The ECB presidency is distinct but not immune from backroom deals

Europe works in strange ways

“THE LONGEST lunch in history” is how Jonathan Powell, an adviser to Tony Blair, a former British prime minister, has described the appointment of the first head of the European Central Bank (ECB) in 1998. The French, keen to have their man in the job, had convinced the Germans that Wim Duisenberg, a Dutchman, should serve only half of his eight-year term before making way for a Frenchman. Mr Duisenberg resisted, giving in only after midnight.

The choice in 2011 of the third and current president, Mario Draghi, an Italian, involved less drama. Even so, France and Italy fell out after Lorenzo Bini Smaghi, another Italian on the bank’s six-strong executive board, initially refused to give way to a French national. “What can I do? Shall I kill him?” Silvio Berlusconi, then Italy’s prime minister, asked Nicolas Sarkozy when his French counterpart complained.

Mr Draghi departs in October. What tales will be told of his successor’s selection? The scope for theatrics is greater than ever. The choice is always political: national leaders make nominations and eventually agree on a name. But Mr Draghi’s term ends in the wake of European elections, as they are also deciding other top jobs. At a summit on June 20th-21st the European Council of leaders aspires to pull off a package deal covering the key roles. Succeed or no, the next few months will be a test of whether the process for choosing the next ECB leader has become any more sensible.

No one knows precisely who is in the running: there is no formal nomination process. Among the five leading contenders, pictured above, is Jens Weidmann, the hawkish chief of the Bundesbank. As a former adviser to Angela Merkel he helped form her hard line on Greece during its sovereign-debt troubles. Olli Rehn, the head of the Bank of Finland and a former EU commissioner, is also seen as a candidate.

Erkki Liikanen, Mr Rehn’s well-liked predecessor in Helsinki and also a former commissioner in Brussels, is in contention, as is François Villeroy de Galhau, the governor of the Banque de France. So is Benoît Cœuré, a Frenchman already on the ECB’s executive board, though the ECB’s rules seem unlikely to permit him a second term as a member. Klaas Knot, the Dutch central-bank head, Klaus Regling, the head of the EU’s bail-out fund, and Sylvie Goulard, deputy head at the Banque de France, are also mentioned.

Officials in Berlin and Paris claim that they see the ECB presidency as distinct from the three more political jobs of the heads of the commission and European Council and the high representative, or the EU’s foreign-policy chief. They describe their approach as “3+1”, says Mujtaba Rahman of Eurasia Group, a consultancy. Perhaps Mr Draghi’s crucial role in keeping the currency union together during the sovereign-debt crises in 2010-12 has taught everyone that the bank’s president needs more than a modicum of competence.

Looming economic threats should remind them why their decision matters. A trade slowdown is hammering the euro area’s economy. A row between Rome and Brussels over public debt risks unnerving investors. Market expectations of euro-zone inflation in five years’ time have drifted below the bank’s 2% target. On June 6th Mr Draghi said the bank would keep interest rates low for the next year, and raised the possibility of further asset purchases.

Mr Weidmann is the most contentious candidate. His vocal opposition to ECB asset-purchase programmes was reportedly derided by Mr Draghi as “Nein zu allem”(“No to everything”). Appointing him would be a mistake, says Christian Odendahl of the Centre for European Reform, a think-tank: the bank would be less activist in downturns and less supportive of fiscal easing. That prospect could lose him the support of countries keen on further integration, such as France and Spain, in which case Germany might instead plump for another northerner, perhaps one of the Finns.

But the decision cannot be divorced entirely from the EU’s tiresome preoccupation with balance of various sorts. Despite their noble talk about “3+1”, leaders still want national balance on the bank’s six-strong executive board, which, together with the 19 governors of national central banks, constitutes its policymaking body. Having had an Italian at its helm for eight years, and a Spanish vice-president, the received wisdom is that the ECB presidency now belongs to a northerner—if not to Germany, which has yet to hold the post.

Such calculations, surprisingly, are the reason Mr Weidmann seems to have support from Italy, even though it is the country most likely to benefit from the unconventional policies he has spoken against so forcefully. Its finance minister, Giovanni Tria, has said that he would be “open” to Mr Weidmann as president. The reason seems to be that once the top job is allocated, any compatriots already on the board tend to step down. If the job goes to a Frenchman or German, that would leave a gap for Italy to claim. Italian economists suspect further Machiavellian plotting: if the ruling populists were to elevate an official at the Bank of Italy to the ECB, that in turn gives them a chance to install one of their own at the bank in Rome, realising their ambition to gain influence over it.

The obsession with balance extends across European institutions. Leaders want to ensure that nationalities, genders and party affiliations are well-represented across the top jobs. Emmanuel Macron, France’s president, sees the commission presidency as the prize, says Mr Rahman. The price could be a German at the ECB.

All this means that expertise is not the sole criterion for replacing Mr Draghi. And until the commission presidency is decided, there are plenty of permutations. A drawn-out process raises the risk that the job is traded for other positions. Other names could emerge. A fudge, with the 68-year-old Mr Liikanen doing half a term and giving way for someone else, is not impossible. Just as a break with the past cannot yet be ruled out, nor can a reversion to it.

US sets course for its next Middle Eastern war of choice

Dick Cheney’s heirs are laying the groundwork for an Iran conflict

Edward Luce

Skilled insiders: John Bolton and Mike Pompeo © Getty

Dick Cheney, the former US vice-president, said that if there was a 1 per cent threat of something happening, America should act as if it were a certainty. By that yardstick, the chances of a US war with Iran are now flashing red. Any such conflict could induce a geopolitical earthquake to exceed what followed the US-led invasion of Iraq.

That war unleashed Isis, empowered Russia and China, and left a bitterly divided America roughly $3tn worse off. In the first Gulf war in 1991, the US led a broad international coalition. By the second one in 2003, the “coalition of the willing” had shrunk to Britain, Spain, Australia, Poland and a handful of Pacific islands. This time, the US would be fighting without any non-Middle Eastern allies.

In the spirit of Mr Cheney, the US should bear in mind parallels between the build up to the Iraq war in 2003 and what is happening today. Much like then, today’s case is led by two highly skilled insiders. John Bolton, the national security adviser, and Mike Pompeo, the secretary of state, are worthy heirs to Donald Rumsfeld and Dick Cheney. They know how to marshal intelligence for their ends.

Each claims that Iran is stoking its proxies in Iraq, Syria, Yemen and Lebanon for imminent attacks on the US and its allies. They have withdrawn non-essential US personnel from Baghdad and ordered the USS Abraham Lincoln aircraft carrier and a bunch of B52 bombers to the region. America would respond with “unrelenting force” to any Iranian attack, said Mr Bolton. US retaliation would be “swift and decisive” says Mr Pompeo.

All that is lacking is clear intelligence to back them up. Chris Ghika, the British major-general who is second-in-command of the US-led anti-Isis coalition, said on Tuesday there was no evidence of an increased Iranian threat. He was slapped down by a US spokesman.

Why tensions are rising in the Middle East:

After the 2003 Iraq war, it emerged that British and US officials had privately complained of White House “cherry picking” to suit the case for war. One of the crucial claims was that Saddam Hussein was in league with al-Qaeda — a contention that was later debunked. History seems to be repeating itself.

In a testimony to Congress last month, Mr Pompeo implied the US could go to war with Iran today under the original 2001 authorisation. Indeed, the grounds were the same. “There is no doubt there is a connection between the Islamic Republic of Iran and al-Qaeda. Period, full stop,” Mr Pompeo said.

Much like Iraq in 2003, the US is presenting Iran with demands that it knows will be rejected. The timetable for military action is clear. Iran has given Europe’s three powers — France, Britain and Germany — 60 days to salvage the 2015 nuclear deal abandoned by the US. Failing that, Iran will resume uranium enrichment and its nuclear clock would restart. Mr Pompeo is depriving the EU3 of any leeway to keep the deal intact — the cost of US sanctions would be too great. Murkiness over who carried out this week’s attacks on oil tankers near the Strait of Hormuz hints at a wider menu of triggers for US military action.

Which brings us back to Mr Cheney. The Iraq war helped bring America’s unipolar moment to an end. The decade and a half since then has seen the re-emergence of great power rivalry. A war with Iran would risk far more. Saddam Hussein had less than 100,000 bedraggled troops. Iran has up to a million in uniform. Iraq had no credible allies. Iran is a Russian ally and a big oil exporter to China.

A US-Iran conflict would provide cover for Russia and China to further their ambitions. Russia could use the distraction to annex eastern Ukraine, or take a chunk of one of the Baltic states, then dare Nato to eject it. China, meanwhile, could present itself as the level-headed alternative to a rogue superpower.

Such a scenario is by no means outlandish — it is entirely plausible. The alternative path is that Donald Trump fires, or sidelines, Mr Bolton and Mr Pompeo. In that case, the drumbeat for war would fall silent. But that seems less likely. By Mr Cheney’s measure, therefore, the world should take out insurance against America’s next war of choice.

The view from Washington

In Washington, talk of a China threat cuts across the political divide

Amid accusations of theft and espionage, opinions have hardened

LAST OCTOBER bosses from some big, innovative companies were invited to an annexe of the White House. Amid the high-ceilinged pomp of the Indian Treaty Room, the executives signed one-day non-disclosure agreements allowing them to see classified material. Then the Director of National Intelligence, Dan Coats, and two senators told them how China steals their secrets.

The unpublicised event was the idea of Senator Mark Warner of Virginia, the senior Democrat on the Senate Intelligence Committee and himself a successful technology investor. He was joined by Senator Marco Rubio of Florida, a Republican on the committee.
Recent arrests of alleged Chinese spies reveal only a small fraction of what is afoot, Mr Rubio says. China “is the most comprehensive threat to our country that it has ever faced”. The aim, he insists, is not to hold China down but to preserve peace. He sees an imbalance in relations between America and China that, if left unaddressed, “will inevitably lead to very dangerous conflict”.

Speaking with rapid precision in his Senate office, Mr Rubio criticises an economic model that presses chief executives to maximise short-term profits. China has learned to use that system to turn firms into “advocates”, he charges. Too often politicians would vow to get tough on Chinese cheating. “Then these CEOs would be deputised by China to march down to the White House.”

Venture capitalists have also been invited to Warner-Rubio China road shows. Mr Rubio grumbles that the business plan of some Silicon Valley tech firms is to get bought up, without necessarily caring if the investors are Chinese.

Members of Congress have drafted proposals for a series of new export controls on products deemed important to national and economic security, notably from industries named as priorities in the “Made in China 2025” plan. That is a Chinese map for building world-beating companies in ten high-tech fields. Chinese investments face ever-tighter scrutiny by the Committee on Foreign Investment in the United States (CFIUS). The Foreign Investment Risk Review Modernisation Act recently extended the remit of CFIUS to new areas, such as property purchases near sensitive sites. A pilot scheme mandates reviews of foreign stakes in a wide array of “critical technologies”. Mr Rubio names telecommunications, quantum computing, artificial intelligence and any industry that collects large data sets as ones he wants closed to China.

The staging of that October road show—a bipartisan endeavour involving Congress and the intelligence agencies, close to the White House but not inside it—is revealing. Views on China have hardened across official Washington. A tough new consensus unites what might be called America’s foreign-policy machine, including members of both parties in Congress, the State Department, Pentagon, Department of Justice, spy agencies and the president’s own National Security Council. The machine includes the vice-president, Mike Pence, who turned a speech last October into a charge sheet of Chinese misdeeds. Mr Trump stands apart.

Pentagon chiefs and members of Congress are ever more publicly sounding the alarm about China’s intentions towards Taiwan, the democratic island of 24m people that America calls an ally but China claims as its own, saying it must be united with the motherland, by force if necessary. To China’s disquiet, Congress has passed laws signalling solidarity with Taiwan, urging the government to allow cabinet secretaries and American warships to visit the island. Some of President Donald Trump’s closest aides are long-time advocates for Taiwan. As president-elect in 2016 he was persuaded to talk by telephone with the island’s president, Tsai Ing-wen. Since then Mr Trump has blocked proposals for high-profile visits to show support for Taiwan as a democratic ally. He sees allies as a burden, and mighty China as America’s peer.

Whose side are you on?

Discerning a united view of China within Team Trump is hard. Trump aides use harsh language about the country. Referring to repression of Uighur Muslims in the north-western region of Xinjiang, the Secretary of State, Mike Pompeo, called China “one of the worst human-rights countries that we’ve seen since the 1930s”. That tone is a sign of their boss’s willingness to trample diplomatic niceties. But while Mr Trump’s views on China overlap with the Washington machine’s, they are not identical. Many officials are sincerely disgusted by Xinjiang, where perhaps a million Uighurs are being held in “re-education camps”. Asked how business ties between America and China may co-exist with get-tough policies, a senior administration official replies: “Concentration camps do spoil the mood, don’t they?”

Yet cold-war-style discussions of human rights are of little interest to Mr Trump. Michael Pillsbury is a China specialist at the Hudson Institute, a think-tank, and an outside adviser to the White House. In his view, “the president is not a super-hawk on China”. Such issues as Taiwan or Xinjiang do not resonate with Mr Trump as much as trade does, he admits. Even on trade, Mr Pillsbury calls him more cautious than advisers such as Peter Navarro, who would like American firms to leave China. Mr Trump has often said he does not want to hurt China’s economy, notes Mr Pillsbury. “He sees China as a source of profit and investment.”

The machine wants to change the fundamental principles guiding China’s rise. In contrast Mr Trump praises President Xi Jinping for putting China’s interests first.

Yet Mr Trump can be riled by aides telling him that China is “stealing our secrets”. He also sees political risks in any trade deal that can be branded a climb-down. “The president understands very clearly that the Democrats are waiting for him to be soft on China,” says Mr Pillsbury. Senator Chris Coons, a Democrat, agrees that being a hawk on China in today’s Congress is “comparable to the 1950s when there was no downside, politically, to being anti-Soviet”.

Tellingly Mr Trump’s China tariff escalation on May 10th was accompanied by defensive tweets asserting that China yearns for a “very weak” Democrat to win the 2020 election instead. A senior Trump administration official endeavours to reconcile the different camps. The aim is not economic decoupling, he says. But in sensitive industries, “the political and financial risk associated with doing business in China will continue to rise”.

Modern-day Chinese mandarins obsess over differences within the Trump administration, not realising that the hardening of the Washington mood predates and will outlast Mr Trump. Evan Medeiros of Georgetown University, a former principal Asia adviser to President Barack Obama, notes that “the bureaucracy of a much more competitive relationship” is being put in place.

Taking a proper gander

Last November the Department of Justice established a China Threat Initiative, staffed by prosecutors and FBI investigators, to detect Chinese attempts to steal trade secrets and influence opinion, in particular on university campuses. At the Department of Homeland Security, a new National Risk Management Centre watches for high-risk firms working on critical infrastructure. A State Department office formerly focused on terrorism, the Global Engagement Centre, has a new mission countering propaganda from China, Russia and Iran.

Pentagon anxieties about China coincide with a realisation that when troops rely on high-tech kit, cyber-attacks can kill. Mr Eikenberry, the former general, observes that in the 1970s or 1980s perhaps 70% of the technology that mattered to military commanders was proprietary to the government, and the rest off-the-shelf and commercial. “Now it is 70% off-the-shelf, much of it coming from Silicon Valley,” he says. Thus when American trade negotiators debate China policy, “the security people are in the room.”

A study commissioned by the Pentagon, “Deliver Uncompromised”, warns that insecure supply chains place America’s armed forces at “grave risk” from hacking and high-tech sabotage, for instance by the insertion of malware or components designed to fail in combat. The study, by Mitre, a research outfit, notes that modern fighter jets may rely on 10m lines of software code, so it matters if tech firms use code of unknown provenance, as some do.

Pentagon chiefs have created a new Office of Commercial and Economic Analysis whose mission includes scouring defence contracts for Chinese companies, down to third-tier suppliers. James Mulvenon, an expert on Chinese cyber-security, explains that “the Pentagon has decided that semiconductors is the hill that they are willing to die on. Semiconductors is the last industry in which the US is ahead, and it is the one on which everything else is built.” He already sees more high-value defence contracts going to semiconductor foundries in America.

Randall Schriver is assistant secretary of defence for Indo-Pacific Security Affairs and a China specialist. Asked if the Pentagon will press businesses to leave China, he replies carefully. “Companies can do what companies do. We are much more aware of and keen to address vulnerabilities in our defence supply chain.”

Official Washington has moved beyond asking whether China is a partner or a rival. The only debate concerns the magnitude of China’s ambitions. According to Mr Rubio, Mr Xi thinks that “China’s rightful place is as the world’s most powerful country.”

Some political appointees in Mr Pompeo’s State Department sound eager to declare that an East-West clash of civilisations is under way. On April 29th the State Department’s director of policy planning, Kiron Skinner, told a forum hosted by New America, a Washington think-tank, that there was a need for a China strategy equivalent to George Kennan’s containment strategy for the Soviet Union. Not content with that bombshell, Ms Skinner ventured that China is a harder problem. “The Soviet Union and that competition, in a way it was a fight within the Western family,” she said, citing the Western roots of Karl Marx’s ideas. “It’s the first time that we will have a great-power competitor that is not Caucasian.”

Leaving aside the ahistoricism of Ms Skinner’s comments—for China’s Communists drew deeply on Marx and Lenin—they are self-defeating. A clash of civilisations leaves no room for Chinese liberals, let alone for Taiwan, a democracy with deep roots in Chinese culture. As for the idea of containing one of the world’s two largest economies, that would be a nonsense even if American allies and other countries were willing to help, which they are not.

There are more cautious voices. A recent essay for the Paulson Institute by Evan Feigenbaum, an Asia hand in the administration of President George W. Bush, argues that those accusing China of remaking the global order are both misstating and understating the challenge. China is selectively revisionist, wrote Mr Feigenbaum. Rather than seeking to replace today’s international system, it upholds many of the “forms” of multilateralism while undermining “norms” from within the UN and other bodies.

In a break between votes, in a windowless office deep in the Capitol, Mr Coons urges Congress to try the hard work of dealing with China as it is and not as America wishes it to be. He does not think China is hostile to the idea of a rules-based order, but concedes that it has “behaved exceptionally badly on the world economic stage”. In today’s Washington, that is dovish talk.

The Rate Cut the Economy Doesn’t Need — but the Markets Do

By Randall W. Forsyth

Photograph by Andrew Harrer/Bloomberg

“Who are you going to believe, me or your own eyes?” That is a quote at the core of Marxist ideology from the most eminent of its authors, Groucho.

And that is a question that the Federal Open Market Committee must confront when it gathers on Tuesday and Wednesday for its highly anticipated meeting. Expectations run high that the Federal Reserve’s policy-setting panel will signal it is ready to lower its key policy interest rate, if not at this gathering, then at the next one, at the end of July.

What seems out of sync with the rising calls for rate reductions is that the U.S. economy and stock market both seem to be doing better than OK, thank you, as the expansion and bull market celebrate their 10th anniversaries. Unemployment is around the lowest level in a half-century. The worst thing seems to be that inflation continues to run slightly below the Fed’s 2% target, a problem that might strike some as similar to being too rich or too thin.

Nevertheless, the federal-funds futures market is pricing in three 25-basis-point reductions in the central bank’s target, from the current 2.25% to 2.50% range, by as soon as year end. (A basis point is 1/100th of a percentage point.) A move is unlikely at this coming week’s confab, although the futures market puts a nontrivial 25.8% chance for a reduction. In contrast, there’s an overwhelming 86.4% probability of a cut at the July 30-31 FOMC meeting, according to CME Group’s FedWatch site. Futures traders have priced in additional 25-basis-point decreases at the Sept. 17-18 and Dec. 10-11 meetings.

Yet these potential Fed rate drops would come while the economy is growing at roughly its long-term trend, which admittedly is a downshift from last year’s tax-cut-boosted 2.9% pace. That said, global growth does face a clear and present danger from tariffs and trade wars, which already are exerting a drag on corporate outlooks. But how much can reductions in already-low interest rates do to offset the contractionary forces on trade?

Those arguing for more monetary accommodation contend that the economic data provide a rear-view mirror image of what has happened. Forward-looking indicators, notably the yield curve, are flashing warning lights that have signaled past slowdowns and should be heeded. Too-low inflation also can become embedded in consumer and business expectations, which then persistently hurt growth, as Japan has demonstrated.

The Fed insists that its policy decisions are data-dependent. The data look good, even if some recent numbers don’t look great, including the disappointing 75,000 increase in nonfarm payrolls in May, about 100,000 shy of forecasts. But a stronger-than-expected rise in May retail sales of 0.5%, plus upward revisions in previous months, has gross domestic product on track to expand at a 2.1% annual clip in the current quarter, according to the Atlanta Fed’s GDPNow tracker, up sharply from its previous estimate of 1.4%, made on June 7.

That would be below the first quarter’s preliminary GDP growth of 3.1%, but the underlying components of the data actually seem to be improving.

Real personal-consumption expenditures, which account for more than two-thirds of the economy, are climbing at a 3.9% annual pace in the current quarter, the Atlanta Fed estimates, an upward revision from 3.2% previously and triple the 1.3% in the supposedly sterling first quarter.

In its previous Summary of Economic Projections, released at the March 19-20 FOMC meeting, the panel’s central forecast for GDP growth this year was 1.9% to 2.2%, a shade above its longer-run estimate of 1.8% to 2%. So the economy would appear to be expanding in line with the Fed’s expectations.

The job market doesn’t seem to be laboring. Despite the smaller gain in payrolls, the 3.6% unemployment rate harkens back to the glory days of the Apollo moon landing and Woodstock. The jobless rate is a lagging indicator, but new claims for unemployment insurance, a leading indicator, also hover near half-century lows. Other surveys find more job openings than applicants, and small businesses having trouble finding qualified employees. Average hourly earnings are growing at a better-than-3% pace. And that might understate wage gains, as prime-age workers make up a higher proportion of the workforce and higher-paid baby boomers retire.

Inflation seems to be the Fed’s main bugaboo, as it remains persistently below the 2% the solons view as the right number. Their favorite measure, the “core” personal consumption deflator, which excludes volatile food and energy prices, is running at just 1.5%. But “trimmed mean” measures of inflation—which throw out aberrant inputs that Fed Chairman Jerome Powell has called “transitory”—are trending much closer to the 2% target.

The Fed also has emphasized the trimmed-mean personal-consumption expenditures indicator lately, which J.P. Morgan economists find useful in predicting PCE inflation over the course of an economic cycle. And those expenditures are remaining around 2%, suggesting no great shortfall in inflation. That has been corroborated by other measures that attempt to reduce the influence of outlier prices. The Cleveland Fed’s mean consumer-price index has shown no easing in inflation, while its median consumer-price index suggests an upward trend, in contrast to the core CPI’s deceleration.

That contrasts with early 2017, when all three CPI measures fell sharply.

One alternative measure of inflation that has shown distinct moderation is the Economic Cycle Research Institute’s U.S. Future Inflation Gauge, which this column highlighted last year to suggest that the Fed might be overdoing rate increases. The institute suggests this has turned down before rate cuts were begun in past cycles.

But the most widely cited indicator pointing to Fed rate cuts has been the bond market, and the yield curve, in particular. The three-month Treasury bill’s yield has remained above that of the 10-year note for five weeks—historically a harbinger of economic downturns. The decline in bond yields has been global and might largely be attributable to factors outside the Fed’s control, notably trade frictions. 

Indeed, nearly $12 trillion in negative-yielding bonds is outstanding, according to Deutsche Bank, with the 10-year German Bund (the benchmark for European bonds) trading at a record minus 25 basis points. That surely exerts a gravitational pull on U.S. bond yields. They stand out globally among top-grade securities, with the 10-year Treasury at 2.08%.

That’s below the 2.18% from a three-month T-bill and even further from the 2.25% low end of the Fed’s target range for overnight fed funds. The implication is that the central bank is holding up the fed-funds rate in the face of market forces pulling down other rates. (For more on this, see this week’s Economy column.)

But there might be another factor behind the near-unanimous calls for the central bank to trim rates. Almost every asset class—stock, bonds, and real estate—is richly priced, compared with rates on cash equivalents. Lowering money-market rates would make asset prices seem less inflated. And that’s the one sort of inflation nobody seems worried about being too high.

There seems to be a lot of confidence—or possibly complacency—that the Fed will fulfill market expectations and signal the rate reductions predicted by fed-funds futures. Those sentiments are borne out in another corner of the derivatives market, futures on the VIX index, the so-called fear gauge measuring volatility on the S&P 500index.

There is a high speculative short position in VIX futures, according to the J.P. Morgan global markets strategy group, led by Nikolaos Panigirtzoglou. Those are bets on continued low volatility; in other words, wagers that nothing will go wrong. The last times such bullish sentiment was apparent were in January and September 2018, when the best-laid plans of low-volatility bettors went spectacularly awry.

As a result, the equity market could be vulnerable to a “more cautious and patient Fed,” which could trigger a correction, the bank’s strategists write in a client note. Even a truce in the U.S.-China trade war would be viewed as only a neutral outcome at the next big market event, the Group of 20 meeting in Japan on June 28 and 29, while a breakdown in trade talks would be a negative, they add.

Complacency is evident elsewhere in the equity market, which the JPM team figures is pricing in a mere 6% chance of a recession, in contrast to the 60% probability that they reckon is implied by the five-year Treasury note’s yield of just 1.83%, well below the three-month T-bill’s 2.18%.

The consensus earnings estimate of $167 for the S&P 500 companies is far from the contraction likely in a recession, they add, and 3% above the benchmark index’s tax-cut inflated profits last year.

The markets are likely to be caught in a tug of war between the positives from falling bond yields and the negatives from sliding earnings estimates, says Cliff Noreen, head of global investment strategy at MassMutual, the big insurer. Look for trade and tariff issues to come up in earnings warnings, as it has at Broadcom(ticker: AVGO), which slashed 2019 revenue guidance, owing to a broad-based slowdown in chip demand and export restrictions.

Strategists with year-end S&P 500 targets of 3000 or higher (just a 4% gain from Friday’s close of 2886.96) are implying a relatively rich 18 price/earnings ratio, facilitated by low bond yields. 

Meanwhile, initial public offerings are partying like it’s 1999 (see Tech Trader). No wonder Wall Street hopes that the Fed spikes the punch bowl.

A Greek Canary in a Global Goldmine

After 2008, Greece came to symbolize global capitalism’s failure to balance credit and trade flows. Today, as the global mismatch between economic reality and financial returns grows, there is clear danger that, once again, the country is foreshadowing a new phase of the global crisis.

Yanis Varoufakis


ATHENS – The eurozone country that has become synonymous with insolvency is today proving to be a treasure-trove for some. Traders who bought Greek assets a few years ago have good reason to celebrate, having banked returns that no other market could have provided. But, as is often the case, an opportunity that seems too good to be true probably is. And this one could portend the next phase of our global crisis.

An investor who bought German government bonds in 2013 has, by now, gained a 7% return, whereas a buyer of a Greek government bond issued at the height of the country’s debt crisis in 2012 would have earned a colossal 231% return. Two months ago, the price of the first ten-year bond issued since Greece’s bailout in 2010 surged for seven consecutive days, rising by 2.8% in a week – a better performance than any other government bond issue worldwide. That bond rally created a psychological slipstream, which, in recent months, pulled the Athens Stock Exchange 26% higher, against the background of a European asset market inexorably bleeding capital.

On the strength of these impressive numbers, it is as tempting as it would be false to herald the end of Greece’s crisis. The Greek bond and equity rally is obscuring a growing chasm between a gloomy economic reality and an unsustainably buoyant financial climate. Rather than reflecting Greece’s recovery, the traders’ high profit margins mirror continued deflationary pressures and fragmentation in Europe within a global environment of decreasing debt sustainability. The numbers from Greece, so exciting to investors far and wide, may well prove a harbinger of fresh troubles for Europe’s economy, and perhaps for the world.

Given the gaping gap between Greece’s nominal national income and its public debt, how is it possible that Greek bonds are soaring? Why is the Athens Stock Exchange rising while business remains hampered by punitive taxation, banks labor under a mountain of non-performing loans, declining unemployment reflects only emigration and some precarious jobs, net public investment is negative, and private investment in production of high value-added tradable goods is absent?

One reason is the proverbial dead-cat-bounce. Given how thin Greece’s equity market is – total capitalization is €52 billion ($58 billion) – the modest influx of capital that came in the wake of the bond rally was enough to drive the 26% rise in its index. But, despite this surge, the Greek market remains 81% below its 2009 level. As for the bond rally itself, the paradox quickly disappears once we recall how the first two bailouts shifted Greek public debt from the private sector to the shoulders of Europe’s taxpayers.

With 85% of Greece’s debt outside the markets, repayments deferred until after 2032, and another €30 billion of official loans extended to the Greek government to cover its repayments to all comers, investors can focus on the small slice of Greece debt that remains in private hands. As long as the Greek government is subservient to Europe’s authorities, traders cannot lose money on bonds it issues at interest rates of more than 3%, at a time when German bund yields are hovering near zero.

Determined to remain upbeat, most commentators point out, for example, that average Greek debt maturity is 26 years, in sharp contrast to seven years for Italy and Spain or ten years for Portugal, giving Greece’s economy the chance to recover properly. What they neglect to mention are the impossible austerity conditions that Greece’s creditors attached to that extension: a permanent primary budget surplus (excluding debt repayment) of 2.2-3.5% of GDP until 2060. In other words, Greek businesses will have to continue paying 75% of their profits to the government (including social security contributions), on average, while the total tax burden in neighboring Bulgaria is no more than 22%.

In short, Greece has gone from being Ground Zero of the eurozone crisis, and the best example of its mismanagement by the EU authorities, to a perfect example of how financial exuberance can ride on the back of economic misery. This disparity’s most worrying aspect is that profit-driven traders are not wrong to snap up the paper assets of a sinking country. From their short-term perspective, it’s an irresistible play – and their bottom line confirms this. But it is wrong, even reckless, to conclude that, because traders are making a mint with Greek assets, the underlying reality must be improving.

The rest of the world would benefit from viewing this disconnect as a symptom of a global predicament. In June 2017, Argentina issued a 100-year bond worth $2.75 billion that sold like hot cakes on the strength of great, and greatly mistaken, expectations of the Argentine economy’s prospects under a new neoliberal administration. While those trades have already proved foolhardy, there is hard evidence that average total returns to investors are higher when they buy the debt of countries that default more frequently. But financiers’ penchant for investing in low-quality debt and talking up non-existent opportunities is most dangerous when applied to private, as opposed to public, debt.

During the first three months of this year, a stupendous 40% of all loans to highly indebted companies in the United States went to the least solvent. According to the Federal Reserve, this over-leveraged lending increased 20.1% in 2018, while other sources report a deterioration in underwriting standards. Credit is being channeled to low-rated, heavily indebted companies, overshadowing the safer high-yield bond market as a source of financing. According to LCD, a division of S&P Global Market Intelligence, the leveraged loan market has now exceeded $1.2 trillion, overtaking traditional junk bonds and undermining less risky covered bonds.

Greece is in the vanguard of this trend, attracting fair-weather, shallow, speculative trades, while patient investment in its economic recovery is nowhere to be seen. After 2008, Greece came to symbolize global capitalism’s failure to balance credit and trade flows. Today, as the global mismatch between economic reality and financial returns grows, there is clear danger that, once again, the country is foreshadowing a new phase of the global crisis. When vultures grow fat on a corpse, they do not revive it.

Yanis Varoufakis, a former finance minister of Greece, is Professor of Economics at the University of Athens.

Studies Show

How Much Alcohol Can You Drink Safely?

By Kim Tingley

Credit Illustration by Celia Jacobs

Humans have been drinking fermented concoctions since the beginning of recorded time. But despite that long relationship with alcohol, we still don’t know what exactly the molecule does to our brains to create a feeling of intoxication. Likewise, though the health harms of heavy drinking are fairly obvious, scientists have struggled to identify what negative impacts lesser volumes may lead to. Last September, the prestigious peer-reviewed British medical journal The Lancet published a study that is thought to be the most comprehensive global analysis of the risks of alcohol consumption. Its conclusion, which the media widely reported, sounded unequivocal: “The safest level of drinking is none.”

Sorting through the latest research on how to optimize your well-being is a constant and confounding feature of modern life. A scientific study becomes a press release becomes a news alert, shedding context at each stage. Often, it’s a steady stream of resulting headlines that seem to contradict one another, which makes it easy to justify ignoring them. “There’s so much information on chocolate, coffee, alcohol,” says Nicholas Steneck, a former consultant to the Office of Research Integrity for the U.S. Department of Health and Human Services. “You basically believe what you want to believe unless people are dropping dead all over the place.”

Scientific studies are written primarily for other scientists. But to make informed decisions, members of the general public have to engage with them, too. Does our current method of doing so — study by study, conclusion by conclusion — make us more informed as readers or simply more mistrustful? As Steneck asks: “If we turn our back on all research results, how do we make decisions? How do you know what research to trust?” It’s a question this new monthly column aims to explore: What can, and can’t, studies tell us when it comes to our health?

The truth is, putting alcohol research in context is tricky even for scientists. The Lancet study is epidemiological, which means it looks for patterns in data related to the health of entire populations. That data might come from surveys or public records that describe how people behave in their everyday environments, settings that scientists cannot absolutely control.

Epidemiological studies are a crucial means of discovering possible relationships between variables and how they change over time. (Hippocrates founded the field when he posited an environmental rather than a supernatural cause for malaria, which, he noted, occurred most often in swampy areas.) They can include millions of people, far more than could be entered into a randomized-control trial. And they are an ethical way to study risky behaviors: You can’t experiment by randomly assigning groups of people to drive drunk or sober for a year.

But because epidemiologists can only observe — not control — the conditions in which their subjects behave, there are also a vast and an unknown number of variables acting on those subjects, which means such studies can’t say for certain that one variable causes another.

CreditIllustration by Celia Jacobs

Modern epidemiology took off in the 1950s and ’60s, when public-health researchers in the United States and Britain began long-term studies tracking a wide variety of health factors in thousands of people over decades and surveying them about their behavior to try to identify risks. What they found when they looked at alcohol consumption in particular was puzzling: People who reported being moderate drinkers tended to have a lower risk of mortality and many specific health problems than abstainers did. Did this mean that a certain amount of alcohol offered a “protective” effect? And if so, how much? In 1992, an influential study in The Lancet observed that the French had a much lower risk of death from coronary heart disease than people in other developed countries, even though they all consumed high levels of saturated fat. The reason, the authors proposed, was partly that the French drank significantly more wine.

The notion that alcohol may improve heart health has persisted ever since, even as further research has revealed that it can cause cancer and other health problems and increase the risk of injury and death. But equally plausible counterhypotheses also emerged to explain why teetotalers fared worse than moderate drinkers. For instance, people might abstain from alcohol because they are already in poor health, and most studies can’t distinguish between people who have never had a drink and those who drank heavily earlier in their lives and then quit. Indeed, over the years, compared with abstinence, moderate drinking has been associated with conditions it couldn’t logically protect against: a lower risk of deafness, hip fractures, the common cold and even alcoholic liver cirrhosis. All of which advances a conclusion that health determines drinking rather than the other way around. If that’s the case, and abstainers are predisposed toward ill health, then comparing drinkers to them will underestimate any negative effects that alcohol has. “This problem of the reference group in alcohol epidemiology affects everything,” says Tim Stockwell, director of the Canadian Institute for Substance Use Research at the University of Victoria in British Columbia. “It’s urgent to establish, What is the comparison point? All we know is that risk goes up the more you drink for all of these conditions.” But without a reliable comparison group, it is impossible to say precisely how dire those risks are.

The authors of the recent study in The Lancet endeavored to address this problem, at least in part, by removing former drinkers from their reference group, leaving only never-drinkers. To do so, they spent two years searching for every epidemiological study of alcohol ever done that met certain criteria and then extracting the original data. They marked those that already excluded former drinkers, which they thought would make the comparison group more accurate; to those that didn’t, they applied a mathematical model that would control for differences between their comparison group and that of the preferred studies.

The results — which are broken down by age, sex, 195 geographical locations and 23 health problems previously associated with alcohol — show that over all, compared with having zero drinks per day, having one drink per day increases the risk of developing most of those health problems. They include infections like tuberculosis, chronic conditions like diabetes, eight kinds of cancer, accidents and self-harm. (The more you drank, the higher those risks became.) This suggests that, on the whole, the benefits of abstaining actually outweigh the loss of any health improvements moderate drinking has to offer. The results, however, also show that a serving of alcohol every day slightly lowers the risk of certain types of heart disease — especially in developed countries, where people are much more likely to live long enough to get it. So, theoretically, if you are a daily drinker who survives the increased risk of accidents or cancers that are more likely to strike young to middle-aged people, by 80, when heart disease becomes a major cause of death, your moderate drinking could prolong your life. Then again, it might be your innate biological resilience that kept you healthy enough to drink. The data still can’t say.

Keep in mind that population studies like these are not meant to directly change individual behavior.

They offer generalizations — in the case of the Lancet study, that alcohol consumption is probably riskier and less potentially beneficial than we thought — that may eventually influence policies, like higher taxes on alcohol or warning labels on bottles. Paradoxically, only if those policies, in turn, reduce the amount that millions of individuals drink will we know whether doing so improved their overall health.

In the immediate term, a better way of understanding the value of scientific studies might be to think of each as a slight adjustment of an eyeglass-lens prescription. Each one answers the question “Is it clearer like this, or like this?” and in doing so, brings our view of reality — our understanding of ourselves and the world around us — into sharper focus. If we dwell too much on the conclusions studies seem to offer, instead of also considering how they were reached, we risk missing out on one of the great benefits of the scientific process: its ability to reveal all that we don’t know.

Kim Tingley is a contributing writer for the magazine.