis and the Saudis. Many countries involved in Syria can’t leave (though not Russia). They have no option but to deal with the Iranians in Syria and elsewhere. The United States can provide intelligence and other support, but it need not and cannot be the primary fighting force. It wouldn’t be welcomed in the long run, and it has other issues such as North Korea, China and Russia with which to contend. The Americans, like the British, can be there and not there at the same time.

Jeffrey has simply stated the obvious. Syria is a problem, but not every problem requires U.S. forces.

Global power is a subtle thing. The Cold War was not.

Once Aging Is Curable, How Long Will We Live?

Patrick Cox

In the past week, I talked to two unconnected researchers whose teams believe they have discovered the genetic mechanisms that control aging. More importantly, both believe that they know how to reverse those mechanisms to restore peak adult health.

If they’re right, the impact will be unprecedented—so it may be wise to begin pondering the possibility of age reversal now.

It’s probably inevitable that the ability to permanently restore animals, including humans, to the point of peak adult health will lead to the use of the word “immortal.” It is, in fact, the biological term for cells that don’t age.

You already have immortal cells in your body. They are the germline, the ova or sperm involved in sexual reproduction. Embryonic stem cells are also immortal.

Another form of immortal cell is induced pluripotent stem (iPS) cells, which are very similar to embryonic cells. I’ve had skin cells from my right arm genetically engineered into iPS cells. Cared for properly, they will live and replicate forever without aging.

Nevertheless, people who are permanently restored to peak adult health will not be immortal. Yes, regenerative medicine will reverse aging and extend healthspans dramatically—but it won’t grant us divinity or superpowers. Something will eventually kill everybody.

There’s No Shortage of Things That Could Kill You

If you travel by air, you are susceptible to the risks of aircraft failure, pilot error, and freak weather events. The odds of death are higher if you’re in a car per mile traveled. Motorcycles and bicycles entail even greater danger.

Living in South Florida, I often risk electrocution by taking a shower. If you hold a metal golf club over your head in an open expanse of grassland, you are at risk—even on a sunny day—from storms many miles away. Boaters increase their odds of being killed by lightning every time they go out on the water. Sailboats with tall masts are particularly effective lightning magnets.

Even if you showered in a Faraday cage and never left your safety bunker, you could join the 5,000 Americans who die of food poisoning every year. If you eat alone, the risk of death by choking goes up.

If you’re ever around bugs, birds, rodents, cats, dogs, or other animals, you are at risk because the pathogens they carry occasionally mutate into lethal diseases. If you live in a region subject to earthquakes, tornadoes, blizzards, hurricanes, floods, or sinkholes, you are subject to potentially lethal dangers.

You get the point. There is no way to completely protect yourself from “freak accidents.” The ancient Greek playwright Aeschylus was killed by a turtle dropped by an eagle. I might have doubted the story, but I used to live next to a tree with nesting eagles that regularly dropped large fish on my roof and yard.

Source: Wikipedia

The risk of being killed by something other than aging is relatively low over the average lifespan of about 80 years, even factoring in traffic accidents, homicide, and suicide. However, it’s a mathematical truism that the probability of dying from something other than an age-related disease will go up over longer lifespans.

Actuarial scientists can estimate how long people would live on average if old age were taken out of the picture.

So let’s play a game…

Guess How Long the Average Non-Aging Human Would Live?

To inform your decision and separate the answer from the question, here a few charts from the CDC on causes of US mortality by age group. The first includes all causes of death, highlighting nonmedical causes. The second ranks all injury deaths and highlights accidental deaths.

Source: CDC

Source: CDC

The answer, according to some actuarial scientists, is that life expectancy in a developed society without old-age-related deaths would be 600–700 years. That assumes, of course, that people in the future won’t be subject to significantly more or fewer risks. Either is possible.

Clearly, a 650-year healthspan is a lot longer—and I’d argue better—than the current 80-year life expectancy. It’s also a very long way from true immortality. Some people, due to bad luck, wouldn’t live past current normal lifespans. Others would live longer than average.

Curiously, the lifespans attributed to the biblical patriarchs, including Methuselah, are pretty close to the sort of mortality distribution we could expect to see in non-aging populations. I’m telling you this only because it’s interesting, not because I’m trying to make some religious point.

It does, however, make the title of my book, The Methuselah Effect, more meaningful. I didn’t actually come up with the title; that credit goes to my editor Shannara. We’re currently revising the book to include dramatic new discoveries that have emerged in the last year or two.

We’re on the Threshold of Something Big

Regarding the two researchers I referenced earlier: I don’t know everything about their discoveries and can’t tell you some things that I do know. These scientists will obviously keep many important details secret until they’ve filed patents and published the results of their trials. What I do know, though, is that they are looking at very similar components of cellular and genetic biology.

In the past, the process of aging was explained using vague hand-waving theories about the body just wearing out due to accumulated damage. I predict we’ll see a new consensus on aging emerge in the next few years.

The new view will be that aging is caused by specific molecular and genetic mechanisms that fully kick in sometime after childhood. Therefore, interventions will not only halt aging but reverse it by restoring regenerative mechanisms normally seen only in embryonic cells.

The attitudes and beliefs of scientists change long before they trickle down to the public, but I expect we’ll see evidence of this profound paradigm shift in peer-reviewed journals within two to three years.