China’s Leader Says Party Must Control ‘All Tasks,’ and Asian Markets Slump

By Chris Buckley and Steven Lee Myers

President Xi Jinping of China, center, speaking on Tuesday at the Great Hall of the People in Beijing. Some investors had hoped for signals that Mr. Xi would take further steps to liberalize the economy or ease tensions with Washington.CreditCreditWu Hong/EPA, via Shutterstock

BEIJING — Facing deepening tensions abroad and anxieties at home, China’s leader, Xi Jinping, delivered an unabashed defense of his policies on Tuesday, using a key anniversary to argue that his recipe of guided growth under strong Communist Party control must not waver.

Mr. Xi made his case to some 3,000 officials and guests gathered in the imposing Great Hall of the People in Beijing to commemorate 40 years since China embarked on far-reaching economic changes after decades of upheaval and malaise under Mao Zedong.

The resonant date had inspired expectations among some analysts and investors that Mr. Xi would give clearer priorities to counter economic headwinds and trade tensions that have flared with the United States. But he offered none, referring only obliquely to the economic and diplomatic challenges confronting China.

Instead, he used the meeting, broadcast live on Chinese television, to stress that only the party’s dominance would allow China to continue its stunning transformation into the decades ahead. The first lesson from 40 years of reform, he said, was the need to maintain party leadership “over all tasks.” 
“It was precisely because we’ve adhered to the centralized and united leadership of the party that we were able to achieve this great historic transition,” Mr. Xi said.

Mr. Xi’s speech, lasting nearly one and half hours, came at a pivotal, potentially fraught moment in the country, when all the contradictions in its governance appeared in stark relief. Mr. Xi’s political power is as great as that of any leader in decades, yet his party’s tightening of controls over the economy and ever more aspects of society suggest a deep-seated insecurity at the highest levels.

Mr. Xi’s government has been forced to make some compromises with the United States as President Trump’s trade demands have escalated. But Beijing has also intensified corporate espionage and reacted with unbridled fury when American prosecutors sought to extradite an executive of Huawei, the Chinese telecommunications giant, who was recently arrested in Canada. China quickly arrested two Canadians, apparently in retaliation.

Mr. Xi said that a country of China’s size and influence was right to hold “lofty aspirations.”

“China will never develop itself by sacrificing the interests of other countries,” Mr. Xi said, but he added that China also would not “abandon its own legitimate rights and interests.”

Throughout his speech, Mr. Xi performed similar rhetorical swerves, promising both greater openness and assertiveness, both strong state companies and prospering private businesses.
The government’s intensifying repression of Muslims in Xinjiang, crackdown on Christians and secretive detention of the Chinese chief of Interpol have clouded its global standing at a time when it aspires to play a larger international role.

Mr. Xi’s speech risked leaving Chinese officials no clearer about his policy agenda at a time when relations with the United States in particular have deteriorated badly.
Mr. Xi’s speech marked 40 years since China began to open up its economy. He said the first lesson from those decades of reform was the need to maintain Communist Party leadership “over all tasks.”.

Mr. Xi’s speech marked 40 years since China began to open up its economy. He said the first lesson from those decades of reform was the need to maintain Communist Party leadership “over all tasks.”CreditWang Zhao/Agence France-Presse — Getty Images

“When everything is a priority, nothing is a priority,” Yuen Yuen Ang, a professor of political science at the University of Michigan, Ann Arbor, who studies China, said by email after watching the speech. “Today, many policy goals in China are in tension with one another. Which ones take precedence? This is what officials will need to know to carry out their work on a practical level.”

Even as Mr. Xi spoke, stock markets dropped in Asia. Though such speeches are not China’s usual vehicle for announcing specific policy measures, some investors had been hoping for signals that Beijing would take further steps to liberalize the economy or ease tensions with Washington.

Mr. Xi and Mr. Trump agreed early this month to call a truce in disputes over trade and investment, and to allow 90 days to reach an agreement.

But Mr. Xi’s speech on Tuesday was likely to dampen hopes of a breakthrough, said Ryan L. Hass, a former director for China at the National Security Council who is now a fellow at the Brookings Institution.

Mr. Hass said his Chinese contacts had “described the speech as the place where Xi would send a signal to Trump on his own terms about the market openings and other reforms on the horizon.”
“If those messages were embedded in the speech,” he added, “they appear to have been well concealed.”

Mr. Xi warned that the future contained “all kinds of risks and challenges,” but he said repeatedly that the party had expertly guided the country thus far and must continue to do so. He emphasized twice that the party had been “completely correct” in its embrace of economic overhauls, a remark that brushed over the many internal debates, as well as ups and downs, that accompanied those changes.

Mr. Xi called for revitalizing Marxist-Leninist doctrine, a reflection of the party’s fears that it could lose its grip over a younger, increasingly wired and well-traveled generation. “Let contemporary Chinese Marxism shine even more brilliant rays of truth,” he said.

According to Julian B. Gewirtz, a scholar at the Weatherhead Center for International Affairs at Harvard, who watched the speech while visiting Beijing, “This was a speech about the party more than anything else.”

It remains to be seen whether Mr. Xi’s remarks will reassure Chinese private companies, as he has tried in recent weeks to do. Business leaders and economists have complained about meddlesome officials, heavy and capricious tax burdens, restrictions on investment and banks that prefer to channel loans to big state companies that enjoy the patronage of party leaders. They have welcomed Mr. Xi’s promises, but also warned that the economy remains troubled by risks.

“Of all the anniversaries related to the reforms — 20 years, 25 years, 35 years — this 40th anniversary is perhaps the least optimistic I have seen,” said Ding Xueliang, a professor emeritus at the Hong Kong University of Science and Technology who has long studied China’s reforms. 
“People in very senior positions also have no clear idea of the direction,” he added. “Not a single person in the past half year who I talked with in China, not a single person, said he or she is clear about the next stage.”

A billboard in the southern Chinese city of Shenzhen this week featured Deng Xiaoping, the late Chinese leader who presided over economic reforms in the 1980s.CreditNicolas Asfouri/Agence France-Presse — Getty Images

Adding to the anxiety were signs that the government was tightening the release of local economic data amid a sharp slowdown. Last month, the southern province of Guangdong stopped releasing the results of a monthly purchasing managers’ index — a survey that takes the temperature of China’s important factory sector — citing a notice from the National Bureau of Statistics. The bureau said on Tuesday that the province had violated regulations on statistics gathering.

In his speech, Mr. Xi repeatedly touted the huge advances China has made since “reform and opening” began in 1978, rattling off detailed statistics on personal incomes, education and life expectancy. Gone are the days when food and clothing were rationed, he said.

“Hunger, food shortages and poverty, which plagued the Chinese people for thousands of years, have been generally left behind,” he said.

Mr. Xi paid tribute to Deng Xiaoping, the former leader who presided over the reforms in the 1980s. In past anniversaries of the reform era, Deng stood out in tributes and displays, but Mr. Xi has shifted the spotlight to his own achievements since he became party leader in 2012.

Mr. Xi has repeatedly promised to ensure that China offers businesses and foreign investors an open, fair market, but many have become skeptical that he will follow through. Instead, many say, Mr. Xi’s drive to extend party control, stifle public debate and defend the state sector have stymied economic liberalization.

“Pledges to reform are sincere, but simultaneous pledges to prevent all instability too often nullify progress,” said Daniel H. Rosen, a founding partner of Rhodium Group, an economic analysis firm that helps keep a running scorecard on China’s promised changes. “Reform necessarily means some instability, and trying to have it both ways will not work.”

The occasion of the speech on Tuesday was the anniversary of a party meeting in 1978, when Deng and other veteran leaders who had fallen during Mao’s Cultural Revolution began to reassert their power and lay out ideas for restoring the economy after decades of strife.

The meeting now features in the party’s heavily mythologized history of that time as a watershed, although it was only years afterward that “reform and opening up” became an official party formula.

Before Mr. Xi’s speech, Chinese economists who favor market reforms had openly voiced frustration with what they said was the slow, muddled pace of change. They appear likely to be disappointed, and even worried.

“We’re sincerely hoping that this big meeting will be able to sound a clarion call for deepening reform,” Xiang Songzuo, a senior economist at Renmin University in Beijing, said at a forum in Shanghai over the weekend.

He cited an estimate from researchers at an unidentified official institute who concluded that China’s real rate of economic growth this year could be just 1.67 percent, or even lower. That projection is at the very low end of economists’ estimates, but Chinese growth is widely believed to be lower than official estimates, which forecast an expansion of 6.5 percent this year.

If there was no strongly reformist call from leaders, Professor Xiang said, “My final conclusion will be that China’s economy is headed for a plight that will last for a considerable time and be very, very difficult.” He did not respond to emails or messages after Mr. Xi’s speech.

Fed Tightening? Not Now

The central bank should pause its double-barreled blitz of higher interest rates and tighter liquidity.

By Stanley F. Druckenmiller and Kevin Warsh  
Fed Tightening? Not Now

Photo: Phil Foster

Around Oct. 1, global central-bank liquidity reversed and stocks began their descent from peak prices. That is no coincidence. The Federal Reserve should take an important signal from recent developments at its meeting this week.

The Fed created quantitative easing as a novel crisis-response tool a decade ago. It bought assets from the public and stocked them away for safekeeping. Market participants understood the not-so-subtle message: The Fed had investors’ backs. The stock market rallied. The cost of credit fell. And the business and financial cycles charged ahead.

The crisis ended in the U.S. in early 2010, but central-bank asset purchases did not. Other large central banks—the European Central Bank, the Bank of Japan and the Bank of England—followed the Fed’s lead. Together they amassed more than $11 trillion of additional stocks, bonds and other financial assets.

In unheralded news a couple of months ago, quantitative easing gave way to global quantitative tightening as central banks withdrew overall liquidity from the market. True, the Fed had begun to taper its balance-sheet holdings 15 months earlier, but that was more than offset by other central banks’ still-growing asset purchases.

As we head into 2019, quantitative tightening is expected to accelerate. It has been paired with expectations of interest-rate increases from the Fed—and the timing could scarcely be worse.

Economic growth outside the U.S. decelerated over the past three months. Global trade growth also slowed markedly, running about one-third lower than earlier in the year. Growth in some important economies, like China, is significantly weaker. No ocean is large enough to insulate the U.S. economy from slowdowns abroad. And no forecasting model adequately captures the spillovers and spillbacks between the U.S. economy and the rest of the world.

U.S. financial-market indicators also signal caution. Market prices may be showing their true colors for the first time since QE’s expansion. These indicators aren’t foolproof, but they have a better track record than economists. Bank stocks are down about 15% since Oct. 1. Other economically sensitive sectors, like housing, transport and industrials, are down by double digits, underperforming the broader markets. Credit markets are softening, and the decline in major commodity prices is foreboding.

These indicators are at odds with strong U.S. economic growth for 2018, which will come in at around 3.25%. Labor markets also remain strong, although they too are a lagging indicator.

The new Fed leadership team faces the most difficult challenge since Chairman Ben Bernanke and his team confronted shocks to the financial system in 2007-08. They deserve forbearance, not censure. But time is tolling, and the Fed is well-advised to break from the old regime.

The Fed should worry less about fine-tuning its communications strategy and more about getting policy right. In recent months, Chairman Jerome Powell stepped up outreach to Congress and other interested parties. He spoke with refreshing humility about the appropriate policy rate setting. And he prudently scaled back on the kind of pinpoint forecasts his predecessors made. These moves, while welcome, are insufficient.

In response to market tumult, the Fed governors recently hinted at less enthusiasm for rate increases next year. The new forward guidance is different from what they signaled in September. But it is no more reliable. The Fed should stop this option-limiting exercise entirely. And if data dependence is the Fed’s new mantra, it should actually incorporate recent data into its forthcoming policy decision.

The Fed’s balance sheet is where the money is. Yet it has provided little additional clarity on its balance-sheet plans since Chair Janet Yellen’s tenure. At a time of global quantitative tightening and uncertain economic prospects, the Fed’s silence on its asset holdings is contributing to the tumult. We were assured by policy makers that QE provided large benefits to the real economy. If so, won’t its reversal in the form of QT come with a cost? It can’t all be rainbows and unicorns.

In a first-best world, the Fed would have stopped QE in 2010. It might then have mitigated asset-price inflation, a government-debt explosion, a boom in covenant-free corporate debt, and unearned-wealth inequality. It might also have avoided sowing the seeds of future financial distress. Booms and busts take the Fed furthest from its policy objectives of stable prices and maximum sustainable employment.

In a second-best world, on Mr. Powell’s arrival in February 2018, the Fed would have shrunk its balance sheet with speed and determination before raising rates. The economic expansion was still gaining traction at home and abroad. Tax and regulatory reforms were jolting the supply side of the economy from its slumber. Accelerated Fed QT, in the absence of rate rises, would have been much less disruptive to the real economy. Asset prices could then have found a more durable equilibrium and laid a stronger foundation for future growth.

The time to be dovish was when the crisis struck and the economy needed extraordinary monetary accommodation. The time to be more hawkish was earlier in this decade, when the economic cycle had a long runway, the global economy ample momentum, and the future considerably more promise than peril.

This is a time for choosing. We believe the U.S. economy can sustain strong performance next year, but it can ill afford a major policy error, either from the Fed or the rest of the administration. Given recent economic and market developments, the Fed should cease—for now—its double-barreled blitz of higher interest rates and tighter liquidity.

Mr. Druckenmiller is chairman and CEO of Duquesne Family Office LLC. Mr. Warsh, a former member of the Federal Reserve Board, is a distinguished visiting fellow in economics at Stanford University’s Hoover Institution.

French Protests

Macron's Ghosts Return To Haunt Him

By Julia Amalia Heyer and Katrin Kuntz

Protests at the Arc de Triomphe in Paris

The protests by the yellow vests against French President Emmanuel Macron aren't showing any signs of letting up despite concessions made by the government. Where is this anger coming from?

A drama has been playing out in the streets of France in recent weeks, an intentionally theatrical rebellion against Emmanuel Macron, the man who has governed France for the past 19 months. Some of the very people who voted for Macron have now taken to the streets to demonstrate against him.

The gilets jaunes, or yellow vests, want to storm the Élysée Palace, and chase him out, like a 2018 version of the Paris Commune, spurred by their dissatisfaction with a fuel tax that was meant to be imposed in January. The tax increase has been called off, but that so far hasn't been sufficient to appease them.

For Macron, for his credibility and authority, which he has orchestrated publicly like few others before him, it is too much. If he ends up having to backtrack on his policies, it will represent a U-turn and a watershed moment for his presidency -- a point from which he will struggle to recover. Rather than playing the role of a Jupiter, he would be an Icarus; a man who wished to fly high, but fell. He would have to govern with clipped wings.

Almost everything he wanted to accomplish for his country is at stake. Up to this point, he and his government had abided by the principle that no matter what happens, they would stay the course. His aim was nothing less than the "transformation" of France. Everything was to become new, different.

But now it appears things could turn out very differently. Will this president, with his penchant for the theatrical and tendency to quote Molière ad lib, manage to calm his opponents, his own people?

On Dec. 1, France saw its most violent riots since the student uprising of May 1968, protests that resumed again over the past weekend. They took place not only in Paris, but all across the country. Countless cars were burned. An apartment building and a prefecture were set on fire in the protests. Restaurants were destroyed, boutiques looted.

'Resign, Macron!'

A week ago Saturday, Place de l'Étoile, the star-shaped roundabout at one end of the Champs Élysée dominated by the Arc de Triomphe, became the site of a fierce battle between the police and the yellow vests until late in the evening. By the end, the monument, which Napoleon had erected to celebrate himself and his victories, was sprayed with slogans, like "Resign, Macron!" and "The yellow vests will win."

The plaster bust exhibited in the center of the arc was bashed in, a grim omen for the country. The riots and blockades of the past few weeks have taken a gruesome toll: At least four dead, more than a thousand injured, including police officers, protestors and passersby. More than 1,000 people have been arrested so far, and millions of euros in damage has been caused.

People in France are no longer speaking of protests, but of a revolt. Will it become a revolution?

All this hate and violence has been set off by the very person who wanted to reconcile the French, as Emmanuel Macron promised the eve of his election. He said it would be a difficult task, but it's unlikely that even he knew just how hard it would be.

'We Will Grill You Like Chickens'

Yves Rousset, a 64-year-old official with the police prefecture in in Le Puy-en-Velay, a small town in the Auvergne region around 400 kilometers (250 miles) south of Paris, stands as he recalls recent events. Before his current job, he helped resocialize criminals, and he thought he was well-suited to extreme situations. But he has trouble putting what happened at his prefecture into words, even days later.

On the evening of Dec. 1, 150 angry people pushed their way to the prefecture. Rousset watched as they broke windows with heavy rocks. Molotov cocktails flew into the yard. Tractors were used to transport tires that were then set on fire. In one wing of the building, offices went up in flames. "We will grill you like chickens!" the protesters yelled. When his police officers tried to push them back, rioters poured flammable acetone on them. One of the demonstrators split open a helmet with a rock. Loud techno music played.

"I've never seen anything like that," Rousset says.

Le Puy is home to just under 20,000 inhabitants, its Old Town paved with cobblestones. At night, cats wander through the empty alleyways. The youth meet up at the celebrations for the fire department. It's the kind of place where people know each other. The people here are rooted in their town.

But since the police prefecture was set ablaze and videos of the violence began circulating on social networks, Le Puy has also become a symbol of France's new anger, and proof that it's not being expressed exclusively in the capital, but everywhere as well.

Anyone who spends a few days in Le Puy is left wondering what could have gone so wrong in this country that it could get to the point where a peaceful town like this could become a tinderbox.

Rousset pulls a list out of the drawer in his desk. It contains the demands of the yellow vests, which he has carefully written on four pieces of paper. They want to reinstate the wealth tax, they're angry about lawmakers in Paris who either don't go to parliamentary sessions or read newspapers when they do. Electric cars, they argue, are not a solution.

It's a wish list from the citizens, the little people, who no longer believe the government is doing things as they want it to. Rousset discussed these points with the yellow vests, and he tried to convince them that it's OK if the Macrons order new dishes for the Élysée Palace, that former presidents should still get salaries and perks. But Rousset doesn't know if they understood him or if they even wanted to understand him.

Forgotten France

Many are now talking about the forgotten France, about the rural areas, largely disconnected from public life, where people eke out a grim marginal existence. They say that in places like Le Puy, the anger is building among people who only want to see everything burn.

When Macron traveled through France during his election campaign, he often spoke of the "feeling of degradation" he witnessed in some places. He wanted to fight against it, he said. But perhaps he should have done more to heed his own advice. When people picture him, they don't exactly conjure up images of him visiting remote villages. The yellow vests' revolt is also one of the rural areas against Paris, led by French people who, contrary to what is often said about them, do not belong to the middle class. It is the little people, the "class populaire," or working class -- those to whom Macron promised social advancement and who voted for him instead of the Socialists in response and helped secure his win.

These people feel degraded, even if that is more of a sentiment than reality. Le Puy is a good example. The city and the department in which it is located are neither rich nor poor. The region is structurally weak, but unemployment is below the national average.

'Our Anger Is Legitimate'

Marine stands at one of the traffic circles that has been occupied by the yellow vests in Le Puy. Until recently, she made 1,400 euros per month working in a tobacco shop. She says she is opposed to violence, but that they could no longer put up with what is happening. "Our anger is legitimate," she says. "We want to eat organic vegetables sometimes, too, not just noodles."

The people with the raging mob who demolished their own prefecture presumably had a job, a small house, a car, and could feed their families. They are radicalized by their fear of decline, which is stronger in France than it is elsewhere in Europe, even though the poverty level in the country has been stable for over 20 years, and even though France has the most generous welfare state in Western Europe.

If you were to try to sum up the yellow vests, as varied as they may be, one would describe them as pessimists and people who trust nothing, especially not things that take a long time. And democracy takes time. These days, they only rely on themselves -- and, if necessary, on their own capacity for violence. They have also registered that this can be effective given the zig-zagging by a government that appears to be increasingly unstable. It might also be that people in France feel particularly neglected because inequalities seem even crueler in a country that constantly invokes the noble virtue of equality.

In his 2014 book "La France périphérique (Peripheral France)," Christophe Guilluy describes how geographic segregation leads to social fault lines. These days, Guilluy's ideas are being widely discussed. The day after Macron's election victory in May 2017, he was sitting in a café on Place de la République, an angular man in his early fifties. He said, unmoved, "This time, Macron won, but the next time it could be Le Pen or another populist." He explained that it was as if the French were on tectonic plates and the weight of their society was constantly shifting from one side to the other. "Everything could capsize at any time." He said Macron's challenge was to see to it that the weak can also benefit from the country's prosperity. But it was also apparent that he didn't believe Macron would succeed in doing that.

At the moment, it looks as though Macron didn't pass the test. The president, for whom everything seemed to be so easy, is suddenly having a tough time. He's silent when he should be talking, and when he does speak, he is no longer striking the right note. Macron, of all people, is becoming the target of an anger that has been growing for years, and even decades. He is paying for others' mistakes, which is, on the one hand, unfair, but, on the other, understandable.

Little 'Backing Among the Populace'

On the Left Bank of the Seine, in a stately villa that looks like the one set on fire by yellow vests on Dec. 1, political researcher Luc Rouban is sitting in a small, cramped office. Rouban is friendly and atypically down-to-earth for this part of France. He gets right to the point: "Macron never impressed me," he says. In the summer, he published a book called "Le paradoxe du Macronisme" (The Paradox of Macronism) in which he analyzed why he believes Macronism will be little more than a chimera, an illusion.

Rouban had started the book in early summer, before one of Macron's bodyguards assaulted a protester and set off the government's first true crisis. Rouban spent months researching the composition of the National Assembly and determined that the new lawmakers might be younger and there might be more women than before, but that there probably had never been so many people with similar backgrounds in the French parliament. He said they are educated and wealthy to an above-average degree, making them representative of only a tiny part of France.

"Macron doesn't have any backing among the populace. Those who want what he wants are very few," Rouban says. Macron's political base of people who really share his opinion, he adds, is only 6 percent.

The president, Rouban says, is a liberal in two senses. Macron isn't just an economic liberal, but also a person who wants a liberal society, and Rouban argues that this doesn't jibe with France's traditional political fault lines. If a person is economically liberal in France, he says, then they belong to the right. But if a person is in favor of an open society and voted for gay marriage, for a tolerant immigration policy, they see the economy as, at most, a necessary evil that needs to be kept on the shortest possible leash by the government. Rouban argues that Macron's philosophy is based on a false notion that the traditional ways of thinking, the division between left and right, are outmoded.

"The French don't want any Hartz IV reforms," says Rouban, referring to the slashing of the German welfare system carried out by former Chancellor Gerhard Schröder of the center-left Social Democrats. "We are not as emancipated as the Germans or the Danes. We believe in the government and in public service."

'Politics ... Has To Be Learned'

He says the French don't like being led by a man who talks like a business executive and acts like a monarch. Now, the fact that Macron destroyed the French political landscape without giving enough regard to what might be lost in the process is coming back to haunt him. The result of that being that the anger is now being focused on him. There are no intermediaries and no buffer between Macron and the anger on the streets. Previously, the established parties could, to a certain degree, contain people's unhappiness and resentment. They knew how to make promises and to comfort people. Their lawmakers had local roots and reported about dissatisfaction in the rural areas. "Politics is a profession, after all, and it has to be learned," Rouban says. Now novices are sitting in parliament, most of whom, like Macron himself, have never held seats in the legislative body before.

Macron has also steamrolled other societal actors with his authoritarian style of governing and the unions are weaker than ever. As such, Rouban sees quite a bit of irony in the yellow vest rebellion. "They're the genies that Emmanuel Macron let out of the bottle himself."

The weariness over the so-called system, which Macron himself has stoked, is now robbing him of his ability to shape policy -- and of his credibility. If you force others to choose between all or nothing, you may end up with nothing yourself.

The Street Always Prevails

That, too, helps explain why the score currently stands at 1:0 for La Rue, the street. And violence has also proven successful. Once again, as the legend of French politics goes: The street always prevails in the end.

To find evidence for that maxim, it isn't necessary to go back as far as Charles de Gaulles being driven from office in 1968-1969. Recent history suffices. In 1995, it was pension reform. A decade later, it was highly unpopular contracts for young workers. The Socialist government even withdrew an environtmental tax in 2014. On that occasion, the mere threat by truck drivers to block the motorways proved sufficient. And this time, too, Macron's supposedly new world looks quite a bit like the old one. On Wednesday, France's prime minister announced that the planned tax increase would likely be scrapped altogether. "If we do not find good solutions, we will not levy this tax," said Édouard Philippe. But he remained mum about what a good solution might look like.

Was it retreat? Or capitulation?

The protests have now been joined by thousands of high school students, and farmers have also announced they will strike this week. Yet despite all of the inconveniences the strikes have caused, seven out of 10 French continue to support the yellow vests.

In a normal situation, the opposition would be seeking to take advantage. But Macron's election destroyed them and they are far away from getting back on their feet.

Just as dangerous, though, is the fact that even some of Macron's allies have been drifting across the lines. Among them is the economist who once help design Macron's policies and who is now calling for the reintroduction of the wealth tax. Repealing it was one of the president's first official acts. Some are also suggesting that the EU's three-percent budget deficit rule be ignored in favor of new borrowing. None of this, however, is consistent with the platform on which Macron campaigned. And then there's the old ally whose support made Macron's election victory possible in the first place. Now he's telling the president: "You can't govern against the people."

One last question for Monsieur Rouban. If the situation was so poor for Macron, then why did he win the election?

'An Excellent Poker Player with a Lousy Hand'

Rouban's answer comes quickly. "He only won this election because there was no alternative." His victory, the political scientist says, was fragile from the very beginning. "Macron," says Rouban, "is an excellent poker player, but he has been dealt a terrible hand."

A few hours after the prefect has placed the list of yellow-vest demands back in his drawer, a helicopter lands in Le Puy. Emmanuel Macron has arrived for an unannounced visit. He looks at the destroyed prefecture and shakes hands with members of the police. The news of his visit spreads like wildfire in the city and dozens of protesters suddenly converge and stand in front of his car, which is standing by to take him back to the helicopter. "Resign Macron!" they shout.

Someone screams: "We are nothing, but neither are you!" It appears as though Macron briefly shakes his head before climbing back into his sedan.

Only days later, Macron will meet with 37 political and business leaders to discuss how the yellow vest protests are affecting the country. And on Monday, Dec. 10, he plans to address the country in a speech in which he is expected to announce political initiatives in response to the protests.

Why Another 50% Correction Is Possible

by: Lance Roberts

All of sudden… volatility.
Well, that is what it seems like anyway after several years of a steady grind higher in the markets.
However, despite the pickup in volatility, the breaks of previous bullish trends, and a reversal in Central Bank policy, it is still widely believed that bear markets have become a relic of the past.
Now, I am not talking about a 20% correction type bear market. I am talking about a devastating, blood-letting, retirement crushing, "I am never investing again," type decline of 40%, 50%, or more.
I know. I know.
It's the "doom-and-gloom" speech to try to scare investors into hiding in cash.
But that is NOT the point of this missive.
While we have been carrying a much higher weighting in cash over the last several months, we also still have a healthy dose of equity related investments.
Why? Because the longer-term trends still remain bullish as shown below. (Note: The market did break the bullish trend with a near 20% correction in 2016, but was bailed out by massive interventions from the ECB, BOE, and BOJ.)
Now, you will note that I keep saying a 20% "correction." Of course, Wall Street classifies a bear market as a decline of 20% or more. However, as I noted recently:
"During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market prices trade below that moving average. This is shown in the chart below which compares the market to the 75-week moving average. During 'bullish trends' the market tends to trade above the long-term moving average and below it during 'bearish trends.'"
In other words, at least for me, it is the overall TREND of the market which determines a bull or bear market. Currently, that trend is still rising. But such will not always be the case, and we may be in the process of the "trend change" now.
The Collision Of Risks
Of course, after a decade of Central Bank interventions, it has become a commonly held belief the Fed will quickly jump in to forestall a market decline at every turn. While such may have indeed been the case previously, the problem for the Fed is their ability to "bail out" markets in the event of a "credit related" crisis. Take a look at the chart below.
In 2008, when the Fed launched into their "accommodative policy" emergency strategy to bail out the financial markets, the Fed's balance sheet was only about $915 Billion. The Fed Funds rate was at 4.2%.
If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to "bail out" the markets today is much more limited than it was in 2008.
But it isn't just the issue of the Fed's toolbox. It is the combination of other issues which have all coalesced which present the biggest risk to a substantial decline in the markets.
One of the most important issues overhanging the market is simply that of valuations. As Goldman Sachs pointed out recently, the market is pushing the 89% percentile or higher in 6 out of 7 valuation metrics.
So, just how big of a correction would be required to revert valuations back to long-term means? Michael Lebowitz recently did some analysis for RIA PRO:
"Since 1877 there are 1654 monthly measurements of Cyclically Adjusted Price -to- Earnings (CAPE 10). Of these 82, only about 5%, have been the same or greater than current CAPE levels (30.5). Other than a few instances over the last two years and two others which occurred in 1929, the rest occurred during the late 1990's tech boom. The graph below charts the percentage of time the market has traded at various ranges of CAPE levels."
Given that valuations are at 30.5x earnings, and that profit growth tracks closely with economic growth, a reversion in valuations would entail a decline in asset prices from current levels to somewhere between 1,350 and 1,650 on the S&P (See table below). From the recent market highs, such would entail a 54% to 44% decline, respectively.
This also corresponds with the currently elevated "Price to Revenue" levels which are currently higher than at any point in previous market history. Given that the longer-term norm for the S&P 500 price/sales ratio is roughly 1.0, a retreat back towards those levels, as was seen in 2000 and 2008, each required a price decline of 50% or more.
One of the bigger concerns for the market going forward is the simple function of demographics. Famed demographer, Harry Dent, discussed the impact of the trends within the economy as the mass wave of "baby boomers" becomes net-distributors from the financial markets (most importantly, draining underfunded pension funds) in the future. To wit:

"At heart, I'm a cycle guy. Demographics just happens to be the most important cycle in this modern era since the middle class only formed recently - it's only been since World War 2 that the everyday person mattered so much; because now they have $50,000-$60,000 in income and can buy homes over 30 years and borrow a lot of money. This was not the case before the Great Depression and World War 2.
And based on demographics, we predicted that the U.S. Baby Boom wouldn't peak until 2007, and then our economy will weaken - as both did in 2008. We've lived off of QE ever since."
The issue with the demographics is that they have only gotten markedly worse. Furthermore, the strain on pension funds has only mounted as required returns to sustain their viability have failed to appear. As I discussed previously:

"An April 2016 Moody's analysis pegged the total 75-year unfunded liability for all state and local pension plans at $3.5 trillion. That's the amount not covered by current fund assets, future expected contributions, and investment returns at assumed rates ranging from 3.7% to 4.1%. Another calculation from the American Enterprise Institute comes up with $5.2 trillion, presuming that long-term bond yields average 2.6%. 
With employee contribution requirements extremely low, averaging about 15% of payroll, the need to stretch for higher rates of return have put pensions in a precarious position and increases the underfunded status of pensions."
"With pension funds already wrestling with largely underfunded liabilities, the shifting demographics are further complicating funding problems."
George Will summed it up best:
"The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today's White House chief of staff vows that the administration will not 'meddle' with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling."


Of course, what fuels corrections is not just a change in investor sentiment but an ignition of the leverage that exists through the extension of debt. Currently, leverage is near the highest levels on record which is the equivalent of a tank of gasoline waiting on a match. As I discussed last week:
"What is immediately recognizable is that reversions of negative 'free cash' balances have led to serious implications for the stock market. With negative free cash balances still at historically high levels, a full mean reverting event would coincide with a potentially disastrous decline in asset prices as investors are forced to liquidate holdings to meet 'margin calls.'"
Of course, the key ingredient is ownership. High valuations, bullish sentiment, and leverage are completely meaningless if there is no ownership of the underlying equities. The two charts below show both household and corporate levels of equity ownership relative to previous points in history.
As can be clearly seen, leverage fuels both halves of the full market cycle. On the way up, increases in leverage provide the capital necessary for accelerated share buybacks and increased speculation in the markets. Leverage, like gasoline, is inert until a catalyst is applied.
It is the unwinding of that leverage that accelerates the liquidation of assets in the markets causes prices to plunge faster and further than most can possibly imagine.
It has only happened twice already since the turn of the century, and both reversions of that leverage resulted in 50% declines. Yet, less than a decade from the last crash, with margin debt at near historic records, investors have once again fallen prey to excessive exuberance and the belief that somehow this time will most assuredly be different.


Another key ingredient to rising asset prices is momentum. As prices rise, demand for rising assets also rises, which creates a further demand on a limited supply of assets increasing prices of those assets at a faster pace. Rising momentum is supportive of higher asset prices in the short term. However, the opposite is also true.
The chart below shows the real Price of the S&P 500 index versus its long-term Bollinger-bands, valuations, relative-strength, and its deviation above the 3-year moving average. The red vertical lines show where the peaks in these measures were historically located.


The Fed's Got It Under Control
This "Utopian" belief of infinite stability within the financial markets is due to ongoing Central Bank interventions and is a most dangerous concept. This is particularly the case, given the structural and economic shifts in the economy due to the rise in debt which has derailed the efficient allocation of capital. As shown below, the economy is currently mired at the lowest average annual growth rate since 1790. (Data courtesy of Measuring Worth)
As a portfolio strategist, what concerns me most is NOT what could cause the markets rise, as we are still somewhat invested, but what could lead to a sharp decline that would negatively impact investment capital.
[Important Note: It is worth remembering that winning the long-term investment game has more to do with avoidance of losses than the capturing of gains. It is a function of math.]
What causes the next correction is always unknown until after the fact. However, there are ample warnings that suggest the current cycle may be closer to its inevitable conclusion than many currently believe. There are many factors that can, and will, contribute to the eventual correction which will "feed" on the unwinding of excessive exuberance, valuations, leverage, and deviations from long-term averages.
The biggest risk to investors currently is the magnitude of the next retracement. As shown below, the range of potential reversions runs from 36% to more than 54%.
That can't happen you say?
It's happened twice before in the last 20 years and with less debt, less leverage, and better-funded pension plans.
More importantly, notice all three previous corrections, including the 2015-2016 correction which was stopped short by Central Banks, all started from deviations above the long-term exponential trend line. The current deviation above that long-term trend is the largest in history, which suggests that a mean reversion will be large as well.

It is unlikely that a 50-61.8% correction would happen outside of the onset of a recession. But considering we are already pushing the longest economic growth cycle in modern American history, such a risk which should not be ignored.
There is one important truth that is indisputable, irrefutable, and absolutely undeniable: "mean reversions" are the only constant in the financial markets over time. The problem is that the next "mean reverting" event will remove most, if not all, of the gains investors have made over the last five years.
Still don't think it can happen?
"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as they have predicted. I expect to see the stock market a good deal higher within a few months." - Dr. Irving Fisher, Economist at Yale University 1929

China’s Boldest Experiment

The conventional wisdom among social scientists is that the demands of advanced economies and growing middle classes can be met only through greater political freedoms and competition. By doubling down on authoritarian single-party rule, China is now testing that proposition.

Dani Rodrik

xi jinping deng xiaoping

BEIJING – Forty years ago this month, China’s leaders set the country on a path of reform that has produced the most dramatic economic transformation in history. Mao Zedong had died two years earlier, in 1976, and the newly rehabilitated Deng Xiaoping succeeded in stamping his vision of economic development and modernization on the Third Plenary Session of the Eleventh Central Committee held in December 1978. In the four decades since, China has transformed itself into an economic powerhouse, portending an equally momentous makeover of the global economy and geopolitics.

China’s reforms started in agriculture, where the crushing burden of state controls was relaxed. Through the dual-track pricing mechanism, farmers were given market incentives. The household responsibility system allowed them greater control over the land they worked. Farmers responded quickly, increasing their efficiency and output.

Reforms were subsequently broadened and extended into other areas. Non-agricultural production incentives were bolstered through a hybrid form of ownership called Township and Village Enterprises (TVEs). As the reforms spread to cities, state enterprises gained more autonomy and were encouraged to become entrepreneurial. Incentives were created for provinces and localities to invest and spur economic growth. And the growth of Special Economic Zones (SEZs) in the 1990s turned China decisively toward integration with the world economy.

The general thrust of these reforms was to increase the economy’s market orientation and external openness. But while China’s share of international trade and private investment grew and that of the state sector steadily shrank in relative terms, the authorities retained a firm hand in managing the economy. Economic restructuring and diversification were promoted through a range of industrial policies. Foreign investors were required to enter into joint ventures with domestic firms and to increase the use of local inputs. The exchange rate and international financial flows remained controlled for the most part.

Through it all, China’s leadership did not follow any guidebook and resolutely marched to the beat of its own drummer. Reform was guided by neither communist teachings nor free-market dogma. If senior policymakers followed one overarching principle, it was what might be called “pragmatic experimentalism.” As Deng famously said, what mattered was not the color of the cat, but whether it caught the mice.

Given the peculiarities of China’s experience, it is not surprising that there remains considerable debate about the lessons to be drawn from it. For many in the West, China demonstrates the benefits of reliance on markets and economic liberalization. Yet if China were an economic basket case today, I suspect the same voices would be quick to attribute the failure to the continued intrusiveness of the Chinese state. For others, China demonstrates the intrinsic superiority of the state-led model. Yet many of the same policies, such as dual-track pricing or domestic content requirements, have failed in other settings.

These opposing perspectives can be reconciled. China has not violated the tenets of mainstream economics so much as it has offered a master class in applying them creatively in complicated political and economic terrain. Dual-track pricing provided market incentives at the margin without undermining the fiscal revenues. TVEs spurred private entrepreneurship, despite weak frameworks for property rights and contract enforcement. SEZs spurred exports and foreign investment without undermining employment among protected state enterprises. Industrial policies allowed infant industries to internalize learning spillovers. In short, China represents the triumph of practical economics – in which second-best strategies, market failures, general equilibrium, and political economy prevail – over the simplistic reasoning of Econ 101.

The biggest test for the Chinese model may be yet to come. Throughout the country’s economic transformation, the political primacy of the Communist Party of China was never in question. But outside observers expected that continued economic development would eventually lead to political liberalization. Instead, under President Xi Jinping, China has taken a decidedly more authoritarian turn. That is bad news for the hundreds of millions of Chinese whose political freedoms are being ever more tightly circumscribed.

Political repression could be bad news for the economy as well, for at least two reasons. First, people’s ability to speak freely provides an advance-warning mechanism for policies that might eventually fail, enabling the authorities to change course before more damage is done. Second, political competition provides institutional mechanisms for channeling opposition, which otherwise might spill over to the streets and fuel civil disorder.

China’s leaders seem to be betting that they can avoid both types of problems. They believe they have their ears sufficiently to the ground that they can remain responsive to any brewing discontent. And they hope they can exercise social control through facial recognition and other new technologies, which they have taken the lead in deploying.

The conventional wisdom among social scientists is that the demands of advanced economies and growing middle classes can be met only through greater political freedoms and competition. The Chinese political elite are skeptical, and not without reason. When they look at the West nowadays, they see populism, demagoguery, and deep divisions, rather than harmonious, inclusive societies. Their attempt to combine a high-growth, technologically sophisticated economy with reinforced authoritarianism is perhaps their most ambitious experiment to date.

Dani Rodrik is Professor of International Political Economy at Harvard University’s John F. Kennedy School of Government. He is the author of The Globalization Paradox: Democracy and the Future of the World Economy, Economics Rules: The Rights and Wrongs of the Dismal Science, and, most recently, Straight Talk on Trade: Ideas for a Sane World Economy.

Unrealistic Return Assumptions

Jared Dillian
Editor, The 10th Man

There is no shortage of stupid people tricks in the financial markets, but probably the worst thing people can do is to have unrealistic return assumptions.
Question to you, dear reader. On a long-term basis, what can you expect your annual returns to be in a broad-based stock market index?

  1. 6 percent
  2. 8 percent
  3. 10 percent
  4. 12 percent

The answer is E. We have no freaking clue! All we know is what stocks have returned in the past. We have no idea what they will return in the future. The conditions that led to prior returns may not be present for future returns.
Most people will tell you that you can expect to earn 8 percent from the stock market per year. That is about what it has returned historically. So, a little perspective. That 8 percent annual return (over a period of about 100 years or so) easily beats any other stock market in the world.
Why is that?

It’s because America has the rule of law, property rights, all that jazz. We have something special here in the United States that other countries don’t have. We have a legal framework that protects private property. This lets financial markets flourish. You see that in varying degrees as you travel around the world. The really dastardly places don’t have stock markets at all.

Anyway, it makes sense that a loss of respect for private property rights or the rule of law might lead to diminished stock market performance. That is one reason the stock market might not return 8 percent. I can think of a bunch of other reasons why stock markets might not return in the future what they have in the past, and a big one is that they have just become so freaking expensive. When stocks get overvalued, forward returns go down. Few people disagree with this.

There are lots of smart people out there who expect future stock market returns to be much lower than they have been in the past. It is not just me being a crank.
Stupid and Irresponsible
The problem is, people take this 8 percent number and extrapolate it out in the future, and they break out Microsoft Excel for the first and only time to figure out how much they need to save every month in order to retire at age X. The FIRE dillweeds have made big news because they think that you can retire at age 35, and yes, they are relying on that generous 8 percent number (or higher) to reverse engineer a future standard of living.
This is dangerous. If you have unrealistic return assumptions for the stock market, you will:

  • Retire earlier, when you should actually retire later—and you will run out of money.

  • Consume more, when you should be consuming less—and you will run out of money.

  • Invest, instead of paying down debt, which could result in capital losses to go along with increasing debt balances—and you will run out of money.
The worst example of this comes from a competitor of mine who claims in his book Total Money Makeover that an allocation to “growth-stock mutual funds” will lead to returns of 12% a year.

The bizarre thing about this claim is that this guy is so conservative when it comes to saving money and paying down debt, and yet so liberal in his attitudes towards investing, which could be downright ruinous. After all, the main small cap growth ETF (IWO) is down about 19 percent from the highs—losses that are difficult to recover from.
Not to mention: in that book, there is no discussion of an allocation to bonds.

A 12 percent assumption for stock market returns is irresponsible and ignorant of decades of global financial markets history. The stock market is not a bank account! It doesn’t pay interest. It isn’t a magic money machine. Average investors can find themselves in a position where they sustain losses over a very long period of time.

I’ll tell you how crazy this is. If someone came up to me with a pitch book for a hedge fund claiming they could make 12 percent a year, I would probably report them to the SEC. The best, smartest, most amazing investors in the world have a hell of a time making 6-8 percent over Fed funds.
Realistic Return Assumptions
So what are realistic return assumptions? Well, I think 5 percent for stocks is reasonable, and maybe 3 percent for bonds, so a 50/50 portfolio will get you to about 4 percent.
Sounds like absolute crap, but that is the reality. If financial assets only return 4 percent going forward, what are people going to do?

They are going to have to save more.
This is the no-spin zone. People should spend a lot less time thinking and dreaming about 8 or 10 or 12 percent returns, and more time thinking about shoveling cash into a bank account which they can link up to Treasury Direct and earn 2.5% on treasury bills risk-free. Sure, 2.5% would be suboptimal, but not the worst thing in the world. It’s capital preservation.

Here’s the real reason not to be loaded up on stocks and hoping for a 12 percent return—when the 19 percent drawdown comes, you won’t panic into a diaper and sell, at which point the compounding comes to an end.

As ETF 20/20 readers know, the goal is to design a portfolio that you can sit in in good times and bad—so you can keep compounding.

Please temper those return assumptions. The stock market does not magically puke out 8-12 percent a year to a bunch of passengers along for the ride. This is not a case of me being pessimistic. We can’t possibly know what stocks will return going forward, so we should probably prepare for the worst.