Easy now

America’s economy is resisting the pull of recession

A healthy jobs market keeps Americans spending, helping to make up for a shortfall in business investment

THIS WAS not the way it was supposed to go. “Four, five, and maybe even six percent” growth was what President Donald Trump promised in December 2017. Even within the relatively sober pages of the budget proposal released by the administration in March this year, Mr Trump’s team forecast economic growth rates of 3% or more right through 2024—which would be the last full year of a second Trump term, were one to occur.

Instead, the American economy, which just missed the 3% growth target in 2018 despite the boost from the president’s budget-busting tax bill, continues to lose steam. In the third quarter of this year GDP, adjusted for inflation, rose at an annualised rate of 1.9%, down from 2% in the previous three months. The question hanging over Mr Trump, and millions of American workers, is just how far the slowdown will run and how deep it will go.

The first signs of trouble for America’s economy appeared in late 2018. Housing construction slumped as higher mortgage rates (pushed upward by Federal-Reserve interest-rate hikes) combined with rising home prices to drive buyers from the market. At the same time, a global slowdown in manufacturing and trade weighed on American producers.

New manufacturing orders dropped fairly steadily from September of 2018 until May of this year, and parts of America’s manufacturing heartland experienced declines in factory employment. Economy-watchers have waited anxiously in the months since to see whether weakness in industry and construction would bleed into the service sector, where most Americans work. 

Mounting anxiety eventually roused the Fed to action. The central bank spent most of 2018 raising its benchmark interest rates in order to keep inflation in check, despite some withering criticism emanating from the president’s Twitter account. As the world economy sputtered, the Fed slowly changed course: first halting its cycle of increasing rates, then cutting them by 0.25% in both July and September of this year.

Jerome Powell, the Fed’s chairman, insisted that the moves represented a “mid-cycle adjustment”, lest markets interpret the cuts as a sign that the end of the boom—America’s longest on record—was nigh.

The cuts appear to have helped. Mortgage rates have retreated; the average rate on 30-year loans, which rose to near 5% a year ago, has dropped back to 3.75%.

That has put a bit of wind back in the sails of the residential construction industry, which began work on about 20,000 more homes in September of this year than in the same month last year.

Residential investment contributed positively to GDP growth in the third quarter, the first time it had done so in nearly two years. Rate cuts also seem to have switched off the bright, blinking recession-warning light which is the “yield curve”.

“Inversions” of the yield curve, which occur when rates on long-term government bonds fall below those on short-term government debt, frequently appear a year or so before the onset of recession.

The curve inverted over the summer, fuelling recession worries, but has since flipped back.

Stock prices, which looked sickly in May, have roared back to touch record highs, buoyed by better than expected earnings reports, as well as the prospect of a trade truce between America and China.

On October 30th the Fed reduced its benchmark rate once more, by another 0.25%. But in doing so it very nearly declared victory in the battle to ward off a downturn.

Markets now expect the Fed to hold its ground for at least the next six months. Mr Powell, while emphasising that the Fed will be watching the data closely, said, “We see the current stance of monetary policy as likely to remain appropriate...We believe monetary policy is in a good place.”

A majority of members of the rate-setting committee reckon the Fed should resume rate increases in 2020.

The Fed’s confidence, while understandable, may be premature.

The conditions which weighed on the economy earlier in the year have eased a little, but the growth scare did its damage.

Consumers have been the motor driving the economy forward through its headwinds. They continue to spend, but their faith seems to have been shaken.

Personal consumption spending grew at a 2.9% annual pace in the third quarter: not bad, but down from a blistering 4.6% pace in the second.

Retail sales in September dropped by 0.3%, suggesting that the quarter ended on a particularly weak note.

Measures of consumer confidence—a guide to how spending may evolve in future—have also slipped.

Firms, too, are behaving cautiously. Measures of business confidence have been softening. Anxiety among bosses is affecting investment: the boost to third-quarter GDP from investment in housing was more than offset by a hefty drop in investment in non-residential building and equipment. Weak investment figures are particularly irksome to economists in the Trump administration, who argued that the president’s tax reform would encourage a boom in business spending.

Business enthusiasm could recover a bit in the months to come, if indeed a trade-war ceasefire is declared. But the trade war is only partly responsible for firms’ woes. More important is the worldwide slowdown. Both Europe and Japan have slipped close to the brink of recession, and the deceleration in Chinese growth shows few signs of abating. A turnaround in American economic fortunes, if it occurs, will begin with homegrown optimism.

Hopes for that hinge in turn on the health of the labour market. The jobs picture has been the most enduring source of encouragement to those looking on the bright side. The pace of hiring has slowed; payrolls have risen by 1.4% over the past 12 months, down from 1.8% over the year before that. But that is not an unexpected development this deep into an economic expansion, when fewer jobless workers remain to be hired.

The unemployment rate, at 3.5%, remains extraordinarily low. So long as firms continue to hire and wages to grow, consumers are likely to keep spending at rates sufficient to steer the economy clear of a downturn.

Given the uncertainty surrounding the path of the economy, the Fed might have been expected to signal its readiness to keep cutting rates, if necessary, more clearly. Confidence is easier to maintain than to restore, and the risks of a surge in inflation have fallen in recent months. The price index for personal consumption expenditures, the Fed’s preferred inflation measure, rose at a 1.5% annual pace in the third quarter: below the Fed’s 2% target and down from 2.4% in the second.

Instead, the central bank seems content to wait and see how conditions develop—and to allow a president facing threats from all sides to twist in the wind.

Can Synchronized Stagnation Be Stopped?

Given the growing risk of economic stagnation, governments may soon need to provide further stimulus – ideally in tandem with broader structural reforms. But with many governments seemingly lacking the political will to take such an approach, monetary policy will likely continue to shoulder the heavy and increasingly unsustainable burden of supporting growth.

Eswar Prasad , Ethan Wu


ITHACA – The global economic slowdown is turning into a synchronized stagnation, with some major economies growing only weakly and others barely at all – or even contracting slightly. For now at least, fears of an imminent global recession seem premature. But policymakers have little appetite for fundamental reforms and limited room for effective macroeconomic stimulus, and thus seem at a loss for ways to revive growth.

The roots of the slowdown are not difficult to discern. Persistent trade tensions, political instability, geopolitical risks, and concerns about the limited efficacy of monetary stimulus continue to erode business and consumer sentiment, thus holding back investment and productivity growth. International trade flows have been directly affected as well. The World Trade Organization recently slashed its forecast for global trade growth in 2019 from 2.6% to just 1.2%. Furthermore, the Baltic Dry Index, a widely watched trade metric based on shipping rates for dry bulk commodities, nearly doubled in the first eight months of this year, but has since fallen by about 30%, erasing hopes of a trade rebound.

Meanwhile, global uncertainty has kept the US dollar strong relative to most other major currencies. Although dollar appreciation has taken some pressure off non-US economies that depend on exports or foreign capital, it has increased the risk of an open currency war.

At the same time, not all indicators are grim. Labor markets remain largely healthy, even in otherwise anemic economies such as Germany, and household consumption remains strong in most major economies. In addition, the September surge in oil prices, which had raised concerns of another negative shock to growth, has since receded.

The US economy reflects this dichotomy. Labor-market performance and household consumption are still relatively robust, but both the manufacturing and services sectors are slowing. Tensions with major trading partners, including China and the European Union, and uncertainty regarding the United States-Mexico-Canada Agreement, have hit business confidence, profits, and investment.

Although Germany continues to flirt with recession while its government eschews fiscal stimulus, other European economies have picked up some of the slack. France, the Netherlands, and Spain are experiencing modest growth and robust employment, despite weakening trade. Italy’s economy, however, seems to have flatlined, and the country remains wracked by political uncertainty.
Japan is facing multiple headwinds, including weak global demand, the contractionary effects of a sales-tax hike, and stubbornly low inflation. Financial conditions remain weak, as does the real economy. Business and consumer sentiment have plunged, which, together with the country’s structural, demographic, and fiscal challenges, augur further prolonged economic weakness.

Brexit-related uncertainties continue to dominate in the United Kingdom. Fears of a disorderly exit from the EU, and ongoing domestic political turmoil, leave little room for optimism about the country’s short-term economic prospects. Most indicators of UK economic activity are either flat or showing minimal growth.

To be sure, low interest rates in advanced economies, coupled with the recent fall in oil prices, have helped some large emerging-market economies. Even so, weak global demand and trade-related uncertainties, in addition to domestic policy constraints, continue to weigh on their growth.

For example, China’s economy is clearly slowing, although not as much as some had feared given the ongoing trade war with the US. But there is no clear prospect of a durable resolution to the conflict, which continues to dampen Chinese business sentiment and private investment growth. The renminbi’s gradual depreciation against the dollar has been orderly so far, but it has had only a modest impact on growth. And while China’s government has room for more fiscal and monetary stimulus, policymakers seem willing to let growth decelerate gradually to a more sustainable level, rather than boosting spending and easing access to credit, which could raise longer-term financial and other risks.

India, meanwhile, is experiencing a sharp economic slowdown, driven in part by tight credit conditions and weak household consumption. The government recently lowered corporate taxes and eased restrictions on foreign direct investment, while the Reserve Bank of India has injected significant monetary stimulus through interest-rate cuts. But without a clear vision for economic reforms from the government, these measures are unlikely to revive private investment.

In fact, economic malaise has taken hold in many key emerging-market economies. Brazil has teetered on the brink of recession in recent months, as trade, employment, and confidence levels remain stagnant. Likewise, Russia’s economy is experiencing zero or near-zero growth, according to most measures of activity. And Mexico, too, recorded zero GDP growth in the second quarter of 2019. The one positive economic note in all three countries is the continued growth of private-sector credit.

Given the growing risk of stagnation, governments may soon have little choice but to provide further macroeconomic stimulus. For this to be effective, policymakers will need to coordinate fiscal and monetary measures and undertake them in tandem with broader structural reforms aimed at improving long-term growth prospects. But with many governments seemingly lacking the political will to take such an approach, monetary policy will likely continue to shoulder the heavy and increasingly unsustainable burden of supporting growth.

Persistent reliance on ultra-low or negative policy interest rates leaves financial systems ever more vulnerable and has little positive impact on growth. And this unfavorable trade-off will continue unless governments make a broader commitment to structural reforms and prudent fiscal stimulus. Should policymakers fail to do so, synchronized economic stagnation will continue – and could give way to much worse outcomes. 

Eswar Prasad is Professor of Trade Policy at the Dyson School of Applied Economics and Management, Cornell University, and a senior fellow at the Brookings Institution. He is the author of Gaining Currency: The Rise of the Renminbi.

Ethan Wu is a student at Cornell University.

Restore monetary sanity — and do the global economy a favour

Carney shouldn’t wait until after Brexit to unwind QE

Ken Fisher

Christine Lagarde, Mark Carney - FT Money
© Bloomberg, AFP/Getty, Dreamstime

Worldwide, flat and inverted yield curves — short-term interest rates approaching or exceeding long rates — are everywhere. Many fear they signal slowing growth or recession. Hence, central banks cut short-term rates, as the European Central Bank and the US Federal Reserve just did.

In Britain, the double Halloween-o-phobia of an inverted yield curve and Brexit heighten pressure on Bank of England governor Mark Carney to follow suit. Instead he should take a better path before his January 31 departure. How? Sell the hundreds of billions in long-term debt the bank bought under its policy of quantitative easing. And he should lobby the new ECB head, Christine Lagarde, to follow his lead.

Conventional central bank wisdom says low rates — the cost of renting money — spur loan demand. So, the thinking goes, cut rates and folks will borrow more, like a store holding a sale. They argue money supply — key to growth and inflation — would rise. This is demand-side thinking. It ignores supply, a stronger influence on today’s lending.

Low rates got us where we are now. Flat and inverted curves usually come from central banks raising short-term rates to fight inflation. But no big central bank hiked in 2019. Instead, yield curves inverted when long-term rates plunged. A year ago, 10-year gilts paid 1.55 per cent. Now? Just 0.46 per cent. Germany’s entire yield curve is negative. Japanese yields are negative at 10 years and barely positive at 30. Ten-year US Treasuries yielded 3.16 per cent a year ago. Now it is half that at 1.53 per cent. Yet global loan growth has dragged. Its Siamese twin, money supply growth, has slowed overall since 2012.

Cutting short-term rates further won’t boost lending much. Why? Banks borrow at short-term rates to fund longer-term loans. Their profit — long rates minus short rates — comes from yield curve spreads. Inverted curves — short rates topping long — kill loan profitability.

Funding costs globally are dirt cheap. Yet with short rates so low, yield curves are flat or inverted. The US’s was positive in January. Today it’s inverted — despite two short-rate cuts. Low long rates squash spreads, shrinking bank incentives to lend. Banks need long rates to rise.

When central banks buy bonds under quantitative easing (QE), long rates fall. The Bank of England tried QE twice. If it were stimulus, lending would have jumped but it dragged. M4 money supply growth was sluggish. Ditto when the US tried it. Loan growth waned during the Fed’s QE, improving only after it slowed bond buying. Inflation? It was sluggish everywhere during QE. In the eurozone, it averaged 1.1 per cent year-on-year since QE started in 2015. The ECB isn’t missing its 2 per cent target despite QE, as many claim. It’s because of QE.

Central bankers fixating on low rates miss something bigger. Businesses won’t launch more projects because of quarter-point — or even full-point — rate cuts. If a project isn’t profitable at current rates it isn’t worth doing at fractionally lower ones — even 0 per cent. The profitability is too scant. Lower rates won’t change that. Forget loan demand.

Focus on supply. Wider spreads between long and short rates encourage bank lending, especially to lower-quality corporate borrowers. That’s what Europe needs. Companies such as Amazon and BP can always borrow. Loan-light banks pinch smaller, lower quality companies that are common throughout Britain and Europe. Stimulating lending, inflation and growth requires lenders eager to fund these borrowers.

Reversing QE is the best way to stimulate lenders. Not at the glacial pace the Fed used until stopping in August. I mean a quick, total disgorgement. The Bank of England should start now — don’t wait until after Brexit. Unwinding QE now would set the stage for a post-Brexit pop, with banks loosening lending just as businesses get the clarity needed to deploy pent-up plans.

Ms Lagarde should follow suit when she takes the ECB’s reins next month. Cancel the ECB’s planned bout of QE and start selling the €2.65tn of long-term debt it bought from 2015-18. US and Japanese central banks should join in, too. Mark Carney would become known as the Pied Piper of monetary sanity, leader of a return to normal central bank balance sheets and higher long rates. Long rates wouldn’t soar — there isn’t enough inflation for that. But they’d rise enough to re-steepen yield curves globally.

The result would be near magic: freer-flowing loans from banks more eager to lend. Business investment would accelerate worldwide, especially in Europe and long-shelved projects would finally be initiated. The global economy would grow faster. Reversing QE would start a revival few expect — the sort of surprise stocks love most.

Ken Fisher is the founder and executive chairman of Fisher Investments and chairman and director of Fisher Investments Europe.

‘Back Door’ Capital Outflows Should Worry Beijing

Officially, China has been successful in preventing citizens from moving cash abroad to avoid a weakening yuan—but all might not be what it seems.

By Nathaniel Taplin

A China Southern Airlines airplane taking flight at Beijing’s new Daxing International Airport last month. Photo: Ju Huanzong/Zuma Press

The Chinese talk of “walking through the back door”—meaning finding a way around the rules, and often implying graft or the use of personal connections.

Beijing has, since 2016, successfully used tough controls on outbound foreign investment and other capital movements to lock the front door through which money used to leave China.

There is increasing evidence, however, that the pressure on the back door is rising, following the recent sharp depreciation in the country’s currency.

The yuan is down almost 6% against the dollar since late April, and 10% since mid-2018.

Should the back door open any wider—or official trade or investment inflows dry up for some reason—Beijing might find itself once again forced to sell down big parts of its currency reserves to avoid a panic.

Worries about cracks in currency fortress China are another reason Beijing is likely to remain wary of aggressive monetary stimulus.

The relevant figure here is China’s “errors and omissions” line in its balance of payments, or BOP.

This number represents the residual of the main BOP accounts registering trade and investment flows—in other words, capital that has somehow moved across China’s borders without being documented.

In most countries, this line item is relatively small. In China, however, since 2014—when the yuan ended its decadelong trend of appreciation against the dollar—it has become persistently and mysteriously large and negative.

Analysts at Rhodium Group and elsewhere have long suspected this item represents undocumented capital flight.

The Great Hall of the People in Beijing. Photo: pilipey/epa-efe/rex/shutterstock/EPA/Shutterstock

Recently, the trend has become even more striking. Errors and omissions hit a record first-half high of $131 billion in 2019, notes Gene Ma of the Institute of International Finance, much larger than the first-half average of $80 billion during the last period of big capital outflows in 2015 and 2016.

That suggests that while measures instituted a few years ago to limit capital flight have appeared effective, China remains vulnerable to rising outflows through unofficial channels.

And the country has yet to report its third-quarter figures, following the big yuan depreciation in early August.

Allowing its currency to take some of the pressure from the trade war has been one of China’s key survival strategies so far.

But with increasing signs that the ocean of capital sloshing around behind China’s dike is finding new cracks—and out-of-control domestic food-price inflation adding to the stakes—that strategy is looking riskier.

China Plays Hardball Over Hong Kong Unrest

Beijing’s willingness to demand silence from Western businesses, despite the risks of alienating them, is a sign of its increasing fragility.

By Phillip Orchard


Last weekend, the NBA unexpectedly found itself at the center of the row between Beijing and anti-government protesters in Hong Kong when Houston Rockets General Manager Daryl Morey expressed support for the protests on Twitter. After the Chinese Basketball Association announced a suspension of cooperation with the league, the NBA scrambled to distance itself from Morey’s views and defuse the situation. China was evidently unsatisfied; broadcasts of NBA games were canceled, NBA merchandise was pulled from Chinese stores, NBA ads disappeared (including one featuring the Brooklyn Nets, which are owned by vocally pro-Beijing Alibaba co-founder Joseph Tsai), and every one of the NBA’s official Chinese partners suspended ties with the league.
This week, Beijing also reportedly forced Apple to remove the Taiwanese flag emoji from iPhone keyboards in Hong Kong, as well as two apps: HKMap.live, which Hong Kong protesters used to crowdsource police movements, and Quartz, a U.S. media outlet whose Hong Kong coverage has evidently crossed a line. U.S. gaming company Blizzard Entertainment, meanwhile, suspended a professional player for expressing support for the Hong Kong protests. The hotel company Marriott, which has been under fire from Beijing for accidentally referring to Taiwan as a country, said it would fire an employee for “wrongfully liking” a tweet by a Tibetan independence group.
If China appears to be increasingly thin-skinned, it’s because the country is entering a period of profound internal political and economic stress. The risk of mass social unrest is as high as it has been at any time since 1989, making the potential rupture of regional fault lines amid these pressures China’s core geopolitical problem. Its uneasy relationship with foreign corporations illustrates the trade-offs inherent to Beijing’s approach to managing the problem. To stave off a political crisis sparked by an economic collapse, China needs the capital, jobs and technology provided by foreign firms. Yet, to stave off a political crisis, it can’t afford to see its control undermined by foreign influences – and won’t hesitate to go it alone if forced to choose.
The Costs Are Real
China’s willingness to draw a line in the sand with foreign firms reflects the country’s staggering growth in power but also its increasing fragility. It’s now home to the world’s second-largest consumer market. China has as many NBA fans, for example, as the rest of the world combined, and last year, the league reaped more than 10 percent of its revenue from China. Increasingly, Beijing is leveraging its market power for a wide range of strategic, economic and political aims. For example, in exchange for the right to sell to Chinese consumers, Beijing often pushes tech firms to share advanced technologies with local partners that it hopes will accelerate the economy’s race up the value ladder. As illustrated by moves like forcing foreign airlines to pretend Taiwanese cities aren’t in Taiwan, no political victory is too small.
Still, at times, Beijing can appear curiously tone-deaf and ham-fisted, pressuring outside institutions in ways that do considerable harm to its reputation abroad for minimal gain. Beijing could’ve just ignored Morey’s tweet, which was unlikely to have any impact on the Hong Kong protests or perceptions of them on the mainland. Twitter is censored in China, after all. Yet, Beijing did respond – even explicitly calling for curbs to free speech in the U.S. – and then kept escalating the matter. As a result, it magnified the spotlight on human rights issues in Hong Kong and Xinjiang (where, until Sunday, the NBA had a training camp), sparked a national conversation in the U.S. about Chinese coercion two days before critical U.S.-China trade talks were set to begin, and gave antagonized NBA fans in China reason to sympathize with Hongkongers. For what gain?
Even when China has clear, worthwhile reasons to take a hard line with foreign firms, moreover, such moves invariably come with costs. For one, China needs foreign investment and technology, now more than ever considering that it’s dealing with the trade and tech wars, the global slowdown, China’s structural slowdown, credit shortages, and the growing awareness in foreign business circles of the difficulty and risks of operating in China. Already, its current account has slipped into deficit, and uncertainty related to the trade war has pinched global investment. Yet, the more foreign firms and investors think that doing business with China comes with risks of stumbling unawares onto Beijing’s naughty list or provoking nationalist boycotts – and, at home, risks of bad PR and pressure from U.S. lawmakers – the more likely they are to stay away.
To be clear, China will remain exceedingly attractive to most firms, particularly those selling to Chinese consumers. The conspicuous silence on the kerfuffle over Hong Kong of otherwise politically outspoken NBA stars has made that much clear. To steal from Michael Jordan: Communists buy sneakers, too. But for firms on the fence or those looking at the country purely as a manufacturing hub, China may not be worth the headaches.
China’s reputation problem carries risks in a number of other strategic and economic areas as well. The power of coercion is king in geopolitics, but hearts and minds still matter. Beijing has immense interest in winning political support for its aims abroad, or at least not antagonizing populations to the point where it creates political risks for foreign leaders of engaging with or conceding to China. In the past couple years alone, anti-China political backlashes have derailed strategically important Belt and Road Initiative projects in places like Sri Lanka and Malaysia. They’ve also undermined Beijing’s goals in regional states like the Philippines, which China needs to flip to solve its foremost strategic challenge. Perhaps most important, the growing impression in the U.S. and elsewhere in the West that China is a neo-fascist, revisionist state whose growth in power must be contained, whatever the costs, has boosted political support for Western trade and tech measures targeting China. The costs are real.
Rocketing Risk
Why, then, is Beijing apparently so unconcerned about winning hearts and minds – or at least so clumsy at it? For one, China often can’t help itself. When an organ of the Chinese state lashes out at a foreign firm, it’s often less a tactical, conscious decision than the reflexive response of an institutional culture that can’t tolerate any questioning of the party line. It’s doubtful, in other words, that Xi Jinping rushed to convene an emergency strategy meeting on whether and how to respond to a tweet by some front office guy with the Houston Rockets. The massive machinery of the Chinese state just responded in the way it’s been programmed to. This is an inherent risk to authoritarian regimes where dissent is not tolerated and nationalism is a boon – and where career incentives push officials to air on the side of being too hawkish. China, moreover, was almost fully closed off to the world just two generations ago, so the system as a whole is still relatively new to the game of massaging foreign opinion and thus prone to seemingly pointless misadventures.
Often, though, China’s moves are indeed the result of risk-reward calculations – ones that underscore China’s increasing political fragility. If it can’t live without foreign capital and technology, but also can’t live with foreign firms undermining its control at home, then it has good reason to make an example of those who flout the party line in hopes of making the consequences abundantly clear to everyone else. If, as a result of the rigid institutional culture this creates, it may be prone to overreach and self-inflicted wounds, so be it. If it makes China’s broader tensions with its neighbors or the West worse, well, none of these tensions would be resolved altogether by playing nice, anyway. Whenever Beijing wields its favorite, seemingly tone-deaf accusation that a Western government or corporation has “hurt the feelings of the Chinese people,” what it’s really saying is that it can survive isolation by nursing powerful historical grievances to rally nationalist support.
The bigger point is that the Communist Party of China is stuck with a lot of bad options. When forced to choose, it’ll almost invariably pick the one that it thinks most solidifies its control. And the more China’s long-term economic interests take a back seat to the CPC’s immediate concerns about political stability, the more risk levels will rise on a range of issues.
Consider Hong Kong. The main constraint preventing Beijing from forcefully ending the protests and taking full control of the territory is China’s dependence on Hong Kong as a gateway for both inbound and outbound investment. The territory accounted for around 64 percent of China’s inward foreign direct investment last year – and it will become all the more important as China’s internal and external economic woes mount. Beijing has a strong interest in preserving what’s left of Hong Kong’s reputation (with both foreign and Chinese firms) as a stable, business-friendly temple to capitalism. Thus, rather than rolling tanks through Tsim Sha Tsui, we expect Beijing to intervene only indirectly, helping Hong Kong police contain and grind down the protests over time.


Still, if Beijing begins to truly fear widespread contagion from the protests in the mainland, China’s concern about spooking foreign investors or derailing trade talks with the U.S. won’t be enough to stop it from restoring stability in Hong Kong the hard way. This would intensify Beijing’s isolation, and thus worsen its economic and political pressures at home. But from the CPC’s viewpoint, at least it would survive to be able to try to solve them.

US Treasury considers selling 50-year bonds

Move comes as global borrowing costs hover near record lows

Colby Smith in New York and Tommy Stubbington in London

The US government is considering selling 50-year bonds, joining other countries around the world that have seized on investors’ hunger for long-dated debt to lock in record-low borrowing costs.

Two years after suggesting there was weak demand among investors for super long-dated debt, the US Treasury has said it is testing market appetite for bonds that mature in half a century — compared with the 30-year maximum in place today.

The decision to consider much longer-dated debt instruments comes after a record-setting bond rally, which caused benchmark 10-year Treasury yields to plummet below 1.5 per cent, the lowest level in three years. At one point, the voracious demand for global bonds pushed yields on roughly $17tn of debt below zero as investors piled into longer maturities in search of returns.

A recent survey of big asset managers by Bank of America Merrill Lynch found that buying US Treasuries is at the top of the list of most popular trades.

“We’ve seen a back-up in yields but we like long-dated US Treasuries,” said Andrea Iannelli, London-based investment director at Fidelity International. “The Fed is one of the few central banks that has meaningful room to cut rates, and they function as an insurance against drawdowns in riskier assets.”

Treasury secretary Steven Mnuchin has repeatedly talked up the prospects of a 50-year bond, or even one that matures in 100 years, given rock-bottom borrowing costs.

He commissioned a report looking into the matter two years ago, only to receive a resounding message from Treasury officials that there was no “notably strong or sustainable” demand for debt beyond 30 years in the US market.

Gennadiy Goldberg, a US rates strategist at Toronto-based TD Securities, said a “century bond” like the ones now issued by Austria, Belgium and Ireland may not be feasible in the US given a potential dearth of buyers. But he does think there could be more traction for a 50-year bond.

In addition to 50-year bonds, the Treasury said it was also exploring the issuance of a 20-year bond, as well as a one-year floating rate note linked to the Secured Overnight Financing Rate, which replaced the scandal-tainted Libor.

Mr Goldberg said he saw the 20-year bond issuance — something the Treasury last did roughly three decades ago — as an easier sell. For one, he said there would be fewer questions about pricing because it already exists on the Treasury’s yield curve and it is likely to trade more frequently than its longer-dated counterparts.

Should enough market participants indicate interest in a half-century bond sale as well, however, the Treasury could very well roll out both. “There’s an old adage in markets — demand generates its own supply,” added Mr Iannelli.

Prices without borders

Low inflation is a global phenomenon with global causes

The price of commodities, trade in goods and capital flows all play a part

ECONOMIC MODELS say that less slack in an economy leads to more inflation. But what defines an economy’s borders? As inflation-targeting took off in the 1990s, globalisation also accelerated. Trade grew from 39% of world GDP in 1990 to 51% at the turn of the millennium, cross-border finance was liberalised and the internet slashed the cost of communicating.

In the 2000s policymakers began to wonder whether integrated markets had made inflation a global process. Economists generally pooh-poohed the idea.

But with central bankers searching for explanations for today’s low inflation, the idea that global forces might be at work has come back into fashion. It has also become more relevant. If globalisation has held down inflation, might its reversal—thanks to the trade war and Brexit—send it shooting back up?

Inflation has been getting more synchronised across borders. On average, a common global trend accounts for nearly a quarter of the variation in national inflation rates since 2001, according to Jongrim Ha, Ayhan Kose and Franziska Ohnsorge of the World Bank.

Add in factors specific to advanced economies and emerging markets, respectively, and trends spanning borders account for more than half the movement in inflation in the rich world and nearly a third of it in poorer countries.

This partly reflects simultaneous trends in monetary policy. But it may also indicate a growing role for global factors. Kristin Forbes of MIT, formerly a Bank of England rate-setter, has studied the drivers of inflation in 43 countries between 1990 and 2017.

She includes in her models global factors such as exchange rates, an estimate of global economic slack, and commodities prices, and finds that their input appears to have increased over the past decade. This is especially true when considering only temporary deviations in inflation from its long-term trend.

There are three main sources of global influence on inflation: the price of commodities, trade in goods, and capital flows. Commodities prices are the most obvious and longstanding.

Synchronicity of inflation rises after large movements in the oil price, such as the shocks of the 1970s. More recently commodities prices have, on the margin, been driven by demand in emerging markets, especially China.

Between 1996 and 2016 the seven largest emerging markets accounted for almost all of the rise in global consumption of metals and two-thirds of the rise in global consumption of energy. As a result, booms and busts in emerging-markets’ demand for commodities are felt everywhere.

In the mid-2010s it was a commodities bust that helped push Europe into deflation.

That much is not controversial. But another effect of globalisation has been to bring down the price of manufactured goods as their production has shifted to economies with low labour costs.

Unlike with commodities, this has been a one-way bet, not a cycle. For decades goods have been getting cheaper relative to services.

Economists can get annoyed by claims that goods trade has dragged down overall inflation.

In theory just some things getting cheaper should not be disinflationary because, with the right monetary policy, average prices will still rise fast enough to make up the shortfall.

In practice monetary policy works only with a delay.

That means changes in relative prices matter. Today, because the Phillips-curve relationship seems to have weakened, central banks often find themselves at the mercy of short-term trends.

Goods trade does not just mean imports of finished products. The recent growth in cross-border supply chains has created conduits along which cost changes in one part of the world flow into the prices of goods that emerge from factories elsewhere.

Research by Raphael Auer of the Bank for International Settlements (BIS), Andrei Levchenko of the University of Michigan and Philip Sauré of Johannes Gutenberg University in Mainz has found that half of global synchronisation in producer-price inflation is attributable to prices that can be traced through supply chains.

Via this mechanism the average country imports one-fifth of any change in inflation in the rest of the world. Prices are more intertwined in integrated trading regions such as America, Canada and Mexico.

If firms can locate their supply chains where costs are lowest, it becomes easier to avoid economies that are running hot. Only if inflation is driven up everywhere are rising costs inescapable.

In other work with his colleagues at the BIS, Claudio Borio and Andrew Filardo, Mr Auer finds that the greater a country’s integration into cross-border supply chains, the more inflation tracks slack in the global economy.

If imports of inputs to production double as a share of GDP, the sensitivity of inflation to global economic conditions also appears to double.

Messrs Ha and Kose and Ms Ohnsorge also find that global factors explain a greater share of inflation in countries which participate more in global supply chains.

This view implies that prices in non-tradable sectors, such as services, will remain sensitive to domestic economic conditions.

That is what James Stock of Harvard University and Mark Watson of Princeton University find in America. Hotels and restaurants, for example, remain fairly sensitive to labour-market slack. Messrs Stock and Watson are even able to separate inflation into an index that is “cyclically sensitive” and one that is not.

The third global factor is capital flows. As inflation has synchronised across borders, so too have long-term real interest rates. For the past four decades they have moved in tandem as saving and investment have been brought into balance globally. And they have moved in one direction: down. In other words, there appears to be a glut of global saving.

The potential reasons for this phenomenon, which was first identified in the mid-2000s, include ageing populations, slower productivity growth, a scarcity of safe assets relative to risky ones, and a dearth of lucrative opportunities for private-sector investors.
It is not just long-term rates that have fallen in tandem. So have the “equilibrium” short-term rates which anchor monetary policy, according to estimates by John Williams, president of the New York Fed, and Kathryn Holson and Thomas Laubach of the Fed in Washington, DC.

Falling equilibrium rates mean that any interest rate central banks choose is less stimulative than it would have been a decade or two ago. In other words, the effects of excess saving spill across borders. Current-account surpluses in, say, Japan and Germany, which together totalled nearly half a trillion dollars in 2018, bear down on the interest rates that must be set by the central banks of other countries to keep inflation on target.

That is fine if central banks adjust accordingly. The problem is that equilibrium rates have been driven close to zero. Unable to cut rates much, central banks find that the only way to fight disinflationary pressure is with unconventional measures like quantitative easing (QE). These are themselves policies with global consequences.

QE is supposed to work in part by getting investors to buy riskier assets. That adjustment happens on the balance-sheets of asset managers who invest worldwide. As a result it sends billions of dollars of capital looking for interest rates to drive down elsewhere.

Ironically, the recent incremental reversals of globalisation provide good examples of the importance of global financial conditions to inflation. In theory tariffs should boost inflation in the country that sets them.

But as the trade war between America and China heated up during 2019, it sparked fears about global growth and triggered a rush into safe assets such as Treasury bonds. Long-term bond yields fell to new depths and the dollar surged. In response the Fed has cut rates and the ECB has restarted QE.

The deflationary impact of a change in global risk appetite has proved far more significant than the modest inflationary impact of the tariffs themselves. Only in Britain has the rolling back of globalisation, via its vote to leave the EU, had a very noticeable upward effect on prices. But even that was due to a fall in the value of the pound; the direct effect of Brexit, if and when it happens, could seem small in comparison.

One group of countries feels the effects of the global financial cycle above all others. For emerging markets, it is so important that they face a distinct set of monetary-policy challenges.

Brexit is a journey without end for Britain

No majority exists for any deal option with the EU. Brexiters are as much to blame as Remainers

Martin Wolf

WEB Comment illustration Martin Wolf
 © Daniel Pudles 

In 1933, Joseph Goebbels stated that, “The modern structure of the German State is a higher form of democracy in which, by virtue of the people’s mandate, the government is exercised authoritatively while there is no possibility for parliamentary interference, to obliterate and render ineffective the execution of the nation’s will.” It is a measure of how far the UK has fallen that Boris Johnson, the prime minister, often sounds rather like this.

Mr Johnson sought to prevent “parliamentary interference” in Brexit negotiations, by proroguing (or suspending) it for five crucial weeks. He dissented from the Supreme Court’s unanimous decision that this was unlawful. He has suggested he could ignore the Benn Act requiring him to seek an extension to the Article 50 deadline, should he not achieve a deal. He condemned this legislation as the “surrender act”. Worst of all, he plans to frame the next election as a battle of “people versus parliament”.

How did the UK reach a position in which its prime minister regards parliament as an obstacle to be ignored? The simple answer is that it decided to insert a particularly ill-considered referendum on an exceptionally contentious subject into a parliamentary system. This created conflicting sources of legitimacy. Worse, the meaning of the option that won a small majority in that referendum was ill-defined. “Brexit means Brexit” is perhaps the silliest sentence ever uttered by a British prime minister. But it was also all that could be said.

Contrary to what Brexiters insist, parliamentary involvement is not an unwarranted intrusion. Any referendum requires legislation. This one also required negotiation and agreement. Alas, no majority exists for any option for a deal with the EU. Brexiters are as much to blame for this as Remainers.

Consequently, “no deal” has emerged as the fallback position. But the Leave campaign said essentially nothing about a no-deal exit. There is no mandate for what every informed observer, including the civil service, knows would be a disruptive and costly result. It would also be just the beginning of negotiations, not their end.

But those talks would occur in worse circumstances. There would be pervasive economic uncertainty. This would be a mad choice. Governments exist to help their countries, not harm them deliberately.

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Among the most important reasons for this outcome is the refusal, especially on the Brexit side, to try to understand the EU. They needed to comprehend that the EU is an existential project for its members, not just a trade deal. Application of European law, under the European Court of Justice, is a central part of that project. The EU, with 27 remaining members, was also sure to be an inflexible counterparty.

What next? The government’s Heath Robinson-esque plan, in which Northern Ireland is to be inside the EU’s regulatory system for goods but not its customs area, will be rejected as leaky, legally unenforceable and incompatible with border-free trade in Ireland.

It also represents a rejection of the UK’s 2017 commitments on the Irish border. This is sure to have further weakened trust in Britain’s reliability. Remember, too, that the EU has long land borders. It will not allow the precedent of intentionally porous borders.

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Some believe this plan ought to fly with the EU. It will not. If Northern Ireland were inside the EU’s customs area, too, it could work. But, if the rest of the UK is to have its own trade and regulatory policies, this would make the Irish Sea the UK’s customs and regulatory border with the EU. That would be unacceptable to the Democratic Unionist party and the Conservatives. It might reignite violence in Northern Ireland.

So what happens if no deal can be agreed before October 31?

One question is whether the EU agrees to another extension when the British government clearly does not want one. Assume that it does, but only with conditions. What might those be?

One possibility would be to try to ratify Theresa May’s withdrawal agreement. That would allow the UK and the EU to move on to negotiating a new relationship. This would also mean a compromise between Brexiters and Remainers, itself highly desirable. But it seems impossible.

For Remainers, it is too little; for Brexiters, it is too much. Remainers want to stay in the EU.

Brexiters reject the Irish backstop that would keep the UK in the EU’s customs area and restrict its trade policy indefinitely.

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A second possibility is another referendum, probably on a choice between no deal and Remain. Such a vote should be legitimate since no deal played so little part in the referendum. But it would require creation of a caretaker government. That would be hard enough to do. It might also be impossible to agree a question and then carry out a referendum, without large-scale violence. To me, another referendum is the least bad option. But it creates great risks.

Finally, there could be an early general election. A drawback is that this would involve many issues apart from Brexit and might lead to another hung parliament. With Mr Johnson campaigning against parliament, it could have dire consequences in both the short and long runs. But it might resolve the Brexit issue, temporarily.

Yet the issue now is not just Brexit. It is far deeper. The Conservative party has become an English nationalist party, busily stoking populist resentment. Meanwhile, the hard left has seized the Labour party. The curse of extremist politics has only just begun.

Once people see opponents as “traitors” to an imaginary “people”, demons of hatred are unleashed. Brexit awoke those demons. Mr Johnson, aided by Nigel Farage and his Brexit party, will seek to win by freeing them. They are sure to wreak havoc for a very long time.

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China and the US Are Dealing With the Easy Stuff

By: Phillip Orchard

The trade war is far from China’s biggest economic problem, but it’s nonetheless starting to become a problem. U.S. imports from China have fallen 12.5 percent so far this year, compared to 2018.

An International Monetary Fund forecast released this week said Chinese growth will plummet by another 1.6 percent next year if Trump follows through on his threats to tax another $267 billion worth of Chinese imports.

It’s unsurprising, then, that over the past two months, Beijing has been quietly laying the groundwork for concessions needed to strike at least a “truce” with the U.S., if not a more substantive deal. On Friday, for example, it confirmed that a deal would include a pledge to keep the Chinese yuan stable in relation to a basket of currencies. Also in the past few weeks, Beijing lifted caps on foreign ownership in the asset management and auto industries, passed a new foreign investment law that received widespread positive reviews, and pledged a host of new measures such as export tax rebates, improved trade financing and credit insurance. It expanded quotas for tariff-free imports of some U.S. farm goods. According to U.S. officials, Beijing has also committed to make new concessions on intellectual property protections.

U.S. Agricultural Exports to China

Senior Chinese officials, meanwhile, have been on a PR blitz at home and abroad aimed at wooing foreign investors. Most prominent among them has been Premier Li Keqiang, a longtime economic liberalization advocate, and Vice President Wang Qishan, Xi’s trusted “firefighter” who is held in relatively more high esteem abroad. When Li and Wang take high-profile trips abroad and feature prominently in Chinese state media, it’s often a signal of growing concern in Beijing about its souring reputation in foreign business circles (and, occasionally, hints at a power struggle in the upper echelons of the CPC).

The timing of the CPC’s Fourth Plenum this week is also noteworthy. Beijing was expected to hold the plenary session a year ago, per tradition, but delayed it about as long as possible under party rules. This, combined with occasional hints of dissent about Xi’s reassertion of state control over the economy, suggested deep factional divides may have been emerging within the party over China’s handling of the economy, including the trade war.
Xi is loath to risk having these divides on display at the plenum, so the fact Beijing is finally moving forward with the meeting, along with the aforementioned rollout of various reforms, could suggest he’s succeeded in restoring enough consensus for China to move more aggressively with reforms going forward.

More likely, though, the plenum will underscore the reality that Beijing is still operating amid tight political constraints and trying to thread the needle between a number of bad options. Based on official releases, at least, the emphasis of the conclave will be on themes like ideological purity, party loyalty and combating the evils of Western-style capitalism – not, say, the virtues of reform and opening.
This would suggest that Xi remains preoccupied with restoring party solidarity and appealing to nationalist forces to curry support. When the party leadership gets nervous, it typically either gets trapped in paralysis or resorts to the tools it trusts most to entrench its power. In short, China wouldn't be capable of inking anything more than a “truce” anytime soon.
The plenum will be held behind closed doors, so watch for subtle shifts in state media coverage, unexpected personnel changes and so forth for clues on Beijing’s ability to move decisively in one direction or another.

What a Deal Won’t Resolve

Already, it’s fairly clear what won’t be resolved in the immediate future, even if a phase one deal is finally put on paper. There’s a common theme among China’s recent moves and expected concessions: They’re all measures China increasingly needs to do anyway. Its moves to boost foreign participation in its financial sector, for example, come on the heels of a near-crisis in which the Chinese banking sector, especially state-owned lenders, proved exceedingly ill-suited for channeling funding to the private sector.
The resulting credit crunch did far more damage to the Chinese economy than U.S. tariffs have yet to do. China’s increased agricultural purchases would come at a time of surging food prices resulting from a devastating outbreak of African swine fever. If it agrees, as reported, to a deal on stabilizing the yuan, it will be at least in part because it hasn’t been intentionally driving down its currency and has a crippling fear of capital flight.

Similarly, its measures aimed at wooing foreign investment come amid mounting concerns about the country’s reputation as a place increasingly hostile to foreign businesses. Beijing needs new foreign investment to sustain employment, boost its flagging growth, and stem the slow-motion exodus of foreign firms to other low-cost manufacturing hubs.
Moreover, it has long relied on Western business circles to block anti-China and protectionist political forces abroad from translating into punitive policy measures. But over time, as homegrown competitors to foreign firms began hoarding market share in China (with ample help from the state), and as well-documented allegations of things like intellectual property theft proliferated, disenchantment among foreign firms with the Chinese model has become widespread.
This is why opposition to Trump's trade war has proved manageable for the White House.
Beijing won’t be able to make the sweeping changes needed to restore foreign confidence. But it makes sense for it to bend over backward to at least appear to be sincere about addressing foreign firms’ concerns.

In contrast, there’s been nary a hint of evidence that Beijing is preparing to make concessions on the main U.S. grievances. On some issues, like forced technology transfer, there’s realistically not that much Beijing can do to fully snuff out the practice. On others, like more meaningful IP protections, it can pass new laws and push courts to enforce them, but it sees such U.S. demands as an infringement on Chinese sovereignty and is thus loath to spark a nationalist backlash by following through with a gun to its head.

On the biggest issues, moreover, Beijing is going in the opposite direction. Its structural slowdown, trade pressure and soaring debt risks are forcing it to lean even more heavily on the state sector, for example. And to avoid falling into the fabled “middle-income trap,” bolster the People’s Liberation Army and reduce its dependence on foreign technologies, it's doubling down on its support for advanced manufacturing sectors. Deepening state control at the expense of market-driven dynamism may ultimately do more harm than good to China’s economy and industrial development. But resistance to liberalization from entrenched state-sector stakeholders in China, combined with the party's existential fear of widespread job loss, means Beijing is defaulting to the tools it trusts most to sustain stability.

There are also a number of points of contention that the U.S. itself isn’t willing to negotiate on – particularly those with national security implications resulting from China’s development of “emerging and foundational technologies." As we’ve long said, the U.S.-China “tech war” will far outlast the trade war. U.S. concerns over military issues or things like Hong Kong will also remain separate. Thus, expect U.S. measures targeting Chinese tech firms like Huawei, scrutiny on research and development collaboration, and inbound Chinese investment to only intensify from here. And since the U.S. will need to hold on to leverage to ensure implementation of whatever Beijing concedes on trade, expect most of the existing tariffs to remain in place for the time being as well.
Looking Ahead in the U.S.-China Trade War

The U.S. will still have ample political and economic interest in striking a more comprehensive deal. The tariffs are accelerating the U.S. downturn, and an election year is approaching. And while the U.S. needs to do far more to reset its trade relationship with China and find ways to pressure Beijing to change, the problem for the U.S. is twofold: One, reaping the easy, low-hanging fruit in negotiations now leaves only the hard stuff. 

Two, absent a cataclysmic loss of CPC control, Beijing can’t and won’t concede on most of the hard stuff just to get out from under tariffs. Rather, they’ll just push China deeper into its Shell.