Uncovering Peru’s neglected splendours

The country fails to make the most of its recent archaeological finds

One night in 1987 the police woke Walter Alva, a Peruvian archaeologist, and invited him to come to inspect some stolen gold objects. The tip would lead Mr Alva to discover the intact tomb of a ruler of the Mochica (or Moche) civilisation, whom he dubbed the Lord of Sipán. It held the lord’s full regalia of gold breastplates and crowns, exquisite nose- and ear-pieces and a unique necklace of giant gold and silver peanuts.

It was the start of an archaeological revolution in northern Peru. Since then Mochica temples, built from mud reinforced with gravel and shells, have been unearthed at Huaca de la Luna, near the colonial city of Trujillo. They are decorated with embossed and colourfully painted friezes of fanged warlord deities and bound prisoners. In 2005 at a site called El Brujo, Régulo Franco, another archaeologist, found a tomb almost as rich as that of Sipán, but of a woman, now known as the Lady of Cao.

These discoveries underline that ancient Peru was one of the half-dozen cradles of civilisation. It remains a creative place, as its gastronomic boom attests. But modern Peru’s dysfunctions are preventing it from reaping the full benefit of the new finds.

The Mochicas thrived from around 100 to 600ad by irrigating the valleys of the coastal desert. Theirs was perhaps the most artistic of Peru’s ancient cultures, far more so than the much later Inca empire. Apart from their metallurgical prowess, they were skilled potters, producing sculpted vessels and stirrup-spouted jars on which they recorded their likenesses, lives, animal deities and religious ceremonies. Thanks to the recent tomb discoveries, it is now clear that some of these representations accurately portrayed priests and rulers.

Although the pots and friezes describe warfare and human sacrifice, archaeologists now believe these were rituals to placate the deities of a people acutely vulnerable to drought and flood. “There are no Mochica fortresses, there are temples,” says Ricardo Morales of the University of Trujillo, who directs the Huaca de la Luna site. Recent scholarship also suggests that there was no Mochica super-state, but rather a collection of local lordships in each valley, linked by a common religious ideology and iconography. Finding the Lady of Cao “changed our conception of power in ancient Peru”, and the role of women within it, notes Mr Franco.

The Sipán treasures are displayed at a superb museum, directed by Mr Alva, in a nearby town. There are museums on site at Huaca de la Luna and El Brujo, both run by non-profit foundations. They represent a kind of miracle. For decades locals lived from tomb-robbing, and Peru’s treasures were melted down or sold on an international black market. The country has around 100,000 archaeological sites. It is impossible to police them all.

Although funds are always tight, the archaeologists are trying to win over the locals. Mr Morales says he sees Huaca de la Luna as a “development pole”. His project employs 38 staff, while another 98 sell handicrafts to visitors. Peru is developing archaeological skills. Whereas many of the Sipán artefacts were sent to Germany for conservation, this was done on site for the Lady of Cao. The archaeologists say that the biggest impact of their discoveries is on Peruvians’ self-esteem. “There wasn’t a native hero,” says Mr Alva. Now there are several. At the village next to El Brujo, dna testing is under way to see whether the residents are descended from the Lady of Cao.

Visitor numbers are rising, but remain low. The Sipán museum received 198,000 last year, mostly Peruvians. Despite recent decentralisation, Peru revolves around Lima. The government promotes the Inca sites of Cusco and Machu Picchu, although they are saturated with tourists (1.4m went to Machu Picchu in 2017). Roads in the north are vulnerable to the El Niño flooding that helped to end the Mochica civilisation. Because of a damaged bridge, the fastest bus between Trujillo and Chiclayo, the two main cities, takes almost five hours to cover 200km (125 miles). There are few good hotels. Official incompetence leaves roadsides strewn with rubbish.

Yet from the top of the temple mount at El Brujo the view is breathtaking: the Pacific breakers, the desert and the sugar-cane fields that stretch to the Andean foothills. Turkey vultures glide overhead. The archaeologists have revealed that what once seemed to be desert hillocks were the ramped, decorated and tomb-filled temples of one of the world’s most sophisticated early civilisations. They deserve to be far better known.

Bringing out the big guns

The Pentagon changes its focus to Russia and China

After 18 years of IEDs in the Middle East, America’s armed forces are planning for high-tech warfare
PATRICK SHANAHAN draws his finger down a list of his priorities for the Pentagon: hypersonics, directed energy, space, cyber, quantum science and autonomy. It could not be further from the dusty battlegrounds of the past 18 years. “When we talk about space, this is not designed for counter-terrorism,” he says. Mr Shanahan, a former Boeing executive, was propelled into the job of secretary of defence in January, having served as understudy to James Mattis for less than 18 months. He has taken the helm of an organisation that is in the throes of change, as it prepares for life after the wars in Iraq and Afghanistan.

In January 2018 the Trump administration published its National Defence Strategy (NDS). Officials lamented that nearly two decades of whack-a-mole against insurgents and jihadists had eroded the country’s military edge, resulting in exhausted and under-trained units armed for the wrong enemy. So the NDS decreed that America would henceforth focus on “long-term, strategic competition between nations”—namely, China and Russia. Mr Shanahan was charged with implementing the vision while Mr Mattis travelled around the world calming ruffled allies.
“This is the first time since the Reagan era where the United States has been motivated to modernise its war-fighting architecture, its technologies,” says Michael Griffin, the Pentagon’s technology chief. “The first time we’ve been forced to think about how we fight war.”

One priority is to re-tool the armed forces with the weapons they need. Mr Griffin paints a picture of each service wielding its own ultra-fast and long-range hypersonic missiles, fed information from a vast satellite network girdling the skies, all of it supported by a procurement process that can spit out high-tech weapons in years rather than decades.

David Norquist, Mr Shanahan’s acting deputy and the Pentagon’s finance chief, points to rising investments in firepower-heavy platforms, like the Virginia-class submarine and new B21 bomber. But he also acknowledges that big planes and ships may not survive for long under a hailstorm of Chinese or Russian missiles. So money is also going to larger numbers of smaller, cheaper and dispersible platforms—like an unmanned boat.

The second priority is ensuring that the armed forces not only have the arms they need, but also the training and readiness to use them in the sort of fighting they would face in eastern Europe and the western Pacific. Disaster relief is nice, says one general, but “this is a warfighting operation.” Ryan McCarthy, undersecretary of the army, says that half his brigade combat teams—freed from what was an intense pace of deployments—are now at the highest level of readiness, up from a small fraction of that two years ago. Basic training is being increased from 14 to 22 weeks.

Training and exercise scenarios are adapting, too. They increasingly reflect “large force-on-force conflict against very high-end adversaries,” says John Rood, the Pentagon’s policy chief. Soldiers who once practised dealing with terrorists’ roadside bombs now drill in dodging enemy air strikes or chemical weapons. The army is raising new battalion-sized forces, one apiece for Russia and China, which integrate cyber, electronic warfare and space capabilities—skills that were lost or neglected in the counter-insurgency years.

A third focus is changing what the Pentagon actually does with its troops, planes and ships. “The basic concept”, says Mr Rood, “is that we’re going to give priority to the Indo-Pacific.” He points out that 2018 saw the longest absence of an aircraft carrier from the Persian Gulf since 2001; two carriers were instead sent to the Pacific.

A working group at the joint staff has been poring through 150-odd “global execution orders” (directives to commanders around the world) that have accumulated over the years, weeding out those which do not fit with the NDS’s focus on great power competition. Seven out of eight advise-and-assist missions in Africa Command have already been cut. Central Command, which covers everything from Egypt to Pakistan, will have more fat shaved off.

But rebalancing is only part of the story. The most significant element of the NDS, says Mr Shanahan, is “dynamic force employment” (DFE in mil-speak). That refers to moving forces around the world quickly and unpredictably to bamboozle adversaries. Last year, for instance, the USS Harry S. Truman, an aircraft-carrier that usually hangs around the Middle East, was abruptly called home midway through her deployment cycle and then suddenly sailed into the Arctic Circle—the first carrier to do so in 27 years—to join massive NATO exercises. For a carrier, whose movements are planned years ahead, that is warp-speed. Similar surprise deployments of bombers, fighter aircraft and surface-to-air missiles are being planned under DFE.

Despite all this, insiders grumble that civilians have not forced services to change spending patterns drastically enough. Rear-Admiral Mark Montgomery, former policy director for the Senate Armed Services Committee, is concerned that the army is still buying too many vehicles initially designed for low-end war, such as light tanks. Chris Brose, the committee’s former staff director, says the Pentagon is not doing anywhere near enough to develop, build and test the huge numbers of autonomous, unmanned systems it needs.

Mr Shanahan urges sceptics to wait for the 2020 budget, which he has called “a masterpiece”. “What you’ll see in these budgets is a sizeable investment in these critical technologies and programmes, whether it’s autonomy, artificial intelligence, hypersonics, cyber. The critics haven’t had exposure to those plans yet.” He adds, coyly, that “there’s a good portion of the budget you won’t ever see”, implying that more radical efforts may be buried in classified spending. And he is confident that he can remould a 700,000-strong bureaucracy. “People like myself, we spend our whole life implementing. We know how to move large organisations. We know where to place our bets.”

Debt machine: are risks piling up in leveraged loans?

Regulators fear looser lending standards for low-rated companies could precipitate the next downturn

Joe Rennison and Colby Smith in New York

© Adam Simpson

With 18.7m followers and a roster of fans that includes the Kardashians and Naomi Campbell, the Instagram page of beauty company Anastasia Beverly Hills offers crafty demonstrations of how to use its products to get the perfect eyebrows and lips. In one image, a model has a tiny heart carved into her manicured eyebrow.

The successful social media account is more than a marketing tool, however, for the cosmetics business owned by Romanian-born billionaire Anastasia Soare. It was also listed as one of the company’s “general intangible” assets in documents for a $650m loan to fund a partial buyout by private equity firm TPG Capital, according to people familiar with the deal.

Even more striking than the eyebrow-raising collateral, the loan came with few of the investor protections that were once standard in loan documents, such as the ability to potentially move assets out of the reach of lenders. Such provisions have been criticised for undermining investors’ claims on a company’s collateral in the event of financial problems — even an Instagram account.

Anastasia Beverly Hills and TPG declined to comment. Anastasia Beverly Hills is one of the many companies that have sought cheap financing in recent years through the so-called leveraged loan market, where credit is typically extended to lowly rated, more indebted companies and which has overshadowed the much better known high-yield bond market as a source of financing.

The leveraged loan market has exploded since the financial crisis, doubling in size over the past decade to $1.2tn, according to data from LCD, a division of S&P Global Market Intelligence. With investors of all different types eager for higher returns, companies have been able to borrow money on increasingly favourable terms, giving them greater flexibility should they run into trouble.

Anastasia Beverly Hills’s loan is not the most egregious example, but it is indicative of a market that has eviscerated traditional investor protections and made looser lending standards common. The shift has prompted a rising chorus of voices to warn that the deterioration in underwriting standards could amplify the next downturn.

Anastasia Beverly Hills, founded by Anastasia Soare, is one of many companies to have sought cheap financing

“All the ingredients are there within this sector of the market for there to be meaningful problems when the economic slowdown does occur,” says Dan Ivascyn, chief investment officer for Pimco, one of the world’s largest asset managers.

Looser lending standards are less important while the economy is robust and the likelihood of companies defaulting is low. But concerns over slowing growth are mounting, and a flash of market turbulence sent leveraged loan prices sliding in December. Although the market has since stabilised, the tumble was arguably a dry run for what could happen in a recession — which some analysts and fund managers say could be within the next couple of years.

The bout of uncertainty has sparked more scrutiny of the leveraged loan market, with organisations such as the Federal Reserve, IMF and the Bank for International Settlements all sounding the alarm about the potential broader risks to the economy.

“If we have a downturn in the economy, there are a lot of firms that will go bankrupt, I think, because of this debt,” Janet Yellen, the former chair of the Federal Reserve, warned last year. “It would probably worsen a downturn.”
 When the global financial crisis erupted in 2008, central banks around the world slashed interest rates and bought trillions of dollars worth of bonds, pushing yields down. That forced investors to look elsewhere for higher returns. One beneficiary was the leveraged loan market.

Loans had performed relatively well throughout the financial crisis, and investors were attracted by the fact that the debt is backed by assets, unlike the unsecured bond market.

The high-yield bond market — often called “junk” and a traditional source of funding for riskier companies — has also grown, increasingly favouring larger deals. But the balance has gradually tipped toward the leveraged loan market, where many smaller, lower-rated companies that might struggle to issue in the junk bond market, have been able to find suitors. Loan issuance has edged past that of the junk bond market as a result.

In December 2015, as the US economy continued its recovery, leveraged loans received another boost; the Fed began to raise interest rates. One of the attractions of investing in loans instead of junk bonds is that the interest rate paid to investors fluctuates in line with benchmark rates. As the Fed embarked on raising rates, loans became an attractive way to take advantage.

But the combination of rampant investor demand and companies willing to take on more debt has led to a gradual deterioration in lending standards. For a third of all loans issued in 2018, leverage levels crept above six times, according to LCD, exceeding guidance put out by the Office of the Comptroller of the Currency in 2013, an independent bureau of the US Treasury.

So-called financial maintenance covenants — things that would limit the amount of leverage a company could take on, or mandate thresholds for the amount of cash they needed on hand to pay interest on their loans — have close to disappeared. More than 80 per cent of the market is now deemed “cov-lite”, according to LCD, meaning financial maintenance protections have been removed.

PetSmart is embroiled in a lawsuit with its lenders

But the loosening of lending standards did not stop there. Neiman Marcus, the department store, and its thriving Munich-based online retailer Mytheresa, which sells pricey garb from designers such as Versace and Balmain, is a case in point. Since Neiman Marcus bought Mytheresa in 2014, Mytheresa’s sales have nearly tripled.

That’s why creditors to Neiman Marcus were aggrieved when its owners — private equity firm Ares Management and the Canada Pension Plan Investment Board — in September transferred Mytheresa to Neiman’s parent company. This potentially put the assets of Mytheresa out of reach of Neiman’s creditors just before the parent company announced it would need to restructure its nearly $5bn in debt.

One of the attractions of investing in loans instead of high-yield bonds is precisely that the debt sits higher up the capital structure, being repaid first if problems arise and giving investors a claim on assets if things turn sour. Creditors were especially unimpressed by the decision taken by Ares and CPPIB to strip out such a valuable asset as Mytheresa, given concerns about Neiman’s solvency.

“You have allowed, or have turned a blind eye to the sponsors’ not-so-subtle, sleight of hand machinations to lure creditors into a false negotiation meant only to perpetuate their self-serving enrichment scheme,” wrote Daniel Kamensky of Marble Ridge Capital in a letter to the parent company’s board just prior to filing a lawsuit in December.

In a statement to the Financial Times, Neimen Marcus refutes Mr Kamensky’s claims. “This distribution was expressly permitted by the company’s credit documents . . . The company is not in default and has never been in default. There is no reason to believe we will be in default in the future. The company is not insolvent and the organisational change to Mytheresa did not change that.”

Neiman Marcus is not alone in pursuing this tactic. Of the top 20 private equity-sponsored loan deals in 2018 approximately 80 per cent contained a loophole that could see loan investors’ claim on collateral diluted, according to Covenant Review, a credit research group.

Documents underpinning a loan to ailing PetSmart, which sells food and other products for household animals, allowed its private equity backers, BC Partners, nearly “unlimited flexibility”, according to Ian Walker of Covenant Review. Not only did PetSmart move valuable assets out of reach of loan holders in June, it also paid a dividend to a holding company controlled by BC Partners. PetSmart is now embroiled in a lawsuit about the legality of the move with its lenders. BC Partners declined to comment. PetSmart did not respond to a request for comment.

Janet Yellen, former chair of the Federal Reserve, has warned of the potential broader risks to the economy © Getty

For some investors, no deal has drawn as much scepticism as Blackstone’s $17bn leveraged buyout of Thomson Reuters’ financial data business — later renamed Refinitiv. The deal, one of the biggest LBOs since the financial crisis, was financed largely with a mix of leveraged loans.

“To me I think Refinitiv would be the poster child of the peak of the market,” says Craig Russ, a portfolio manager at Eaton Vance, which manages some of the largest loan mutual funds. “It was a very aggressive deal, highly leveraged, crappy docs but people bought it up.”

The Refinitiv deal was seen as one of the most striking examples in the leveraged loans market of the use of so-called “add-backs” to earnings before interest, taxes, depreciation and amortisation. By counting potential cost savings or other ambitious, theoretical efficiency improvements, companies can appear more creditworthy. But if these “add-backs” are not realised, the actual leverage levels can spike dramatically.

At 5.7 times when the deal was issued, Refinitiv’s leverage levels seemed quite modest at first glance. However, to get to this figure, it factored in $650m worth of cost savings within three years. Should Refinitiv fall short of this lofty target, its leverage levels could balloon, according to Minesh Patel, a director at S&P Global Ratings. Blackstone declined to comment.

The private equity firms behind some of these loans say many of these concerns are overblown. For a start, they insist that investors know exactly what they are signing up to — the changes to covenants appear in legal documents. They also argue that no legal safeguards could protect investors from lending money to a bad company.

“The main point is if a manager is bad at credit underwriting, the existence of covenants alone won’t protect you from bad credit risks and eventual realised losses — credit selection is the most important factor,” says Keith Ashton, the co-head of structured credit at Ares Management.

Tighter loan conditions can still help investors, however. Rating agencies say that given the weaker lender protections, the amount that investors can recover will be far lower than in the past if highly leveraged companies begin to default.

The US default rate is now just 1.6 per cent, well below the historical average of 3.1 per cent, says Ruth Yang, a managing director at S&P Global Market Intelligence. In fact, they could stay this way for some time in part because covenants remain so loose.

“Cov-lite takes away the canary in the coal mine for lenders,” Ms Yang says. “But it also allows borrowers who are struggling but are still well placed financially to keep making required payments on loans to not be forced into default.”

Moody’s estimates that recoveries on so-called first-lien loans — which rank first in a debt workout — would likely fall from the historical average of 77 cents on the dollar to 61 cents. The recoveries on riskier “second-lien” loans will tumble from 43 cents to just 14 cents, the rating agency predicted.

Christina Padgett, senior vice-president at Moody’s, warned last year that a “combination of aggressive financial policies, deteriorating debt cushions and a greater number of less creditworthy firms accessing the institutional loan market” was creating credit risks.

Thomson Reuters chief executive Jim Smith. Blackstone’s $17bn leveraged buyout of Reuters’ financial data business drew scepticism from some investors © Reuters

The first inkling of the potential trouble ahead came in the final weeks of 2018, when investors grew nervous over the combined impact of slower economic growth and higher US interest rates, sending financial markets tumbling.

Loan prices slid more than 3 per cent in December, the worst month for the loan market since August 2011 when the US government was downgraded and lost its coveted triple A rating. Between November 15 and January 2 investors pulled more than $16bn out of loan mutual funds and exchange traded funds. Much of that was concentrated among a handful of dominant players.

But the new year has brought some renewed optimism to the market. The S&P loan index has recovered by 2.2 per cent. Douglas Peebles, chief investment officer of fixed income at AllianceBernstein and long a leveraged loan bear, now thinks the market is healthier, after the sellout cleared out some of the “weak hands” in the market.

The December sell-off also forced Wall Street banks stuck with unsold loans to offer better terms to investors.
“To get a deal through the market now, it is going to have less leverage, tighter documents and a higher coupon,” says Mr Russ.

But some lawyers say they will still try to keep the balance tipped towards borrowers, especially when it comes to loosening lender protections further.

Our job is to make sure that our clients have the maximum amount of flexibility to execute [their deals],” says Jason Kanner, a partner at law firm Kirkland & Ellis. “We’ll come up with new stuff.”

How Bad Is the China Slowdown? U.S. Companies Offer Some Answers

Fourth-quarter results from U.S. companies indicate that slowing growth in China is modest, but broad

By Austen Hufford and Theo Francis

An employee drives a forklift loaded with vehicle panels at the SAIC-GM-Wuling Automobile Co. Baojun Base plant in Liuzhou, Guangxi province, China. Qilai Shen/Bloomberg News

An employee drives a fork lift loaded with vehicle panels at the SAIC-GM-Wuling Automobile Co. Baojun Base plant in Liuzhou, Guangxi province, China.

To gauge the scope of China’s economic slowdown, begin with forklifts.

The factory workhorses are a barometer of the manufacturing sector’s fitness. Changes in demand can ease or worsen concerns about China.

By that measure, EnerSyssees trouble.

The Reading, Pa., maker of batteries that power forklifts said those sales in China fell in the latest quarter after rising 10% or more earlier in the year.

“We’ve seen a slowdown,” said Michael Schmidtlein, EnerSys’ finance chief. “Given that forklifts are a good indicator of economic activity, their general economy has slowed, and maybe far greater than the authorities are indicating.”

Fourth-quarter results from U.S. companies highlight the many and varied ways that China’s cooling economy affects American business, and, in turn, offer a glimpse of what’s happening inside China. The indications are that slowing growth there is broad, if still modest.

For U.S. businesses, the repercussions extend well beyond slowing sales at companies with the biggest exposure to China’s vast economy.

Companies like EnerSys are struggling with weaker demand from export manufacturers in China, which are pulling back amid fears that trade tensions will worsen. Retailers and other companies catering to Chinese consumers face signs of weakness among the country’s growing middle class. They are buying fewer cars, phones and are traveling less. 

Some analysts expect that China’s slowing growth, and its effects on U.S. companies, will worsen in the first quarter. A recent business-sentiment survey from Oxford Economics found that many North American and European businesses see elevated risks of a sharp global downturn, with many citing China’s economy and its policy response as significant risks.

“The expectation is that Q1 is going to be brutal,” said Brad Setser, former deputy assistant Treasury secretary for international economic analysis in the Obama administration, and now a senior fellow in international economics at the Council on Foreign Relations.

Chinese exports slowed in December and are likely to decelerate more sharply in the first quarter, Mr. Setser said, especially if trade tensions with the U.S. aren’t resolved: “The question is, will the trade truce plus China’s internal stimulus put China’s economy back on a stable path?”

U.S. and Chinese officials will meet this week for trade negotiations ahead of a March 1 deadline. President Trump in early December delayed plans to increase tariffs on $200 billion of Chinese goods to 25% from 10%, giving the two sides time to strike a comprehensive trade deal.

The uncertainty over the path of China’s economy has gripped the attention of U.S. executives and Wall Street analysts. They mentioned China 225 times during investor conferences and calls for current S&P 500 companies through the first full week of February—the most over the same period in at least a decade, according to a Wall Street Journal analysis of transcripts from FactSet. 

General Motors Co.reported a 25% decline in the number of vehicles it sold in China in the fourth quarter compared with a year earlier—a grim turn in a year with a 9.8% sales drop. GM’s sales shrank faster than those of the industry as a whole, which declined 20% in the fourth quarter and about 6% for the year.

GM attributed its weaker performance largely to its lower-margin Wuling and Baojun brands in smaller Chinese cities, where a softening real-estate market has soured consumer sentiment. The company’s luxury Cadillac brand, however, rose 17% last year over 2017, driven by sales in China’s largest and most affluent cities.

One bright spot comes from continued spending by wealthy buyers. Estée Lauder Cos. said sales in the Asia-Pacific market, led by China and Hong Kong, rose 20% in the second half of last year. Chief executive Fabrizio Freda said in an earnings call last week that high-end beauty products are a relatively affordable luxury that younger Chinese shoppers keep buying, despite a decelerating national economy.

Jeweler  Tiffany & Co. ,which rings up as much as 30% of its sales from Chinese consumers, said sales in China rose by more than 10% in the two-month holiday period ended Dec. 31.

Outside China, the prospects look less cheery. Analysts say most of Tiffany’s sales to Chinese consumers are from Chinese tourists shopping in Hong Kong, Europe and elsewhere. That business hasn’t held up as well. Chinese tourists bought less in the Americas and in Hong Kong in the quarter that ended in late October, the company said.

Tourism sales also slipped over the holiday period, Tiffany said in a mid-January report. The company traces softened tourist sales to a stronger dollar, which raises travel and overseas shopping costs for Chinese consumers.

Gene Ma, head of China research for the Institute of International Finance in Washington, D.C., said government rules to stem capital outflows, including tighter ATM withdrawal limits, likely depressed sales to Chinese tourists abroad, among other factors.

China’s girth

Despite slowing, China still posted economic growth above 6% last year, easily surpassing the U.S. and Europe.

The country’s 1.4 billion people and rising middle class bought nearly $52 billion worth of iPhones and other Apple Inc.products in the fiscal year that ended on Sept. 29. Rapidly expanding megacities such as Shanghai are dotted with Starbuckscoffee shops, and new buildings ferry passengers on Otis elevators made by United Technologies Corp.

China’s size and rapid growth in recent years, together with the expansion of American businesses within its economy, mean even a modest slowdown can be felt along supply chains that stretch world-wide.

Chinese tourists pass a Tiffany & Co. store in Hong Kong.
Chinese tourists pass a Tiffany & Co. store in Hong Kong. Photo: Kin Cheung/Associated Press 

As more companies flagged economic weakness in China in their fourth-quarter results, investors and analysts have worked to untangle the impact on U.S. companies and economic sectors. Many companies disclose sales in Asia, and to a lesser extent in China, but exposure to the Chinese economy is much broader.

Companies such as Mastercard Inc.,for instance, have no direct business within China’s domestic economy. Yet it can see the effect of slowing growth, Mastercard CEO Ajay Banga told analysts in a Jan. 31 conference call. “Given the size of the Chinese economy, it does impact the global economic picture.”

About a third of companies in the S&P 500 generate no direct revenue from China, according to estimates by FactSet, based in part on company disclosures. Another third generate at least 3% of sales in China. About 60 of the biggest U.S. companies generate 10% or more of sales there.

Many are technology and industrial companies that sell components to manufacturers that make products in China for export elsewhere, limiting their exposure to a slowing Chinese economy.

“Everything is built in China but it doesn’t necessarily stay in China,” said Christopher Rolland, a semiconductor analyst at Susquehanna International Group. Sales numbers, he added, can be “an overrepresentation of true Chinese demand.”

Not all business problems in China are driven by tariffs or slower growth there. Tupperware Brands Corp., which markets its plastic food containers through a network of individual sellers, last month said revenue and profit across several of its units were below internal projections. The company, in part, blamed weakness in China. The company’s shares fell 27% that day.

Doug Lane, who runs a boutique investment research firm, said other direct sellers haven’t mentioned similar problems in China. “When companies are reporting numbers below expectations, they tend to blame a lot of things,” he said.

Tupperware said it generated more than $200 million in revenue in China in 2018, or about 10% of its sales, through 6,700 independent retail locations. It declined to comment.

Under pressure

EnerSys, the Pennsylvania-based battery maker, is feeling pressure from all sides: a slowing Chinese economy, new government rules and the China-U.S. trade battle.

The company generates about 5% of its total sales in China and about 60% come from the Americas. But it makes some of its batteries in China, and the company competes with Chinese battery makers that sell backup power supplies.

EnerSys said sales in Asia in its most recent quarter fell 11% from the prior quarter. A government mandate prompted one of its largest Chinese customers to use more recycled batteries.

In response to slowing sales, EnerSys had planned to use a Chinese factory to produce more products for export to the U.S. That idea was scrapped when the U.S. imposed tariffs on batteries imported from China. EnerSys says now it will export from its Chinese factory to other countries.

The cooling Chinese economy has driven down the price of raw materials, including the lead used to make batteries, but it isn’t much of a silver lining.

“Our inputs are cheaper but the broad demand for our product is less,” said Mr. Schmidtlein, the EnerSys finance chief.

A General Motors Co. car dealership in Shanghai, China.
A General Motors Co. car dealership in Shanghai, China. Photo: Qilai Shen/Bloomberg News 

Other companies are benefiting from lower-priced raw materials on the one hand, and getting pinched by U.S. tariffs on the other.

Masco Corp., which makes Delta faucets and Hansgrohe shower heads, said it was poised to benefit from lower copper and zinc prices in the second half of last year. Masco also faces increased costs of about $150 million if the U.S. follows through on its threat to raise some tariffs on Chinese imports to 25% this year, the company said in its annual report filed Thursday.

If forklift demand is one rough gauge of economic growth, microchips are another. Consumer appetite for high-price electronics, including smartphones, has slowed. So has construction, which means fewer appliance sales. Both are bad news for semiconductor makers, whose chips span all those products.

“Industrial and consumer end markets have been especially weak in greater China,” Keith Jackson, chief executive of ON Semiconductor Corp., said.

Chinese manufacturers are cutting back orders of microchips to avoid being left with unsold goods, in case the U.S.-China trade dispute yields higher tariffs, and demand for Chinese-made goods falters.

“They’re risk averse. They’re not going to take any chances. They’re not going to hold inventory,” Thad Trent, the financial chief at Cypress Semiconductor Corp., said Jan. 16 at a conference. “We see customers waiting at the last minute to place orders.”

Chip makers link China’s slowing growth with the U.S.-China trade fight. “Trade is the problem why Chinese economy is weakening so much,” said Steve Sanghi, CEO of Microchip Technology Inc., which makes microcontrollers used in electronic and industrial components.

Some executives and analysts have said economic softness would dissipate if the trade issues were resolved. Others aren’t so sure.

“There are some underlying economic and end-demand issues in China that still need to be dealt with and resolved,” said John Vinh, a semiconductors analyst with KeyBanc Capital Markets Inc. “There is not potentially a quick fix as easy as resolving the tariff conflict.”

The invisible border

Technology could make a hard border disappear, but at a cost

Background surveillance would need to be high

IT IS AN all too familiar scene. Long lines of people and vehicles waiting to cross a border, paperwork all in a flutter and stony-faced customs officials rummaging through belongings and peering into the back of lorries. The question on many minds is whether technology can do away with such perturbations. And the answer is yes. New systems are making it easier to cross borders on land, at ports and in air terminals. Within a few years it should be possible, at least in theory, for a border to become invisible. People and goods would flow through without stopping, leaving all the formalities to take place electronically and out-of-sight.

This might appear the ideal answer to the seemingly intractable problem of the nature of the border between Britain and Ireland when Britain leaves the European Union. There is no appetite on either side for the return of a “hard” border of physical infrastructure, with its associated security and customs checks. But the legal constraints which retaining an open one would impose on Britain’s freedom to change its laws in ways that diverge from the EU’s are unacceptable to many on the British side, who see them as tantamount to keeping Britain in the EU.

If technology could make the border invisible on the ground, leaving legal checks to be done elsewhere, that might be enough to satisfy most parties. Yet as promising as the technology to do this is, in practice the cost of fully deploying the kit required for an open border is likely to be expensive, and the accompanying level of electronic surveillance too high for many to stomach, especially in Ireland.

Paperwork be damned

Despite these concerns, a number of borders around the world are being modernised with new technology, in order to become more open. The starting point is taking the “paper” out of the paperwork. Documentation involved in shipping goods from one country to another is going virtual. Electronic customs declarations are being made easier to submit, allowing the pre-clearance of shipments and the online payment of tariffs.

Switzerland, for one, aims to digitise its border procedures with the EU fully by 2026. A SFr400m ($400m) programme known as DaziT will provide a central online portal for all customs services. This will, for instance, allow travellers to use smartphones and tablets to declare foreign purchases on which duties may be owed.

The security of such systems is likely to be protected by blockchain, the technology that underpins cryptocurrencies such as Bitcoin. A blockchain records transactions on a decentralised register in a way that is difficult to tamper with. Last May Singapore introduced electronic certificates of origin, based on blockchain, for goods travelling into and out of the country. The system, developed by vCargo Cloud, a local firm, allows a mobile-phone app to be used to scan a QR code, a fancy type of matrix bar code, attached to the goods in question. The app will reveal the certificate.

Singapore’s busy port, along with ports in Hong Kong, Rotterdam, Philadelphia and other places, have started to use a blockchain-enabled process called TradeLens. This is the result of a collaboration between Maersk, a big Danish shipping firm, and IBM, an American computer firm. TradeLens provides access to a range of electronic data tracking shipping containers and their contents for importers, freight forwarders, port operators and customs authorities.

One of the advantages of using blockchain is that it readily reveals if things have been tampered with. Every time a code or a sensor attached to goods is scanned, that event is automatically logged in the blockchain and tagged with other data, such as the location of the goods. But no system is foolproof, so authorities will want to ensure that whatever crosses their borders is what the data purport it to be. Hence some sort of facility for physical checks will still be needed.

That is largely the case at one of the most technologically advanced land borders, that between Sweden, an EU member, and Norway, which is part of the EU’s single market but not a member of the EU’s customs union. The 1,600km border is largely open for travellers, although automatic number-plate recognition (ANPR) cameras are used to monitor passing vehicles, and officials will pull over any suspicious ones. Electronic pre-arrival customs declarations have been introduced and, in some cases, Norway will let companies ship goods across unmanned crossings. Most lorries, however, still need to stop at specific manned crossings to have their details checked. If it is not too busy, this need take only a few minutes.

Lars Karlsson, a Swedish customs expert, looked at what technologies could be used to reduce or eliminate the need to stop and undergo border checks, with a particular reference to Ireland, in a report presented to the European Parliament in 2017. Mr Karlsson said any such system would, as a starting point, require a fully electronic environment for documentation and payments.

It would work something like this. Pre-registered companies, sometimes called “trusted traders”, would have to submit additional information, such as details of the lorry being used and the person driving it. The driver might need an enhanced licence containing biometric data (facial scans, for example). As the lorry approached a border it would be identified by ANPR cameras. Other roadside sensors would detect a code placed on the driver’s mobile phone, which would identify him. The system would text a customs release note to the driver and alert authorities that the goods stated on an electronic manifest have just passed over. At a hard border, the release note might instead open a gate automatically for the lorry to drive through.

Trust. But verify

No country has yet put together all these elements to create an open border. The obstacles are not technological, though. For one thing, since it would need co-ordination between different customs authorities, the negotiations could be protracted. Some companies have also expressed concern that trusted-trader schemes might prove bureaucratic and expensive, especially for small firms.

Assuming such problems can be overcome, authorities would still want ways to catch smugglers. Again, there are things that can help. It is now reasonably straightforward to use mobile-phone networks and satellites to track people, goods and vehicles. This would permit authorities to check that cargo arrives at its intended destination. Fujitsu, a Japanese firm, says cameras can be used to read not just number plates but also the identification markings on containers, and check that seals have not been tampered with. Using AI techniques, the company reckons cameras can be taught to recognise the faces of drivers as well.

At some point physical checks will be needed, although these do not have to be carried out at a border. Vehicles could be pulled over at other locations for random shakedowns or because the data flag something as suspicious. Mobile customs units could carry out checks, even at delivery locations, using hand-held devices to scan, at a distance, smart tags attached to individual products and cartons. And other techniques are available, too. Container x-ray scanning is becoming faster, more powerful and capable of identifying not just outlines but also detail, including people hiding inside. Some of this scanning equipment is mobile.

As for keeping an eye on people crossing borders, systems being developed for use at airports might find wider use. One idea is a single digital travel “token” to speed people through airport terminals, even on multiple legs of a journey. A prototype of such a system has been developed by SITA Lab, a Swiss technology group owned by the airline industry. The token would reside on a traveller’s mobile phone and represent encrypted travel documents, passport details and other information. Whenever a traveller arrives at a checkpoint or is stopped by an official, the app is used to generate a QR code. That code is scanned to confirm the traveller’s details in a database that is, as is to be expected, secured by blockchain. Regular commuters across borders could carry similar tokens on their mobile devices.

For remote borders with little or no infrastructure there are various techniques which could keep an eye, or rather an ear, out. QinetiQ, a British firm, has a system called OptaSense, which uses a fibre-optic cable laid in the ground. Sound from above create vibrations in the cable, which affect its light-carrying properties. These changes can be detected at a distance by shining a laser through the cable. The equipment is sensitive enough to discriminate between the sounds made by different types of vehicle, such as a tractor or a lorry, and to detect people walking about.

Given enough money and determination, it should therefore be possible to make a hard border disappear. The difficult bit is the politics—especially whether the level of background surveillance required would be acceptable to people. In Ireland, with its long history of troubles, that is unlikely to be the case. Even a solitary ANPR camera at an Irish border crossing might be blown up. However, in other parts of the world, where hard borders now exist, travellers are likely to find their passage will become easier.

France and Germany Must Change the Game

After years of France and Germany marching to different drummers, the two countries have finally come together to renew their post-war partnership. But now, they must go much further, by developing a new innovation, security, and governance strategy to bring the European economy into the twenty-first century.

André Loesekrug-Pietri

macron and merkel

PARIS – Late last month, 56 years after French President Charles de Gaulle and German Chancellor Konrad Adenauer signed the Élysée Treaty, the current leaders of France and Germany met in Aachen, the historic capital of Europe, to sign a new cooperation pact.

The new Treaty of Aachen should be welcomed by all Europeans. Despite their domestic political difficulties, and amid a European growth slowdown and the chaos of Brexit, French President Emmanuel Macron and German Chancellor Angela Merkel came together to reaffirm their countries’ mutual understanding. The agreement lays the groundwork for a new Franco-German economic council, as well as closer cooperation on security and defense.

It is, however, regrettable that the Treaty’s 28 articles are very vague.

It is absolutely essential that this text be accompanied by a new method, adapted to the current world in which we live – a world where politics is no longer conducted in the muffled debates of ministerial meetings or through convoluted communiqués. Genuine involvement by civil society is the only way to stimulate two struggling governments and overcome their conservatism.

After all, we have entered an era in which speed, even more than money, determines the course of events, and where the capacity for experimentation across all sectors is an essential factor for success. In today’s winner-takes-all economy, the bulk of newly created wealth accrues to those who innovate the fastest.

Most Europeans may not realize it, but the European Union has allocated more for research and innovation – through the €77 billion ($87 billion) Horizon 2020 program – than the US Defense Advanced Research Projects Agency has in the past 60 years ($55 billion). Yet while DARPA research led directly to the Internet (through Arpanet), the microchip, stealth technologies, GPS, voice recognition, and autonomous vehicles, one can only wonder where the EU’s world-changing innovations are. Clearly, it is the method that counts, not the size of the expenditure.

We Europeans may think that we are maintaining a competitive position with respect to research, even if the United States and China are far ahead when it comes to creating “unicorns” and the digital behemoths of the future. Unfortunately, we aren’t. At the latest Conference on Neural Information Processing Systems, the US accounted for 85% of published research papers on artificial intelligence (AI), compared to just 7% for all European countries combined.

It is no surprise that Europe’s disconnected, fragmented national innovation strategies are falling behind. When it comes to AI, the size of the data pool is everything, which means that national and local initiatives such as a purely French one or an “AI Made in Germany” are hopelessly insufficient. Kai-Fu Lee, the former chief of Google in China, recently described AI as a coin with only an American and a Chinese side. For many, it is as if Europe doesn’t even exist.

It is time to take the initiative again. The first step is to change the method. Neither French Jacobinism nor German ultra-decentralization are appropriate for today’s world. Insofar as it will position Europe to pursue radically new initiatives, the Treaty of Aachen should be regarded as a welcome opportunity to restore European civil society not only as a provider of political ideas, but as a co-pilot for implementation.

To that end, many concrete measures could be implemented immediately. The first is to establish an innovation agency that is open to all EU member states, oriented toward nurturing cutting-edge research and development, and driven by the innovation ecosystem to ensure maximum agility.

Moreover, we must be bold in terms of cybersecurity, to protect our public infrastructure and democratic systems alike. Unlike Russia and the US, European countries lack the capacity to “attribute” and determine the origins of cyber attacks. Only with a cybersecurity alliance, data sharing, and law-enforcement coordination can Europe recover this essential element of lost sovereignty.

Finally, Europe must be strategic about space, because that is where the race in communications, geolocation, and autonomous-vehicle technologies – to say nothing of military conflicts – will be decided. Unfortunately, the European rocket maker ArianeGroup has already had to shed 25% of its staff, owing to European member states’ obsession with securing short-term returns for themselves.

Such narrow-mindedness is undermining Europe’s ability to act. We must adopt a radically different and more agile strategy before it is too late. The Treaty of Aachen could be a good base – but bold, immediate, and decisive action is needed.

André Loesekrug-Pietri is a technology investor and Speaker of the Joint European Disruptive Initiative.