Commodity Woes Run Deeper Than China

The commodity selloff should worry investors, but not because of China per se

By Nathaniel Taplin

China is the world’s heavyweight consumer of most industrial commodities. So when things go wrong in commodity markets, it’s always tempting to point the finger there. This time, that might be a mistake.

Iron-ore prices plunged nearly 10% on Monday, following a sharp fall in steel prices earlier in November. The weakness in both comes after a tough summer and autumn for other major commodities such as aluminum and copper, which are down 8% and 12%, respectively, since June. Is this a sign China is collapsing after all?

China is the world’s heavyweight consumer of most industrial commodities, including iron ore.
China is the world’s heavyweight consumer of most industrial commodities, including iron ore. Photo: vincent du/Reuters

There’s little doubt that weaker seasonal demand from China is weighing on prices. But on a year-over-year basis, the fundamental drivers of Chinese commodity demand still look strong.

Housing prices in medium-size cities, which drive the nation’s iron-ore and copper demand, are zooming along, rising nearly 10% in October, the fastest pace since at least 2010. Industrial growth accelerated in October, too. And steel inventories look comparable to their level this time last year: lower for rebar, slightly higher for hot- and cold-rolled coil. There’s still no sign of major problems in China’s critical construction sector, in part because until very recently, it was still receiving a major boost from housing subsidies.

Unfortunately, the same thing can’t be said for the rest of the world. China’s manufacturing purchasing managers index has edged down 1.1 points since January; over the same period, Germany’s is down by 8 points, the U.K.’s by 4, Japan’s by 1.9 and the U.S. by 1.4. Weakness in copper and aluminum, first evident in January and February, lines up far better with the widespread decline in global PMIs this year than with China specifically.

Meanwhile, this week’s selloff aside, the metal most closely linked with China—iron ore—has mostly trended sideways. Iron ore started the year at $68 dollars a metric ton; after Monday’s drop it stood at $65. Copper has lost 15% of its value so far in 2018. So has aluminum.

The broad commodity selloff this year should certainly worry investors, but not because of China per se. China’s growth will deteriorate further in early 2019. Global growth, however, is clearly slowing nearly everywhere outside the U.S.—that is what really ails commodities. And with the U.S. PMI and financial markets now also showing signs of strain, the outlook is set to worsen further.

Most investors will be glumly nursing their eggnog this year. By next Christmas, the weather outside could be even more frightful.

Pay, Power and Politics: Where Did Carlos Ghosn Go Wrong?


The rapid fall from grace of automotive legend Carlos Ghosn is reverberating throughout the industry and casts a shadow over the future of the Renault-Nissan-Mitsubishi alliance, the largest automotive group in the world that he created and led. It also sets up a standoff between Japanese and French authorities.

Last week, Ghosn was arrested in Japan for allegedly underreporting his pay as chairman of Nissan and using company assets for personal purposes. He reportedly has denied the allegations. Ghosn was ousted from both Nissan and Mitsubishi, where he was also chairman, but he retains his job as chairman and CEO of Renault. Meanwhile, French authorities said they are waiting to see evidence of the executive’s alleged improprieties. Ghosn is a French citizen and the French government holds a 15% stake in Renault, which owns 43% of Nissan. Nissan has a 15% non-voting stake in Renault and owns 34% of Mitsubishi.

Ghosn is an industry icon who led the turnaround at both Nissan and Renault. He is also the first person in the world to run two Fortune 500 companies at the same time. In an industry that has seen failed mergers such as Daimler-Chrysler, he is credited with successfully managing the automotive alliance, which by some measures became the world’s largest seller of vehicles in 2017, for the first time. With Ghosn’s future in doubt, a key lesson for corporations is the risk of concentrating too much power in a single executive.

Wharton management professor John Paul MacDuffie said he was “shocked and amazed” by the downfall of Ghosn. MacDuffie is the director of the Program on Vehicle and Mobility Innovation at Wharton’s Mack Institute for Innovation Management. “I know some of the tensions in the alliance but also many of its strengths,” he said. “None of that gave me any inkling of this personal scandal [involving] Ghosn.”

MacDuffie happened to arrive in Japan the night before Ghosn’s arrest, and got a ringside view of the unusually strong impact it had on Nissan. In a news conference after the arrest, Nissan’s CEO, a protégé of Ghosn, was “unusually personal and candid for a Japanese senior executive, talking about his shock and sorrow and anger over that,” MacDuffie recalled.

Richard Dasher, director of the U.S.-Asia Technology Management Center at Stanford University, suggested that Ghosn perhaps had trouble brewing for him for a while. He described Ghosn as “an autocratic leader” in the style of a Steve Jobs at Apple, and that “[he] was not particularly liked, although he had to be respected.”

“This looks a little bit like a setup job by the new leadership in Nissan,” added Dasher. “It sounds like they got him on something. Executive compensation packages are very complicated.” But he noted that Ghosn has not been accused of a brazen act like taking unethical cash payments. “It seems that this had to do with the company buying four luxury overseas properties and providing them for the use of Mr. Ghosn. And he did not count what the company paid for these properties as part of his own income, which they are required to state.”
Many people view Ghosn “as one of the saviors of the auto industry” and the accusations against him are upsetting, according to Tim Hubbard, assistant professor of management the University of Notre Dame’s Mendoza College of Business. “When news like this happens where it’s a personal issue at a company, it’s very disappointing,” he said. “It’s one of those situations where you hope if a CEO or a chairman is going to lose their job, it’s over a performance issue, and that it’s not over something where they’ve chosen to benefit personally from the firm in a way that is illegal to the point that the Japanese officials have arrested him.”

A Coup or Misconduct?

Ghosn earned compensation of $8.4 million from Renault and $6.5 million from Nissan in fiscal 2017, according to CNBC, not counting pay from Mitsubishi. However, he allegedly reported to the Tokyo Stock Exchange only about half the roughly $89 million in his compensation over five years, according to a Reuters report.

Transparency over pay is critical, especially for an executive of Ghosn’s standing, according to Hubbard. “This is one of those cases where we really expect the board of directors and the public to know exactly what a chief executive officer is being paid,” he said. “And when there’s a discrepancy of this amount, it’s [because] there wasn’t this transparency.”

According to Hubbard, that apparent shortcoming in transparency occurred against a backdrop of discomfort in France and Japan over CEO pay. “He made more four times more than Toyota’s CEO and so he was already making a lot of money,” Hubbard said. “In this case, he was able to make more and hide that in the [regulatory filings] and keep it out of the public eye.” Ghosn’s case represents “an unusual situation, because he has to balance the corporate governance requirements and the expectations of Japanese companies, at the same time as [those of] French companies.”

However, because of Ghosn’s success in managing the Renault-Nissan-Mitsubishi alliance, “I’m sure that his demands for high pay were probably accepted pretty quickly,” MacDuffie said. Dasher added that although Ghosn’s pay “is rather high, it’s comparable” to what Mary Barra, chairman at General Motors, and Jim Hackett, CEO of Ford Motors earned last year (reportedly $22 million and $16.3 million in 2017, respectively).

According to MacDuffie, much of the grudging over Ghosn’s pay was because of “the unusual governance arrangements where he is the single person at the apex of all three of those companies, and therefore claiming CEO-level pay from all three of those companies.” He attributed that factor to having “pushed the tension” over his pay to a high level. “The tension would still be there in the absence of the alleged personal abuse of those funds. I can see why people are wondering if it’s a palace coup or if there’s something that’s suspicious in the timing of [Ghosn’s arrest]. I guess we’ll learn more as the full story comes out.”
Too Much Power?

Did Ghosn have far too much control at the three companies? Apparently yes, noted MacDuffie, pointing to a Nissan director’s comments at a news conference where “he was critical of how much power is centralized in one person” in the alliance. Ghosn, 64, is approaching retirement and had already announced his plans to exit all roles in the alliance by 2020. “If he hadn’t emerged as such a hero from the early stages of this turnaround [at Nissan and Renault], many people would have said it’s a little risky to concentrate that much power in one person.”

“There’s too much power in this case,” added Hubbard. “The board of directors of each of those companies is embedded with [Ghosn], and over 20 years he’s been involved in all three of these companies — Mitsubishi Motors a little bit less. But in that amount of time, he’s been able to solidify his power in relation to other directors, and I think that’s [helped] remove some of the monitoring capabilities that we would expect from a board of directors. … Oversight from the board of directors is there to prevent these types of things from happening.”

Dasher saw the clash over Ghosn’s power coming to a head. “I’m a little concerned that what we’re seeing is old style Japanese consensus management trying to replace or get rid of the foreign, autocratic style of management,” he said. Based on remarks at the Nissan press conference about one person having too much power, he added, “This makes me suspect that you’ve got a group of directors and other senior executives who would like to go back to the way things were in Japan.”

MacDuffie noted that Ghosn has been criticized for not doing enough with succession planning. “But I can’t think of another situation like it in the world — to have one person be the chairman of three different auto companies, and the CEO of two of them,” he said. “On the other hand, this alliance from the start has had an unusual form of corporate governance, and some people think it’s the reason for its success — it was not a merger or an acquisition. At least the rhetoric has been that the [alliance companies] are equal parties to all decisions.” He added, though, that the French government might have a “disproportionate influence” on the running of the alliance because of cross-holdings.

“Ghosn might be the glue that’s holding [the alliance] together and making it work,” said Hubbard, noting that each of the companies is run independently and they share models and technology among them, which is helped by the quality of coordination around the three companies. “That might actually be the reason for [the alliance’s] success — that there is a powerful leader who is able to take charge in each of the three. It could be that without him in there, there might be issues with the alliance going forward.”
Even those who want Ghosn removed give him grudging respect. Mitsubishi CEO Osamu Masuko does not think one person could fill Ghosn’s roles at the three companies. “I don’t think there is anyone else on earth like Ghosn who could run Renault, Nissan and Mitsubishi,” he said, according to The Guardian. Nissan, too, has credited Ghosn for its turnaround: “Mr. Ghosn was the lead architect of the Nissan Revival Plan, which transformed the company from near-bankruptcy to profitability within two years.” The company added that under his leadership, it has had “higher profit margins than many rivals and has expanded geographically.”

Road Ahead

The turmoil at Renault-Nissan-Mitsubishi is occurring at “a stressful time, but also an exciting time for the traditional auto industry,” said MacDuffie. The industry is grappling with multiple changes, from electric vehicles to autonomous vehicles and mobility-as-a-service (such as Uber and Lyft), and many new competitors coming from Silicon Valley and elsewhere, he noted. “These firms are scrambling to figure out how best to deal with all of those new developments while trying to run the traditional business.”

At least, the alliance has had some success. “Frankly, they’ve been doing fairly well,” MacDuffie said. Nissan is seen as a leader in both autonomous vehicles and electric vehicles in Japan and elsewhere in the world.” He noted that Renault has done well with engineering “some extremely frugal designs” for markets in Eastern Europe, India, and lately for China as well.

Any changes in the way Nissan is run after Ghosn formally exits will depend on how much power he actually wielded, said Hubbard. For now, though, the stock market sees Ghosn removal as a problem for Nissan as shares plunged after the arrest. “If this was a traditional dismissal, where there were issues with the chief executive officer and removing them from the company was a good thing … we would have seen stock prices [rise]. It’s an arrest, so the downside of the stock price made sense. But at the same time, if the change in management was going to be beneficial for each of the firms, we might not have seen as strong of a downward trend.”

According to MacDuffie, “The alliance probably has a lot of strengths and reasons to continue through this crisis.” But the wild cards are the depth of the scandal and conflicts among the French government, the Renault board and Nissan’s board over what each sees as the best approach forward. He pointed to tension over a proposal for a full merger in which Renault’s dominant ownership stake would give it a more permanent power, and that it was strongly resisted by Nissan. “The corporate governance complexities here could destabilize the alliance — which would be a shame, because there’s a lot of strength there.”

A Tactical Retreat in Warsaw

Poland compromises but the EU isn’t satisfied.

By Jacob L. Shapiro

Poland will not impose early retirement on its Supreme Court justices after all. Bowing to an October European Court of Justice ruling, the Polish legislature has voted to repeal a law that lowered the mandatory retirement age for its Supreme Court justices from 70 to 65. That law, part of Polish judicial reforms passed in 2017, ran afoul of the European Commission, which has repeatedly described the reforms sponsored by the ruling Law and Justice party, or PiS, as incompatible with “EU laws, values, and principles.” Publicly, the European Commission is pleased. In Warsaw on Friday, its vice president called the repeal of the retirement provision a “welcome step.” Under the cover of anonymity, however, EU officials told the Financial Times that the move “would not resolve the broader standoff with Warsaw.” If that is the European Union’s true stance, it raises the question of whether Poland can do anything to completely satisfy Brussels short of bending the knee.
Much-Needed Reform or Threat to the Rule of Law?
Judicial reform in Poland is admittedly a complicated issue. Poles believe that their judiciary needs reform: An August 2017 Public Opinion Research Center poll found that 81 percent of those surveyed believed that reform was necessary. At the same time, Poles are highly skeptical of the PiS’ changes. A July 2018 survey by the Warsaw-based Institute for Market and Social Research found that 54 percent of respondents had a negative view of the reforms and just 39 percent approved. Those numbers are in line with overall support for the PiS, which won parliamentary elections in 2015 with 38 percent of the vote.

In ruling that Poland’s democratically elected government violated the rule of law by responding to a legitimate desire of the Polish people, the European Union has gone out of its way to inject itself into a member state’s highly charged, decidedly domestic political debate. That member state’s government conceded to the ECJ’s ruling and reinstated justices that were forced to retire in July – making it difficult to argue that the rule of law is in jeopardy in Poland. The argument is even harder to make considering that PiS performed dismally in local council elections in October, winning just a 32.3 percent plurality of votes and losing the Warsaw mayoral race by 4 percentage points. If Poles are still unhappy with PiS’ performance, they can show the party the exit via the ballot box in the November 2019 parliamentary elections.
Poland and the EU Need Each Other
Poland’s government is euroskeptic, but its people are not. An April 2018 European Parliament survey found that 70 percent of Poles believe their country’s membership in the European Union is a good thing. Just 5 percent say it is a bad thing – tied for the second-lowest EU disapproval rate in the soon-to-be EU27. (The remaining 25 percent are ambivalent.) This is not surprising. The European Union emerged from institutions that were designed with two key functions in mind: to tie Germany into an economic system that would prevent it from attempting continental domination again and to unite European powers against the Soviet Union. In other words, the EU is designed to weaken Poland’s two greatest historical enemies. EU membership has economic perks, too. From 2008 to 2015, EU-supported government spending accounted for over 5 percent of Poland’s annual gross domestic product. In 2017, Poland received 12 billion euros ($13.6 billion) from the EU – 2 percent of GDP – while contributing just 3 billion euros.


It is little wonder, then, that PiS has executed this hairpin turn. Whatever the merits of the claims that PiS judicial reforms violated the rule of law, Polish opposition parties have effectively made the case that PiS’ reforms could jeopardize Poland’s EU membership. The current Polish government is both nationalist and euroskeptic, but it isn’t suicidal: To continue to defy popular opinion would have been bad politics, and it knows that it will not survive as the ruling party if voters are convinced that its reforms could cause Poland to crash out of the EU or, at the very least, be subject to serious EU sanctions. Poland’s desire for greater autonomy and the continued existence of the EU are not necessarily mutually exclusive.

It is also in the interests of the EU’s major powers to keep Poland in the fold. For Germany, Poland is not simply another export market – for years, Germany has capitalized on Poland’s cheap and well-educated labor pool to maximize the efficiency of its supply chain. Germany also needs the EU to continue buying German products, and it needs still more markets to which it can sell. Poland’s cooperation in this is critical. The goal for Germany is to bring more countries into the EU fold, not fewer. Brexit can be explained away by the U.K.’s historical distance from and suspicion of the European project – but any real move by Poland to exit might cause a domino effect in Eastern Europe. As for the EU’s other heavyweight, France is both less in need of Polish cooperation and less important in Europe than it thinks. While France has a powerful military, the EU has become an economic entity, and there are limits to how hard France can push without toppling the structure – an eventuality that, like Poland, its interests dictate it must avoid.
Why Brussels Won’t Sacrifice Its Authority
Indeed, the issue here is not Poland, nor is it Germany and France: It is the European Union. Poland aims to preserve its independence by keeping Germany and Russia in check. Germany needs markets for exports. France, too, needs to keep Germany in check and has nostalgic delusions of imperial grandeur. The entity that is causing trouble here is not any EU member state, but rather the union itself. The EU has an imperative of its own – to maintain and increase its authority over its member states. Bureaucracy has created an entity that no longer pursues the interests of its members but instead pursues the interests of a bloc that is more authoritative and sovereign than its members originally thought it should be. Case in point: The same survey that found that 70 percent of Poles support Poland’s membership in the EU also found that just 42 percent of Poles think the EU is “going in the right direction.”



For 46 years, Poland was shrouded behind the Iron Curtain. Membership in the EU is not just strategic or economically beneficial for Poles. It also ties the Polish people to the European project. Polish identity is no longer wrapped up in enforced isolation: Poles are now proud citizens of an independent country that is also an emerging power in Eastern Europe and is as European as any other EU member state. This is not a country that wants a standoff with the EU and yet the EU is behaving like Poland wants to bring the whole edifice down. If the EU is acting in good faith, the standoff should soon be resolved. The ECJ ruling found two legal problems with the PiS reforms: the application of new retirement ages to previously appointed judges, and the granting of discretion to the Polish president to extend judicial service of Supreme Court judges. The PiS government has effectively addressed half of the ECJ’s concerns, and if it is willing to compromise on the former, it will likely compromise on the latter, especially in its weakened state.
But this is not (and never has been) about judicial reforms. The EU sees in the PiS government a potential challenge to its authority. It has singled out Poland, as it has singled out Hungary and Italy, because Brussels cannot tolerate defiance from the periphery. On this particular issue, there will be no significant backlash: For one thing, a large majority of Poles agree with the ECJ, and for another, membership in the EU is far more important, even for the PiS government, than securing the authority to make certain judicial appointments. Eventually, whether in Poland or elsewhere, the EU will intervene this heavy-handedly on a more contentious matter. At issue will be not whether a judge can serve until the age of 65 or 70, but the sovereignty of the member state in question. Even in as europhilic a country as Poland, that will smack of tyranny too much to abide.

A Trade War is No Reason to Ease Monetary Policy

A trade war is a negative supply shock, and central banks cannot counteract the negative effects of current policies on real incomes in the United States, the United Kingdom, and many other countries. Only voters can do that.

Jeffrey Frankel  
federal reserve chairman

CAMBRIDGE – The world is in a trade war, and there is no sign of peace breaking out anytime soon. By now, the disruption to trade appears extensive enough to factor negatively into forecasts for economic growth. Does that mean the Federal Reserve should stop gradually raising interest rates?

The answer is no. Monetary policy cannot mitigate the damage done by foolish trade policies.

The biggest trade conflict is between the US and China. In January, the US is scheduled to raise recently imposed tariffs from 10% to 25% on Chinese imports worth $250 billion. President Donald Trump has also threatened to impose new tariffs on the rest of Chinese imports, worth $267 billion. He will meet with Chinese leader Xi Jinping at this week’s G20 summit in Buenos Aires. Some hope that the two leaders will achieve a major breakthrough in the trade impasse. But that seems unlikely, partly because the US demands are either beyond China’s capacity to deliver (such as a substantial reduction in the bilateral imbalance) or are too fuzzy to be verifiable in the short term (such as ending forced technology transfer).

It is a truism among the economically literate that there are no winners in a trade war. But it is also true that even relatively large statistical effects for individual economic sectors tend to have a relatively small impact on quarterly GDP, at least in the short run. The discrepancy partly reflects the dominant share of services in modern advanced economies, relative to manufacturing and agriculture.

As the trade war broadens and deepens, however, economic-growth forecasts around the world are darkening. The OECD just became the latest international agency to downgrade its global growth forecast, from 3.7% to 3.5% in 2019 and 2020.

The trade war appears to be among the reasons for a renewed slowdown in China. The Chinese slowdown, in turn, will have spillover effects on other countries, especially commodity exporters.

The European economy has also slowed in 2018, with Germany even reporting a surprising contraction in the third quarter. Trade is among the reasons: reduced demand from China, unprecedented uncertainty about US trade policy, and the looming prospect of a “hard” Brexit in which the United Kingdom leaves the European single market and customs union.

Of course, trade is just one of many factors driving economic growth, which has been strong in the US this year, largely owing to late-cycle fiscal stimulus. But the effect of the tax cuts and spending increases implemented since December 2017 is expected to fade soon. The forecasts show US growth slowing from 2.9 % in 2018 to 2.1 % in 2020.

Not everyone agrees that protectionism is bad for the economy. If one focuses on net exports, following Keynesian or even mercantilist arguments, might one not expect to find that Trump’s tariffs stimulate US economic growth, with others’ losses being America’s gains?

The experience of the last year indicates the opposite. If anything, Trump’s protectionism is hurting the US trade balance (when one includes the effects of his administration’s fiscal policies). The monthly US trade deficit reached $54 billion in September, exceeding in nominal terms the deficits recorded every month from 2009 to 2017. The tariffs are presumably having a negative effect on US imports, but negative effects on US exports are also large.

This was predictable. When income growth among trading partners slows, they buy less from the US. Moreover, China and other countries have retaliated against US goods with tariffs of their own. Meanwhile, because of the rapidly rising US budget deficit – a remarkable development in a country at full employment – an excess of spending power has spilled over into imports. And the dollar has appreciated against most currencies, undercutting US exporters’ competitiveness, again in line with theory.

But while some commentatorsseem to presume that slower growth calls for monetary easing, protectionist measures also increase prices, which has the opposite implication for monetary policy. True, the effect on inflation has been small so far. But there is more to come. Goldman Sachs forecasts a base case (with the 10% tariff on the rest of Chinese imports taking effect early in the second quarter of 2019) in which the impact on US core inflation reaches 0.17% by June. If Trump follows through on his threats to impose tariffs on all car imports and to apply the 25% tariffs to all imports from China, the impact on US core inflation (which strips out food and energy prices) is to reach 0.3% by September 2019.

Adverse trade developments are a negative supply shock. Skillful monetary policy can help offset a negative demand shock, but can do little or nothing to offset a supply shock. Slower growth and higher prices are inevitable effects. The Fed understands that if it were to apply monetary stimulus in an effort to prolong the current expansion artificially (as Trump has pressured it to do), the result would be to fuel inflation.

Trade is not the biggest factor in the US economy. But it is dominant in the United Kingdom these days. Many believe that Brexit’s feared negative effect on UK growth has not yet materialized, partly because the Bank of England eased monetary policy. But it is also because the supply shock did not hit when the 2016 vote took place. Arguably, the only impact so far has been on demand (owing, for example, to lower investment in anticipation of the coming rupture). Such a fall in demand is something that monetary policy can offset.

Next time could be much worse. Britain’s actual exit from the EU is set for March 2019. Perhaps the UK and the EU will conclude a deal, or, better (though less likely), hold another referendum and call the whole thing off. But if Britain “crashes out” of the EU in March, with no arrangements to preserve open trade across the British Channel, monetary policy cannot shore up GDP, as Governor Mark Carney recently warned.

Current trade policies are working to reduce real incomes in the US, Britain, and many other countries. But monetary policy cannot counteract the effects. Only voters can do that.

Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.