Capitalism Without Competition

By John Mauldin

The Soviet Union’s collapse and spread of semi-free markets through Eastern Europe seemingly ended the socialism vs. capitalism argument. Capitalism had won. Collectivist economies everywhere began turning free. Even communist China adopted a form of free market capitalism although, as they say, with “Chinese characteristics.”

The fruits of capitalism: millions of people freed from abject poverty and a few who got rich indeed. Nor is this a recent phenomenon. Capitalism in the last three centuries, with all its faults and problems, with all its contradictions, generated the greatest accumulation of wealth in human history. From a few hundred years ago when the vast majority of the people of the world lived below the poverty line, barely above subsistence levels, today we have less than 10% doing so and that number is shrinking every year.

Yet now, perhaps because this prosperity is so easily taken for granted, some on the left are again embracing socialist ideas and irrationally high tax rates. What drives this thinking? One problem is “capitalism,” in practice, does indeed provide many points for justifiable criticism. It is, to paraphrase Winston Churchill, the worst of all systems, except for everything else.

Today’s capitalism has a contradiction that is increasingly hard to ignore: lack of competition in key markets. That’s a problem because competition incentivizes producers to get more efficient and reduce prices for consumers. Without competition, you end up with bloated monopolies that may be highly profitable for the owners, but don’t serve the greater cause of economic growth.

My good friend Jonathan Tepper, with whom I wrote Code Red and Endgame, has an excellent new book on this: The Myth of Capitalism: Monopolies and the Death of Competition. He and co-author Denise Hearn explain why this is a serious problem with world-shaking consequences. I highly recommend the book and today I want to give you a brief taste of it, plus a few more thoughts afterward.

Monopoly Rents

Before we get to the book, let’s deal with one contradiction. People think capitalism and government are opposing forces. Certainly, there’s tension between them, but in fact they need each other. The government needs a thriving economy to generate tax revenue, and business needs the civil order that government protects.

Capitalism in its current form would not exist unless governments had sanctioned corporate business structures distinct from their human owners. The Romans had something like this, but it really took off with 17th-century mercantilism. That’s when the Dutch East India Company emerged along with similar groups in England like the South Sea Company (now often used to describe asset bubbles).

Corporate structures shield business owners from personal liability, which lets them take greater risks and ultimately produced the economy we have today. But that protection depends on a government guarantee. And because governments are prone to corruption, capitalists almost immediately began using their influence to reduce or eliminate competition. This is nothing new. It dates back centuries.

If you would like to understand the 19th-century creation of the modern corporation and subsequent monopolies, read The First Tycoon, the amazing biography of Cornelius Vanderbilt. Vanderbilt was possibly the only trillionaire in history (in current inflation adjusted dollars). He and his friends and government contacts literally created the modern corporation seemingly from scratch. As noted, there were precedents, but Vanderbilt brought it to the level we would recognize today. He and the other 19th-century robber barons created wonderful monopolies and vast wealth for themselves. Later the same government that enabled these monopolies broke them up.

These monopolies had dire economic consequences, as we can see in the “Monopoly” board game. Gain ownership of all the properties on a street through which everyone must pass, and you can charge higher rents without delivering any additional benefits. But then what happens? Eventually the renters run out of money, go bankrupt, and the game ends with your monopoly rendered worthless.

Something along those lines is happening right now in numerous industries. Usually it’s not a single-company monopoly (though these do exist, like state-protected utility companies), but duopolies are growing common.

The vast majority of personal computers run on either Microsoft Windows or some version of the Apple OS. Those two companies are often your only choices. Google is trying to break in, but has hope only because it is so huge and ubiquitous. Smaller players are effectively locked out, no matter how superior their products may be (cf. Firefox). Creating a new operating system and effectively marketing it would be prohibitively expensive. As a result, we pay more and receive less. That may not be the best way to grow an economy.

With that as prologue, let’s look at The Myth of Capitalism.

Not Free to Choose

Like me, Jonathan respects capitalism and capitalists. He’s not a leftist shill. It’s because he respects capitalism that he wants to see the best version of it, just as we all want our children to reach their full potential. Sometimes, that means pushing them to change.

The book refers to Milton Friedman’s old TV series “Free to Choose,” then says this.

"Free to Choose" sounds great. Yet Americans are not free to choose.

In industry after industry, they can only purchase from local monopolies or oligopolies that can tacitly collude. The US now has many industries with only three or four competitors controlling entire markets. Since the early 1980s, market concentration has increased severely. We’ve already described the airline industry. Here are other examples:

·         Two corporations control 90 percent of the beer Americans drink.

·         Five banks control about half of the nation’s banking assets.

·         Many states have health insurance markets where the top two insurers have an 80 percent to 90 percent market share. For example, in Alabama one company, Blue Cross Blue Shield, has an 84 percent market share and in Hawaii it has 65 percent market share.

·         When it comes to high-speed internet access, almost all markets are local monopolies; over 75 percent of households have no choice with only one provider.

·         Four players control the entire US beef market and have carved up the country.

·         After two mergers this year, three companies will control 70 percent of the world’s pesticide market and 80 percent of the US corn-seed market.

The list of industries with dominant players is endless. It gets even worse when you look at the world of technology. Laws are outdated to deal with the extreme winner-takes-all dynamics online. Google completely dominates internet searches with an almost 90 percent market share. Facebook has an almost 80 percent share of social networks. Both have a duopoly in advertising with no credible competition or regulation.

Amazon is crushing retailers and faces conflicts of interest as both the dominant e-commerce seller and the leading online platform for third-party sellers. It can determine what products can and cannot sell on its platform, and it competes with any customer that encounters success.

Apple’s iPhone and Google’s Android completely control the mobile app market in a duopoly, and they determine whether businesses can reach their customers and on what terms. Existing laws were not even written with digital platforms in mind.

So far, these platforms appear to be benign dictators, but they are dictators nonetheless.

It was not always like this. Without almost any public debate, industries have now become much more concentrated than they were 30 and even 40 years ago. As economist Gustavo Grullon has noted, the “nature of US product markets has undergone a structural shift that has weakened competition.”

The federal government has done little to prevent this concentration, and in fact has done much to encourage it. Broken markets create broken politics. Economic and political power is becoming concentrated in the hands of distant monopolists.

The stronger companies become, the greater their stranglehold on regulators and legislators becomes via the political process. This is not the essence of capitalism.

Now, to be clear, some industries require such massive scale that they can only support a small number of producers. Passenger aircraft, for instance: You have Boeing, Airbus, and a handful of smaller players (like Canadair and Embraer, who make smaller planes).

Most industries aren’t like that. Banking certainly isn’t. Lots of studies show the economies of scale stop improving once a bank passes $50 billion or so in assets. Yet the megabanks have grown larger without growing more efficient, in the process killing many of the local banks that once financed local businesses on favorable terms.

That’s a problem because we need those small, local businesses. Here’s Jonathan again.

Ever since the time of Thomas Jefferson, Americans have idealized the yeoman farmer and the small business. While family neighborhood stores are a critical part of the economy, it is important to distinguish between small businesses and the high-growth startups that Haltiwanger describes.

Small businesses like restaurants and dry cleaners create most jobs, but they also destroy most jobs. They create most new businesses, but they have the highest rate of failures. They are important, but they don’t drive productivity.

It is the small companies that become big, like the next Costco, Southwest Airlines or Celgene. All of these started small.

Geoffrey West, in his masterful book “Scale,” showed that companies are like living organisms. Just like in the animal world, many startups die when they are very young, but those that survive and grow quickly tend to grow exponentially, which leads to higher profitability and productivity.

Note, this is not an argument against large companies. They have an important role. But the real innovation and growth starts much lower on the food chain. So, it is a problem when small business loses the chance to thrive and prove itself.

As you know, I go fishing in Maine every summer with a group of economists. Maine has complex rules for its lakes, governing which fish you can keep or must release. We rely on professional guides to know the differences, but the general idea is to give the younger fish from underpopulated species a chance to grow. This preserves the lakes as a resource for everyone.

We might look at small businesses the same way. Most won’t grow into big businesses, but it serves everyone to protect their opportunity. As Jonathan points out, that isn’t happening. We’re already paying a price and it is getting worse.

Data Oligopoly

Faulty government aggravates the monopoly problem but isn’t its only cause. Another factor is that modern technology requires connectivity, which requires some degree of uniformity and naturally reduces choice.

You’ve heard of the “network effect,” when additional users make a product more valuable. A social network with 100 million users is generally better than 10 social networks with 10 million users each, because it helps to have all your friends in one place. Even for very narrow markets, your social network needs significant penetration to be useful.

Again, this isn’t new. It existed in telephones over a century ago, and is one reason hundreds of small phone companies eventually combined into the Bell System, which eventually grew so powerful it, too, was broken up. But this time something else is happening. The Bell companies weren’t selling ads based on the content of your phone conversations. In various ways, today’s social networks, internet providers, internet search engines, retailers, and others make money from the data we give them.  

I saw a story last week noting that on a revenue-per-user basis, the FAANG companies keep growing even when they don’t add any new benefits for users. How is that? One reason is because as time passes, they gather more and more data and can target users more precisely, which makes advertising more effective and advertisers willing to pay more. That’s not to say there is no benefit. There is, but it goes to advertisers instead of users. Like the distressingly accurate joke goes, you aren’t the customer. You are the product.

The data oligopoly isn’t just costing us money. It is rapidly rendering “privacy” obsolete, at least in the sense we once knew it. We have traded it away without considering the cost, and I’m not sure we can ever go back.

This is an area where China is unfortunately leading the way. Data merchants there, many state-owned, gather data far more aggressively than the US companies and often hand it over to the government. Beijing is creating a social scoring/credit system that uses online activities to assign each citizen a certain value. Your score can mean higher access and lower costs, can improve your chances of getting a date, and even allows the state to say whether you should own a dog or not. If you jaywalk in certain areas of China, the system, armed with facial recognition software, recognizes who you are and sends a fine to your phone within seconds. Welcome to the future. The link above is actually scary reading for Western eyes but apparently, most Chinese approve and think it helps make everything better.

Very little prevents the same from happening in Western democracies because we are so happy to give up our data. Most people (especially younger generations) simply don’t care. Much of the Millennial cohort wants everything it does to be on video. And where does the video go? On Google-owned YouTube, where it sells targeted ads.

Now we have in-home devices and even cameras that we think (hope?) only capture us when we ask them to. Orwell’s 1984 “telescreen” is no longer fantasy. The technology exists now, businesses are making money from it, and governments would love to have the data.

I personally saw a demonstration around five years ago where a gentleman was able to start audio recording and taking pictures on another person’s phone, without their knowledge or approval. I told the developer that I knew he was brilliant, but if he was doing it…? He readily agreed that there were others who likely could. And that that technology is now five years more advanced.

In a less concentrated economy, this might be a smaller problem. We would have more choices about how our data is gathered and used, and those that gather would have less influence on governments. That is not the case. Monopolies aren’t just costing us money; they are taking our privacy and, ultimately, maybe our freedom as well.

Who owns your data? Could the government step in and require companies using your data to get your permission via your private block chain identity? And pay you for the privilege? As an incentive to let them use your data? Watch this become a political topic in the near future.

Jonathan and Denise performed a great service by highlighting the loss of competition and bringing more attention to it. I don’t necessarily agree with all their proposed solutions, which I think could have serious side effects. But we certainly have a problem. And it calls for vigorous debate and discussion. Read the book to learn more.

We will talk more in the coming weeks about the ways that government and business interact, but one negative impact is that government banking regulations increasingly mean that it is more difficult for banks to lend money to small and medium-sized businesses. But that doesn’t mean the businesses still don’t need money. And that becomes an opportunity for regional brokers, hedge funds and other groups to step in meet the various and sundry needs that local bankers used to.

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Through SMH you can access a wide variety of private equity, private credit, venture capital and private partnerships. Their professionals have the experience to help you find the right investments that may be a fit your particular portfolio needs.

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(Full disclosure: In this regard, I am the president and a registered representative of Mauldin Securities, LLC, member FINRA and SIPC, and receive referral fees for the introduction. Please read the risk and disclosures of all investments offerings before you actually invest.)

Puerto Rico, Dallas, Houston, Cleveland, New York, and Austin

That string of cities sounds like a lot of traveling, except that it is one city after another rather than separate trips. Right now, I am happily ensconced in our home in Puerto Rico, enjoying the weather. And because the letter is already running a little long, I will hit the send button without further comments. You have a great week!

Your thinking about governments and business analyst,

John Mauldin
Chairman, Mauldin Economics

China’s slowdown is of its own doing

Blaming the trade war with the US is a dangerous mischaracterisation

Harry Broadman

The Great Hall of the People in Tiananmen Square, Beijing. The Communist party still dominates the Chinese economy © Bloomberg

The noose around the neck of China’s economy has been getting tighter, but hardly as a result of the tariffs imposed by the US. This is a dangerous myth celebrated by Washington and used as a scapegoat by Beijing.

Rather, the squeeze is largely self-induced. It stems from the lack of further reform — in some cases, the reversal of past reforms — in an economy still heavily dominated by the state and whose largest enterprises remain governed by the Communist party. The power to alter China’s economic fortunes lies largely in Beijing’s own hands.

The overarching symptom is a secular fall in China’s real GDP growth. Except for an upward blip in 2010, the growth rate of the Chinese economy has been on a steady decline over the past 10 years. Such a pattern cannot be the result of China’s trade war with the US, which began in earnest only last year. And, despite the US imposition of tariffs, China’s trade surplus has expanded, not contracted.

The trend continues. Last week, Beijing announced that its official recording of real GDP growth for 2018 was 6.6 per cent, the lowest rate China has experienced since 1990, the year following the student protests in Tiananmen Square. Beijing downplayed the news, casting it as fully in line with the government’s forecast for 2018 and a sign of the maturity of the Chinese economy.

Those of us who have worked on the ground in China for decades, however, know full well that even if one takes the country’s official economic statistics at face value (which few of us do), the exercise Beijing utilises to set its growth projections lacks rigour and is tinged by political imperatives.

Worse, the process is almost a tautology: official forecasts for a given year are not released before the year’s start. Thus, only this March will Beijing unveil 2019’s projection — that is, after a quarter of the year has already passed. That’s a sure-fire way of improving the accuracy of any forecast.

As to China being a mature economy, it’s highly doubtful whether the majority of the country’s citizenry would agree with Beijing’s characterisation. While a number of reforms put in place since 1978 — some of which have been truly ingenious — have lifted millions of out of poverty, many Chinese remain poor by any standard. On a purchasing-power-parity basis, China’s per capita GDP is below the global average. It is on par with countries such as Serbia, the Dominican Republic and Botswana — countries whose economies don’t leap to mind as being mature.

If a precursor to economic maturity is sustained high growth that is widely diffused nationally — no small feat for a country that has a large population and occupies a vast geographic space — China is moving in the opposite direction. Indeed, the IMF forecasts China’s growth to continue to fall, to 6.2 per cent for 2019 and 2020.

By way of comparison, consider India, the other Asian giant with comparable characteristics to China and widely considered to be in an economic race with China to reach maturity. India’s growth in 2017 was below that of China, exceeded it in 2018 (at 7.3 per cent) and, the IMF predicts, will speed up to 7.5 per cent in 2019 and 7.7 per cent in 2020. Unlike China’s, India’s growth trajectory is upwards. Neither country is close to being mature, but India — at least at the moment — is looking more sure-footed than China in this regard.

What is at the core of China’s growth problem? Simply put, it’s the contradiction inherent in the country’s self-titled, oxymoronic “socialist market economy” programme, initially launched by Deng Xiaoping and formally enshrined in 1992.

At its roots, China is not a market-based economy. Its separation of business and government remains ephemeral. Property rights are ill-defined and unenforceable, providing strong incentives for corruption. Identification of beneficial owner(s) and of who has ultimate control over decisions in some of the country’s key enterprises is opaque. The large state-owned banks hold little check, if any, over the large, backbone state-owned enterprises (SOEs) to whom they lend, and which often never pay off debts owed. Communist party officials occupy some of the most senior positions in the enterprise and financial sectors, including the recent appointment of the country’s top banking regulator as party chief and deputy governor of the central bank.

As well as all that there is a Potemkin non-state enterprise sector (often referred to as the “private” sector), which some well-respected China analysts a few years ago thought was on a sustainable growth path and would potentially overtake the SOEs’ role in the Chinese economy. But they were confused by cyclical aberrations (a bit of irrational exuberance) to a cemented secular trend of SOE dominance. In the past, the authorities worked to facilitate bank lending to the non-state sector. This year, there has been a return of the constraints placed on shadow banking, which is ossifying the flow of credit and raising funding costs to small and medium-sized private companies.

The socialist market economy paradigm is a stark illustration that the Chinese are trying to have their cake and eat it too. The rub is that SOEs constitute the Communist party’s raison d’être.

Perhaps the clearest sign of China’s self-inflicted ball and chain on growth is how global investors have been shunning foreign direct investment in the country. Between 2013 and 2017 — long before the onset of the trade war with the US — worldwide net FDI inflows to China fell steadily. Indeed, their magnitude in 2017, at $168bn, was below where they stood in 2008, at $172bn. Since annual net FDI inflows can be quite variable, measuring them as a share of GDP gives a more accurate depiction. This yields a particularly sobering picture: China’s net FDI inflows relative to GDP have been on an unmistakable downward trend, from 6.2 per cent in 1993 to 1.4 per cent in 2017, the lowest level since 1991.

To help rectify this problem, Beijing is trying to pass a new foreign investment law this year. The draft presently under debate was first unveiled in 2015. That fact alone illustrates that it has not been, and may still not be, an easy task to bring the party around to opening up the domestic economy as a means of generating new opportunities for growth.

Harry G Broadman is chief executive and managing partner of Proa Global Partners LLC, an emerging markets investment transaction advisory firm; a member of the Johns Hopkins Faculty; and an independent director on several corporate boards. He is a former US Assistant Trade Representative; private equity investment executive; PwC chief economist; World Bank official; and faculty member at Harvard University.

Speculators Are Making the Dollar Look Cheap

Investors may be wise to brace for an unwinding of the carry trade

By Jon Sindreu

The U.S. dollar has traded mostly sideways against the euro for the past six months, while losing ground against emerging-market currencies.
The U.S. dollar has traded mostly sideways against the euro for the past six months, while losing ground against emerging-market currencies. Photo: Mark Lennihan/Associated Press

Few would disagree that the outlook for the global economy has worsened over the past six months.

But the U.S. dollar hasn’t gotten the memo.

Every day brings fresh evidence that the Chinese slowdown is rippling across the globe. On Monday, oficial data showed a contraction in the U.K. economy in December, only part of which is likely attributed to Brexit. Last week, eurozone officials downgraded their 2019 growth forecasts following lousy German and Italian economic data.

Yet the greenback has traded mostly sideways against the euro for the last six months, while losing ground against emerging-market currencies.

It isn’t surprising that the dollar, as a haven asset, hasn’t benefited from this year’s recovery in risk appetite. What is strange is that it hardly gained during the market panic late last year.

Many investors point to the Federal Reserve, which has signaled a slower pace of rate increases.

This is seen as driving money out of the dollar into higher-yielding currencies.

Returns between currency pairs this year have been closely related to the difference between the yields offered by the currencies, as Meera Chandan, a foreign-exchange analyst at JPMorgan, recently pointed out. That suggests speculative flows—so called “carry trades”—are at work.

But high returns now are an unreliable indicator of future currency strength: If the difference between two countries’ expected economic potential shifts, so will their currencies. This is what happened to the dollar against the euro in late 2017 and early 2018: After years of woes, Europe’s future was looking brighter, so the euro rallied against the dollar despite Fed rate rises—puzzling many analysts.

It would be reasonable now to expect the opposite: a stronger dollar. The U.S. is one of the few countries with enough domestic might to offset a Chinese slowdown.

A bit of volatility would likely be enough to reverse speculative trades, since U.S. rates are still higher than in many other countries. And because a weak dollar helps developing economies attract funds, the unwind could prove painful. Emerging markets may be less safe than they look.

Lessons of East Asia’s Human-Capital Development

Given the effect of human capital on national productive and development capacities, developing countries should be placing a high priority on boosting human capital. The experience of East Asia’s prosperous economies holds valuable lessons.

Lee Jong-Wha  

school in hong kong

SEOUL – Nelson Mandela once said, “Education is the most powerful weapon which you can use to change the world.” Education does not just enable individuals to improve their lot in life; it enriches an economy’s human capital, which is vital to prosperity and social progress.

Nowhere is the value of human capital to development more apparent than in East Asia. The top four (of 157) spots in the World Bank’s recently introduced “Human Capital Index” – a composite measure of survival, learning-adjusted years of schooling, and health – are occupied by East Asian economies: Singapore, South Korea, Japan, and Hong Kong.

The new index estimates that a child born today in Singapore will be 88% as productive when she grows up as she could be if she enjoyed complete education and full health. In Sub-Saharan Africa, by contrast, a child will be only 40% as productive. Globally, 57% of all children born today will grow up to be, at best, half as productive as they could be.

Given the effect of human capital on productive and development capacities, developing countries should be placing a high priority – as East Asia’s most prosperous economies have – on boosting human capital, as they pursue sustainable and equitable growth. What lessons can East Asia’s experience provide?

From the early 1960s to the late 1990s, when many East Asian economies were undergoing rapid industrialization, the development of a well-educated and skilled labor force, combined with well-directed economic policies, was key to enabling the diversification and upgrading of export industries. In a virtuous cycle, rising incomes and industrial upgrading stimulated continuous investment in education and skills, which contributed to productivity increases, technological progress, and the achievement of equitable growth.

Public policy was central to this success, with East Asian leaders ensuring that economic-development plans and associated measures always accounted for human-capital objectives. In South Korea, each of the five-year development plans implemented from 1962 to 1996 contained action plans for manpower development, including education and training policies.

Such policies – designed and implemented in close coordination with industrial and trade policies – enabled East Asian countries to meet evolving economic demands in a cost-effective manner as the industrial structure continued to be upgraded. The key was a sequential approach.

Faced with a growing school-age population, weak educational infrastructure, and limited funding, owing to low levels of national income, the East Asian economies could not simply overhaul the entire system at once. So, early in the development process, as governments promoted labor-intensive industry, they focused on basic education. Later, when governments were promoting heavy manufacturing and technology-intensive industries, they focused on developing upper-secondary and tertiary education, vocational education, and training programs.

Another component of the East Asian economies’ strategies for developing human capital was a gradual shift in focus from quantity to quality. At first, when primary education was the emphasis, policymakers sought to get every child in school, even if it meant accepting lower-quality inputs, such as large class sizes. They then began to invest more in boosting the quality of primary schooling, say, by reducing class size and improving resources, from books to teachers. When the focus shifted to secondary and tertiary education, the same sequence was followed.

Of course, even with this sequential approach, considerable – and expanding – financial resources had to be directed toward education and skill development. From the start, governments allocated large shares of their budgets to these objectives. As national income rose and birth rates dropped, total and per capita educational expenditures increased continuously.

In the earlier stages of human-capital investment in East Asia, countries also relied on foreign aid. External financial and technical assistance was a great help to South Korea and Singapore, for example, as they established their education and training systems.

Later, the private sector played a significant role in East Asia’s educational and skills development, especially at the upper-secondary and tertiary levels. In South Korea, for example, about 60% of upper-secondary students were enrolled in private schools in the 1980s. The private sector was also encouraged to provide training: in Singapore, employers contributed to a skills-development fund to promote upskilling and retraining workers.

Learning from these experiences, developing countries today should move to invest a substantial and growing amount of the public budget – augmented by foreign assistance – into education and skills development, while working to attract private investment into higher education and skills training. They should take a more cost-effective sequential approach to upgrading their education and training structures, which complements their stage of development. And they should enshrine human-capital development in policy.

Many developing countries today boast rapidly growing young populations that could be a boon for economic growth and dynamism. But, to meet their potential, these young people need strong educational and employment opportunities. Without deliberate and practical human-capital strategies, that will be virtually impossible to deliver.

Lee Jong-Wha, Professor of Economics and Director of the Asiatic Research Institute at Korea University, served as Chief Economist and Head of the Office of Regional Economic Integration at the Asian Development Bank and was a senior adviser for international economic affairs to former President Lee Myung-bak of South Korea. His most recent book, co-authored with Harvard’s Robert J. Barro, is Education Matters: Global Schooling Gains from the 19th to the 21st Century.

Central Banks Signal End to Short-Lived Era of Restraint

Reversal could support markets in the months ahead, including sectors like housing and autos that are sensitive to interest rates

By Brian Blackstone

Jerome Powell indicated that the Federal Reserve was done raising interest rates for now, fueling a market rally.
Jerome Powell indicated that the Federal Reserve was done raising interest rates for now, fueling a market rally. Photo: Alex Brandon/Associated Press

A slowing global economy and low inflation has central banks around the world rethinking plans to gradually pull back financial stimulus from markets and the banking system.

The role reversal could support the economy in the months ahead and bolster markets and sectors like housing and autos.

Central bankers have geared their messages toward pausing on tightening steps rather than imminently launching new stimulus. That is because they doubt the global economy is going beyond a slowdown toward outright recession.

The Fed on Wednesday signaled that it was done raising interest rates for now to see if recent weakness abroad and political uncertainty leads to a sharper-than-expected slowdown in U.S. growth.

“We think that these…risks are going to be with us for a while,” Fed Chairman Jerome Powell said, after officials voted to hold rates steady. In a further sign of the abrupt shift, officials removed all language from their policy statement that had previously pointed to additional rate increases.

Central banks in South Korea, Malaysia and Indonesia kept rates unchanged this month after raising them in 2018. At its meeting last week, the Bank of Japan downgraded its inflation forecasts, suggesting no end in sight to its asset purchases and negative policy rate. China’s central bank, meanwhile, has taken a number of steps to improve credit to businesses.

In Canada, where the economy is sensitive to the U.S. and commodity markets, the central bank kept rates unchanged at 1.75% in January—it had raised them four times in a little more than one year through last October—and signaled a wait-and-see approach on future increases.

The Bank of England is expected to leave its rate at 0.75% when it meets next week, and future increases depend on how smoothly Brexit proceeds.

And last week, the European Central Bank downgraded its assessment of the European economy, opening the door to new stimulus including a promise to keep interest rates where they are for a longer period or a fresh batch of cheap loans to Banks.

Mario Draghi warned that recent economic data for the eurozone have been weaker than expected, and that continuing uncertainties, particularly relating to trade protectionism, are weighing on economic sentiment.
Mario Draghi warned that recent economic data for the eurozone have been weaker than expected, and that continuing uncertainties, particularly relating to trade protectionism, are weighing on economic sentiment. Photo: stephanie lecocq/Shutterstock

On Monday, ECB President Mario Draghi said restarting the giant bond-purchase program that ended in December was an option “if things go very wrong,” though he also said that isn’t his forecast.

Globally, trouble spots including Brexit and the U.S.-China trade dispute could sort themselves out, giving policy makers space to get back on track with rate increases later this year. Unemployment is low in many parts of the world and wages are rising, providing support to household spending.

Under this optimistic scenario, this year could turn into a repeat of 2016, when the Federal Reserve spent most of the year on the sidelines, after a single 2015 rate increase, while it monitored market correction triggered by worries of a sharp slowdown in China. It resumed rate increases at the end of that year.

The Fed’s Mr. Powell raised the analogy to 2016 at a Jan. 4 panel discussion when he sought to dispel market fears that the U.S. central bank was on a preset path to raise rates.

There is a risk that the global economy will turn out to be weaker than it was three years ago. With the U.S., China and Europe all slowing, the window for central bankers to increase interest rates and significantly shrink their bondholdings may have already closed. The International Monetary Fund this month cut its 2019 forecast for global economic growth to 3.5% from 3.7%, citing weakness in Europe and Asia.

“You can’t be in a tightening cycle if the economy doesn’t support it,” said Roberto Perli, head of global policy at Cornerstone Macro. The annual inflation rate in Europe and Japan is below the 2% rate that central bankers consider optimal, and could fall further. In the U.S. it has shown signs of slowing.

In Europe and Japan, negative interest rates are likely to persist for many months if not years, keeping bond yields low. In addition to holding interest rates for now, the Fed is eyeing a larger bond portfolio than it had considered before.

“The coordinating tightening of monetary policy can have effects on a weak economy, so the postponement of that tightening may have the effect of stimulus,” said Raghuram Rajan, who led the Reserve Bank of India from 2013 to 2016.

If the current pause turns into a full stop, then the Federal Reserve is best equipped among major central banks to pivot to interest rate cuts to reduce long-term interest rates and spur spending and investment should the U.S. economy falter. Its policy rate is in a range of 2.25% to 2.5%.

Still, the Fed’s policy rate is just half a point above the rate of annual inflation, a narrow gap 10 years into an economic expansion when inflation-adjusted rates are usually much higher. “If the economy can’t handle even that, and that growth is going to be hit, it does suggest a fairly weak global economy still,” said Mr. Rajan.

In contrast, negative rates in Europe and Japan give central banks there little recourse but to buy large amounts of public and private debt, or lend money to banks, if needed in a downturn. Credit is already ultra cheap in Europe, so it is unclear how much more stimulus can be delivered.

“If the next global downturn is anything more than a modest one, then central banks will quickly have to dip into their unconventional tool kits,” said Neil Shearing, chief economist at Capital Economics.

That is a shift from last year when the ECB was widely expected to raise its policy rate—which has been at minus 0.4% for nearly three years—later in 2019. Countries outside the eurozone but dependent on it for trade, like Switzerland which has a minus 0.75% policy rate, were expected to follow the ECB by the end of this year. But those forecasts have been pushed off as well.

—Nick Timiraos contributed to this article.

Dissenting Opinions: On an Intervention in Venezuela

George Friedman and Jacob L. Shapiro offer different perspectives on a potential intervention.

By George Friedman and Jacob L. Shapiro



Editor’s note: We at GPF are a group of (more or less) like-minded individuals writing for a common purpose – to make sense of the world. It’s a daunting job that makes it impossible for us to agree on everything, so rather than shrink from the task, we have decided to embrace the impossible by publishing the first of what we hope will be many Dissenting Opinions, a column that lays out what we disagree on and why. Your feedback, as always, is greatly appreciated.
For years, Venezuela has been the picture of protracted collapse, a feat made all the more impressive by the fact that its downfall was largely unassisted. Yet talk of foreign intervention abounds. A Russian plane recently landed in Caracas, and the rumor is it’s meant to pick up a few hundred million dollars worth of Venezuelan gold. The amount of money is less meaningful than the signal its transport sends – that President Nicolas Maduro is closing up shop. And since the United States has effectively severed ties with Citgo, Venezuela’s major financial asset and a subsidiary of its state-owned oil firm PDVSA, that may well be the case.
Parsing Maduro’s intentions isn’t all that interesting, and it’s not the point. What’s interesting is that the United States has for years observed the self-imposed failure of Venezuela with uncharacteristic nonchalance. Now it has acted, so the Russians and the Chinese are reacting as well.
Yet it’s difficult to think that any of them care enough to militarily intervene in Venezuela. Even Washington’s interests there are only mildly compelling. One is oil, but the importance of Venezuelan oil has declined, partly because of the surge of global production, especially in the U.S., and partly because Venezuelan production has steadily declined. Disruptions there affect some companies but are no longer strategically significant. (The wreckage of PDVSA is a legacy of the Chavez-Maduro era.) Another is narcotics. Colombian production has been vectored through Venezuela and the rumor is that senior Venezuelan government officials are involved in the trade. But this seems a thin reason to get directly involved in regime change.
Indeed, these interests are neither new nor, where the U.S. is concerned, particularly pressing. Venezuela is simply pretty low on Washington’s list of strategic considerations. It would prefer that Venezuela and Latin America be stable, so in that sense, there are a variety of regional implications of Venezuela’s demise. The country’s economic deterioration has produced a massive outflow of migrants to other Latin American countries, which are naturally worried about the costs, real and perceived, that immigration entails. These countries would ordinarily oppose U.S. intervention – they remember Washington’s legacy in that regard, and they certainly want to avoid being Washington’s next target – but many believe that something must be done about Venezuela, hence why most of Venezuela’s neighbors support opposition leader Juan Guaido, and that the U.S. is the only one that can do it. (They will, of course, reserve the right to criticize the U.S. when it suits them.) Where stability is concerned, sanctions and speeches are low cost and high return.
But intervention is never easy, even if it’s “welcomed,” since so many outside players are involved. For one, an action against Venezuela is also an action against Cuba. The reconciliation started by President Barack Obama’s administration has gone nowhere. Powerful forces in Cuba, most notably the intelligence service, are doing extremely well under the communist government in Havana, and they have no desire to liberalize the economy. (President Donald Trump, too, is skeptical of Cuban relations and so has undone some of the progress made by his predecessor.) Cuban intelligence has, meanwhile, been a major factor in guaranteeing the survival of the government in Caracas. Hugo Chavez and Maduro got to stay in power, and Cuba got discounted oil and a foothold in South America. Allowing Maduro to fall goes against Cuba’s interests.
Then there are the Russians, who are looking for every opportunity to demonstrate their relevance to the world and to their constituents. They are not global players, so they need to make global gestures. Without the resources to stabilize the Maduro government, they’ve resolved to nibble on the edges, hinting at using Venezuela as a base for military operations and landing a cargo plane there. Flying to an embattled country to collect gold certainly sends a message of importance. Offering to broker talks between the U.S. and Venezuela does too. It may or may not be an effective message, but it does drive home the notion, in theory, that Russia is powerful.
China is playing a similar game. It is opening a door for military bases in the country, something that Maduro would welcome but is ultimately pointless considering Venezuela is on the wrong side of the Panama Canal, from a Chinese military perspective. Maintaining a substantial ground or air force at that distance requires a maritime-based logistical system, and that system would be highly vulnerable to U.S. counteraction. The Panama Canal is, by definition, a chokepoint that could easily disrupt those logistical systems. It’s understandable why China would hypothesize such a strategy; doing so would capture Washington’s attention, taking its focus off the South China Sea. But the idea falls apart as soon as it’s examined.
Venezuela, then, is a strategic crisis for no one other than Venezuela. For others, the country is a source of irritation and opportunity. The U.S. is irritated at Maduro and at the Cubans. So it takes minimal steps with maximum effect, using vague military threats that would lead to a backlash in Latin America the U.S. doesn’t need. The Russians are sending planes and diplomatic notes to irritate the United States and to try to get the U.S. to do something foolish. As part of its strategy to appear as if it is deploying to the Western Hemisphere, Beijing won’t pass up an opportunity to make a suitably meaningless gesture.
No one will take major risks for or against the Maduro government. The noise surrounding its demise is made by those who want to use Caracas as a cudgel against their adversaries. That’s not to say that escalation is impossible, or that things won’t get worse for the Venezuelan people before they get better. It’s just to say that more often than not, strategy dictates decisive action.
Jacob, I understand that you don’t fully agree with my assessment. I’d love to hear your thoughts on why that is.
George Friedman, founder and CEO

It’s clear we agree that the White House’s stated reason for involving itself in Venezuela – the restoration of democracy – is not the real U.S. interest here. That is the kind of argument made by Trump administration officials who believe that a vibrant democracy in Venezuela is a matter of U.S. national interest. (Some of them are the same decision-makers who guided U.S. foreign policy through the invasion of Iraq in 2003.) But I differ with you, George, on what the United States’ primary interests are in Venezuela. I don’t think they are oil and drugs. The U.S. interest in Venezuela is maintaining the U.S. position as the strongest power in the Americas and preventing foreign powers from intervening in their affairs. Venezuela’s slow decline creates opportunities, even if they are remote ones, for others to challenge the U.S. in a sphere of influence it claimed for itself as early as 1823.
My biggest disagreement is that the U.S. has already shown that it’s interested enough in Venezuela to intervene there in every possible way except militarily. Last Tuesday, the vice president of the United States called Juan Guaido, head of the National Assembly, and told him that the U.S. government would support him if he took over the Venezuelan government. The next day, Guaido declared himself interim president, and Washington immediately recognized him as leader of Venezuela. In other words, Guaido is the United States’ handpicked choice as Venezuela’s next leader. Then on Monday, the United States imposed sanctions against state-owned oil company PDVSA to cut off the Maduro government’s primary source of revenue and redirect it to Guaido. The U.S. also wants to give Guaido control over some Venezuelan assets held by the Federal Reserve Bank of New York and other U.S.-insured banks. This harkens back to the heavy-handed U.S. intervention in Central and South America throughout the 20th century, and it confirms one of our key forecasts for the region in 2019.
We both know that most sanctions deliver more bark than bite, but the ones the U.S. imposed this week are going to hurt. Nearly half of the Venezuelan government’s revenue, and practically all of its export earnings, comes from oil. U.S. crude oil imports from Venezuela have declined by almost 40 percent in the past two years, but even so, the U.S. consumed almost half of Venezuela’s total oil output before the sanctions were put in place. With a glut of oil already on the market, and with U.S. production increasing, the U.S. can use these sanctions as Teddy Roosevelt’s proverbial “big stick.” Soon after the sanctions were announced, Guaido said he was beginning the “progressive and ordered takeover” of Venezuelan state assets abroad, in addition to naming new boards of directors for PDVSA and its U.S. subsidiary, Citgo. Guaido has not yet been able to secure the support of the Venezuelan military, but the U.S. is doing everything it can to ensure that the buck (or the bolivar) no longer stops at Maduro.
The U.S. is doing all this not simply because it’s irritated but because it can’t afford to manage all the foreign policy issues it needs to manage globally if Venezuela is a glaring vulnerability.
The proof is in the breakdown of which countries support Guaido and which do not. Russia and China continue to recognize Maduro and are the likeliest countries to use Venezuela as a pawn against the United States. To your point, George, neither China nor Russia can sustain military forces in the Atlantic Ocean, so neither is able to use Venezuela the way, say, the Soviet Union used Cuba in the 1960s. For Moscow and Beijing, the important thing is to distract Washington with Caracas, not to co-opt it completely. If the U.S. overreacts by deploying its military, even that could play to their advantage as it would bog down the U.S. in yet another conflict. China is playing a long game, and from its perspective, the more hostility generated between the U.S. and Venezuela, the better the prospects for a strong relationship between Caracas and Beijing.
Iran and North Korea have also announced their support for Maduro. This is hardly surprising, but you can start to see the faint lines of what could become an unintentional yet potent axis of significant anti-U.S. powers. The responses of two other countries – Turkey and Mexico – are more surprising and thus more interesting. Turkey has grown closer to Venezuela in recent years, a small facet of its overall attempt to reposition itself as a regional power instead of as a U.S. lackey in the Middle East. Mexico, though, is the stunner to me. President Andres Manuel Lopez Obrador didn’t criticize Venezuela during his presidential campaign, but I didn’t think that meant he would break with the U.S. on an issue this serious. Under the administration of former President Enrique Pena Nieto, Mexico joined the U.S. and most South American countries in opposing Maduro, but under Lopez Obrador, Mexico is now advocating a policy of non-interference and refusing to recognize Guaido. Put simply, Mexico is opposing the United States’ most serious attempt at regime change in South America since the 1970s, and in so doing, it’s aligned with U.S. strategic competitors. These are the sorts of unintended consequences that could become a much bigger problem than the fate of Maduro.
I agree that Venezuela’s internal crisis is not a strategic problem for the United States. But I also think the deterioration of the Venezuelan economy and political structure presented a strategic opportunity for U.S. adversaries, who already had a foot in the door after Chavez’s rise to power in the early 2000s, to sink their claws in deeper. The United States has decided to intervene, with a combination of political and economic measures, to achieve regime change and install a friendlier government while the cost is still low. The question now is whether Washington’s cure is worse than Venezuela’s disease. Previous U.S. interventions in Latin America created brittle pro-U.S. regimes that often turned the hearts and minds of the people against the U.S. – and in other cases simply caused chaos. They may have had some short-term benefits, but over the long term, these interventions caused as many problems as they solved. It’s hard to see how Venezuela will be any different.
I do not agree that Venezuela is so unimportant that no country would be willing to take major risks on its behalf. The U.S. just took a major risk by committing political and economic resources to remove Maduro from power. It’s doing so because it has the opportunity to oust a regime hostile to the United States at a time when Venezuela’s boisterous allies are incapable of coming to its aid. Tellingly, the U.S. has had a hard time articulating its interests in these stark terms, so it has resorted to the justification of advancing democracy. The last time the U.S. tried to advanced democracy in a foreign country – Iraq – it set off a chain of events that Washington is still dealing with today. The challenge going forward will be ensuring that this intervention does not precipitate the very strategic crisis it is meant to prevent.
Jacob L. Shapiro, director of analysis