Ray Dalio Is Kinda, Sorta, Really Wrong

John Mauldin

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”

John Maynard Keynes

“Nothing is more dangerous than a dogmatic worldview—nothing more constraining, more blinding to innovation, more destructive of openness to novelty.”

Stephen Jay Gould

“Inequality has emerged as a major issue in the US and beyond. A generation ago it could reasonably have been asserted that the overall growth rate of the economy was the main influence on the growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.

The share of income going to the top 1 percent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy. It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.”

Lawrence Summers (in the Financial Times, February 2014)


Ray Dalio is the thoughtful, somewhat controversial founder of the world’s largest hedge fund, Bridgewater Associates, which he started in 1975. While much of his writing is private, I (and many others) peruse every word we can of his and the Bridgewater team’s thinking. I find it to be some of the most interesting market commentary I read.

Lately Ray (read his bio here) has been far more open with his thinking, posting books and essays. This letter is the beginning of a response to his articles, Why and How Capitalism Needs To Be Reformed, Parts 1 and 2 and a follow-up piece titled It’s Time to Look More Carefully at ‘Monetary Policy 3 (MP3)’ and ‘Modern Monetary Theory’. He posted both publicly on LinkedIn.

On first reading those, I will admit to thinking, “Ray Dalio is kinda, sorta wrong.” I agreed with much of Part 1, with a few quibbles. Ditto for Part 2. But when I read the third piece I found myself thinking, “Ray Dalio is really, really wrong.” In that essay he basically endorses Modern Monetary Theory (MMT).

Coming from someone of Ray’s stature, and knowing that others like Bill Gross are beginning to endorse MMT either obliquely or directly, I found myself wanting to shout, “Stop! This is dangerous!”

As it turns out, Ray and I have mutual friends, and none describe him as particularly dangerous. They have nothing but good things to say about him, both businesswise and personally. He is clearly a generous man. And watching him in interviews and on stage, he is both disarming and comes across rather warmly. Definitely not dangerous. But ideas have consequences…

Ray’s essays are in his typical conversational style. There are plenty of footnotes and explanations in the combined 12,348 words (which fill 42 pages, not counting footnotes and appendixes). Almost any reader would agree with much of the first two-part essay.

Ray has done us all a service by pointing out the elephants in the room (some tinged with pink), which are rarely mentioned in public discourse. We discuss various parts of the elephant, but seldom the entire creature. By that, I mean the rapidly growing potential for left-of-center “progressive” control of both Congress and the White House. Part of that growth stems from an increasing frustration over the perceived differences between haves and have nots, between the protected and unprotected, combined with fascination for government solutions to our society’s perceived ills.

As The Economist reported recently, 51% of those polled between ages 18-29 have a positive view of socialism. That should scare you.

Source: The Economist

A growing number of that generation are taking that view into the voting booth. Democratic presidential candidates are all burnishing their “progressive” credentials. I have zero insight into who might win that nomination fight, but there is a more than reasonable chance it will be the most left-leaning presidential nominee in a very long time, since at least George McGovern (for whom I voted). And given the potential for recession between now and the election, they have a reasonable chance of winning.

Just as Trump figured out how to energize the frustration of enough voters to win the presidency, it is likely we will see a populist nominated on the Democratic side. A Democratic president and Congress will give us higher spending and taxes, and if that election happens amid recession, there will be an increasing drumbeat to “do something” radical. The already-huge $2-trillion deficit we will have by then could easily swell even more.

Dalio, to his credit, recognizes that would be a negative outcome. He proposes dealing with the increasing deficit and debt via Modern Monetary Theory (MMT) or directly printing money. He also hopes it would help equalize the increasing income and wealth disparities.

But I’m jumping ahead of myself. Today, I’ll begin an open multipart letter back to Ray in a conversational response. He addresses problems that are quite real and proposes solutions. We may not like them but at least he has ideas. His tone invites discourse, and so I intend to reply in that spirit. This is a potential learning moment for us all.

Dear Ray,

First, I want to thank you for the insight and wisdom you’ve offered over your career. They have intellectually enriched many of us. I find much to admire in your most recent essays but a few points leave me with serious trepidation.

That being said, I think we generally agree on the problems, and specifically that they pose a serious threat to US economic and social well-being. You use the word “existential threat” (or risk) several times in the essays. Someone as thoughtful as you doesn’t use that language lightly.

You talk about wealth and income disparity as a failure of capitalism.

Quoting from you:

Over these many years I have also seen capitalism evolve in a way that it is not working well for the majority of Americans because it’s producing self-reinforcing spirals up for the haves and down for the have-nots. This is creating widening income/wealth/opportunity gaps that pose existential threats to the United States because these gaps are bringing about damaging domestic and international conflicts and weakening America’s condition.

I think that most capitalists don’t know how to divide the economic pie well and most socialists don’t know how to grow it well, yet we are now at a juncture in which either a) people of different ideological inclinations will work together to skillfully re-engineer the system so that the pie is both divided and grown well or b) we will have great conflict and some form of revolution that will hurt most everyone and will shrink the pie.

…which explains why I think that not reforming capitalism would be an existential threat to the US.

…These conditions pose an existential risk for the US.

The previously described income/wealth/opportunity gap and its manifestations pose existential threats to the US because these conditions weaken the US economically, threaten to bring about painful and counterproductive domestic conflict, and undermine the United States’ strength relative to that of its global competitors.

I agree with this. The current situation could easily become a series of crises that would in fact be “existential,” as seen from today’s relatively benign world. We are being forced into difficult choices, both political and economic, and the longer we kick the proverbial can down the road, not dealing with the real fundamental issues, the more difficult and starker those choices will be.

We are rapidly approaching a time in which there will be no good choices, only extremely difficult, controversial and/or bad choices, none of which resolve the fundamental problems.

That said, we need to make sure our choices don’t exacerbate the problems.

Let’s start with what I think we agree upon: We both recognize that there is widening wealth and income disparity in the US. I would point out that that is a worldwide trend but agree it applies to the US in particular. This is causing political frustration, with what you term the potential to bring about “painful and counterproductive domestic conflict.” If by that you mean serious partisan divisiveness and angry rhetoric, I completely agree. The risk is that we veer widely from side to side of the road and never find the middle.

Income and Wealth Inequality        

For the benefit of this letter’s readers, let’s recap some of your charts along with a few from my own letters on these subjects. You generally compare the top 40% and bottom 60%. You could have made a starker comparison using 80/20 or 90/10 or even 99/1. I congratulate you on avoiding the extremes to make your case.

Let’s look at some of your charts. This first one is self-explanatory, showing the top 40% have seen their incomes rise significantly while the bottom 60% have been flat for almost 50 years.

Source: Ray Dalio

I find in these next charts some of the more disheartening trends you describe. As I’m sure you know, survey data shows this may be the first generation in a long time that doesn’t expect their children will see higher living standards. Whatever the American dream is, the hope that we have for our children is embodied in it. That hope seems to be slipping away and it aggravates the political angst that concerns us both.

Source: Ray Dalio

The difference is even clearer when you look at the top 1% versus the bottom 90%...

Source: Ray Dalio

…and when you look at income distribution and growth by quintiles over the last almost 50 years? It’s a very sobering reality.

Source: Ray Dalio

My friend Bruce Mehlman shows it in different ways, which I used recently in a letter on inequality.

Source: Bruce Mehlman

Here’s another one comparing stock market growth with family net worth.
This isn’t really surprising since we know the top quintile owns most of the stocks. The lower 80% see little direct benefit. But the magnitude of the disparity is still remarkable.

Source: Bruce Mehlman

I agree with you that the following is the most discouraging trend:

While most Americans think of the US as being a country of great economic mobility and opportunity, its economic mobility rate is now one of the worst in the developed world for the bottom. As shown below, in the US, people in the bottom income quartile have a 40% chance of having a father in the bottom quartile (in the father’s prime earning years) and people in the top quartile have only about an 8% chance of having a father in the bottom quartile, suggesting half of the average probability of moving up and one of the worst probabilities of the countries analyzed. In a country of equal opportunity, that would not exist.

Source: Ray Dalio

This is yet another cause of the widening political and social divides. When parents no longer have hope their children can lead better lives, when children no longer feel they can rise above, the result is higher partisanship and populism.

[Sidebar: Ray does a more in-depth analysis of education, productivity, and economic outcomes in his Part 1. His analysis of the dismal state of public education in the United States is particularly discouraging.]

Is Capitalism the Problem?

You argue that capitalism is not achieving its goal of more equitably distributing the fruits [read: profits] of capitalism. To your point, my good friend Ben Hunt of Epsilon Theory notes that the S&P 500 companies have the highest earnings relative to sales in history.

Source: Ben Hunt

Let me push back with what is admittedly a small quibble in the grand scheme of things. I think of capitalism more in the context of property rights, rule of law, and free markets. Properly understood, it provides a level playing field for entrepreneurs to offer goods and services that produce incomes and profits. I don’t think equitably distributing those profits is capitalism’s role.

Ensuring that all participants are treated fairly and, to some extent, regulating these personal and corporate endeavors is the role of society in general and government in particular. So when you say that capitalists are not very good at sharing profits, I would say that capitalism is not designed to do so. That is the role of society and government.

Yes, capitalists are part of that society, and in general prefer to keep more of their profits and have less regulation. I agree that “capitalists” are not very good at distribution because of their own self-interest. And as you point out, when people begin to sense that their own particular interests are not being fairly addressed, there is the potential for political crisis. Quoting rather extensively from your letter:

The problem is that capitalists typically don’t know how to divide the pie well and socialists typically don’t know how to grow it well. While one might hope that when such economic polarity and poor conditions exist, leaders would pull together to reform the system to both divide the economic pie and make it grow better (which is certainly doable and the best path), they typically become progressively more extreme and fight more than cooperate.

In order to understand the phenomenon of populism, two years ago I did a study of it in which I looked at 14 iconic cases and observed the patterns and the forces behind them. If you are interested in it, you can read it here. In brief, I learned that populism arises when strong fighters/leaders of the right or of the left who are looking to fight and defeat the opposition come to power and escalate their conflict with the opposition, which typically galvanizes around comparably strong/fighting leaders. The most important thing to watch as populism develops is how conflict is handled—whether the opposing forces can coexist to make progress or whether they increasingly “go to war” to block and hurt each other and cause gridlock. In the worst cases, this conflict causes economic problems (e.g., via paralyzing strikes and demonstrations) and can even lead to moves from democratic leadership to autocratic leadership as happened in a number of countries in the 1930s.

We are now seeing conflicts between populists of the left and populists of the right increasing around the world in much the same way as they did in the 1930s when the income and wealth gaps were comparably large. In the US, the ideological polarity is greater than it has ever been and the willingness to compromise is less than it’s ever been. The chart on the left shows how conservative Republican senators and representatives have been and how liberal Democratic senators and representatives have been going back to 1900. As you can see, they are each more extreme and they are more divided than ever before. The chart on the right shows what percentage of them have voted along party lines going back to 1790, which is now the greatest ever. In other words, they have more polar extreme positions and they are more solidified in those positions than ever. And we are coming into a presidential election year. We can expect a hell of a battle.

Source: Ray Dalio

I sadly agree that we are entering a period of rather severe partisanship. As a long-time participant in the political process, I think we are further from reasonable discussion and compromise than at any time of my life. I suspect you would agree as we are almost the same age.

Let me offer some thoughts on how the conflicts will unfold, and then present another possible solution. As you will see, I think MMT would make our problems even more intractable and raise the likelihood of a severe crisis…


Next week we will deal with Ray’s further analysis of our problems (some of which I agree with) and then we’ll get into the most significant dispute, that of using MMT.

I think this is an important conversation, not just between two people but throughout the entire nation. The answers to the questions posed by the problems we agree upon will make a huge difference to both our society and our children’s future. Not to mention our own future.

Boston, New York, and ???

I am enjoying the beautiful weather here in Puerto Rico. At the end of the month, Shane and I will fly to Boston to be with our good friends Steve Cucchiaro and (his future bride) Jama to help celebrate their wedding. Then Shane goes to California for a week while I meet with my Mauldin Economics partners in Boston, and then take the train down to New York for a few days of meetings and media. Then on July 4 I fly to…? Well, I’m not sure. The next destination is up in the air as no meetings have been confirmed. Hopefully I will know by this time next week. Then I will meet up with Shane and we will go back to Puerto Rico.

Puerto Rico, or something, has been very good for me. Ten years ago I developed what my doctor (Mike Roizen, author of many best-selling books and otherwise known as Oprah’s doctor) diagnosed as late onset high blood pressure. Sometime around age 59 someone took my blood pressure dial, which for all my life had been quite normal, and cranked it to the right.

Mike told me, “There are 10 things that are important about staying healthy and the first three are blood pressure, blood pressure, and blood pressure.” He put me on two standard blood pressure medicines. They brought my blood pressure back under control. A few years later I stopped taking one of them as my blood pressure became more stable.

In my latest checkup, this year they found a little plaque in one of my arteries. In addition to prescribing a mild statin, Mike really stressed the importance of my diet. Shane has me eating mostly fish and chicken, in addition to cutting out cheese and dairy. This has been good for my weight but oddly, a few weeks ago, my blood pressure began to drop significantly.

The answer was to adjust my blood pressure medicine to an even smaller dose. I seem not to need as much because my body likes either the fish or the island lifestyle. Maybe some of both. It will be interesting to see if I reach the point where I don’t need any medicine at all. One can dream…

It’s time to hit the send button. I want to thank the many people who have been talking with me about Ray Dalio’s writings (you know who you are). This has been a significant learning experience for me and it certainly helped clarify my thinking about what I have been calling The Great Reset and Japanification. The cloudy crystal ball is getting a little bit clearer.

Let me wish you a great week and, if you are in the Midwest, a little sunshine and less rain!

Your rapidly developing an island lifestyle analyst,

John Mauldin
Chairman, Mauldin Economics


The long-term decline in bond yields enters a new phase

What will happen when interest rates eventually start to rise again?

AT THE END of 1989, an American in London received a call from a friend back home. The caller had watched the fall of the Berlin Wall and the toppling of Nicolae Ceausescu in Romania with growing dismay. He was at the end of a four-year course in Russian Studies at an elite university with hefty tuition fees. He had learned all the Kremlinology a would-be cold warrior could need—but not that the cold war might suddenly end. “I just took a $60,000 bath,” he said.

This story comes to mind not so much because of fears of a new cold war, this time with China, but because of the bond market’s recent response to such fears. Long-term interest rates have tumbled almost as swiftly as communism fell in Europe. The yield on a ten-year Treasury bond has plunged from 2.5% to 2.1% in the past month. Ten-year Bund yields have turned negative again and have reached a new all-time low.

What happens to long-term interest rates in large part reflects what is expected to happen to short-term rates. The bond market’s Kremlinologists expect the Federal Reserve to cut them soon. Other central banks will seek to keep money easy. One consequence is that the secular decline in real interest rates is unlikely to reverse soon (see chart). The implications are far-reaching: the whole edifice of asset prices is founded on a low-rate regime. But what if that regime were to come to an abrupt eventual end?

It is hard to be truly confident about the future path of real interest rates. The reasons for their decades-long decline are not well understood or agreed upon. One school stresses an increased desire for saving. Demographic change is part of this story. As a large chunk of the rich world’s population approaches the end of their working lives, they seek to set aside more of their income for retirement. The integration of high-saving China into the world economy is another factor. In this view, long-term interest rates had to fall simply to clear the saturated global market for savings.

Another school says that low bond yields are a distortion caused by the policies pursued by central banks in the rich world. They have kept short-term interest rates close to (or in some cases below) zero for much of the past decade. They have also spent trillions of dollars buying government bonds with the explicit goal of driving down long-term interest rates. In their defence, central bankers say they set interest rates to keep the economy purring. If they had pressed down too hard on the monetary pedal, the result ought to be a burst of rising prices.

In the absence of rising inflation it seems reasonable to expect that the era of low interest rates will last. If yields on the safest government bonds remain low, the expected returns on other assets—the earnings yield on equities, say, or the rental yield on property—should stay in line. The result would be that all assets will continue to look expensive relative to their long-run averages.

As logical as this seems, it is nevertheless disquieting. At some stage the influences that have pushed down yields will attenuate, even if this is not soon. Long-term interest rates will surely rise again. It is reasonable to believe that this will not be sudden. Demographic change happens slowly. So perhaps asset prices will adjust slowly to the new reality, whenever it dawns. But it is quite hard to imagine a world in which real interest rates grind upwards and asset-holders avoid taking a capital loss, says Shamik Dhar of BNY Mellon, a fund-management group. The uncertainty about the timing of even a gradual adjustment creates headaches, for instance for someone hoping to own a home. Buy at the wrong time, and you end up with a house that slowly loses value.

And what if real interest rates rise a lot more quickly than they fell? Well, they might. China is already a spent force in the global savings glut: its current-account surplus has dwindled to next to nothing. Baby-boomers moving into retirement might step up their spending. If rich countries turn once again to fiscal policy as a tool for ginning up their economies, there are plenty of asset-heavy projects (airports, roads, fibre-optic networks) to soak up savings.

Kremlinologists look for signs of shifting authority, for who’s up and who’s down. But when everyone is focused on who will be the next boss, they may all miss signs that the regime itself is cracking. For now, financial-market Kremlinologists are preoccupied with which assets to hold and which to avoid. But at some point capital will become scarcer. Somebody may find that they have taken an expensive bath.

Donald Trump is updating America’s historic ruthlessness

Promising US voters ‘greatness’ has led the president to celebrate a brutal past

Gideon Rachman

Donald Trump says so many strange and outrageous things that it is impossible to remember them all. But one Trumpian remark that has stuck with me is the US president’s repeated insistence that, after conquering Iraq, “we should have kept the oil”.

To the ears of the Washington establishment, this was yet another Trump gaffe. Even Dick Cheney, the former vice-president and most hawkish of hawks, had never portrayed Iraq as a war of conquest. But Mr Trump’s deliberately provocative remark was an insight into both his philosophy and his appeal to voters.

When many Americans feel frightened that both US power and their own living standards are in decline, Mr Trump is making an appeal to American ruthlessness. The US president says to voters that the country cannot afford to be “politically correct” any more. The way to Make America Great Again, in the words of his slogan, is to rediscover the ruthless instincts that made America great in the first place.

In a nod to past American ruthlessness, Mr Trump has hung the portrait of Andrew Jackson, US president from 1829-1837, on the wall of the Oval Office. Jackson was once seen as one of the great builders of the American nation and his statue stands in Lafayette Square, opposite the White House. But a more recent generation of historians has accused Jackson of complicity in genocide for ordering the forced removal of Native Americans from their land — a policy that led to the “trail of tears” in which thousands died. By honouring Jackson, whom he praised as a “very tough person”, Mr Trump is honouring the brutal policies that allowed the US to conquer the west.

The president’s approach signals to voters that he too is a tough guy. And it has the added political benefit of playing into America’s domestic culture wars. By celebrating presidents like Jackson, and recently praising the Confederate commander and slave-owner, Robert E. Lee, Mr Trump is telling rightwing Americans what they want to hear — that there is nothing to apologise for in American history.

This is not just a historical debate. It is also intensely political and contemporary. These Trumpian provocations are coming at a time when the left — particularly at universities — is taking a much more assertive stand on facing up to the ugly aspects of American history. Buildings associated with supporters of slavery have been renamed at Yale and Georgetown; Amherst College has dropped Lord Jeffery Amherst as its mascot because the colonial-era commander was an advocate of genocide against Native Americans. Mr Trump’s praise for Lee came amid continuing demands for the removal of the general’s statue from Charlottesville, the scene of violent clashes between white supremacists and counter-demonstrators in 2017.

Oddly, Mr Trump and the progressive left share some attitudes. They both believe that the American nation was founded on acts of ruthlessness and brutality. The difference is that the left feels that America should makes amends for that history. Mr Trump and his followers argue that America should embrace its entire history — including the brutal bits — and return to the values of the past. The Trumpian view is that the US has gone soft and risks ruin if it is too scrupulous when dealing with ruthless adversaries such as Isis — or, even, with Russia and China.

Mr Trump’s approach has a certain unsparing honesty about it. But there are also telling limitations to this honesty. In praising the likes of Lee and Jackson, Mr Trump hints at his attitudes to racial injustice — without ever fully spelling it out. But those who want to embrace the viciousness of the past need to be asked just exactly how far they want to go back: are they endorsing racial segregation; slavery; giving your enemies blankets covered in smallpox, as Amherst wanted to do in 1763? Presumably not.

The idea that returning to some of the most reactionary ideas will help make good on Mr Trump’s vague promises to the voters is also highly questionable. On the contrary, it looks like a formula for domestic division and strife rather than “greatness” — which is one reason why Russian internet trolls often stoke America’s culture wars.

An America that turns its back on liberal values will also be weaker internationally. If the struggle with China is only about the relative power of the US and Chinese economies, America could well lose: China’s economy is already larger than that of the US in purchasing-power terms. As for weaponry, Russia has a nuclear arsenal that is as formidable as that of the US; and China’s fleet is now larger than America’s.

But there is one area where China and Russia struggle to compete with the US — and that is the battle of ideas. Autocracies such as Russia and China fear the attractiveness of the American model of personal and political freedom, human rights and the rule-of-law. They spend a lot of time and energy repressing people and organisations that are attracted to these subversive ideas.

The US president was once routinely labelled “the leader of the free world”. But it is hard to apply that label to Mr Trump — a man who seems to envy dictators and to feel only contempt for liberal values. That weakens America’s ability to attract allies and partners around the world. As the saying goes, “It is worse than a crime, it is a mistake.”

Something Huge Just Happened In Europe

Critics of modern monetary policy have been predicting that the day would come when a central bank would cut interest rates (or at least promise to), and the financial markets, instead of throwing a party, would fall. Then it would be game over for easy money.

This has yet to happen in the US. Both when the Fed stopped tightening in January and when it promised to resume easing more recently, stock prices soared, which implies that the addict is still responsive to new injections.

But in Europe, where monetary policy is further down the road to universally-negative interest rates, the story is different. On Thursday, European Central Bank chair Mario Draghi went back to his tried-and-true “whatever it takes” script, promising to restart QE and cut interest rates even further if the weak EU economy doesn’t pick up steam.

The markets, instead of reacting with their typical euphoria, seemed to recoil. Most EU member bond yields went up rather than down, bank stocks fell and the euro — which would normally be expected to fall on the prospect of easier money — rose.

This is both huge and, like I said, expected. Once a central bank has pushed interest rates below zero and bought up most of the available high-grade bonds, lower interest rates and more bond purchases ought to lose some of their punch. And it appears that they have.

Now comes the panic, as stock and bond markets start to roll over in the face of ECB impotence, forcing Draghi and his soon-to-be-announced successor into even more extreme policies like buying up junk bonds (including Italian sovereign debt) and equities. The question then becomes, will upping the dose give the addict a few more months/years of life, or kill him immediately?

That, like the rest of this, is unknowable because it’s uncharted territory. Negative interest rates and massive QE were already experimental. The next, even more extreme policies will be more so, which means the point where they stop helping and start hurting won’t be clear until after the fact.

But Europe is proof that that day is coming.

The Popular Bonds That Could Turn Into Unpopular Stocks

The Federal Reserve’s shift on rates has pushed investors back into a trendy debt market whose risks are unusual and badly understood

By Jon Sindreu

Banks are leading a double life in financial markets, as investors scoff at their equity but can’t get enough of their debt. This should spell caution for those who have piled into the gray area in-between: Bank debt that turns into equity.

After this week’s selloff, bank stocks in Europe are trading close to their lowest levels on record relative to the wider Stoxx Europe 600 index. Having failed to keep pace with the broader market rally this year, they are now down 30% over the past half-decade.

Meanwhile, investors have gobbled up bank debt. This actually makes sense: After the 2008 crisis, policy makers saddled banks with regulations and ultralow interest rates that damaged their profitability—what stock investors care about—but made them less likely to fail—the focus of debt investors.

Yet it puts European banks’ contingent convertible instruments in an ambiguous position. Also known as additional tier 1 (AT1) capital, these are bonds that turn into bank equity in certain conditions, for example, if capital buffers are eroded. The principal never has to be paid back.

Over the past five years, contingent convertibles have returned 36%, compared with 21% for European high-yield debt, according to indexes by ICE Bank of America Merrill Lynch. The Federal Reserve’s shift away from raising interest rates this year has made investors buy even more of them.

Valuing banks is already a daunting task for investors. Here, a trader blows a bubble with gum as he watches his screens on the floor of the New York Stock Exchange. Photo: Richard Drew/Associated Press

European regulators made banks sell AT1 bonds to increase their capital buffers at a time when the high premium demanded by stock investors made issuing equity unaffordable. But if adding this obscure form of debt truly cheapens banks’ funding, investors will likely be the ones paying for it.

Spain offers an example: After 2008, domestic regulators sought to bail out banks and allowed similar hybrid instruments to be sold to regular savers. The savers lost most of their money shortly after.

While buyers of AT1 debt are from Wall Street rather than Main Street, many also seem to be operating under over-optimistic assumptions, including the idea that banks will always buy back the debt at key dates—a tradition that Banco Santander recently broke.

As Colin Purdie, head of Aviva Investors’ credit team, puts it: “there is still a lot of tourists in the AT1 market that don’t have the analytical ability to understand them.”

Of course, if a swift conversion of AT1 into equity avoids a market panic during the next crisis, it could benefit issuers and investors alike. But unlike defaults in the junk-bond market, conversions remain a rarity, making it hard to quantify the associated risk and ensuring panic when a bank does get close to key triggers. The alarm in 2016 about Deutsche Bank ’sAT1 debt can attest to that.

Valuing banks is already a daunting task for investors. Buying their most complex security just adds to the risks.

Canada: A Casualty of ‘America First’

China is proving tough on Canada, and the U.S. has yet to come to its neighbor’s aid.

By Jacob L. Shapiro


Canada’s relations with China continue to deteriorate. Shortly after Canada arrested Huawei Chief Financial Officer Meng Wanzhou at the United States’ behest in December, China arrested two Canadian nationals, including former diplomat Michael Kovrig, in a tit-for-tat move meant to bully Canada into releasing Meng. When that didn’t work, Beijing tried a new strategy, effectively punishing what it perceived as Canadian intransigence by restricting access to the Chinese market for key Canadian sectors such as canola, peas, soybeans and pork. Those measures are now beginning to hurt the Canadian economy, and with little prospect of resolving the issue bilaterally, Canada is reaching out to the United States for help – but its closest ally has been unwilling to render assistance.

Deteriorating Relations

China’s market-blocking maneuvers have been mostly unofficial thus far. What concrete steps China has taken to block Canadian exports have all been taken under the guise of plausible deniability. China suspended the export permits of two Canadian pork producers last week, ostensibly because of a labeling problem. In February, China banned shipments of canola seed from two Canadian companies, claiming that it discovered pests in the shipments, and in April, it filed a quality complaint against a third Canadian canola exporter. Now, there are reports of Canadian soybeans and peas facing unusual obstacles when reaching China, including lengthy inspection delays far exceeding the norm and intense scrutiny of Canadian products.

Some Canadian officials have tried to put on a brave face despite these developments – Saskatchewan province’s premier recently dismissed the reports on all Canadian exports besides canola as little more than “hearsay,” while Canada’s agriculture minister insisted last week that the reports reflect little more than the routine issues that periodically emerge during routine customs inspections. Perhaps, but that explanation seems doubtful, especially considering that China’s African swine fever epidemic means China needs to secure sources of pork imports, in particular. It’s more likely that China has made an intentional decision to block certain Canadian exports, even if it means China must find alternative sources for those goods.

Whether intentional or not, the Canadian economy is beginning to feel the effects of China’s emergent fastidiousness. Canadian trade statistics for February 2019 show an almost 25 percent decline in monthly exports to China compared to prior months. Canola exports have been hit particularly hard; exports to China declined in February by almost 60 percent compared to November 2018, with canola meal (51 percent) and canola seed (38 percent) registering substantial declines as well. And that data will likely be worse when March and April figures are released. At least some of the decline can be attributed to Chinese New Year celebrations in February, but the drops are too precipitous for that to be the only factor. Indeed, an April 29 Reuters report detailed how Chinese buyers were canceling purchases of Canadian canola on short notice, forcing Canadian companies to resell to buyers in countries like Pakistan and Bangladesh at steep discounts.



With little in the way of leverage to change China’s behavior, Canada has turned to the United States for help. Multiple Canadian government officials have stated publicly that they would welcome U.S. support and that such support could make China more willing to find an accommodation with Canada. No such American assistance has been forthcoming. The U.S. State Department has expressed concern over China’s canola bans, and the U.S. Senate Foreign Relations Committee passed a nicely worded bipartisan resolution in March “commending” Canada for “upholding the rule of law” and arresting Meng. In practice, however, the U.S. has done very little. Thus far, the U.S. has elected not to address the Huawei issue – including Meng’s arrest – in its trade negotiations with China or to make China’s Canada-targeted measures an issue. In addition, according to Canada’s ambassador to the U.S., Washington has not been particularly forthright with the Canadian government about U.S. intentions for Meng.
‘America First’
The United States’ unwillingness to use its influence with China to protect its northern neighbor fits with the broader foreign policy of the Trump administration – namely, “America First.” This is, after all, the same U.S. government that raised tariffs against Canadian steel exports to the United States by citing a “national security threat” and that has used Canadian Prime Minister Justin Trudeau as its favorite rhetorical punching bag. The U.S. is pursuing negotiations with China to secure better trade terms for American companies – not for Canadian ones, even though China’s economic expansion in recent decades has posed similar problems for both countries. The United States is not interested in using the extensive leverage it holds over the Chinese economy to help other countries, even its most stalwart allies – in fact, the U.S. is simultaneously pursuing new trade arrangements with such allies, including Canada and Japan.

It is hard to overstate how radical a departure this is from previous U.S. foreign policy. The U.S. cemented its position as a global power after World War II by doing the exact opposite – by not putting America first. The U.S. did not do this out of generosity or nobility but because it calculated that doing so would give the United States more power. The U.S. was rich and powerful enough that it could afford to pass on the benefits of that power to other countries and, in so doing, build a network of relationships, partnerships and alliances that countries like the Soviet Union then and China now – which has hardly any allies to speak of besides a despotic hermit regime on the Korean peninsula or an eternally fractious Pakistan – can only dream of. By not putting America first in all things, America was first in arguably the most important thing: power.

A country like Canada cannot afford to break with the United States. From a political, economic and security standpoint, Canada is essentially a U.S. province, hardwired into a U.S.-led alliance structure whether it wants to be or not. Certainly, U.S.-Canada relations are not going to crumble because the U.S. is unwilling to use its leverage over the Chinese to protect Canadian companies or because Trudeau and Trump don’t like each other. Still, American power has always been at its most effective not when countries can’t afford to break with the United States but when countries don’t want to. That is exactly why China has singled Canada out. “America First” may mean the U.S. will get what it wants out of trade negotiations with China, but if the U.S. isn’t careful, it might also mean that down the line, its allies will have far less of a reason to put America first themselves.

An Industrial Policy for Good Jobs

So-called productive dualism is driving many contemporary ills in developed and developing countries alike: rising inequality and exclusion, loss of trust in governing elites, and growing electoral support for authoritarian populists. But much of the policy discussion today focuses on solutions that miss the true source of the problem.

Dani Rodrik , Charles Sabel


CAMBRIDGE – In developed and developing countries alike, a combination of technological and economic forces has created a segment of advanced production, concentrated in metropolitan areas, that now co-exists with a mass of relatively less productive activities and communities. This productive dualism lies behind many contemporary ills: rising inequality and exclusion, loss of trust in governing elites, and growing electoral support for authoritarian populists. But much of the policy discussion today focuses on solutions that miss the true source of the problema.

For example, redistribution through taxes and fiscal transfers accepts the productive structure as given, and merely ameliorates the results through handouts. Likewise, investments in education, universal basic income, and social wealth funds seek to strengthen the workforce’s endowments, without ensuring that better endowments will be put to productive use. Meanwhile, job guarantees and Keynesian demand management offer little in the way of improving the mix of jobs.

To be sure, we need many of these policies. But they will work best – and in the long run perhaps only – with a new set of “productivist” measures that intervene directly in the real economy, targeting the expansion of productive employment.

The strategy we have in mind would comprise three mutually reinforcing components: an increase in the skill level and productivity of existing jobs, by providing extension services to improve management or cooperative programs to advance technology; an increase in the number of good jobs by supporting the expansion of existing, local firms or attracting investment by outsiders; and active labor-market policies or workforce-development programs to help workers, especially from at-risk groups, master the skills required to obtain good jobs.

None of these three components is novel, and elements of each can be found in actual government programs. But existing policies are typically rooted in regulatory frameworks that work poorly under conditions of high uncertainty. What is a good job? How many can be reasonably created? How do technological and other firm-level choices influence job creation? Which complementary policy levers are available? How can that set of instruments be expanded?

These are necessarily local, contextual questions. They can be answered, and periodically revised, only through an iterative process of strategic interaction between public agencies and private firms. A common theme that emerges from studies of so-called place-based policies, such as regionally targeted employment subsidies and infrastructure investment, is the heavily contingent nature of success. Few policies work off the shelf and reliably across diverse settings.

Competitions among states and localities to attract large employers with tax and other subsidies work especially badly. Recent high-profile deals for Foxconn and Amazon, in Wisconsin and New York respectively, have blown up. In addition to being lopsided, they were predicated on a stable environment, reflected in fixed and detailed contractual terms. When Foxconn faced changes in demand and technology, and Amazon confronted unexpected political fallout, there was insufficient room for revision or renegotiation.

Governance regimes must fully recognize the provisional, iterative nature of any effective policy framework. Fortunately, the principles on which such regimes can be constructed do not need to be invented from scratch. They can be borrowed from innovative governance arrangements that firms, regulators, and other public agencies have already developed in other spheres.

In a recent paper, we provide detailed illustrations from two domains: the nurturing of technologies by the Defense Advanced Research Projects Agency (DARPA) and its offshoot, the Advanced Research Projects Agency-Energy (ARPA-E) in the US, and the environmental regulation of dairy farming in Ireland.

Under extreme uncertainty, none of the parties – neither regulators nor firms – have reliable information about the possibilities and costs of adjustment in the medium term, and only vague conjectures regarding future possibilities. The response – in innovation promotion, environmental regulation, food safety, and civil aviation among other areas – is the creation of an information-exchange regime that ties ongoing specification of goals to continuing exploration of new solutions.

In the European Union, for example, the regulator establishes “good water” as an ambitious, open-ended outcome. The regulated entities and affected parties – firms and farms, member states, local governments, civil-society actors – are obligated to make plans to achieve the goals and to report results regularly. Penalties are imposed for failure to report honestly, or for persistent failure to achieve feasible results (as demonstrated by others in a similar position).

These methods are not self-policing. Like all institutions, they can be corrupted or degraded. But with proper public oversight, they work when conventional approaches fail.

Apart from a few notably successful community college training programs, such governance arrangements have not been deployed in pursuit of good jobs. But they can be adapted to that end. The concept of a “good job,” like clean water, is imprecise and needs to be operationalized in a way that is both evolving and context-dependent. A good-jobs strategy could be introduced in four steps.

First, by legislation or other means, the government commits to address the problem of bad jobs, creates an inter-agency body to review and prompt improvement of regulatory responses, and provides funds and authority for voluntary programs. Second, regulators currently overseeing areas directly affecting job abundance and quality – vocational training, agricultural and manufacturing extension, standard setting, and the like – introduce governance mechanisms that not only induce innovation, but also anticipate the need for support services to help vulnerable actors comply with increasingly demanding requirements. The requirements could take different forms, including specific employment quantity targets and/or standards.

Third, where current regulatory authority doesn’t reach, the government creates volunteer, public-private programs to advance the frontiers of technology and organization, or – perhaps more important – provides support services and possibly subsidies to help low-productivity/low-skill firms move to the advanced sector. Finally, conditional on the success of voluntary arrangements, the scope of these practices would gradually be made obligatory for non-participating firms, starting with mandatory submission of credible plans for improving the quality and quantity of jobs.

An attractive feature of the good-jobs strategy we propose is that the same institutions of interactive governance that enable the parties to specify and solve the problems they face under uncertainty also enable them to develop the trust and mutual reliance they need to deepen and broaden their efforts. The broad coalition needed for the approach to succeed need not already exist; it can and will likely be the result of pursuing the strategy. Trust and new alliances are as much – or more – the outcome of joint problem-solving as its preconditions.

Dani Rodrik, Professor of International Political Economy at Harvard University’s John F. Kennedy School of Government, is the author of Straight Talk on Trade: Ideas for a Sane World Economy.

Charles F. Sabel is Professor of Law at Columbia University.